Crucial Steps for the “Pre-Go” Years Before Retirement

0:01What you should be doing right before and as you enter retirement. This week on the Saturday Personal Finance Edition of the Motley Fool Hidden Gems Investing Podcast.

0:14I'm Robert Brokamp and you know retirement is the number one financial goal for most people. We spend years squirreling away money so we eventually hope to live off it. What should we be doing as we get closer to the big day? Well here to provide some suggestions is Dana Ansbach, who has been a financial planner since 1995 and is the CEO and founder of Sensible Money, a fee-only planning firm in Arizona. She is also the author of three books, including her latest, Living Off Your Acorns, Your Guide to the Four Phases of Retirement. Dana, welcome to the show. Great to be here. It's my first time on this podcast.

0:50I'm excited. Well, we're excited to have you. And you talk about four phases in your book. I think most people have probably heard of three of those phases, the go-go years, lo-go years, no-go years, terms that come from a 1998 book by Michael Stein. But in your book, you added the pre-go years, which you believe can actually be the most important. So when do the pre-go years begin and what makes this time period so crucial when it comes to retirement planning? You know, I think the pre-go years begin about 10 years before retirement or whenever you really get serious about, wow, I'm going to retire one day.

1:28And for some people, that doesn't happen until the year before retirement or until they get a layoff notice. It's not the way we want it to happen. I'm lucky being in this profession that I think about these things more. And for me, my pre-go years began about two years ago at the age of 53, where I really suddenly connected emotionally to the idea that I was going to really retire one day. I'm a self-professed workaholic. I love what I do. I'm very lucky. But for me, that idea of retirement, even though I do retirement planning for a living, just I thought not for me, right? That's just not for me.

2:07And that has shifted dramatically over the last two years because of this awakening, this idea that, wow, I'm in those pre-go years. I'm starting to talk about and think about these four phases of retirement, connect more with them. Other people may connect with the idea of retirement more strongly, but not have the financials in order. And I talk about the importance of both. You have to have the emotional connection and the finances. I had the finances, no emotional connection. You know, if you have the emotional connection, then that 10 years prior, that's when you really need to get your finances in order and make sure what you want to do is feasible.

2:46I think one of the trickiest aspects of this, and perhaps one of the least appreciated aspects, is that workers in general aren't actually that good about predicting when they retire. And you kind of touched on that. And I think some studies show that the difference is about three years. But, you know, some people retire sooner because they maybe made that emotional connection and they had enough money. Might be they didn't have a choice. They got laid off for health issues, either their own or their spouses. So do you think that everyone should plan on retiring sooner than they probably expect?

3:17I love that idea from the financial planning perspective. So when we have someone who isn't sure about their retirement date, we like to align both the plan and the portfolio as if they do retire a few years earlier. Some people reach financial independence and decide they enjoy what they do and, you know, they're going to keep doing it as long as that enjoyment is there. And so they may work longer, but you're going to be much better off if you've planned for an earlier retirement than if you are caught off guard and expecting those last few years of savings to get you over the hurdle of where you need to be.

3:56Or if you simply didn't plan ahead and you're caught off guard because, oh my gosh, you know, I thought I was going to have five more years. I wasn't really going to think about it until the year before retirement, suddenly here I am having to make these readjustments very quickly. That's not a great place to be. And the research also shows that when retirement is forced upon you, people have more trouble adapting, more trouble figuring out that next step of how to be happy and find purpose in retirement. So there's some work there on the emotional side that has to be done when these events occur.

4:31I think of it as instead of, whoa, my gosh, can't believe this happened to me, being realistic about this could easily happen to me. I could be out of work at 60 or 62 or 65 if I'd been planning to work till 70. Once you reach that point in your career, you could call it maybe the fourth quarter of your career, 10 years before retirement or so. Obviously, one aspect of this is the de-risking of your portfolio. Does that begin 10 years, five years beforehand? And practically speaking, how do people do that? ideally the de-risking would begin 10 years out you know i like the concept most people don't do it but i like the concept of staying 100 equities until about 10 years from retirement for your retirement money you know i'd rather have the potential for the returns that equities can deliver and if i'm investing over a 30 or 40 year time horizon to me that makes a lot of sense and then to begin making that shift about 10 years out i have encountered people that stayed 100 percent equities until six months before retirement.

5:33Wow. Until retirement. I have a paper out there called The Wind Down that talks about how you begin this shift, and it compares that strategy of waiting until the cusp of retirement to de-risk or starting farther out. And of course, it all depends on the markets. I don't want my retirement or client's retirement depending on the market outcomes. If we were to get another recession right on the cusp of retirement, I wouldn't want to take that kind of risk with my money. Ideally, you would start, let's say you're 10 years out from retirement, you are still 100 % equities. You would have a financial plan that shows you, okay, year one of retirement in 10 years, I'm going to need, let's say that's$50 ,000 of withdrawal from my portfolio.

6:20So I'm going to sell 50 ,000 of my equity holdings. I'm going to buy a, we like to use the concept of an income ladder, a CD, an agency bond, a safe investment that's going to mature at that 10-year time frame. And so I know when I get there, that$50 ,000 is secure. It's going to earn interest along the way. But when that principal matures, that's what I'm going to use to fund my withdrawal. And then the next year, you're nine years away from retirement. You do that again. and then the next year you're eight years away and you do that again. And by the time you got to retirement, if the equity markets were solid along the way, you would have this 10-year income ladder, or I think of it as a runway to say, okay, I now have, you know,$50 ,000 a year maturing for the next 10 years.

7:07That is what I'm going to live off of. And along the way, when equity markets are strong, I will sell some and replenish what I've used. And when equity markets are not strong, I'm just going to let that part be and give it time to recover. So that would be the mechanics of how you would get there. It never happens exactly like that. Like so much, right? We have how it would work on paper. And then realistically, we could have two strong years of equity markets where you're doing a lot of de-risking and then a bear market comes along and you don't de-risk that year. And then a good market comes along, you may have another year of de-risking and then a flat market.

7:42You don't de-risk that year. So realistically, by the time you get to retirement, if you started 10 years out, you could have anywhere from maybe a five to a 10-year income ladder in place, depending on that de-risking path and what the market's delivered to you over that timeline. So that's good advice for managing the portfolio. But as IRA expert Ed Slott likes to point out that we're not the sole owners of our portfolios. Uncle Sam is a part owner. And in your book, you talk a good bit about taxes and you emphasize that when it comes to tax management, it's not just how am I going to lower my taxes this year, but how am I going to lower my taxes over the course of my retirement, which is really over the course of our lives.

8:23So given that, what do you think people in the pre-go phase should be thinking about when it comes to taxes? I think they should be thinking about something that's objective. and so we often see people still in the mindset that I should not withdraw from my retirement accounts until required minimum distributions begin which is now age 73 or 75 depending on when you were born and that's a long time to put off withdrawals and in reality there are many we call them the opportunity years between retirement and when those required minimum distribution start, which could be a 20-year window in some cases.

9:04If you retired at 55 and your required minimum distribution start at 75, there's a 25-year window there where tax planning opportunities are often plentiful by looking at when your different income sources are going to start, social security, maybe a pension if you're lucky to still have that, maybe you have a rental property that you're going to sell somewhere in that timeline, you could have deferred compensation plans coming in. You could have bonuses from former employment. There's all kinds of things that can make your income path very uneven during that 20-year timeline. And so that means there's planning opportunities, years where your taxable income could be quite low, where doing either a Roth conversion or a withdrawal from retirement plan, a 401k and IRA, could fill up some of those lower tax rates, and that money is then taxed at a lower rate than perhaps it would be if you waited and put those withdrawals off.

10:02And so it's complicated math that software now does. I also tell people be cautious about some of the simplistic calculators. They don't take into effect some of the nuances of the tax code. For example, your Medicare Part B and D premiums are tied to your adjusted gross income. The way social security is taxed is dependent upon your other sources of income. So some very simplistic calculators that just look at your tax brackets aren't going to take all of that into effect. But there is tax planning that can take all of that into effect, planning it all out and saying, okay, this looks like an opportunity to strategically take withdrawals or strategically realize capital gains in a year where I might be at zero percent.

10:45And that can make a big difference. We've seen tax planning make as much as half a million dollars or more difference over the lifetime of someone's plan. Wow, that's amazing.

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12:50Vanguard investors own shares of Vanguard index funds and those funds own shares of the companies they invest in. Available for Vanguard index funds that participate in investor choice. Vanguard Marketing Corporation Distributor. Those are the pre-go years. Eventually, the big day comes, the worker retires, and they're entering the go-go phase. First of all, why do you think they're called the go-go years? And roughly speaking, in your experience as a financial planner, about how long do they last? I think they're called the go-go years because generally we're healthy. We suddenly have free time that we didn't have before.

13:26It's often when people get excited about traveling, sometimes remodeling the home, sometimes moving to a different area of the country that they've always wanted to live in. And those are times where we have both usually the financial means and the energy and health to do these things. How long do they last? there's a great blog post by Dan Haled. He runs the Humans vs. Retirement podcast. You're familiar with him out of the UK. And he calls it your 12 good years. Does that mean it's only 12 years for all of us? No. But looking at the stats, many people have, let's say, between 60 and 72 or between 65 and 80 if they're lucky.

14:10Around age 80, for most of us, but not all of us, cognitive changes begin to impact us. We're often not even aware that these changes are happening because the part of the brain it's impacting is also impacting the self-awareness that we have around our behaviors. I have a good friend who helps place people into long-term care facilities, Denise Kay, and she describes it as we become basically a full-grown adult, but with suddenly middle school age decision-making abilities. She sees this often happens at around age 80. There are some people that are called super cognitive agers that this doesn't seem to happen to, or they have remained fully capable well into their 90s.

14:57That's what we all hope for, but we need to plan that it could come earlier. And for that reason, I think it's important to do the things you want to do in those go-go years. We've seen people so concerned about safe withdrawal rates, which are already calculated as if the Great Depression began now at the point of retirement. And then to be even safer, they'll use a withdrawal rate lower than that. And the research shows that many of those people who were great savers end up with even more funds at the end of retirement than they had at the beginning. And there's nothing wrong with that if that's your goal, if that's where you really want to pass along wealth to the next generation.

15:39But if you are foregoing opportunities or things you wanted to do or helping the kids while you're here to see the benefit of what you're doing, or maybe that's a charity or an organization you want to contribute to. Many of those things are possible if you step away from a safe withdrawal rate mindset and look at the plan holistically and you look at it through the lens of these phases. Oh, I can spend a little more during this go-go time because spending naturally slows down during these slow-go and later years. Yeah, that's another aspect of safe withdrawal rate research that is perhaps too conservative.

16:15They almost always assume that retirees need their income to go up every year along with inflation. That's generally not what happens. We had David Blanchett on the show a few weeks ago talking about his research into that. And so I was going to ask you, as an actual financial planner who likely works with people who have above-average wealth, is that what you see in real life with your clients? It is what we see. So, you know, we try to help people spend more during those go-go years, but invariably they will get into their mid-70s and we have withdrawals planned and inflation increases built into the plan.

16:51So we may say, hey, you know, inflation, especially the last few years, we know food costs more and gas costs more and electricity certainly costs more. Do we need to increase your withdrawal? We've built in an extra thousand dollars a month. And they'll say, no, Matter of fact, we're not even spending what you're sending us now. And even despite these inflationary times, as someone enters that mid-70 timeframe, that is still often the answer we hear. And so that tells us they're comfortable. They have the means to continue to spend at the level that we have projected, but they're not needing it.

17:29And the research shows J.P. Morgan has some great research on the spending that even in the demographics with a one to three million net worth, spending often shifts toward gifting, toward more aspirational things. And I think there's that shift that happens where people really realize, wow, okay, I'm not going to run out of money. I'm okay. And now they start to look for things, not to spend frivolously, but things that are meaningful, things that give them a sense of purpose, things that benefit someone they care about or an organization they care about. And so you will see spending shift, but even including those gifting elements, overall spending in real terms is declining.

18:11It's not keeping up with inflation dollar for dollar. I think the takeaway here is, and I talked about this with David Blanchett as well, is that for many people, they might be able to either retire a little sooner or maybe spend a little more in those go-go years and feel safe and enjoy the money while they can. Yes, absolutely. I mean, and enjoy it without that constant fear of, oh my gosh, you know, we find as financial advisors, one of the key things we're bringing to retirees is truly that permission to spend. And sometimes it's alignment between spouses. Sometimes it's simply someone who realizes there's a level of self-awareness.

18:53Wow, I've worked so hard to save. I'm anchored to this net worth number into watching my account balances. And I will not enjoy these years unless someone is telling me, yes, you can do this. You know, here's your monthly paycheck direct deposited into your account. And it is important. I mean, we have a limited time on this earth, this amazing place, and doesn't take money always to be happy. But there are things that can bring us comfort. I use the example of someone who I for years, I tried to convince them to hire house cleaner, They could afford it, but in their mind that felt perhaps extravagant, not the way they were raised.

19:30And so I was so happy one day when I received the email that we hired the house cleaner. You know, it might be something simple that makes your life easier like that. It doesn't have to be big or grandiose or, you know, a fancy car or eating out at the fanciest restaurants. It can be things that make a difference in our lives. I love that story.

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22:13You know, anyone who reads a book about retirement planning, such as your book, might feel at times a little overwhelmed because it could be pretty complicated, a lot of things to think about. And what I enjoyed about your book is that you provided this framework for sort of categorizing decisions, red, yellow, and green. Talk a little bit about that and how that can help people sort of figure out where the ray zones in their retirement planning. Red, yellow, green is a framework I love. So red would be a decision we look at and financially the numbers say, don't do this. Green would be a decision we look at and the numbers are like, yes, you must do this.

22:53And so many decisions fall in the yellow. So I'll use a simple example of paying off your mortgage. We've had people who have mortgage rates under 3%. and we would categorize that as financially it really doesn't make sense to pay off that mortgage. You're not going to see rates like that again. It just doesn't make sense. Now if there's not a long time frame where the mortgage isn't that large when we run the numbers perhaps the couple thousand dollars of you know potential earnings that they could have in an account in excess of the mortgage rate aren't going to materially impact that plan. And that would then turn that same decision into, well, you know, just from interest rates, we would say red, but when I run the numbers, maybe you're$10 ,000 ahead if you earn 5 % in your accounts and don't pay off the mortgage.

23:44That then shifts that to a yellow decision where it really becomes about your values. And given that decision, one household may say, I just have so much peace of mind from having that mortgage paid off. I know financially I might be a little better off if I didn't pay it off at this low rate, but I'm just going to feel better. And that's an okay decision when it's in that yellow area. Another household might go, I love leverage. I love the idea of arbitrage. I love the idea that I can earn more on my investments than this mortgage rate. I get it in an inflationary environment. This kind of low cost debt makes sense.

24:20And they might say, absolutely, I'm not paying that off. And you know, both households made a decision that was right for them. And that's the amazing thing about finances. It's not all math. We can run the math and quantify a decision. But ultimately, people have different values. And especially as you approach retirement, I think that sleep at night factor has to be part of the equation. And so that's what red, yellow, green really does is it helps quantify things and then talk about that sleep at night factor your values and help you weigh that out and make a decision that's right for you. I love it because it helps you narrow in on the tougher decisions, right?

24:59You have many decisions related to retirement, but if you can get the red and the green out of the way, and then you know, I just need to focus on these in the yellow zone and it doesn't feel quite so complicated. Yeah. And those decisions can come down to, you know, Roth conversions often fall in the yellow decision. Delaying Social Security, not so much for most retirees. You know, I would call that a green decision that the higher earner needs to delay unless there's some extenuating circumstances. But we've had some very high net worth households that look at those numbers. And for them, it's an immaterial decision.