How To Plan For Big One-Time Expenses Before You Retire

It is free and in the description of this episode , whether you're watching on YouTube or listening on our various podcasts , I'm going to read this comment and then we're going to get to address it . So you ready , james , I'm ready , cool . This comes from Gary R and he posts and says his subject line is one time expense soon to be retired . Howdy y'all .

I'm in my final recreational employment months . So he's speaking our language either four or 10 to retirement and thinking of having some work done on the house approximately 40 K . This brings up the question of where to pull portfolio funds from . I'm firmly in the 24% tax bracket . Now he's just flexing on us guys .

Okay , with the possibility of dropping to 22% post retirement , lower in retirement , confident my portfolio can handle the hit without an impact on my retirement goals . That being said , I'd still like to pull the funds , as Ari would say , optimally . Here are the options as I see them Taxable account , which we call the superhero Of all potential sources .

The 40K would represent the largest percentage of our brokerage accounts , other than any cash we have , but we would get the benefit of the long-term capital gains rate . So that's number one , option one . Option two tax deferred account . So although I'm not 59 and a half , I'm still able to pull money for my 401k without incurring a 10% penalty .

Whoa , whoa , whoa . How do you do that ? We'll mention that in a little bit . I could pull from here and pay 24% without this fear of jumping to that next bracket , 32 . And then the third option is tax-free .

He says I don't have access to all of the money in my Roth , but I believe I could pull from what represents my personal contributions , which , by the way , he is correct on that is allowed . Which brings us to option four . I could just use cash , but it would more severely deplete my cash reserves . Thoughts all .

So the beautiful thing here , james , is he's asking the whole group here , not just us .

And I think he's approaching this the right way . The you know generally we look at okay , can I retire ? Okay , what does that come down to ? It comes down to can your portfolio meet the needs that you need it to meet that go beyond what social security or any potential other non-portfolio income sources , like a pension , are going to generate ?

So , basic example you have $500,000 in a portfolio . You need $20,000 per year from your portfolio . Cool , that's a 4% withdrawal rate that should be sustainable if your portfolio is invested the right way for call it , 30 plus years , Call it good .

Well , what about that person that needs $20,000 per year also has a major home renovation that's going to cost them $200,000 . Well , you take that $200,000 out of the 500 . Now you're down to $300,000 . Can that 300,000 still support the $20,000 per year that you need ? Now , all of a sudden , that's over a 6.5% per year withdrawal purchases .

Is that a new vehicle ? Is that a home remodel ? Is that sending kids to college ? Is that paying for a wedding ? Is that all these different things ? So think about that first . What portion of your portfolio is needed for these one-off expenses ?

And then , is the remainder enough such that a sustainable withdrawal rate taken from that portfolio could continue to meet your call it your core basic income needs along the way ? So it sounds like that's already been taken care of . Gary's already gone through that . He says something I'm trying to look for the exact quote here .

He says I'm confident my portfolio can handle the hit without any impact on my retirement goals . So I'm going to make the assumption that Gary has looked at that . The second thing is how are you invested ? By the way , the third thing is taxes . To skip ahead . I think Gary's looking at the tax piece , and that's the question .

There needs to be a progression here to get to that piece . The first piece is can your retirement still support that ? Number two is investments , and this is actually an important one of how should your investments be allocated in order to support that ? So , for example , if 100% of Gary's assets are invested I'm using extreme example here .

He's 100% invested into McDonald's stock , every single account , all McDonald's stock . He needs $40,000 . And after one year of retirement , McDonald's stock has tanked 50% because no one wants their hamburgers anymore . Well , what's he going to be required to do ? He's going to be required to sell McDonald's stock when it's down 50% to free up that $40,000 .

In other words , he's going to have to sell a good chunk of stock at a severe discount . So what do you do ? Number one , you don't just own one stock , obviously . But number two , you say what's the right mix of investments between , at a high level growth investments and stable investments ? We call it root reserves internally . So what's the growth allocation ?

Things are going to grow for you to keep up with inflation . What's the right things of internally , as we'd speak about it , root reserves . Root reserves is going to include any outflows you need from your portfolio over the next , uh , call it , five years .

So this would be something that Gary would say in addition to my monthly need from my portfolio , how much do I need to pull for this $40,000 to remodel ? So now I'll finally get to his actual question .

Once you've determined how much needs to be stable so that you have five years worth of that , so that , even in a downturn in the market , you can still meet your needs . Now it's a tax piece . Now this is where you should have a tax strategy that , essentially , is helping to understand what tax bracket we want to be in . Now .

Of course , we all want to be in the 0% . If we could just wave a wand and say I'm in the 0% tax bracket , cool , we'd do that . But what do we want to be in today ? So that I'm minimizing or not jumping into any extreme tax brackets in the future . So what Gary should do is today he's in the 24% bracket .

It sounds like , if I'm reading between the lines , he'll be in the probably the 22% bracket when he retires . That's not the full picture , though . What are you going to be in , Gary , say , 10 years from now , 20 years from now ? Who knows some things . But specifically , what about when social security starts ? What's that going to do to your tax bracket ?

What about when required minimum distributions kick in ? What's that going to do to your tax bracket ? What about when certain I don't know if there's windfalls of selling a home , moving states , other pensions coming into play ? Understanding the full landscape of what will your tax bracket look like over the course of retirement . So you're not just looking .

Okay , I'm in the 24% bracket today . Well , so what ? What are we comparing that to ? What we should compare that to is where you're going to be , which , yes , is somewhat of an educated guess , because tax brackets and tax law can and will change .

But when he starts to do that , he can start to say , oh , maybe , for example , I shouldn't exceed the 12% bracket . Well , the good news about retirement planning is you get to fully dictate this . I shouldn't say fully to an extent , because you can pull the right amounts from cash versus taxable accounts , versus traditional IRAs versus Roth IRAs .

You can manufacture the taxable income that's right for you . So if he's looking at this and if he looks at his whole tax landscape and says I should never really be above the 12% bracket , well then , come up with the right mix of withdrawals . Is that more from cash and brokerage and then a little bit from the IRA , just to fill up the 12% bracket , versus ?

If he says I should really be filling up the 32% bracket today to avoid being in a 35% bracket in the future , it probably means he has an enormous traditional IRA .

So that's kind of an extreme example , but it's essentially looking at where am I going to be , when am I today , as is , and then where should I pull funds from to try to fill up the right bracket . But here's one last thing . There's a theme here . Are you asking me a question ? I take way too long to answer it , so sorry about that .

But here's what I see some people doing . They have cash on hand and we almost get addicted to that cash on hand because it's there and it's tangible and we're going to you know , we're going to implement our Roth conversion strategy because we're going to be living on this cash .

Well , if Gary pulls more money from his IRA today and that pushes him into the 32% tax bracket because he wanted to preserve that cash , and now next year he's living on the cash and converting only up to the 22 or 24% bracket , he kind of shot himself in the foot doing that .

He said wait , use your cash to prevent going into the 32% bracket , not to allow you to convert in the 22 to 24% bracket . So we almost have to detach ourselves from being too connected to any of our specific accounts . That cash account tends to be something that people get pretty connected to .

To say objectively where should I pull funds from today to minimize the lifetime tax liability I'm expected to pay ?

I have clients that will say no matter what , I need 50,000 . I couldn't tell you why . It's not scientific , I just sleep better . Okay , great , then your analysis should not be cookie cutter .

Even though the conversion analysis or the withdrawal strategy says you should pull from this account over that account , it should be based on yeah , take the finances into consideration and then go , wait a second . I'm a human , I'm not a robot , and the mistake that we'll see is let's just use Gary's example for a second . Let's assume Gary goes optimally .

If I don't want to pull from cash , what are my options ? Okay , so I could use this rule of 55 thing , I could try this Roth tax-free thing . I could do this superhero thing . Well , on paper , the capital gains rate seems great , but we have no idea if Gary's got all McDonald's because he hates Burger King , like . We just don't know .

So what we need to get clear on is like hey , what's going to let you sleep at night and what does the tax answer say ?

With assumptions that are well-known and I apologize because I've told this story a few times , but I'll do it one more time because I think this is helpful which is I went to a doctor this was months ago and I said , doc , what you just said there , it sounded great . I think you think it sounded great . Don't know what you just said , so try again .

So he goes , okay . So he starts explaining to me the lab that the pills are made in that he wants to give me for my issue , and I said , doc , respectfully , I don't care about the lab , I need to know why I need to take this pill or why I don't need to take this pill , and I'm not going to take it blindly .

So I want you to educate me as to why I'm going to take this pill . But you're going too deep in the lab and sometimes this analysis paralysis occurs .

Gary , I'm not calling you out to be mean , I don't know if you're doing this , but if we are spending all of our time on the analysis when , in reality , there's a simple answer that's going to allow you to take action . Maybe it's not even optimal , which you know how much I hate saying that , since you called out my optimal word in here .

Sometimes that can be the best answer too . So we want to give you guys hey , here's like the pill , but here's what I need to know about first , what's your health goals ? Legacy , yada , yada .

Let's assume , just for simplicity , that someone has they're retired and all their money's in an IRA and they're pulling money out of their IRA and they're partway between the 12% and the 22% tax bracket and they're not doing the Roth conversions because they say , you know what we ?

We don't need to because required distributions aren't going to be a huge issue for us in the future . We're just going to , we're going to live here in the middle between the technically a 12% bracket , but partway between 12 and 22% , and that individual is planning to have a big home remodel in five years and that home remodel is going to cost $150,000 .

Well what ? And then in year five they might spike up into the 24% bracket and then back down to the 12th . Well , how do you plan ahead for that ? That's actually pretty simple . It's the same concept of a sinking fund .

You know , if I want to be able to take one big trip with my family once a year and it's going to cost $12,000 , to use a easy math number , well , I'm not going to try to pay $12,000 from one month of salary that month I actually take the trip .

I'm going to set aside $1,000 a month each month , so that by the end of that 12th month it's all there and I'm good to go to take my trip . Well , same thing here . Almost think of like a sinking fund . Don't just wait for year five to take out a giant amount from your IRA that pushes you up a couple of tax brackets .

Take out enough in the years leading up to that to say , okay , I can still take a little bit more at a 12% rate and maybe I put that into a brokerage account or maybe a cash account , depending on how far out I am from the incurring the expense .

And in doing that , you're preparing for this one-off expense using your lower tax brackets , as opposed to getting trapped in a much higher one .

Well , you probably weren't going to feel comfortable taking out $140,000 to buy an RV , because you've probably never bought anything worth that amount of money , maybe aside from your home . But now you're able to do it because you're like I was intentional about saving for that . Yes exactly .

But still , there's oftentimes a mental hangup . But that just hurts to pull out $40,000 , $50,000 , $100,000 when that's your portfolio , that's your livelihood , that's what you've worked for . So keep that in mind too . It's not going to be easy . Even if you have the right retirement and investment and tax strategy , there still might be a mental hangup .

So prepare for that , prepare that it might not just be easy to do , to write a five-figure , six-figure check , whatever it might be .

But when we start thinking about what's the true purpose of our money it's not to keep growing bigger and bigger , making us richer and richer until we die one day it's to say what are the experiences I can have in my retirement to make the most of it ? So just another perspective piece on those expenses in retirement .

Do you have an emergency fund ? And when we think of an emergency fund , I'll think what's the purpose of this and this is an emergency fund is I want to go tap into something if I need it , if my car breaks .

But when you're in retirement , you don't really need an emergency fund because , yes , you want cash on hand , but the traditional sense is I don't want to have to go pull for my 401k , where there's a penalty . And what if markets are down and you name it ? Well , you already explained here , gary . You have the ability to access those funds .

So it puts you actually in a more difficult position , as odd as it may sound , because it's like hey , when you have more money , you have more decisions that feel like they weigh more , because you're like why is that the case , though ? I saved and invested . It's the same reason .

People reach out to us going hey , why am I more stressed with 10 million versus when I had 500,000 ? Well , there's more to lose and these decisions become really difficult .

Collective is a community of , as as of now it's launched a week ago , two weeks ago , 1500 plus people in that community interacting , sharing tips . Um , really cool things happening . So join . The collective link is in the show notes . Anything else already we missed ?

Any mention of rates of return are historical and illustrative in nature and are not a guarantee of future returns . Past performance does not guarantee future performance .