Positioning Your 401K and Pension Assets for Retirement

Welcome to the Common Sense Financial Podcast, a podcast all about finances, mindset and personal growth. The goal? Helping you make smart choices with your money in your home and in your business. And now your host, Brian Scribonia.

Hello everybody and welcome to episode number two of the Common Sense Financial Podcast. My name is Brian Scribonia. I've been in the financial services business since 1993 and I've had actual face to face conversations with thousands of business owners, families and individuals, helping them develop solutions for real life situations. And it's my goal with this podcast to bring these real life experiences to our audience and offer a way to think about these topics and how they apply to your situation. Today we're going to be talking about positioning assets for retirement. And many of you have 401ks or pensions that you need to begin using for your retirement plans and may have some uncertainty about what to do. Or perhaps you're an existing client who simply wants a refresher on the plan you have in place. Either way, I'm glad you're joining us today. So when it comes to retirement, there's no doubt it's one of the biggest transitions that you'll have in your lifetime. And it requires a lot of careful planning. And there are so many things to consider. And the information I'm about to share with you will hopefully bring some clarity. This topic of retirement. So approaching retirement can be confusing and there is a lot of uncertainty that revolves around it because of outside influences. You know, we work with people, we have friends and family that have opinions, we have neighbors, we read books, we listen to the news or the media. And there's a lot of contradictory information out there that we have to sort through and determine what's most suitable and what makes the most sense for your situation. The first podcast we talked about mindsets and one of the mindsets we really hit on hard was the accumulation versus utilization. Because it really is the pivotal point in your retirement that you have to understand while you're making decisions. Because when you're accumulating money, when you're working and accumulating, you're saving money while you're working, you're not needing the money you're saving, you're putting it away for retirement, you're living on the income that you're receiving. Everything really is about just watching that account value grow. And you really tend to hone in on what rate of return that you're earning. When you reach retirement and shift over to utilization, it really is no longer about rate of return. Though we all want to make money, that's not the focus. The focus of retirement and utilization of your assets is having money available when you need it. So how do we go about that? Well, we have to work on trying to protect the purpose of the money that you have. There's really two purposes that we have for money. Money can be either used as a resource to produce income. It's that proverbial golden goose. It produces that income each month or each year for you, for whatever duration of time that you need it for, or it's money that you'll ultimately spend. So this is money that's set aside, that's going to be used for big ticket items, cars, home improvements, for some college expenses, vacations, that type of thing. And the other pool of money that I just described for income, that's just that consistent flow of capital coming in that you can live off of. So we have to determine when we're looking at your assets, you know, what is for income and what is money that you ultimately spend. So how do we go about determining that? We determine how much money you need for income by understanding your cash flow. And we learn how much money you're going to need to spend by understanding the chronological cash needs that you have. So what is cash flow? It really is just an understanding of how much money you're going to need and when you're going to need it. So when we think about your cash flow, you have regular monthly expenses. These are those items that are reoccurring. Most people can rattle these things off in their sleep. Those are our regular expenses. Then you run into what we would call irregular expenses. These are expenses that are going to pop up throughout the year. Maybe they're sporadic throughout the year or one time a year, but they're definitely within that annual cash flow need. And then you're going to have money that you're storing. So you have regular expenses, irregular expenses, and then money you really don't need right now, you're just setting aside for those future needs that you have for cash. And we would call those more along the lines of big ticket items that you're going to need going forward. So when we map out your chronological needs, we're looking for things such as the automobile purchases, we're looking for the home improvements, we're looking for those things leading up to five, six, seven, even 10 years out into the future. So we understand when we're storing that money, how it's ultimately going to be used and when you're exactly going to need to Use it. So if we want to make sure that you have money available when you need it, it makes sense to think that we first have to know how much you need and when you need it. So that is really what cash flow is all about. And you have to understand all of this before you can have a retirement plan in place. Because there's really no way to work on a plan to have money available when you need it. If you don't know what you need or when you need it and how much you have to put towards it, it just really just won't work. So your cash flow design really becomes our blueprint for how to arrange the assets that you have. And I'm going to walk you through a couple of examples of 401k positioning and pension elections to try to bring this together for you. Once we know the purpose of the money, we can then focus on arranging your assets to fulfill its purpose. And the purpose being either using the money for income or using that money to ultimately spend on big ticket items. So let's, so let's look at an example here. So let's say that Hypothetically, you have 500,000 sitting in a retirement plan at work, a 401k, perhaps even a pension. And let's also assume that you need $4,000 a month to live on. And we know when you get ready to retire, you're going to have $2,500 a month of that being fulfilled through Social Security. So $4,000 a month needed, 2,500amonth coming in from Social Security. So that leaves a $1,500 a month deficit. So how do we go about figuring this out? So if we take this 500,000, how much of that needs to be designated for income and how much of that should be designated potentially just to be used later to store it for a future purpose? So we would take this 1500amonth and multiply it out by 12 months, and that shows us that we need $18,000 a year from this asset. Now, there's different distribution rates that we can assume. We can assume a 4%, 5, 6. Let's just land in the middle and say that we're shooting for a 5% distribution rate. So if we take this 18,000 and we divide our 5% distribution rate into that, that tells us that we need a principal amount of $360,000. So 360,000 of that $500,000 that you have sitting in your retirement account, we would, in this example, earmark that for income. We would take that 360 and shoot for a 5% distribution rate, which gives you your $18,000 a year or your $1,500 a month, which then fills the gap in that budget of needing 4,000amonth, 2,500amonth from Social Security, and then $1,500 a month coming in from your, your 401k or retirement asset of 360,000. That's how we go about doing that. Now, there are some financial advisors out there who want to lead and discuss with you products with an attempt to sell a benefit of a plan without first determining what your needs are and what you really want to try to accomplish. And so these products are not necessarily a bad product, but it may not be suitable for what you're looking for. Or perhaps not all of your money should be being put into these types of programs. So we're not getting into products today. We're just talking about conceptual ideas and helping you think through these things. But you really have to understand your cash flow before making any decisions about distributing your 401k or pension. Hopefully it's starting to click and starting to make sense as to why that is so important. Because a lot of times people when they're working, they tend to think that, hey, I've got money left over at the end of the month. We're pretty comfortable. I don't need to be tracking things, I really don't need to be planning things. You know, I get a bonus every year or I have plenty of money coming in. That's really not a good idea. In order for us to maximize your cash flow, maximize the use of the money that you have, we really need to be working on a cash flow strategy from day one. However, when you hit retirement age, it is more and more critical to get this ironed out. Otherwise there could be some mishandling of assets. And we definitely don't want to do that. When we're Talking about potentially 10, 20, 30 years of retirement, that's a long time to be trying to replace income. So the other option that you may come across through your employer is the option of a pension. These are fading away. We don't see them as much as we used to. But there are still a lot of pensions out there. And a lot of pensions have a couple of options. One option may be a monthly option or another option may be a lump sum. We're seeing more and more lump sum options. It's my belief that the reason why we're seeing them is because a lot of pensions want to get out of the business. So they are looking to to provide you with a lump sum so they don't have that future liability. So let's go through and talk about what that looks like, what that means, and how you should be considering these things. So the example I came up with here is, and this is a quite normal option here, is that if you have $2,000 a month options, so if you get ready to retire and they're going to offer you $2,000 a month, or you can take a lump sum of 480,000, and if you take that lump sum option, there's no $2,000 a month. So you don't get them both. It's an either or situation. So how do we look at this? How do we break it down? How do we know which one's best? Well, that is really determined upon how you feel about things and what your cash needs are and your beliefs are, et cetera. But here's a couple things to consider. If you take this $2,000 a month benefit, you are literally giving away the 480,000. So you're forfeiting that money for the pension provider to keep that money and just provide you with the $2,000 a month benefit. So you're 100% reliant on them being solvent, 100% reliant on them making good choices to worry that 2,000amonth continues to come into you for a lifetime. One thing to consider with this is that that $2,000 a month may come to you for life, may even come to your spouse for life. We're going to talk about that in a second, but it will not go to your kids. So if you have a benefit that's being received and it's going to you, or it's going to your spouse and then you both die, it stops. So we don't know how long that benefit may last. So you really do disinherit the kids. The other factor to consider is that you have no access to cash. Oftentimes in a retirement situation, you know, after 5, 10, 15 years into retirement, your priorities may change, some of your needs may change. And having access to cash and having the flexibility and control of those dollars helps you make good, solid decisions for yourself down the road. If you take that $2,000 a month benefit that's irrevocable, you no longer have the option of going back and trying to renegot 480,000, it is gone. If you take the 480,000 over the $2,000 a month benefit, you receive the 480 relieve the pension provider of their future obligations, and now you have $480,000. What does that mean? Well, that means that you have complete control over that money. If you and your spouse pass, that money then goes to the kids. Any plans that you put in place today have the ability to shift going forward and change because you have the money, you have the asset. So if, and here's another point to make with this is that if you take that 480,000 and you use that same distribution rate we talked about earlier of 5%, that's 24,000 a year. And if you divide that out over 12 months, that's the same $2,000. Now, not every pension is going to work out that way. Sometimes taking a lump sum will require you to accept a lower possible payment. And in some cases that makes a lot of sense, depending on what your focus is. If you're really just focused on the maximum amount of monthly income today, with no other things being considered, a lot of times taking that monthly benefit from the pension makes sense. However, if you may not need the income right away, or you want to have some flexibility, or you want to have control over that money, or you don't like the idea of giving that money away to the pension, if you die, you and your spouse die, and the kids don't get anything, then it is advisable to take the lump sum option and forfeit the $2,000 a month. So that's how to view that. I'm not saying one's right and one's wrong. I'm just saying that you do have choices and things to consider there before you just make that alone election because it is irrevocable. Now, in some pension situations, a lump sum is not even an option. You may have a $2,000 a month benefit, and that's what you get. But with those, oftentimes there are spousal benefits that are tied into them. So for an example, let's take that same $2,000 a month. That may be a benefit that's received while you're living, so you receive that for the rest of your life. But if you pass, then your spouse gets nothing. Another option may be that you take what they call a reduced option and you receive $1,500 a month. But if you pass away, your spouse continues to get that $1,500 a month. Okay, so that's a popular option. A lot of times people want to take care of their spouse, and the spouse, of course, wants to be taken care of. But again, just like with everything we have to dig down into the details and really try to figure out what's going on. So let's do that. So if you take that 2,000amonth versus that $1,500 a month that you're voluntarily taking a reduction, that's a $500 a month difference. That really is what we would call a $500 a month cost because you could be taking 2,000. Instead, you're taking 1,500 for a benefit that would be received when you die. So if you take the 1,500amonth, that's $500 that you're giving up back to the pension. You're giving that $500 a month up because you know that that $1,500 a month you're receiving would continue to your spouse if you die. So when you think about that, you're paying a $500 a month cost, or what we would call a premium for a benefit that's received when you die. And when you think through that for a second, that's kind of the definition of life insurance, isn't it? You pay a premium every month for a benefit that's received when you die. That's what you're doing with the pension. There's a couple of things to consider with that that kind of ties into exactly what we talked about a second ago is that if you take that reduced benefit and you die, your spouse gets the reduced benefit. But if she dies, then the kids don't get anything. Or in some pensions, if your spouse dies before you, you may not have anything paid out to anybody. So there's just some what we would call a pension trap there that we want to be careful of. So this 500amonth is a cost that you're paying. Now think about this for a second. A lot of pensions have what they call cost of living adjustments built in, or a short acronym for that's cola. And that COLA is based upon, you know, consumer price indexes and whatnot. But it's really in there to protect the person receiving the pension from the erosion of inflation going forward. So if we have a cost of living adjustment factor of 5%, because I really don't have any way of knowing what exactly the amount would be, but let's just say it's 5%. Now, this is going to be a benefit to you when you're receiving that fifteen hundred dollars a month because you're getting 5% on that each year. But it also works against you in a way because that $500 a month cost that you have for that pension also is being affected by that cost of living because it's lost opportunity there. If you would have taken that 2000amonth, you would be receiving 2000 or 5% on the 2000. Because you took the 1,500, you're getting 5% on the 1500. So we have to look at that $500 that you're giving back to the pension department, because if you take that 5% on that $500 a month over 10 years, that's $750 a month. Now that you're paying for a benefit that'll be received when you die in 20 years, it would be $1,250 and so on. So it would. This, it's kind of similar to this, is that what if your insurance person came to you and said, hey, we have a really good idea for you. I have a life insurance policy that the cost goes up every single year and the benefits go down every single year. Now, if you were described that type of policy, you probably wouldn't get real excited about that. Probably wouldn't do it. But that's more or less what you're doing when you purchase that insurance through the pension department, because every year you live is one year less that the spouse is going to receive the benefit. And plus, with that cost of living adjustment, that cost of that benefit's going up each and every year. Now, I'm not suggesting that a person with these pension options should simply elect a single option or a maximum benefit and not cover their spouse. Just let me be clear. That's not what I'm recommending. What I am suggesting is to look for alternative planning options by using a personal life insurance policy that's outside of your pension. What you're doing is you're creating more control of how much life insurance you purchase. You're also maintaining control on how long you maintain that policy. And there's different variables to that. If your spouse passes away before you, you may then elect to get rid of that policy and still maintain your maximum pension option. This could be a less expensive option. It could be a more expensive option. We wouldn't know. These depend on your health and what other factors you have going on in your life. But when you look at the fact that you do have more control with this type of arrangement, you're taking the maximum option with your pension and you're purchasing a separate life insurance policy outside of the pension plan. And let me just make a specific note here, is that a term life insurance policy will not work. In this scenario, you it really does require a permanent form of life insurance, a perpetual death benefit, one that will not expire on you and you do not want one that is going to escalate in cost. You want a more predictable premium and you want a perpetual death benefit. So we know that it's there when you need it. So when you think about retirement planning, when you think about everything we just talked about, retirement planning is about having access to money when you need it and having as much control as possible over the purpose of the money. Now, these strategies are the result of 20 plus years of conversations with people planning their retirement. And the handling of your money is not about finding the best product. It's always about knowing how you plan to use the money that you have. If you would like to discuss any of this in more detail, give me a call at 636-296-5225. Again, 636-296-5225. That concludes today's podcast. In our next podcast we will continue on the topic of retirement and we will have a special guest with us talking about Social Security and Medicare. You won't want to miss this episode, so be looking for this in the next couple of weeks. I am Brian Scribonia and thank you for listening to the Common Sense Financial Podcast.