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How to Make Your Money Last Longer During Retirement – Episode 65

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Saving is only one part of the retirement equation. Whether you’ve already reached the end of your career, or are still in accumulation phase, you’ll need to know how to spend down assets in the right order to get the most out of your nest egg. In this episode of Dentist Money™, Reese & Ryan talk about which accounts to pull from in the early years of retirement, how to keep your tax rate down, distribution requirements on your 401(k), and how assets like your house and practice can be utilized to lengthen the life of your other accounts.

Show notes:
Survey link: dentist


Reese: Welcome to the Dentist Money Show where we help dentists make smart financial decisions. I’m your host, Reese Harper, here with my trusty old cohost Sir Ryan Isaac.

Ryan: Good morning, Reese. Welcome back to the Dentist Money studio. How was your trip to sunny Southern California? I hope you got some sunshine.

Reese: I did, but that made it sound like it was a vacation.

Ryan: You surfed the whole time, right?

Reese: I was indoors in a small 15×20 room attending a two-day seminar on how to improve my skills as a business owner. It worked out well; I really enjoyed it. But I didn’t get to go surfing.

Ryan: Did you improve your skills?

Reese: We’ll find out over the proceeding decade as I pursue the skills that I’m trying to obtain from the event.

Ryan: Every time I think about Southern California, I think of the skit on SNL “The Californians.” It’s a fake soap opera where they are really dramatic. Every time they say something, they introduce the roads they drove in on or the roads they are going to leave on. Do you remember that?

Reese: Yes. “Reese you need to take the 101 to the 110, and let it dump off on the 405.”

Ryan: Those are all roads. I don’t think they connect though. So, on most of our podcasts, we talk about preparing for retirement. Getting ready and looking ahead. It’s always about saving your money, putting it in the right places, building practice equity, paying off debt, growing net worth—all that kind of stuff. But while you’re accumulating wealth throughout your career in a bunch of different places, you have to eventually take it out to live on it later. It’s just as important to know how you are going to pull money out of these different places once you retire, as it is where to put it during your accumulation in your working years. It’s not just saying, “I’m done working; Friday was my last day, I’m just going to start pulling an equal amount out of every account that I have; or I’ll just randomly draw money from whatever one seems most convenient.” There has to be a strategy because it will affect your tax rates, fees, costs, and it will affect your ability to get certain investment returns and have time horizons. It’s not just as simple as “start spending your money.”

Reese: We had someone ask us about that recently. It was a listener who wanted us to cover that subject. I think it’s a really good topic. This dentist was approaching the point where he wanted to start spending down his money and wanted to make sure he was doing it the right way during retirement so that it lasts as long as possible. And this podcast is not just for people who are retired or getting close to retirement. All the young docs listening also need to know how spending during retirement works so you can start putting your money in the right buckets while you are still working. It’s really important to make sure you nail both the accumulation side of this equation and during retirement that you’re approaching this subject with good knowledge and the right tactical withdrawal strategy.

Ryan: I thought it was a great question too, and something we discuss a lot with clients and people that are in retirement as well as a lot of people before that. So today we will address some of the most common questions people have about spending down their assets in retirement. We’ll talk about what you can do in the years leading up to actually retiring to prepare and make sure you have plenty of flexibility when you do get older. To get started, let’s begin with some of the questions from this listener that asked us these things. One of the main questions is: which accounts should I pull from first? Where do I begin?

Reese: This is really common, asking, “What accounts do I pull from? Should I let everything just grow evenly and pull out money equally in proportion?” Doing this correctly and understanding how it’s going to work really early on is important because it will affect the way you invest money. Just keep this in mind—not every one of your accounts is equal. Not all of your accounts have the same value to you at retirement. Stuff that’s inside of your 401K or IRAs—anything that hasn’t been taxed yet—those are effectively not as valuable of accounts as ones that have already been taxed. So if you have three million dollars in a 401K vs. three million dollars in a brokerage account, the three million dollars in the 401K is actually worth less than the three million dollars in a brokerage account, because you’re going to have to pay taxes on that 401K money. And so if the question is: which account should I pull from first? You want to first look at which things have the least amount of tax associated with spending them down. The idea is to defer the tax as long as possible. For those of you who don’t know—Sir Ryan Isaac, what age do you have to start pulling out of that 401K?

Ryan: It’s just after seventy. Seventy and a half.

Reese: I don’t know why they say seventy and a half.

Ryan: It’s just the IRS. I love the way they do it. It’s beautiful. Poetry in numbers.

Reese: Just pick an age. We already have a 10,000-page tax code, so why not start giving people half birthdays? And say, on your half birthday, that’s when it kicks in.

Ryan: What if you’re born in Leap year?

Reese: Now I’m really confused. So, you want to defer the 401K and IRA monies out as long as possible, until age seventy and a half, and at that point you’re going to be required to take some money out. That’s called a “required minimum distribution.” There’s a formula—you basically take the total amount of money that you have out on your half birthday, and you divide it by a factor that the IRS gives you in this chart. You can go online and look at an RMD retirement chart. You’ll be able to figure out how much you have to pull out. You might have to pull out 6% or 7% of your account, or 5 or 8% depending on when your are withdrawing that money. Usually it’s not a massive amount. It’s typically going to be in the low single digits. Does that answer your question?

Ryan: I was going to jump in too—this makes me think a lot about how spending affects when and where you will take money from. Statistically people don’t spend much less in retirement than they did before retirement, especially in the beginning years. Everyone is thinking—oh my kids are gone, mortgage is paid off, debts are gone. Well, not everyone’s debts are gone in retirement. Your kids have kids; some kids still live at home; health care costs rise. You now have more time on your hands to do more things and spend more money. I think we can speak from experience working with people that spending doesn’t change a lot in retirement, and statistically that’s pretty true too. Studies have shown that people spend between 80-100% of what they spent pre retirement. There’s got to be some point where spending does dwindle because of your physical capacity to go spend money, do things and travel. Although healthcare might keep rising.

Reese: I see that happening in late seventies, early eighties. There’s definitely a spending change. And if you retire in your fifties, there’s no way you are going to be spending less than you were. You’re usually spending the same. And it’s usually similar in your sixties and early seventies. People don’t start slowing down until they start not wanting to travel or be as active.

Ryan: Let’s talk a little bit about something that happens on the emotional side of spending money in retirement. Someone asked, “What if I don’t want to use money or spend it on assets in certain categories?”

Reese: What does that mean?

Ryan: We’ve known people who have received inheritances or they were gifted stock from grandpa, or it was a life insurance settlement. It could be a building that just has a lot of history and years, or it could be the primary residents. This is something called mental accounting. And mental accounting is where we mentally partition our money into different buckets or segments. And place more or less importance on those buckets depending on some factor that is not data-driven or scientific in any way. For example, mental accounting error might be that we get a tax return, and it kind of seems like you could blow that money because it’s not even real money that you’re going to get any way; or it’s a bonus. Some people might have a fund for something when they are carrying high interest rate debt, and they have got a fund for a dream car or the big vacation that might not make financial sense. Mental accounting happens in retirement where people will emotional value on a certain asset or bucket of money and not use it to their detriment. It might hurt their tax rate; it might be inefficient with fees and costs. Do you want to touch on a few of these? We’ve seen them a lot of times with personal residences or inheritance money—things like that.

Reese: Yeah, I want to touch real quick on this first question you asked, and then I want to go into that one because I think they are related. The first question you asked was: Which account should I pull from first? We talked about leaving qualified plans like your IRA and 401K until the end. I want to just highlight that a lot of people don’t think about the sale of their practice as a retirement asset they’re going to spend. I had lunch with someone yesterday who had a very conservative investment portfolio, and this person was in their mid-to-late forties. And this is common. I probably get this feedback once a month from a perspective client that will say, “I’m not planning on selling my practice for much. I don’t really want to bank on getting money out of my practice, so I’m not really using that in my retirement calculations. And when I look at that I’m going—ok this person’s practice was really healthy. It was likely that they were going to have a sale of that practice. And because they didn’t want to plan on that, they were investing all of their money very conservatively. More than they should have been for their age because they weren’t using that practice sale money as a factor in their retirement planning. They’re thinking, “Well I don’t know if I’m going to see anything from that. Because I’ll never get any money from my practice, I’m going to invest it a certain way.” And the reality is that at some age, maybe 55-62, this person was going to sell their practice. And they were going to get a million dollars or more for that practice when they sold it. And that would be a big bucket of money that we probably couldn’t save or invest in a very aggressive way because they’re in retirement now. We haven’t had any time frame to appreciate our securities and assets. So that money is probably going to get spent down first because it’s the money that has the shortest time frame for investing. So if I receive cash from the sale of that practice, I’ll probably start spending that money the soonest, and I’ll let my other investments continue to grow. And in preretirement planning, it’s important to think about how there will be probably the biggest windfall of cash in any one calendar year that any of you have ever had. The sale of a practice is a significant event, and I think it’s something that too many people discount until they get into their fifties and it becomes a reality. In their thirties and forties we talk about it like it will never happen, and then in our fifties we are thinking—oh, it really is going to happen.

Ryan: Well that’s about the time when you start seeing equity in that thing and think, “Oh if I sold today, I could get half a million or a million dollars.”

Reese: And it’s really meaningful. And so, which account should I pull from first? You need to take a look at how the sale of that practice is going to affect your withdrawals from your other accounts. I think that’s just really crucial. So for people who are already in retirement, it’s pretty simple math. You want to defer taxation as long as possible. And you don’t want to be withdrawing a huge percentage from any of your accounts either. So the other rule of thumb to follow when we talk about pulling money from different accounts is, if you’re going to be pulling more than 5% from an account per year, it really affects how you can invest that money. Because you’re not going to be able to grow something in today’s interest-rate environment at a predictable rate much higher than that. And you’re going to be depleting your account pretty quickly. A lot of people will be withdrawing 10-12% from an account per year, and they still haven’t invested in a way that is super aggressive. And they are tilted very heavily to the stock market, or at least half of their money is. And the reality is that having money invested in the stock market when you’re withdrawing 10% or more of it in a calendar year—that’s just not prudent. Because all you’re going to do, is if we have a down year like 2008 or 2009, you’re going to be yanking money 10% out of your account when it’s down 20% or more. So which account should you pull from first? It’s a rule of thumb that you can use to say—which ones have the least amount of taxes that I will have to pay? And then second, what percentage am I going to be pulling from each account? Because the only exception to that taxes rule for me would be if somebody had the bulk of their money in their 401K—let’s say they had two million dollars in their 401K and they had five hundred thousand dollars in after-tax money. If you use the “tax only” rule, you’re going to be withdrawing money from the five hundred thousand dollar account first, and then go to the 401K. But in that case I would say: I don’t want to be withdrawing such a high percentage from my after-tax account. I would like to maintain some after-tax monies available. Because if I get to the point where all of it’s coming out of the 401K, my tax rate could be a lot higher than if I balanced it maybe 70/30 or 80/20. So it’s really a question of: what percentage of the account will you be withdrawing if you were to follow that tax rule first? And if the percentage is too high. You’ve got that example I just gave of two million and five hundred or 2.5 and five hundred—2.5 in the 401K and five hundred in the after tax. If you need to withdraw 15% a year out of the five hundred thousand dollar account to meet your living expenses, it may not make sense to get it all from there because you’re going to burn through that money in a really short period of time. It’s kind of a tricky question, but I think it really is something that you should get some advice from multiple people on. It needs to come from your CPA who knows your tax situation really well, and it needs to come from a financial advisor who is really familiar with RMD rules and retirement withdrawal strategy because it’s not simple and a lot of it depends on your specific spending and social security benefits. I wish I could give a cookie-cutter answer to it, but it’s a multi-faceted problem.

Ryan: Well we like cookies. You know, as you’re saying that though it reminds me the other side of that is: if you’re able to think about this stuff before you get there and you’re able to maintain a good balance of pre and after-tax money, think about the implications that it has for your investment strategy and your returns. If you know that you don’t need to touch a certain pile of money until into your seventies (your 401K, qualified plans, pre tax stuff), and you won’t need that money. That gives you maybe an extra 10-20 years depending on when you retire and when you’ll even need that money which changes the way you would invest it right from the beginning. So we will talk about how to think about this long before retirement, but that changes the whole picture. That could be the different in hundreds of thousands of dollars in larger accounts because of returns if you were investing it more aggressively because you knew you would have enough after-tax money to live until that point and you could just let it sit and keep letting it grow. Having a lack of balance or just not anticipating this kind of stuff can lead to poor returns and worse investment decisions along the way, too.

Reese: I think it’s really important to emphasize the affect that taxes have on your investment returns. You might be getting 10% returns and someone else is getting 6%, but if they manage their taxes a lot better than you do, they could actually have a better retirement income stream than the person that got higher returns but mismanaged their taxes. Meaning, if someone during retirement was forced into a higher tax rate because they didn’t appropriately manage their taxes during their accumulation years. It’s really important to focus on taxes, capital gains taxes, and income taxes as you think about your investment strategy both during your accumulation years and your retirement. Let’s jump back to your question Ryan about the examples of mental accounting in retirement and how that works. The biggest one for me, and the only one I’ll really touch on in length is the primary residence for most people has a really emotional and sentimental value, and they don’t want to spend down that equity. They want to leave their house free and clear during retirement. It feels comfortable, and the thing you were taught to do from an early age about getting out of debt and paying off the house. I don’t have any problem with that, but I think the reality for most people is that will be a luxury that some people won’t have. Some people won’t have the ability to have a completely paid off primary residence and have plenty of money left over anyway. And what I sometimes will see happening is a case study: someone has a $750K house paid off free and clear. They have got $500K in their after-tax account and they have $1.5 million in their 401K. So you’ve got a net worth maybe of $2.75 million. So $750K is sitting in the house, and the person says they are not going to take money out of their house. Let’s say they need ten grand a month to live on, and $120K/year to live on—that’s going to 20% of your $500K account. So that will be a huge withdrawal from that account. So it will be a very large percentage from your $1.5 million account. That will be almost 7%?

Ryan: Yeah, together with the after tax and the pre tax that’s about a 10% withdrawal. But if you had the home equity, it’s about a 4%.

Reese: So if you look at the home equity and the after tax and pre tax account, you’ve got maybe a 4% withdrawal rate, which is a very sustainable withdrawal rate. But not if you yank it from one account at too high of a rate. Now this person would most likely go for the after-tax money first, and then they would start getting money out of the 401K. The problem is they are going to hit a point where all their taxes are pretty high because all their money is going to come out of the 401K. And we could minimize their taxes during retirement of some of the money came from the house, some came from the after-tax brokerage, and if some of the money came from the 401K plan.

Ryan: My question is: how do you measure that? How does somebody know if they are going to run into that problem or not into retirement?

Reese: Well, they would have to use our proprietary metrics that we have.

Ryan: Boom. Set you up nicely. Little softball. Underhanded, out of the park. That’s exactly right, Reese.

Reese: Let’s take a break for Ryan to do some shameless self-promotion.

Ryan: I think what you’re saying is there will be a lot of cases where maybe you live in an expensive area and you had no choice but to buy a home that was expensive and ended up being a good chunk of your net worth. It could be a third of your net worth when you retire. You just have to be conscious and aware that it’s a possibility. If you pile a lot of money into your home and it’s an expensive home. If you’ve got seven figures in a home that’s paid off—that’s a really significant amount of money and it’s common to not have saved enough outside of that expensive home to never need the equity.

Reese: If you don’t respect that, you might need to get money out of that house. You could end up jacking your tax rate up super high. And your net worth effectively won’t last as long. Don’t you see people making that mistake quite often?

Ryan: Yeah, but it’s so hard and so emotional. I think about people we know that are in retirement that live in very large homes that cost a lot money. They have seven figures of equity that’s paid off free and clear. They’ve probably got decades to live and maybe 5-8 years of liquidity and then the rest of the net worth is sitting in that house. It was an asset of sorts if you’re going to use it. You piled a million dollars into an asset.

Reese: So what are we saying about this? There’s really only two ways to get the money out of the house. One: you reverse mortgage the thing, which there is a lot of downside in our opinion to doing that. You want to get advice not from the mortgage broker or from the lender that’s selling you the reverse mortgage. A reverse mortgage is basically a way for you to stay and live in your house, but then have them start making you get an income stream. And it’s an option. The right reverse mortgage and fee structure—it’s not like a Ponzi scheme. But there’s another way of doing it, which is you’re either going to have to do a reverse mortgage or a forward mortgage. You’re going to have to borrow the money out of the house somehow. You’re going to either refinance it and get cash out and have payments, or just have a large home equity line of credit against the house that you can just start spending down that equity. You could also sell it to someone and sign a rental agreement for life, and just get your cash out but then sign a rental agreement back with that investor. Some people will want to do that, they love having long-term rental contracts. Those are options, but you just might need to consider it. The way we look at someone’s situation, if you’ve listened to the podcast before—we take what someone’s spending is on an annual basis and we multiple that. First we start with what you’re worth. The example I gave earlier: the 750K house value, the 500K of after-tax money, and the 1.5 million of 401K would give someone roughly a $3 million net worth. We’ll call it $3 million so people don’t get lost in all this math that I’m throwing out there. We have a $3 million net worth, and you spent $100K/year. You’re what we call a 30 TT or 30 Total Term. You have a net worth that’s 30 times what you live on in the year. By all objective measures, you could have a comfortable retirement and be just fine. You might not pass on a huge inheritance if you live for a long time, but you will definitely be able to live the extent of your retirement quite comfortably, because even if your money didn’t grow at all, you could spend 100K of it a year and you could go for about thirty years. We all know your money will grow some, so if it grew at about 3.33% per year, then you would be able to have that hundred thousand a year forever, and you would never spend your $3 million. So that’s the way we look at people’s health. What we do is we take that 30 Total Term and we divide it up into four categories: real estate, practice/business equity, 401K type retirement plans, and then we have liquid accounts. We call the first type your Real Estate Term; the second type is your Practice Term; the third type is your Qualified Term—that’s what the 401K stuff is; and the fourth type is your liquid term. If someone is a 30, Ryan and I look at that and we go: they’re a 30, great. Technically they can probably retire, but we’ve seen people that are a 30 who that 30 multiple is all in what we call their RT or real estate term, almost all of it. I met a surgeon who has a 33 TT and almost 100% of his money was in a primary residency and about a hundred grand to his name. And he spent about a hundred thousand a year. Just mathematically what I’m saying is it’s really hard to get to a 30-35 TT. Most people won’t be able to get to that level, and so just because it’s all in a house doesn’t mean you have failed. You did a really good job. You saved money; you just paid down a bunch of debt, and you chose to live in a really nice property. If that’s where the bulk of your net worth is at your retirement, you just chose to live in a really nice place. You’re probably in a city, by the beach, mountains, or a beach-mountain. Your net worth gets tied up in that residence, and that was just a choice you made. It wasn’t the optimal choice, but it doesn’t necessarily mean you can’t retire comfortably. You just need to get ready for the fact that if you’re at a 30 multiple and more than 30-50% of it’s in real estate, you’re probably going to need that money. The ideal retirement is you have a paid off home plus you have a 30-35 TT, right? So backing your house out of it you have that net worth to retire, even without the house. That’s the ideal. And I think the perfect retirement would be: I’ve got a house, a second home at a place I like to vacation, both of those are paid off free and clear, and I’ve got a 30 multiple of my spending. I am so set, so happy, and all of it’s in liquid term. Not even in a 401K. That would be the perfect scenario, and some of you listening are like: check, check, check.

Ryan: I think what you’re saying, is know this stuff helps. It is a near impossible decision to yank money out of the house when it dawns on you at seventy. You can’t be told that at seventy. It’s really tough to tell somebody that late in life that the dream home has gotta go or else there’s not going to be any money to spend next year. But if you know at forty that you live in an expensive city, or you chose to buy an expensive house and that at some point if your Total Term is not high enough without the primary residence we’re going to have to get at it, then you can be disappointed earlier in life and it makes it easier later.

Reese: I just think the important thing to think about your net worth in these groupings and accumulate in a way that gives you balance across your practice equity, your real estate, your 401K and IRA-type investments, and your after-tax investments.

Ryan: Okay Reese, let’s take a quick break here. When we come back, we will finish up the conversation by talking about something people wonder a lot about which is guarantees in retirement and what they can do about these questions.

Reese: Let’s talk a little bit about guarantees. Explain a little bit about this subject.

Ryan: The question comes because, without the earned income of practicing every day, there’s that question: I’m now living on money that I’ve saved. It’s invested in things that go up and down in value, and that can make some people feel uncomfortable. And so a lot of people naturally start wondering: can I get a guarantee on this money? Is there somewhere I can put this money that will guarantee that it will either never run out or never go down? The answer is yes: yes there are places you can put your money that it will never go down or run out, but it’s not a free lunch, and there are costs a lot of times that are hard to understand or not explained very well or hidden to getting those guarantees. So let’s just chat for a minute about how someone should view guarantees on their retirement income once they reach that point.

Reese: This is actually a good time for me to talk about this because I just had a long conversation yesterday with someone that was sixty-eight and the reality of this person’s situation is that they have social security income and they have a decent investment portfolio that supports them, but isn’t to the point to where they just have plenty of money and they don’t have to worry about anything. It supports them, but there’s still some uncertainty. This is probably the average person in retirement. There’s still a little bit of uncertainty but it’s not like they’re broke and they didn’t save anything. But it’s not so much to where they are not worried about their money. I mean, they’re worried about their money on a regular basis. And the older you get, the more worried you get. Because you start losing some of your ability to reason with your own emotions and the markets and these political messages and advertisement you see on TV start having more of an affect on you. Everything starts to seem scarier, and everything about the world starts to seem more rigged. And I would say that’s a fairly common occurrence for people. I don’t want to label everyone, but I do think as people age their ability to think rationally starts to decline. That’s why it’s really important to work with a good financial advisor early on so that as you start to get to the point where maybe your emotions are kicking in, that that person can help protect you from some of the choices you might otherwise make that could cost your family or your estate a fairly large amount of your net worth. I’ve had a lot of people want to do things with their money in their mid to late seventies that definitely weren’t good for them.

Ryan: That they wouldn’t have agreed with ten years earlier.

Reese: No, and all the sudden a light bulb comes on and we’ve got to change our plans. So here’s the case in this situation: this person has a decision of either getting a guaranteed return on their money and buying what we call an annuity—that’s what Ryan was referencing to earlier when he talked about guarantees. An annuity is a product that an insurance company offers. An immediate annuity would be, you give your insurance company your money and they guarantee to pay you a monthly income for the rest of your life that’s a higher percentage you could get if you just kept your money and started withdrawing it. So let’s say you have a hundred thousand dollars and you give it to an annuity company. Maybe in that scenario if you give a hundred thousand dollars away to that insurance company, they might give you $650 a month or somewhere in that range. So if you run the numbers on that, maybe that’s a 7-8% withdrawal rate that you would have to pull out of your own account if you kept the hundred grand. But we all know that’s a pretty high amount of money to pull out. So what the insurance company does, is they guarantee you get a little bit higher income stream than you would be able to get if you just invested the money. But you have to give up all of your money to that insurance company and say goodbye to it. Because when you pass away, that whole lump sum of money goes to the insurance company. And you can also elect to have a beneficiary receive payments for ten years if you were to die really early, or up to twenty years. There are some guarantees you can get that make you feel a little bit more comfortable. But the reality is, the insurance company promises a slightly higher monthly income stream than you would feel comfortable pulling out of your account. Because if you go and invest your money, you might get 3 or 3.5% return which is only going to kick off $400/month or so.

Ryan: I was reading a study about this a couple weeks ago. What you’re saying is true—you can get a higher withdrawal rate back from the insurance company in the annuity. But let’s say you give a hundred grand to the annuity and they’re going to give you a 7% withdrawal rate every year, $650 a month—what ends up happening is that’s the bear bones plain vanilla annuity. Nobody buys that stuff because there’s things called riders, additions, and different benefits that can be added onto these policies. Every time you add one thing on to the policy, it costs money and reduces the amount of money you get every month. And so I was looking at this data, and it was interesting because if you took just the straight annuity with no riders and no benefits, which nobody does, it was actually what you’re saying. Close to 6-7% withdrawal rate every year. But when you start adding on the benefits that everybody elects to take, then the withdrawal rate actually gets down to close to what you would do by yourself. It gets near 5 and the high 4s. And I’ve seen this with my own grand parents and the annuities that they’ve got—which I didn’t sell to them because I don’t sell annuities—and you see this all the time. A lot of those benefits that people are buying, a lot of these companies are coming back and asking for those benefits back. Companies are saying: we will give you a little bit more money, but we need to discontinue these benefits. My grandma would send me these notices that they are trying to take away this extra guarantee, which is the reason I wanted it, and they are offering pennies on the dollar to get these guarantees back. A lot of times they are not sustainable guarantees in the first place, and their business model can’t handle it. I just wanted to say that because I was reading that a couple weeks ago, and it’s interesting that it is a higher withdrawal rate that you get but by the time most people add in the most common riders and benefits to these policies the withdrawal rate is not even that exceptional anymore.

Reese: And I totally agree. The tricky part is that the main premise here is just the word “guarantee” and the idea that you get a promised benefit is enough for some people to want to do whatever it takes to get that word “guarantee” built into their investment. The crazy part is, these insurance companies are highly leveraged. Some insurance companies are very financially strong. Some are super strong, and some are not. Each insurance company has to pay into a big pool every year to guarantee that they can stay solvent and meet all their claims. If any insurance company can’t meet their benefits they promised inside of an annuity then other insurance companies have to help, and the state that you live in has to help back that claim up. It’s a more complicated process than people realize. This individual was saying, “I don’t want my principle balance to go down. Is there a way to guarantee that I get 5%?” Well, in today’s interest rate environment—we’re in 2017 in March, there’s not a way to get a guaranteed 5% return that is a formal guarantee. There’s bonds. On average you an get a 5% return, you just can’t get a guarantee month-to-month, year-to-year on that kind of a rate of a return because guaranteed rates of return right now from fixed income from bonds are more in the 2-3% range. That’s where the treasury yields are. The ten-year treasury bonds are at 2.5% right now. The thirty-year treasury is still in the low threes. Right now you can’t guarantee yourself 5%, but what you can do is say, “I can get three, or I can get two and a half.” So let’s say you have a million dollars, and you needed $70,000 a year out of that account which would be 7%. If you put it all into an annuity and you bought one of these no frills annuity like Ryan said, you give up your million dollars but you might get that $70,000 that you need. You would have to say goodbye to your million bucks. And then when you pass away your money goes to that insurance company, unless you have some riders like Ryan talked about that you pay more for but then some of the money might go to the family and then the rest goes to the insurance company, which reduces that monthly guarantee. So if you were to say: I’m just going to get my 3.5 or 4%. I know I can do that. If I can get $40,000/year that comes from interest, then I will let the other $30,000 I need reduce my principle for a year. I’ll start with a million, and then at the end of the year I’ll have $970,000, and then at the end of another year I’ll have maybe $940,000. And then at the end of another year I’ll be at maybe $910,000. You could go on like that for a really long time, and my point in bringing this up is that’s kind of the point of retiring. The point of retiring is, at some point you need to let your principle balance go down, but I would much rather prefer to be in the situation where I’m an investor where my principle balance is going down, but I have control of my entire principle. I have control of my entire asset, and if I need liquidity—like $20,000 to buy a car. But you have the liquidity there to pull it out and go do things like take a trip. So I hate to see people in pursuit of higher guaranteed income give up their principle balance and then go and purchase an annuity that gives them that mental satisfaction of having a guarantee. But then they gave up their principle and all their liquidity and then they need money in the next six months, but they have depleted all their liquidity so they don’t have that kind of access to cash anymore. That’s a big subject; it’s super important for people in their sixties and seventies to understand annuities really well. If you go to the state you live in and you go to the State Securities Commission, there’s a California, Utah, Florida, every state has its department of securities, and read on their homepage of their website of biggest scams. Most states will talk about annuities in detail trying to protect consumers from that product. Insurance products are very complicated, and you need a professional to analyze them. Now just because Ryan and I don’t like selling annuities doesn’t mean that there aren’t annuities that we do support or do think make sense in some situations. Some of those annuities can be fee-based annuities where there’s not big commissions paid to sell them. Some of them are very no-frills annuities that are designed to salvage old annuities that you have that might be very expensive and not in your best interest. There’s a lot of reasons to use an annuity. In some cases you might want to annuitize some of your retirement balance instead of all of it to just give you the mental ability to take more risk in some of your other accounts. So maybe in that example of the million dollars someone chose to annuitize $250,000 of it. It might not be the highest possible return they could get, but it might allow them the mental ability to let their 401K account continue to grow a little more and be a little more aggressive because they have that stability that comes from that annuity. All I want to point out is that each person is different in terms of their ability to handle risk and volatility. Annuities are not inherently bad, but they are a big red flag when a financial professional is leading with that and it’s their primary mantra or that’s what their seminar is about. That’s not a good sign, and that means you are probably not getting objective advice. Especially if they are getting paid a commission to sell you that. On a million dollar annuity sale, it can be a six-figure pay day for a broker.

Ryan: It likely would be from a million bucks. And I would say, from experience seeing people with annuities at all different stages of life, I can think of a few scenarios like you’re saying where it has been appropriate later in life when it’s been well researched and everybody understands what’s going on and there’s a good balance between the mix of all the assets you have and what might go into the annuity. On the other side of that, I haven’t ever seen somebody young with a good annuity strategy. I haven’t ever met somebody in their thirties or forties that was sold an annuity that it made sense or was even helpful. We see a lot of it, but not in a good situation. This week working with somebody who’s got four of them and he’s just over forty, and we’re trying to figure out how to get rid of all of them as fast as we can without incurring too many of the costs because it just doesn’t make this sense this early in life. They’ve been very expensive; they perform poorly; there wasn’t a point at all. So I would add to that: the time to consider those things is not when you’re young.

Reese: Well, I think this has been a really great summary today Ryan. We’ve talked a lot about which accounts I should pull from first, the tax consequences of those withdrawal rates, and how much to pull from what account. We’ve talked about annuities and guarantees and a lot of different asset-spending techniques. I think next podcast just so listeners know, we are going to have a follow up to this podcast but focus on some of the logistics of how you would withdraw money from certain accounts—different tax implications that might be there. And how to prepare early on in life for having the right withdrawal strategy and maybe how long you should hold on to illiquid assets like business ownership and real estate. And then talk a little bit about if you have some life insurance with a permanent cash value or you have an annuity with some money in it, how we would recommend looking at it, analyzing it and then cleaning it up so you are better prepared for retirement.

Ryan: Great, sounds good. Thanks everybody for listening. We invite you to please take a second to “Like” Dentist Money Show on Facebook and Instagram. Be sure to visit where you can see all of our episodes and leave comments and questions. Also while you’re on the site you can book a free consultation with one of our advisors by clicking the link at the top of the page. We’re always happy to talk to you about your financial goals and questions. Thanks again for listening.

Investing, Taxes, Spending


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