Take These 7 Steps (Most People Stop At Step 2) Before You Retire

If you’re thinking about retiring but are unsure if you’ve done enough planning, this post is for you.

Unfortunately, it’s very difficult to find a financial advisor who does real financial planning. Oftentimes, their portfolio management services are pitched as financial planning but is a far-cry from the real thing. And if they do offer planning, it’s nothing more than a half-hearted Monte Carlo analysis that provides little-to-no value to their clients.

In today’s post, I’ll go through the 7-step financial planning process that all of my clients are taken through from beginning to end to give you an idea of what you should have in place before you pull the trigger.

Step 1 - What Do You Want?

This step is actually called “Who are you, and what do you want”, but my wife tells me that’s a bit too aggressive. The objective of this step is to organize your entire financial situation and define precisely what it is that you want to accomplish with your money.

It starts with taking inventory of everything – all of your income sources, accounts, spending needs, insurance policies, professional contacts, estate planning documents, beneficiaries, goals (such as target retirement age and expense needs, other goals such as traveling more or charitable giving, etc) and ends with putting it all into once place.

We start with chaos and end with order. And over time, a planner should bring more order to this picture by helping you consolidate assets, reduce redundancy, tie up loose ends, etc.

Step 2 – What Will That Take?

Once we know what you want, we can determine what it will cost to achieve.

In my practice, we tackle this question in two ways – first, we answer the question mathematically with some advanced time value of money calculations. Then, we answer the question statistically by looking at a Monte Carlo analysis.

The mathematical answer is reported in our Retirement Savings Report Card, the summary of which for Michael and Holly looks like this:

Next, the Monte Carlo. A Monte Carlo is a method of analysis that randomizes variables over thousands of scenarios to evaluate the probability of an uncertain outcome. In our case, the variables being randomized are different stock market environments (from good, to bad, to everything in between).

In general, a score of about 85% on these is optimal.

Most “financial plans” offered by other advisors stop here. They take some basic information from their clients (and even this is usually sparse), run a Monte Carlo that they don’t understand, and give their clients this and a 100+ page report full of tables and other nonsense that neither they nor their clients will read.

At AnCap, however, we’re just getting started.

Step 3 – What Will That Look Like?

In this step, we start to answer some more practical questions such as, “where will my income come from in retirement?”

Here, we get clarity on how your retirement paycheck is going to be constructed – every dollar of expenses needed is mapped one-for-one to various sources of retirement income in every year of your life.

We’ll see how your portfolio distribution rate is expected to change over time and use that information to begin Step 4.

And for clients who aren’t retired, we’ll map out your cash flow leading up to retirement to ensure you’re making the most of your income between now and then.

These first three steps comprise Phase 1 of our planning process: the Blueprint phase. In Phase 2, we optimize our blueprint for risk first and taxes second.

Step 4 – Optimize For Risk

The name of the game in this step is risk-optimal portfolio management.

In early retirement, one of your biggest risks is a period of bad stock market returns. In financial planning, we call this sequence of returns risk – a bad market early in retirement is far riskier than a bad market later on.

The further away you retire from key retirement checkpoints such as Medicare and Social Security eligibility, the more important it is to plan for sequence of returns risk.

In my practice, we employ two strategies to mitigate sequence of returns risk – first, we employ the Guardrails strategy for portfolio withdrawal sustainability. Second, we always keep five years’ worth of anticipated portfolio distributions in conservative assets.

The guardrails strategy is a dynamic distribution rate model that many financial planners prefer to the “4% Rule”, which has many problems and is not a good model for retirement planning. We use our Retirement Income Report Card to look at this with clients. Michael and Holly’s look like this:

The proper asset allocation is also key here. Ample research supports an “equity glidepath” strategy for portfolio management where portfolios are more conservative in early retirement and become more aggressive later on – the exact opposite of the advice you’ll hear from most financial advisors.

At AnCap, we use our Portfolio Design Report every single year to show clients how and why we invest their portfolio the way we do. Michael and Holly’s look like this:

Step 5 – Optimize For Taxes

Now, my personal favorite step – tax planning.

There are three pieces of really low-hanging tax fruit that almost every retiree can take action on that will save them a TON in taxes. In the order we go in, these are asset location, withdrawal sequencing, and tax rate arbitrage. Asset location is typically where we’ll start because it’s right where we left off in the Portfolio Design report.

Asset location just refers to the strategic holding of certain assets in certain accounts based on their tax-efficiency. In general, more conservative securities are held in pre-tax accounts and more aggressive holdings are held in Roths and taxable accounts. Michael and Holly’s asset location look like this and is expected to save them $2M in taxes assuming they live until 100:

Withdrawal sequencing is the order in which we take distributions from your various account types in retirement. Getting this right can dramatically change your taxable income and, consequently, your taxes without changing your take-home pay. Typically, the optimal withdrawal sequence is taxable, pre-tax, then tax-free, although much more precision is warranted year-to-year.

To keep things simple now, we’ll just apply the high-level ordering to Michael and Holly combined with asset location as well. This is expected to save them $3M in taxes assuming they live until 100:

Finally – everyone’s favorite: tax rate arbitrage (fancy word for Roth conversions). The steps we’ve taken above amplify the impacts of Roth conversions which is why we address them first. While there are other things that fall into the arbitrage category, Roth conversions are by far the most popular and impactful, so that’s what we’ll focus on here.

Typically, we aim to keep our clients in the 12% tax bracket in the years leading up to RMDs. Michael & Holly’s situation might warrant some more aggressive conversions. To keep it simple, we’ll convert up to the 22% tax bracket for Michael and Holly in every year we’re able to and combine it with the other two strategies discussed above. All of this is expected to save $8.6M in taxes assuming they live until 100:

At AnCap, these three things are the minimum. There are plenty of other strategies that your advisor should be implementing when applicable – backdoor and mega-backdoor Roth contributions, tax loss/gain harvesting, itemized deduction bunching, premium tax credit opportunities, among others.

And keep in mind that, for the sake of brevity, we’ve gone to massive lengths to oversimplify not just every section up until now, but the tax planning section in particular. A good planner is exhaustive and precise at every level – but especially this one.

Step 6 – Plan Your Legacy

Phase 2 of the planning process is done and we close things out with Phase 3 – “Protect”. The hard work is behind us, and now we can look to the future.

Most of our clients are in the fortunate position of being almost certain that their money will far outlive them. They recognize that they are stewards of this wealth and want to pass it on to posterity as smoothly and thoughtfully as possible. Some of them have charitable giving objectives, while others want to give to their children or establish college funds for their grandchildren, etc.

What many mistake this step (and estate planning in general) for is “getting our ducks in a row”. While that’s certainly important, and is foundational to this step, legacy planning often begins and is far more impactful well before you pass away.

Of course, great care should also be taken to ensure that beneficiary designations and account ownership align with your plan.

Step 7 – Plan For The Unexpected

Last, but certainly not least, we plan for what can go wrong.

Here, we take care of as many of the “what-ifs” that could spell disaster for your plan if they aren’t insured against. Questions such as:

• What if I pass away prematurely? Will my spouse be ok?

• What is something happens to the house?

• What if we’re sued?

• What if one or both of us need long-term care?

  
  

These questions are addressed through an insurance needs ands gap analysis.

Partner With Someone You Can Trust

As you can see – a lot goes into financial planning! Unfortunately, it’s common in my industry to reduce financial planning to nothing more than a Monte Carlo or a portfolio. This means that most families are being severely underserved and, consequently, are leaving a ton of value on the table.

If you want me to do this for you and see how each step applies to your circumstances, reach out and apply to work with us!