100 Rules of Success: Investing Part 4

What follows is the continuation of success habits that will become part of a book I’m writing, “100 Rules of Success”. 

RULE:  Build the Perfect (Trifecta) Retiree Financial Statement.  When you reach retirement, if you had the perfect financial statement, what would it look like?  This is a topic most people never consider.  People tend to think the more money you have, the better…and this is a true statement but you can significantly magnify the effective power of your retirement money if you do a few things right along the way.

For example, investing through tax deductible retirement plans (IRAs, 401ks), for most people is the best way to grow your wealth because the federal government is helping you in the form of an income tax deduction and tax-deferred growth on earnings, dividends and interest.  You may also receive additional benefits in the form of employer matching contributions.  While this seems to make perfect sense, once you retire, a different approach can make your retirement less ‘taxing’.

Let’s assume you will need and accumulate $2,000,000 for your retirement.  If, instead of $2 million in an IRA, you had $1 million in an IRA and $1 million in a personal (after tax) investment account. With a little bit of income tax planning, we have found you can significantly reduce your taxes and extend the life of your money.  While conventional wisdom suggests postponing any withdrawals from retirement plans until required by federal law (Required Minimum Distributions – at age 70½), by optimizing distributions between personal and retirement accounts, we have found that we are often able to hold the client’s effective tax rate to 15% or lower.  This strategy allows clients to ‘bleed’ money out of their retirement accounts at very low income tax rates.

To carry this idea of the perfect retiree financial statement one step further, throw in a ROTH IRA.  I call this the Trifecta Retiree Strategy.  By accumulating additional funds in a Roth IRA, you now have three very distinct types of retirement investment accounts: one where withdrawals are fully taxable as ordinary income (IRAs); one (personal account) where withdrawals may have elements of long-term capital gains, dividend income (typically taxed at lower rates than ordinary income), interest income (ordinary income); and one where distributions are completely income tax free (Roth IRA).

What’s critical to maximizing your success here is to do a ‘trial income tax return’ before the end of each calendar year.  These trial tax returns will allow you to determine where to pull your cash flow from to have the best balance between paying taxes now versus later and extending the life of your money.  The answer is very individual facts specific.  For example, we have a case where, for some unusual reasons, we wanted to pay zero income taxes for as long as possible (normally, we are happy to pay taxes in the 15% or lower effective rate).  Because this client couple had both a large IRA and an equally large personal investment account, we have used tax planning to pay near zero taxes for more than twenty years.

One final piece to this perfect retiree financial statement is to plan to be debt free, including home mortgage, by the time you retire.  I know there can be advantages to having a home mortgage, but I believe those advantages do not outweigh the real and psychological advantage of knowing you are completely debt free.  There are many strategies to plan your way to debt free status including:

  • Make extra payments on your mortgage enough so that it’s paid off by your anticipated retirement date.
  • Downsize your home. At retirement, sell your mortgaged home and use the remaining equity to buy a less expensive home for all cash.

One final thought: A little bit of earned income goes a long way in retirement.  I have observed that an awful lot of folks get bored during retirement.  Consider:

  • Continuing your current work on some sort of ‘flex’ or part-time schedule;
  • Turn a hobby into a money-making venture; or
  • Find a part-time job you enjoy.

Recently, I caught an Uber to the airport and the driver became an Uber driver because since retirement, he was bored and enjoyed meeting people.  It was not the extra money that attracted him, but that made him happy too!  A little bit of extra money pays a lot of basic bills and occupies your time which means you’re not out spending more money!