Transcription
In this video, I'm going to walk you through a case study of someone who retired at 56 with $3 million, and they wished they had waited. And why the regret had nothing to do with running out of money, and it had everything to do with the decisions that they made in the first 2 years that created tax pressure that they're still paying for.
You know what I've seen with clients who leave work early with large balances is this. Most of them assume that $3 million solves everything. And I get it, right? I mean, that's an incredible number, but $3 million without a plan around it creates a specific set of problems that don't show up until year three or four, and then the window to fix them has already narrowed.
Now, this isn't a story about someone who couldn't afford to retire. They absolutely could. But the way they retired, the order of their decisions, the timing of their income, the accounts that they pulled from, it created some consequences that proper planning, maybe starting years before retirement, would have prevented entirely.
Look, most people who I talk to who retired early, they don't say they regret it outright. What they describe is more like a slow realization that some things could have gone differently. That a couple of decisions in year one set the tone for everything that followed. And that's a different kind of regret. And it's worth understanding. And that's why the people who get early retirement right at $3 million, they don't just leave work when the balance is big enough. They leave when the plan is ready. Because how you set things up on the way out really has a lot to do with determining how much you get to keep, and what determines whether $3 million feels like freedom or maybe a little bit of frustration.
So today, I'm going to break down exactly what went wrong, why the regret exists, and what should have been done differently. So let's get right into it.
So here's the story that I'm going to change a few details to protect privacy, but the numbers and the decisions are the ones that I see regularly in this work. So Dave, he spent 30 years working his way up to vice president of operations at a midsize tech company. Good career, solid saver. By 56 years old, he had accumulated $3 million. And here's how it broke down. $2.4 million in a traditional 401k and a rollover IRA. $350,000 in a taxable brokerage account. $250,000 in cash.
Now, his wife Susan was 54 and she had stopped working the year before. She had $200,000 in a traditional IRA and $50,000 in a Roth. So, combined Dave and Susan had $2.6 million in tax-deferred accounts, $350,000 in taxable and $50,000 in Roth, and $250,000 in cash. So, they had no pension, no debt. Their paid-off home. They wanted to spend $150,000 a year. And look, the math checked out. So $3 million at a 5% withdrawal rate produces $150,000. Social security at 67 or maybe even 70 would have eventually, you know, equaled say $60 to $80,000 on top of that. So on paper, this worked.
So Dave, he told his employer on a Friday. He cleared out his desk on a Monday and he posted about it on social media that next night. Now, of course, we didn't know them yet, but 18 months later, Dave and Susan were sitting in my office, and they were telling us how they wished that they would have started planning a few years earlier before they retired.
Now, before I tell you what went wrong, I want to be clear about something. So, this wasn't a math problem. Again, $3 million for them was enough. And this is really a sequencing problem, a timing problem. So, in the first 18 months of retirement, Dave and Susan made four decisions. And none of those decisions felt dramatic at the time, but together they created some tax pressure that's going to follow this household for the next 25 years.
So, here's what happened. So, first, they funded the entire first year of their spending by pulling $150,000 straight from Dave's traditional IRA. Now, that sounds reasonable, right? Except Dave had a partial salary from the final months at work that were still in that tax year. So that $150,000 IRA withdrawal stacked on top of the earned income, and it pushed them into a 32% bracket. So that killed any chance of doing maybe a low-rate Roth conversion in year one, which would be, you know, potentially the cheapest tax year of their retirement, or maybe year two. And they, they accidentally made it a really expensive year.
Okay. The second thing was is that Susan qualified for Social Security spousal disability benefits, and she claimed them at 55. And I understand why they did it. Um, you know, income coming in, it feels like it's a win. Um, you know, especially when you stopped working, you want that money coming in. But that added taxable income during the exact years when they should have been keeping their income low so they can maximize conversion space or maybe use other money. That would have been a better tax situation. So it narrowed that window before they even knew that that window existed for them.
And then third, nobody set up ACA healthcare coverage. Now, Dave and Susan, they just defaulted to using COBRA. Now, to be fair, COBRA keeps you on your employer's plan. And so if you have like preferred doctors or ongoing health needs, well, that familiarity has real value. So for some people, it's the right call. But for Dave and Susan, who were healthy and they had a wide-open conversion window, it was an expensive default rather than a deliberate choice. Somewhere between $1,500 and $2,500 a month for 18 months. So if they had managed their income intentionally that first year, they would have qualified for ACA subsidies at a fraction of that cost. So the issue wasn't COBRA itself. The issue was that nobody sat down and ran the comparison before they signed up.
And then fourth, and this is the one that probably stung them the most, Dave and Susan, they did zero Roth conversions in the first two years. So, the reason for that, well, it was they were taking a break from making financial decisions. They just wanted to kind of space out for a few years. They worked hard. They wanted to decompress. And I completely understand that on a human level. But those two years, like Dave at 56 and 57, so those were the widest, cheapest tax brackets that they were ever going to see in retirement. You know, no salary, no RMDs yet, no Social Security that had started, right? That's a window that, you know, most retirees, they really never get that back, and they just let it kind of sit there empty.
So here's where things stood. By the time they walked in my office at 58, two full years of conversion opportunity gone. $43,200 spent on COBRA that didn't need to be spent. $300,000 pulled from Dave's IRA at the highest effective rates of their retirement. And so their traditional IRA balance, well, it was still sitting above $2 million. Nothing had really moved. Nothing had been restructured. The tax problem that they had, that they're beginning to realize, it hadn't shrunk at all. The regret wasn't really that Dave left work at 56, because again, they could afford that. The regret was really just about leaving at 56 without planning for what was going to come next.
Now, if you're in a similar spot to Dave and Susan, maybe you've got significant savings, maybe you're thinking seriously about retirement, but you're not confident about, you know, having a plan that will happen for you on day one for retirement and beyond. I want you to click the link below in the description. I put together a training that walks through exactly how we help people to think through this sort of thing, and you can kind of take what you learned from that and you can apply it to your own situation. So, be sure to check that out.
So, by the time Dave and Susan sat down to visit with us at 58, the frustration in the room was noticeable. Dave had started with $3 million and he felt like he was hemorrhaging money. The balance that he had, I mean, it had moved, but the tax problem hadn't really moved. The traditional IRA was still sitting near where it started. It was still compounding. It was really just still a future problem to deal with. So, this first year tax bill was one of the largest of his life, and it really surprised them. It was larger than any single year while he was working, because that $150,000 IRA withdrawal stacked on top of six months of salary, it pushed that income north of $220,000. And for them, that was, you know, very impactful. The IRS, they don't care when you retired. It just sees the number.
The COBRA bills had drained $43,000 from their cash reserves that should have lasted three years. Gone. And it not in a way that really built anything for them or moved the needle on their plan. It was just gone. And then there was the Roth conversion piece. Two full years of 12% bracket space just, you know, where maybe they could have moved $180,000 to $200,000 into Roth at a fraction of what it would cost them later. It just sat there unused. And that one is hard to sit across from somebody and explain, because you can't go back and fix it. You can only look at what it's going to cost moving forward.
But honestly, the hardest part of that meeting wasn't the numbers. Susan was angry, and she had every right to be, because before Dave retired, she had really pushed for a plan. She wanted them to sit down with somebody and map out the first three years before he handed in his notice. And Dave's response was, "$3 million is enough. We don't need a plan." Now, every quarter when their estimated tax payments went out, that conversation gets brought back up. The retirement that really was supposed to feel like freedom, it really felt like a series of expensive mistakes that they couldn't undo. And every one of those mistakes was preventable. Not with just a last-minute checklist before Dave cleared out his desk, but really if you have a real plan in place, a few years or more before retirement, when there's still time to move accounts, you can test income levels. You can make decisions without the pressure of the clock running.
So, we're going to take a moment. We're going to break down what went wrong, okay? What should have been done differently, and how can you avoid the same mistakes.
So when Dave and Susan came in at 58, we didn't start with solutions, okay? We started with questions, because before you can fix anything, you have to understand exactly how you got here. So these are the six questions that we walked through them with. And honestly, um, it's the same questions that we'd ask anybody in a similar situation.
So, first, you know, why did you fund year one spending entirely from the traditional IRA when you had $350,000 in a taxable account and $250,000 in cash just sitting right there? So, this one matters because the decision, like it was almost certainly avoidable. Between the taxable account and the cash alone, Dave and Susan had enough to fund two to three years of spending without touching their IRA at all. So if they had done that, the 32% bracket hit in year one likely would have never happened. And that's not a small thing. That's the most expensive tax year of their retirement, and it didn't have to exist.
So second question, what did your income actually look like in your final working year? And did you account for how the IRA withdrawal would stack on top of your remaining salary? Most people don't think about this until after the fact and they pull the money out. Dave retired mid-year, which means six months of VP-level salary was already on the books for him for the tax year. So pulling $150,000 from the IRA on top of that, it didn't just create a tax bill. It created the highest income year of their entire retirement, more than any year that Dave was working full-time. Understanding that stacking effect is what makes the year one sequencing decision so critical.
Third question is, why did you default to COBRA instead of shopping the marketplace coverage? And do you know what the ACA subsidies would have saved you? So in the years that Dave and Susan retired, managing their income sources better, what it could have done is it could have qualified them for a meaningful premium tax credit. So that potentially would cut their healthcare costs significantly compared to COBRA. So that would have brought their total healthcare costs over 18 months down well below that $43,000 that they actually spent. Now, COBRA isn't again, always the wrong answer, okay? If you're if you have ongoing health needs or preferred providers that you want to work with, the familiarity of your employer plan has real value. But for Dave and Susan, again, it just it was a default. Nobody ran the comparison before they signed up.
And then fourth, how much Roth conversion space did you have in year one and two? And what did you actually use? So, the answer was zero. And at their income level with the brackets as open as they were, $160,000 to $200,000 could have moved from traditional to Roth at 12% during those two years again. So that's a meaningful shift in the long-term tax picture. The cost of taking a break from financial decisions for them wasn't zero. It had a very specific price tag attached to it.
The fifth question we asked was that, you know, given that those early conversion years are now gone, what does the traditional balance look like at 73 compared to what it would have looked like with proper planning from the start? So this is where the compounding cost of that missed window becomes real. So every dollar that stays in the traditional account, it just keeps growing, which it sounds good until you remember that every dollar of growth is also a dollar that will eventually be forced out as a required minimum distribution at whatever rate the tax rate is then for you. So the dollars that Dave and Susan could have converted at 12%, they're still in there. They're still compounding into a larger future tax bill. So the window didn't completely close. It just got more expensive to use, you know, every single year that they didn't use it.
Okay. And then the sixth question that we asked is, and this is probably the one that most people don't think about until it's too late. What does the survivor scenario look like with $2.4 million still sitting in traditional accounts? So, when one spouse passes, the surviving spouse loses the married filing jointly brackets and it shifts to single filer rates. So, that $2.4 million in traditional accounts doesn't disappear. It becomes the surviving spouse's RMD problem, forced out in that compressed single filer bracket at rates that can be significantly higher than what most couples pay today. And that's not a hypothetical, right? That's just a real math problem with a known answer. And it's one of the reasons why we want to look at that survivor scenario early in the planning process before it becomes somebody's reality.
Now, I want to pause here for a second, and, you know, in our profession, when we walk through a list like this, I understand that it can start to sound like we're pointing fingers, and that's genuinely not the intention. Like, Dave didn't make bad decisions because he was careless, right? He made reasonable decisions without complete information. And that's exactly why we ask these questions, not to assign blame, but to find the leverage points. Because if we know where the pressure came from, well then we can, you know, know where the opportunity still exists for them.
So here's how we worked through this with Dave and Susan. So the first thing we did was, before we talk about solutions, we want to look at the cost in real dollars. We really model out the cost of those four mistakes versus what proper planning started years before retirement would have produced. So, the IRA withdrawals stacking on the salary, the early Social Security claim, the COBRA default, the empty conversion years, we put a number on all of that, not to make anybody feel worse, but because you can't make good decisions about the future without understanding the true cost of the past. So, when Dave and Susan saw that number, it was sobering, and it also motivated them. That made the case for urgency, because the flip side of that number is that opportunity still exists.
The second thing we did is we build the recovery plan from age 58 moving forward. RMDs don't start until 73. So that's 15 years of conversion window still remaining. Not, you know, maybe as clean as starting at age 53 or 54, but far from over, right? We front-loaded conversions in every available year that they wanted to do them. And we shifted spending from the taxable accounts and the Roth to keep those brackets open. And when we get to the ACA coverage, we really manage their income levels. And so we look hard at whether Social Security's claiming decision can be adjusted or suspended or restore some conversion space for them to make a little bit more room for that. So it's not a perfect plan. It's a recovery plan, but, you know, but a well-executed recovery plan from 58 still produces a dramatically better outcome than doing nothing.
Third, we address the emotional weight that they're carrying. The regret shouldn't really be about retiring at 56. The balance supported it. The regret is about retiring without a plan for what came next. And that's a very different thing, because, you know, one is a permanent verdict on a decision that can't be changed, and the other one still has a solution. So, we close every meeting like this one the same way. We tell them, "Stop punishing yourself for the past. Start executing the plan that protects the next 25 years."
So Dave's story isn't about retiring too early. It's about retiring without a plan for what came next. So if you're sitting on a large balance and thinking about seriously about maybe making an exit, the balance isn't the finish line. The plan is. I'll leave a link below if you want to watch my training on how we help people to build that type of a plan so that retirement feels like freedom instead of a series of decisions that you're still paying for. Thanks for watching.