Category Archives: Early Retirement

A Reader Asks: SPIA inside of an IRA

Thank you for taking the time to read this blog post.  I recently received a rather complicated question from one of the frequent readers of this blog.  His question was about how he could buy an SPIA inside a Traditional IRA account.

The question came from a reader named Bill.  Bill provided me with a good amount of information about his financial situation.  Since I am not a financial advisor, I told Bill that I do not give financial advice, but would write about his situation on my blog and request feedback from other readers in the comment section.

Bill is 59 years old.  He is going to retire from his career as a truck driver next year when he turns 60 years old.  To fund his retirement, he owns three duplex rental properties that produce a generous income of $7,200 per month.  He has a portfolio of a few dividends paying individual stocks including Johnson & Johnson (JNJ) and Procter & Gamble (PG) worth $200,000.  Bill also has a safety deposit box full of EE Bonds that he has been buying for the past 30 years estimated to be worth about $50,000.  Bill also has a 401K with his long-time employer that has a balance of over $650,000.

Bill told me that the income from his rentals and the dividends that he receives is more than enough to cover all of his living expenses.  Bill is planning on taking Social Security at age 65, but if money gets tight for some unforeseen reason, he will tap Social Security at age 62 instead of 65.  Bill explained that he lives a frugal lifestyle and does not project that happening.

He wants to hold off on taking any money from his 401K that he is going to roll-over into an IRA until he turns 70 years old.  His goal is to grow the value of the IRA until he is required to take RMD’s.  Bill also wants to invest this money in a way that will provide guaranteed income in the future.

The exact phrase that Bill used was creating a growth and income strategy for himself.  He asked me what I thought about taking $600,000 from his IRA and buying a Single Premium Income Annuity (SPIA).  An annuity salesman from a major brokerage house quoted him a monthly payment of $2,800 per month, with 20 years certain, and a minimum payout of $665,000.

Bill does not want to spend the $2,800 per month at this time.  He wants to take the $2,800 per month and have it invested in a balanced mutual fund with a conservative asset allocation within the IRA.  His plan is to do this for 10 years.

At age 70, he wants to spend the $2,800 per month when RMD’s are required.  He projects that a balanced fund of 50% invested in stocks and 50% invested in bonds should return around 5% per year over the next 10 years.  That would provide him with another $440,000 in retirement savings.  Bill estimated his RMD’s to be around 4% and that $440,000 would give him an additional $1,400 in retirement income.

Bill asked me what I thought about his plan.  He was not concerned about receiving the best return on investment.  He was also not interested in any type of variable rate product.  He wants to have a guaranteed income at age 70, but also have some conservative growth over the next 10 years.

I am grateful that Bill took the time to send me an email about his unique idea.  He has set himself up for a comfortable retirement.  He just does not want to have to deal with market volatility and simply wants to buy himself a pension for the latter part of his life.

Bill does not want to put any of the $2,800 per month of future income in jeopardy.  Since he does not need it now, he wants to have it grow and earn a reasonable return. He referred to the extra $1,400 per month as gravy.  My thought was that the extra money could come in handy to offset future inflation.    

Since I am not a financial advisor and am not familiar with annuities, I told Bill that I would post his situation on my blog and ask for readers to comment.  My blog is read by many members of the financial independence community and a few financial advisors.  I will ask their opinion.

The main question that I have about Bill’s plan is can an SPIA be purchased in a traditional IRA?

What about the monthly payments, can they be kept within the IRA and be distributed to a mutual fund until RMD’s are due?

Would the combination of payments from the SPIA and withdrawals from a mutual fund impact the RMD’s when Bill is 70 years old?  

Thanks again for taking the time to read over Bill’s situation and plan.  Bill and I would truly appreciate any feedback about his plan of using an SPIA in an IRA to produce some growth and future income.  Please share in the comments section below if you have expertise or experience with using an SPIA in a Traditional IRA.

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The Roth IRA is 20 Years Old

The Roth IRA is 20 years old.  Where does the time go?  Time sure does seem to fly when you are having fun.  It seems to go faster when you are dollar-cost-averaging and building wealth.

That is exactly what the Roth IRA has done over the past 20 years.  It has been a great wealth building tool for many individual investors.  Since it was created, I have been depositing money into my Roth IRA in the form of dollar-cost-averaging with almost every paycheck for the past 20 years.

The Roth IRA has come a long way in 20 years.  The Roth IRA is named after William Roth a Senator from the state of Delaware and was part of the Taxpayer Relief Act of 1997.  What makes the Roth IRA different from a Traditional IRA is that unlike the Traditional IRA, there are not any immediate tax deductions.  The Roth IRA is funded with after-tax earnings and when the money is withdrawn at retirement, it is tax-free.

When I first started investing, the Roth IRA was not available.  It did not become available until I was investing for about 1-year.  As soon as I learned about the Roth IRA, it sounded like a great wealth building tool.

When the Roth IRA was first introduced, the annual contribution limits were only $2,000 per year for an individual who qualified. From 1998 until 2001, the contribution limits were $2,000. The contributions limits have slowly been increasing over the past 20 years.  In 2002, people over 50 have been allowed to contribute more in the form of a catch-up contribution as they got closer to retirement age.  In 2018, individual under the age of 50 can contribute $5,500 per year and people who are over age 50 can contribute $6,500 per year.

There are income limits on who can take advantage of the Roth IRA.  Single filers who earn less than $120,000 qualify for a full contribution.  Single filers who earn between $120,000 and $135,000 are eligible for a partial contribution.  Joint filers who earn up to $189,000 can take advantage of the full contribution.  Joint filers who earn between $189,000 and $199,000 are eligible for a partial contribution.

Since my wife and I earn less than $189,000 we are able to better diversify out retirement tax strategy.  We contribute to our Traditional 403B accounts to reduce our annual taxable income. We also contribute to our Roth IRA accounts to have money that can be withdrawn tax-free later on in retirement.

What if you want to contribute to a Roth IRA account, but do not qualify.  For those folks, there is a Backdoor Roth IRA method that could be used to convert a traditional IRA into a Roth.  That approach is more complicated based on taxation.  It might be wise to check with a CPA before trying to implement this strategy.

Unlike a Traditional IRA or 401K, there are not any Required Minimum Distributions (RMDs) with a Roth IRA.  In a Traditional IRA account, the money has to start to be withdrawn at age 70 ½. That is not the case with a Roth IRA.  The money never has to be withdrawn.  It can remain in the Roth IRA and the money can keep growing.

Since the money never has to be withdrawn, it is recommended by many financial professionals to drawdown Roth IRA accounts last.  We have added that strategy to our retirement drawdown plan.  Based on our age and different types of investment accounts, we will be following a Buckets Approach to funding our retirement.

We will first drawdown our taxable accounts.  The second source of retirement income will come from our Traditional IRAs based on the RMD schedule.  If we live long enough, the last source that we plan on drawing down is our Roth IRA accounts.

There are many benefits with passing on a Roth IRA to a surviving spouse.  They are not forced to take RMDs. They can roll the inherited Roth IRA over into their own Roth IRA.  They can also continue to contribute to the Roth IRA with new earnings.  These benefits do not apply to someone who inherits a Roth IRA who is not the spouse.

Another benefit of a Roth IRA is that you can withdraw money from the account prior to being age 59 ½.  With a Traditional IRA, there is a penalty for early withdrawals.  The money that a person withdraws early is taxed as ordinary income.  There is also a 10% penalty unless it is considered a special circumstance.  With a Roth IRA, there are not any penalties if the money that is taken out is limited to contributions.

Over the past 20 years, the Roth IRA has become a very popular type of retirement account.  According to the Employee Benefit Research Institute, more than 29% of all individuals have a Roth IRA account.  That is an amazing statistic since so many Americans struggle with saving money for retirement.

There are few things in life that most people agree on.  In the world of personal finance, I cannot think of anyone in the financial independence community who does not like the benefits of investing in a Roth IRA account.  It is hard to not see and embrace the ability to build wealth in an account that allows people to have tax-free income at retirement.

Do you invest in a Roth IRA account?

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Selling your Stocks at Retirement

Have you ever considered selling your stocks at retirement?  Who wants to have to deal with the ups and downs of the markets when you are no longer dollar-cost-averaging?  Are you afraid of a major market crash when you are drawing down your portfolio?

The market is near its all-time high.  With retirement right around the corner, are you tempted to sell all your stock holdings and call it a day?  It might sound tempting.  This market cannot keep going up, can it?

Every investor has the right to feel exactly how they feel about all of the scary things that are going on in the world.  Don’t lose your head.  The world has always been a volatile place and unfortunately, it always will be.  If it is not one thing, it is something else.

Yes, it might be tempting to pull the trigger and sell high.  You would walk away as a winner.  Before you do that.  Let’s look at how an all-bond portfolio might serve you in retirement.

For this exercise, let us assume that you are now sitting on $1,000,000 in your 401K.  At retirement, you want to draw down 4% per year.  How would an asset allocation of 100% in bonds hold up over the course of 30 years?  To find out, I am going to run this test based on the Monte Carlo method by using the Vanguard Retirement Nest Egg Calculator.

There is a 69% chance that your savings will last 30 years.  I do not like those odds.  I especially do not like them for a person who retires early.

What about if a person wants that $1,000,000 to last 40 years?  The percentages are getting much worse.  There is now only a 36% chance that money will last 40 years.

Could you imagine going broke after being retired for 40 years?  What would you do?  Would you go back to work?  Who would hire you at such an advanced age?  Sure, employers cannot discriminate, but let’s be honest about the opportunities for someone who has been unemployed for that long.

What could an investor do to improve the chances of their savings lasting 30 years or even 40 years for those who enter early retirement?  In Benjamin Graham’s book The Intelligent Investor, he gave a few suggestions for defensive investors.  He suggests that a balanced portfolio made up of 50 in equities and 50% in bonds is a good place to start.  He also suggested that an investor should never exceed an asset allocation of 75/25.  In other words, an investor should never have more than 75% or less than 25% in equities or bonds.

I know that you are seriously considering selling your equity holdings and exchanging them for bonds.  You have told yourself that you are finished with the market.  Volatility is no longer for you.  You want to enjoy your retirement without having to worry about how stocks are performing.  If you do that, the odds are still not in your favor of not running out of money.

How would your $1,000,000 fair if you followed what the late Benjamin Graham suggested in his classic investment book?  How would keeping only 25% in equities change the projected outcome?  Would adding a more volatile asset class help or hurt the likely hood of running out of money?

By keeping 25% in equities, the percentages have dramatically improved.  There is now a 78% chance that your money will not run out over the course of 30 years with a 4% drawdown rate.  Over the course of 40 years, there is a 57% chance that your money will last.  By keeping 25% of the portfolio in stocks, there was an improvement of 9% over the course of 30 years and an improvement of 21% for 40 years.

Holding a small allocation of equities sure goes a long way.  What about if you took it a step further and went with a mix of 50% in stocks and 50% in bonds?  I know, I know. You are finished with stocks.  Keeping 25% of your money in stocks is one thing, but going to 50% is just too aggressive for your retirement account.

I understand how you feel.  You do not want to own stocks when the next recession occurs.  A long stock market correction can be scary.

During a drawdown period, how does having 100% in bonds compare to an asset allocation of 50% in stocks and 50% in bonds?  Over the course of 30 years, the 50/50 mix has an 85% chance of success.  Over the course of 40 years, the 50/50 mix has a projected success rate of 74%.  Compared to the portfolio made up of 100% in bonds, the 50/50 mix has a 16% better chance to not run out of money over the course of 30 years.  For the period of 40 years, the 50/50 mix has a 38% better chance of not running out of money.

There are many factors to consider when selecting the asset allocation that is right for your retirement.  How old will you be at the time of retirement?  How long does your money have to last?  How will RMDs impact your drawdown?  What type of lifestyle do you want to live during retirement?  Are you planning on leaving a legacy?

I am not trying to convince you on how you should allocate your portfolio during retirement.  That is ultimately your decision.  Everyone has a unique financial situation.  The purpose of this post was to examine how different conservative portfolios might perform during the drawdown period.  I am just trying to convince you to do your due diligence before you rush to any financial decisions that will impact your quality of life down the road.

After reviewing these results, it shows that diversification is still important during the drawdown period.  Just as holding 100% in stocks is too aggressive for most investors during their working years, holding 100% in bonds might be too conservative for investors during the drawdown period.  When an investor is working on building their wealth, holding a percentage of bonds helps to reduce the impact of how stock market volatility impacts a portfolio.  During the drawdown period, holding a small percentage of equities greatly improves the likelihood of not running out of money in retirement.

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What Stage of Financial Change Are You In?

If you choose to pursue financial independence and an early retirement, you will need to reject many of the popular, preconceived mindsets and behaviors that you’ve been taught about your relationship with money.

Over the past two decades, the average age at retirement has been increasing. Studies predict the average age of retirement for Millennials may reach 75 due to the growing costs of rent and prevalence of student loan debt.

The good news?

You don’t need to follow the same financial path as your peers (no matter what generation you were born in).

The “bad” news?

To reach retirement earlier than your peers, you will need to handle your money in a different way as well.

Pursuing financial independence will require self-education, practice, and persistence. You may or may not have the support of your friends, co-workers, and even family members… but you will need to make financial changes in your own life regardless of their own money habits.

In this post, you’ll learn more about the five stages behind every major life change, how these stages apply to your personal finances, and how you can use this model to stay committed on your journey toward financial independence.

The 5 Stages of Financial Change

In the academic world, the stages of change are more formally recognized as the “transtheoretical model of behavior change.”

This model was first proposed by psychology professors in 1977. The model is often applied to health-related changes, such as quitting smoking, starting a new exercise or diet plan, and managing anxiety and depression.

Here are the five stages:

    1. Precontemplation (not ready to change)
    2. Contemplation (considering change)
    3. Preparation (getting ready for the change)
    4. Action (making the change)
    5. Maintenance (reinforcing the change)

While you typically progress sequentially through the first four stages, it’s possible to “backslide” and revert to an earlier stage if maintenance is unsuccessful (breaking your diet during the holidays, for example).

This model not only applies to physical behavior changes but can also be applied to belief changes or decision-making as well.

Let’s take at how you may journey throughout these stages as you make significant changes in your financial habits.

Precontemplation

During the precontemplation stage, an individual is not seriously considering making a change. In fact, they may not realize that a change is necessary at all.

In the context of a health-related issue, a person in the precontemplation stage may assume they are totally healthy – perhaps unaware that their high cholesterol or blood sugar may already have them on a trajectory for a heart attack or diabetes down the road.

If you have just started your professional career, you may find yourself in the precontemplation stage of your retirement planning.

Perhaps you are contributing a small percentage of your 401k toward retirement each month. What you may not realize is that contributing just 5% of your salary is going to place you squarely in the “retire at 75” club.

To move out of the precontemplation stage may require a “financial epiphany.” This could be saving up to buy a house, preparing to have a child, or earning a salary for the first time. At this point, you’ll realize it’s time to make peace with your financial past so you can reach your goals.

Contemplation

The same year that psychology professors created the “model of behavior change,” film director Woody Allen was attributed in the New York Times for his popular quote, “Showing up is 80 percent of life.”

Just by “showing up” to read this post, you may have already progressed out of precontemplation into the next stage of behavior change: contemplation (surprise!).

During the contemplation stage, an individual is aware of their problematic behavior but are still weighing the pros and cons of change: Can I make time to exercise without hurting my career? Will my friends support me in my decision to quit smoking or drinking?

In a stage of financial contemplation, an individual may be considering their financial goals and the associated trade-offs.

  • Should we be focused on saving up a down payment for a home or paying down student loans instead?
  • Is it worth the inconvenience of downsizing our home or moving in with roommates to save additional money?
  • Can we commit to meal prepping for a few hours each Sunday night to reduce spending on lunch during the work week?

Preparation

An individual in the preparation stage has determined the pros of change outweigh the cons. At this stage, they may start performing research, creating a plan, or making small steps toward their improved for behavior.

If you are someone who wants to lose weight, your preparation might be purchasing a healthy cookbook, grocery shopping for nutritious foods, or signing up for a gym membership.

Many times, it’s tempting to skip from the contemplation stage directly into action (which we’ll discuss below). It’s important to spend time in the preparation stage to lay a framework for success.

You may have to remove barriers from your financial goals as well. This could involve learning more about debt payoff strategies, calculating your net worth to understand your current situation, or building a solid budget that organizes your finances.

Action

In this stage, individuals begin to actively change their behavior. This decision is often one of the shortest stages of change – most of the effort is either exerted in (1) building motivation during the contemplation the stage, or (2) maintaining and reinforcing change.

If quitting smoking is your health-related behavioral change, then the action stage would be the first few weeks of cessation. The behavior change requires consistent, active effort to make. You may be using aggressive strategies like substituting a new behavior in its place, rewarding yourself for the proper behavior, and avoiding any scenarios that trigger the old behavior.

There are many ways to take action and improve your personal finances. You may start scheduling recurring payments on your debt, setting aside an additional portion of your income with direct deposit, or creating a budget to keep yourself living within your means.

Maintenance

In a successful behavioral change, the maintenance stage will have the longest duration. The goal of the maintenance stage is to reinforce the new behavior to minimize the chances of a relapse. With time, the new behavior will become second nature.

It is not uncommon for individuals to relapse back to a previous stage. A successful behavior change will depend on how an individual responds to this situation:

Do you prepare yourself to eat healthily by going grocery shopping and planning your upcoming meals – or do you tell yourself that you’ll try again next New Year’s?

Financial independence is a long-term objective that requires maintenance as well. You may have to dip into your emergency fund to cover an unexpected expense. You might splurge and make an impulse purchase that falls outside your budget.

It’s important to avoid letting one setback justify additional bad behavior. Even if you aren’t perfect with your money, you can find ways to improve your finances each and every day.

How can you maintain your positive personal finance habits to minimize the impact of a setback?

  • Continue learning new financial principles with personal finance blogs and books
  • Surround yourself with like-minded individuals who share your goals and values
  • Be publicly accountable for your goals by sharing them with family and friends
  • Automate your behaviors with recurring transfers, payments, and direct deposits

Conclusion

To do something spectacular with your personal finances, you will need to adopt different beliefs and behaviors about money that may be different than your peers.

You can make this financial change easier by understanding the how the “stages of change” model applies to you and your personal finances, assessing your current status in the model, and finding ways to reinforce the right behaviors until our reach your goal.

No matter how long you’ve been focused on your personal finances – whether you’re just contemplating your goals or maintaining your progress – there are strategies you can use to make good financial behavior easier.

How do you stay committed to maintaining the positive financial changes in your life? 

Author Bio:

Aaron is a lifelong entrepreneur and internet marketer who started Personal Finance for Beginners to share experiences and insights from his own financial journey as he pays down student loan debt, sticks to a deliberate budget, and saves and invests for the future. You can find him at Personal Finance for Beginners or on Twitter @PFforBeginners.

Early Retirement: Removing Barriers

Many people dream of reaching early retirement.  Few people, however, are willing to do what it takes to make it a reality.  In most cases, to reach early retirement, a person must live differently from how the masses live.  People generally don’t want to be viewed as being different from their fellows.

The masses are living for the day, spending most of what they earn, landing in debt, and are in denial about their personal finances.  They have high hopes that their financial future will be secure.  Hope, however, is not a strategy.

To reach early retirement, a strategy is needed.  That strategy will require action and more action.  The primary objective of that strategy will be to first reach financial independence.  Financial independence is what enables people to retire early.  If a person is no longer working, the money to sustain their lifestyle needs to come from somewhere.  For most early retirees, that somewhere is their passive investments.

The path to being able to retire early is full of barriers.  Many are external like being able to maintain a budget while marketers are doing everything they can to get you to break your budget and buy whatever it is they are selling.  Some barriers are mental.  The purpose of this post is to identify a few of these barriers and to establish a plan of action to avoid them.

Ignorance

Most people are unaware of what is required when it comes to planning for an early retirement.  That is even true for those who have attended college.  People who hold a 4-year degree or beyond still struggle with doing what is required to escape having to work for a living.

When it comes to establishing a financial plan, many people truly do not understand what is required.  They feel that things will just work out like they have in other areas of their life like landing a good job or getting a mortgage to buy a house.  They are generally in denial about what is required to build a large enough net worth to sustain their desired lifestyle once they are no longer working.

The good news is that once a person decides to learn more about personal finance, there is an abundance of great information.  Once a person takes that first step towards learning about budgeting, saving, and investing, they have removed one barrier.  Once that barrier has been removed, they will discover that the basics can carry a person a long way.  The basics alone might be enough to carry some people to financial independence.

Procrastinating

Procrastinating is another barrier that stands in the way of reaching early retirement.  Not knowing about a topic is one thing.  Knowing and not doing anything is another.  To reach early retirement, it takes many years of earning a salary, saving a large percentage of that income, and investing it wisely.

The longer a person waits to start this process, the harder it becomes.  That is based on compound interest.  Let’s assume that an investor needs to have $1,000,000 saved to declare financial independence.  They also want to reach this milestone by age 50.

Based on an 8% percent return, if an investor starts to save $1,800 per month at age 30, it will take 20 years to reach their goal.   If they wait until age 40 to start saving, they will have to save almost $6,000 per month.  If they started at age 22, however, they would only have to save $900 per month.

When you are young, time is on your side.  The older you get, the harder it becomes.  Don’t procrastinate if your goal is to reach early retirement.

Not investing in stocks

To receive a return close to 8%, an investor will need to have a large percentage of stocks in their asset allocation.  Based on how investments are projected to perform for the next 10 years, an 8% return might not be reasonable.  Large-cap stocks are projected to earn 6.7% threw 2026.  For that same period, investment grade bonds are projected to earn 3.1%.

The average person has the tendency to shy away from stocks.  In the short-term, they are volatile.  Over long periods of time, they are one of the best wealth building investments for individual investors.

Instead of parking your money in a money market that returns 1%, consider adding stocks to your asset allocation.  A good place to start is to look at a balanced portfolio of 60% stocks and 40% in bonds.  This allocation is popular because it provides growth from the stock allocation and the bond allocation reduces volatility when the stock market has a correction.  Another general rule of thumb is to invest (110 minus your age in stocks).  If you are age 25, you might want to consider having around 85% of your asset allocation in stocks.

Lifestyle Creep

Lifestyle creep is a form of inflation.   As a person advances in their career and their earnings increase, it is natural for their spending to increase.  As raises and promotions pile up, people have the tendency to upgrade their lifestyle.  Instead of saving more of their earnings, people buy bigger houses, fancier cars, and go on expensive vacations.

If there is lifestyle creep in your life, it is a major barrier between reaching early retirement and being stuck as a wage earner.  Lifestyle creep inflates how much money you need in your retirement account before you can retire.  In contrast, if you keep your monthly expenses low, the less you will need to be able to retire.

If you plan on withdrawing 4% from your retirement account, have $100,000 in annual expenses, you will need $2,500,000 in retirement savings.  For those who only have $40,000 in annual expenses, they just need to save $1,000,000.  The higher your annual expenses are, the more you need to have in retirement savings.

To avoid lifestyle creep, some management is required.  A solid budget is needed.  A financial plan is also a vital tool.  First, focus on the big expenses.  Keep your housing, transportation, taxes, and education costs low.  For example, live in your starter house forever, buy an economical car, live in an area that does not have high taxes, and take advantage of public schools and state universities.

If you can avoid lifestyle creep on the major expenses, you will have more money for savings.  This will also lead to less financial stress.  Instead of stressing to cover your bills that are always increasing, you will be able to better enjoy your life because there will be less demand for having to earn more and more.

Conclusion

For most people, the road to early retirement takes a long time.  It generally takes a couple decades of solid earnings, a high savings rate, and compound interest.  To achieve this ambitus goal, there are barriers that need to be identified and managed.

To be successful with personal finance, education is required.  The great news is that there is an abundance of good books, blogs, and forums that provide unlimited information.  A good place to start is the Resources page on this blog.

There is no such thing as an overnight success.  Most overnight success stories have been a fifteen-year work in progress.  If you want to be financially successful and retire early, start today.  It is not an overnight endeavor.

Without some risk, there will only be a little return.  Identify the correct mix of stocks and bonds for your situation.  Be sure to take your age and risk tolerance into consideration.

Manage your expenses.  The greater your expenses, the more money you must save and grow.  By keeping your expenses low, the less money you will need in retirement.

There will always be barriers that stand in the way of reaching early retirement.  Once they are identified, they can be managed and overcome.  Keep your eyes open for other barriers that might pop-up.  Be vigilant and stay focused and you will be sure to reach financial independence and retire early.

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