Transcription
When was the last time you sat down to figure out when you would be able to retire? An actual number, the actual math behind it. If your answer is, "I haven't," you're not alone.
I recently saw an ad that had one title, and it said, "If you're looking to determine when you can stop working, start." And then it was cut off. That cliffhanger, it's brilliant. So, I'm going to use that to title this video. Hey guys, what's up? I'm Aaron and welcome back to the channel.
Most people spend more time planning a vacation than they do the last chapter of their life. And that can actually cost you years. So today, we're going to change all that. By the end of this video, you're going to have a real framework for figuring out exactly when you can stop working. We're going to cover the math. We're going to cover the money. And we're going to cover something that most retirement videos skip, the behavioral side. Because as it turns out, one of the biggest hurdles when it comes to finance and retirement is psychological.
So let's start with one of the biggest questions. Before we run a single number, we need to define the destination because "stop working" means very different things to different people. There are really three versions of this. First and foremost, traditional retirement. This is where you completely stop working altogether and instead embrace in hobbies or anything else you want to do that is not paid. Maybe it's golf, travel, visiting your grandkids, you name it. This is traditional retirement.
Then we have work optional. Maybe you quit your day job but you decide to do some consulting or freelance or you take up some part-time work but you do this by choice. And finally we have financial freedom. Here you work only because you want to, not because you have to. You have enough money to fully fund your life for the rest of your life, but you get enjoyment, engagement, whatever it is, you get that from your job, so you want to continue.
Now, these different versions of retirement matter because they require radically different plans. Someone who wants $12,000 a month directly from their portfolio forever needs a completely different portfolio than someone who plans to work part-time throughout their 60s earning an additional $3 to $4,000 a month from consulting. The math changes. And here's a behavioral truth. Many high achievers don't actually want zero work. What they want is autonomy, the ability to say no, to choose the work. And if that's you, own it. It actually makes the financial math much more achievable. So before we go any further, which version are you planning for? Because that answer shapes everything that comes next.
A lot of the content out there kind of approaches this in a backward fashion, focusing solely on your income and replacing that income once you step away from the workforce. When the real question is, how much does my life actually cost? Your retirement number is a spending number and many people are genuinely surprised when they run it, especially high income earners. Let's say you're making $300,000 during your working years. Once you get to retirement, you might actually only spend 110 or $120,000. After all, you're no longer paying payroll tax. You no longer have to save 15% of your income. Maybe your mortgage is paid off. Your kids might be fully grown and fully financially independent out of the household.
Here are the categories that actually add up. Housing, this is the mortgage, the rent, taxes, insurance, maintenance, health care, we have premiums, deductibles, and out-of-pocket costs. Food and daily living, travel and leisure, family support, taxes, yes, they still exist in retirement, and discretionary spending.
Once you have a real annual spending number, now you have a foundation. We have something we can actually work with. Let's say you want to spend $10,000 a month. That's $120,000 a year. We can work with this. We can build from this. Here's the formula that changes how people see retirement. Annual spending minus guaranteed income equals your portfolio's burden. Your income floor is everything that shows up without you having to touch your investments. Social Security, pension income, rental income, perhaps annuity payments, or part-time or consulting work.
So, let's run an example. Your target number is $120,000. Social Security income for the household is $55,000 a year. Let's say you have part-time income of $25,000 a year. Now, your portfolio must fund $40,000 a year. That gap, that $40,000 is what your portfolio must generate.
And when we look at social security, this is where the timing of social security becomes one of the most important financial decisions of your entire retirement life. The difference between claiming social security at 62 versus 70 is enormous. For the median worker, waiting from age 62 to 70 will increase your benefit by about 76%. Often a difference of a,000 to $1,500 per month. Over a 25-year retirement, that is potentially $300 to $450,000 in additional lifetime income. And most people have never pulled their SSA statement. So, go to ssa.gov this week and make sure you do that. Every dollar of income you can build into that floor is a dollar your portfolio does not need to generate, and that can move your retirement date earlier.
Now, we get to the number everyone wants to know. Here's the foundational formula. Portfolio need equals your income gap divided by the withdrawal rate. Your withdrawal rate is simply the percentage you take from your portfolio each year. Here are some common guardrails. We have the traditional 4% rule. This is the classic and fairly conservative rule that we all know and it's traditionally built for a 30-year retirement and it has recently been revised to 4.7%. If you're willing to adopt a more diversified portfolio, then we can consider a withdrawal rate in the ballpark of 3 to 3 1/2%. This is more conservative and maybe it's more appropriate for an early retiree or someone with a really long time horizon. Maybe someone who's planning on a 40 or a 45-year retirement. Then we could look at a rate of 5 1/2 to 6% or so. Yes, this is more aggressive, but it can absolutely work if your spending is flexible. If you're willing to adjust your withdrawals up or down based on market performance.
So, if we use our previous example where we have an income gap of $40,000 and we adopt a withdrawal rate of 5.5% assuming we're willing to be flexible, our target portfolio needed is $730,000. Now, one note of disclaimer here. We said that our target spending was $120,000 a year. So, we did not factor in taxes into this situation. So realistically, once we factor in taxes, we would have a larger portfolio need, maybe in the ballpark of $800,000 or so. So know when you're running your numbers, are you looking at total spending or are you looking at your desired income? You are going to have to factor in taxes at some point.
Now, this is a really simple and powerful formula, but it is incomplete on its own because it makes a few assumptions. Namely, it assumes that the markets are fairly steady. And we know markets are not steady. They tend to be volatile. So, here's where we want to add in a stress test. This is important. If you retire into a bare market and you're in a situation where you need to take draws from your portfolio, if the bare market is severe enough, you could permanently damage your portfolio in a way that jeopardizes its long-term viability. This is called sequence of returns risk and it is one of the biggest threats to a retirement that should theoretically work on paper. Think about someone who retired in early 2000 just as the dot bubble burst or in 2008 right into the financial crisis. We could have the exact same savings rate. We could use the exact same withdrawal as somebody who retired say 5 years earlier or 5 years later than these events and we would have dramatically different outcomes.
There are three primary things you can do to protect against this. Number one is have a cash buffer. This might be 12 to 24 months in cash or cash-like equivalents or short-term bonds so you're not forced to sell your equities when the market is depressed. You can allow it the time it needs to hopefully recover. Also a bond allocation or a diversified portfolio. Having a diversified portfolio protects you from experiencing 100% of the market losses. You aren't 100% invested in equities. And really adapting spending flexibility. The ability to trim your portfolio draw by even 10 to 15% can enormously improve the probability of success of your retirement. So really, the best portfolio is the one you won't sell when the market drops 30% or 40% or potentially even more. Keep in mind, when it comes to retirement, behavioral risk matters just as much as market risk.
The math often moves more than people expect once you pull the right levers. These are the big ones. Lever number one, social security timing. I know we already covered this one, but it absolutely bears repeating. If you're willing or able to delay social security until the age of 70, this can reduce your required portfolio need by hundreds of thousands of dollars. For many people, that single decision is more powerful than saving more aggressively for several years.
Lever number two is tax strategy. Two retirees can each have a $2 million portfolio, and it can generate wildly different after-tax incomes depending on how their portfolio is structured. There's really three different buckets to focus on. First, we have a taxable brokerage account. Now, so long as you've held the investments in the account for longer than a year, we get more favorable long-term capital gains rates on these draws, often 0% or 15%. Then we have a traditional IRA or 401k or similar type account. These draws are taxed as ordinary income. And, [clears throat] finally, we have a Roth IRA or Roth 401k again or similar type account. These provide tax-free withdrawals in retirement. Strategic Roth conversions in your 50s or your 60s if you happen to have low income years in that stretch before social security kicks in, before RMDs kick in, can lower your lifetime tax bill by tens of thousands of dollars. Good tax planning doesn't just save money, it can truly buy you years of freedom.
Lever number three, the health care bridge. Something you need to pay attention to if you retire prior to the age of 65. If you're planning to retire before the age of 65, before Medicare kicks in, you could easily be looking at an annual health care bill that's maybe $15,000 or even $25,000 a year. And that can be a shock if you're not ready for it. This is where it's worth looking into the ACA marketplace. Look at their premiums. They do have subsidy cliffs that you need to pay attention to based on your income. Know what the deductible you're planning on might be. This is truly one of the most underestimated costs in an early retirement. So, if you're planning on retiring prior to 65, make sure you model this in your plan.
Now, for some good news. Many retirees actually find that once Medicare kicks in at the age of 65, their health care costs become much more manageable than they were in the years prior to the age of 65. And Medicare decisions matter because choosing the wrong plan can easily result in additional thousands of dollars of expenses, whether that's in premiums, prescription drug costs, or just out-of-pocket expenses. That's why I've partnered with Chapter. Chapter helps you compare Medicare options across carriers so you can make a confident, informed decision. They are completely independent. The call with them is free and they can walk you through whether Medicare Advantage or a Medigap plan is a better fit for you and make sure that you receive the care you need at a cost that is reasonable to you. Somebody who uses Chapter on average saves about $1,100 a year. So, if you're approaching Medicare or want a [clears throat] second look at your plan, feel free to give them a call or reach out to them through the affiliate link down below. And just so you know, if you use the affiliate link, I may receive compensation.
Lever number four, working one more year or one year less. Each additional year of work does three things simultaneously. It adds to your savings, it adds to your social security benefit, and it removes one year from the draw down period. One intentional year can close an enormous gap. So, it's worth sitting down and running the numbers. And I do have a video that can help you do just that. And having this information can be incredibly empowering.
Okay, so we've done the math. We've built the framework. Now, I want to ask you a question that most financial videos skip entirely. Can you emotionally tolerate not earning? This one hits harder than a lot of people expect. Research by Michael Frink shows that a lot of people even if they're ready to retire delay or struggle once they do retire. And this really comes down to that work for many people provides something that money alone can't. Perhaps it's identity thinking, "I am what I do," or structure, a reason to get up, having a schedule or a purpose to your day. Or perhaps there's a sense of community. You have colleagues, you have relationships, a sense of belonging to something greater. And for many, it's status. Your role, the title, the recognition that comes with that you've worked years to get where you are.
Retirement failure is often psychological before it's mathematical. The people who struggle most in retirement are often the ones who planned their finances perfectly and their life, not at all. I'm certainly not sending the message of don't retire. I'm saying that you want to plan your life as much as your finances. What are you planning to do on say, a Tuesday morning at 10:00 a.m.? What gives your life meaning? Who are you outside of your role at work? And these are the questions that really determine whether retirement feels like freedom or a loss.
So, let's bring it all home. Rate yourself honestly from 1 to 10 in each of these five areas. Number one, money. Do I have enough saved? Number two, cash flow. Do I have reliable income sources beyond the portfolio? Number three, taxes. Am I withdrawing efficiently across all three buckets? Do I have all three buckets? Number four, flexibility. Can I adjust spending if the markets turn? And number five, and just as [clears throat] important as all the others, the psychology. Am I ready for life after work?
If you're scoring seven or above across all five categories, you might be closer to retirement or financial freedom than you think. But if you've got a nine in money and a three in psychology, that's an indicator that you have some work to do. And keep in mind, we're not giving this as a pass/fail test. We're looking at this as a map and as a guide how you can ensure that you're ready to step into the retirement that works for you.
Most people treat retirement planning as a destination, a number to hit, a date to reach. But the people who actually get there on their terms with confidence, treat it as a process. Start early. Update the model as your life changes. And make intentional decisions. Intentional decisions about social security, about your tax buckets, about what you want life to look like and mean once you actually get into retirement. The math in this video works, but the math is only the starting line. If you want to have a successful retirement, you need to make both the finances and the psychological side work. You're ready to stop working when the math works and your mind does, too. Today's video is about building the foundation for both.
So, here's your homework for this week. Number one, pull your social security statement from ssa.gov. Most people have never done this. Do this even if you're in your 30s, your 40s, or your 50s. Number two, write down what your life actually costs each month. Not income, spending. Number three, run your gap number using the formula we covered. Number four, ask yourself honestly, what does "stop working" actually mean to me? So, that's what you have to do. And once you do it, you'll be able to build a much more comprehensive plan for your situation.
Have you done this before, or is this a new set of tasks? I'd love to hear. Post your comments down below. I'm also on LinkedIn now. So, if you're over on LinkedIn, give me a follow. I post new commentary about finances almost daily over there. And I post new videos every single day here on YouTube. If you got anything at all out of this one, please give it a like. If you're new here, please consider subscribing. Or if you know of someone who might get something out of this type of content, please consider sharing. I'll see you soon. Bye.