Chapter 2 - "Starting with the Planning Basics"

In this episode, podcast host and author of “Control Your Retirement Destiny” covers Chapter 2 of the 2^nd edition of the book titled, “Starting with the Planning Basics.”

If you want to learn even more than what there is time to cover in the podcast series, you can find the book “Control Your Retirement Destiny” on Amazon.

Or, if you are looking for a customized plan for your retirement, visit us at sensiblemoney.com to see how we can help.

 

Chapter 2 – Podcast Script

Hi, this is Dana Anspach, founder and CEO of Sensible Money, a fee-only financial planning firm that specializes in helping people plan for retirement, and author of Control Your Retirement Destiny.

In our previous episode, we discussed highlights from Chapter 1 on the topic of “Why It’s Different Over 50.” In this podcast, I’ll be covering the highlights from Chapter 2 of Control Your Retirement Destiny, titled, “Starting With the Planning Basics.”

Before we get into Chapter 2 content, a brief history on the publishing and reception we’ve gotten with the book. Control Your Retirement Destiny was initially published in 2013, out of my passion for helping people navigate their way through retirement and to combat the popular retirement rules of thumb in the media that are hurting people more than helping them. Naturally, I was nervous when it was released. Will people like it? Will it help them?

I’m honored at response I’ve received and the feedback on the book – it has incredible 5-stars reviews on Amazon. And it is often the reason clients initially seek us out for assistance.

Before we get going, just a reminder that if you like what you hear today, go to Amazon and search for Control Your Retirement Destiny. You won’t be disappointed. And if you are looking for a customized plan that fits your specific retirement needs, visit sensiblemoney.com to see how we can help.

Let’s get started.
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In this Chapter you learn how to use a set of basic schedules to build a financial plan. I’ll be explaining these schedules, but first, a story to illustrate why the basics are so important.

I was lucky enough to grow up with a dad who taught me the value of not only smart financial decisions, but also of health and fitness. In my mind, there’s a lot of correlation between the two.

As a family, we went to the gym together. To this day, when I visit my parents in Des Moines, Iowa, we still all go to the gym together.

This habit of working out has served me well. I don’t have to think about it, it’s just what I do. For me, it’s the same with managing my finances. I’ve made it a habit to track what I spend and to save regularly. I don’t have to think about it, it’s just what I do.

Currently I work out at a gym called LA Fitness. They have a slogan that pops up on their TV screens throughout the gym, and a women’s voice exclaims it aloud. This slogan reminds me of how important this chapter is. She says, “What gets measured, gets improved.”

I hear this woman’s voice echo in my head all the time… “What gets measured, gets improved.”

Whether it be the calories you’re consuming, the number of days a week you work out, or the amount of money you spend, when you measure, things improve.

The first time I really experienced how measuring could impact my finances was about a year out of college. I downloaded Quicken, a program that tracks your spending by vendor and category.

“Holy cow,” was what I thought, as I realized I was spending $400 a month on what I called the “Walmart and Target” category.

Now, that may not seem like much if you are running a household with many family members. But for me, just married, a year out of school, living in a 700 square foot apartment, it was a lot.

I started to pay attention to my behavior. Let’s say I needed something basic, like a bottle of Windex. I’d go to WalMart, and come out with $100 worth of items. Most of the time they were decorative knick-knacks that we certainly didn’t need.

How was I going to fix this spending leak I wondered? I decided to experiment and only visit these stores once a month. Amazingly enough, I still only spent $100 each time I went. By only going once a month, there was instantly about $300 more a month in the budget – and we still always had what we needed.

By measuring, I became aware of what was happening. Then I was able step back and experiment with ways to improve the outcome.

Somehow, like so many things that work well in life, what did I do? … I stopped measuring.

Several years later, after going through a period of low income and no measuring, I found myself $25,000 in credit card debt and with no savings.

I hated opening my credit card statements. It was painful. I would mentally beat myself up.

I was working at a CPA firm at the time, and one day one of the managing partners announced he was retiring – at a very young age. “How did he do that?” I wondered.

He stopped by my office a few days later, and I was able to find out the answer.

He said, “Dana five years ago, I had a negative net worth. I earned an attractive salary, but I realized I wasn’t doing anything with this money but spending it.”

“How did you change things?” I asked.

He said he had this realization that he was in a hole - and he was determined to dig his way out. He started by regularly measuring his net worth. There was that word again “measuring!”

Each month he’d record his debt balances. He quickly paid off his debt. Then, he started looking for investment opportunities. He was lucky enough to catch the real estate market on an upswing and in five years his net worth went from negative to over $10 million.

I get that it’s not realistic to think we can all go from negative to $10 million in five years. But we can all make progress.

His story inspired me to get my butt in gear. I went home that day and tallied up all my debt balances. Each month, as painful as it was, I tracked the balances and payments. At times it seemed the balances only inched down. I didn’t get out of debt quickly, but I never gave up. Today, there is no credit card debt, and in place of tracking debt, I track my net worth.

Tracking your net worth is a simple process of recording total account balances and asset values as of the same date each year, such as at year-end, or at the end of each calendar quarter.

Measuring both your spending and your net worth are the starting points for getting a handle on your entire household financial situation.

When it comes to planning a transition into retirement, measuring is more important than ever. In Chapter 2, of the 2nd Edition of Control Your Retirement Destiny I cover the 5 basic schedules you can use to measure, and you can see examples of each schedule.

These five schedules are a spending plan, a personal balance sheet, an income timeline, an expense timeline, and a deposit/withdrawal timeline.

In Chapter 2, we begin to follow a couple, Wally and Sally. Wally and Sally are in their early 60’s and starting to plan their transition into retirement. Let’s take a look at how Wally and Sally use these 5 basic schedules to see if they can afford to retire.

Note – for the sake of this podcast, I am rounding all numbers so they won’t match exactly what you see in the schedules in the book.

First, they start with a spending plan.

A spending plan is an assessment of where your money goes.

I prefer the term “spending plan” instead of budget, because a budget sounds so restrictive! A spending plan sounds flexible – and actually it is. By laying out a plan you can make sure you are spending money on things that are most important to you.

To build their spending plan, Wally and Sally print an entire year’s worth of checking account statements and credit card statements. They use these to come up with a total of what they spent last year. They categorize everything into both fixed and variable expenses. When all is said and done, their total comes to $62,000, or just over $5,000 a month.

This $62,000 does not include taxes or any items that come directly out of their paychecks. But it does include everything else, from property taxes and insurance to groceries and cell phone bills.

Wally and Sally recently paid off their home, so last year with $5,000 a month, and no house payment, they felt comfortable. They figure if they can spend about that same amount each year in retirement, then they’ll be comfortable.

But they aren’t sure how to figure out if they have enough saved.

Wally and Sally’s next step is to make a personal balance sheet.

A personal balance sheet helps you assess what you have to work with. Once you list all your assets and accounts, you can organize them into categories. This helps you see which accounts are available for the purpose of retirement, and which are not. For example, if you have a savings account where you put money for upcoming travel, that asset is not available for retirement income.

Wally and Sally list all their major assets, and subtract out any debt. When they add everything up they have a net worth of $1.5 Million. Their home, worth $300,000 is included in that total.

They realize they don’t want to sell the house, so they take that asset back off their balance sheet so they can see only the amount of savings and investments that are available to fund their retirement. That ends up being about $1.2 million.

With $1.2 million of savings and investments, do Wally and Sally have enough to spend $62,000 a year in retirement?

In order to answer that, Wally and Sally have three more schedules to complete. This last set of schedules are formatted as a series of timelines. I call them an income timeline, an expense timeline, and a deposit/withdrawal timeline.

Let’s briefly go over each of these three timelines and how Wally and Sally use them to lay out version one of their retirement income plan.

We’ll start with the Income Timeline.

Really, I should call this a fixed income timeline. In planning, the purpose of the income timeline is to layout all the guaranteed sources of income. This does not include dividends or interest – as those numbers vary and are not guaranteed.

It does include pensions, Social Security, deferred compensation payouts, and guaranteed annuity income.

The only source of fixed income that Wally and Sally have is Social Security.

Wally and Sally both worked most of their life and plan to work one more year. Once retired, they each plan to start Social Security early, at ages 65 and 63.

Note - This isn’t necessarily the best thing for them to do – but this is version one of their plan. So first, we’ll look at what they originally planned to do. Then, in subsequent chapters, we’ll look at how they can do things differently to improve their retirement.

Wally’s birthday is in March and Sally’s in February. This means if they file for benefits to begin on their birthday during the first year they are retired they won’t get 12 Social Security checks each. Wally will get 10 months’ worth and Sally 11 months’ worth.

When they add all this up, they estimate the first year they are retired they’ll receive about $38,000 of Social Security. The second year, when they both get checks all year long, they’ll get about $45,000.

They open up a spreadsheet and put a calendar year in the top of each column. In year one of retirement they input $38,000 of Social Security, and in year 2, $45,000.

They also know Social Security goes up each year with inflation, so starting in year 3 of retirement, in their spreadsheet timeline they increase their estimated Social Security by 2% a year. They figure inflation might be a little more than that, but they want to be conservative and so they assume that their benefits only go up by 2%.

Wally and Sally project their Income Timeline for 29 years, which stretches it to Sally’s age 90.

Out of curiosity, they add up all the Social Security they estimate they’ll get over that 29 years. They are surprised to see it adds up to just over one million four hundred and seventy-five thousand.

That number is important, because in Chapter 3, we’re going to show them how they can get even more.

Right now, we’ll assume that is all they have to work with.

What they need next is an Expense Timeline.

When you build an Expense Timeline, you start with what you spend now. Then you project how it will change over time.

Why can’t you just take your current spending, and use that?

Well, some expenses go away. A mortgage is a good example. If it will be paid off in ten years, then in the expense timeline, the expense shows up for the first ten years, then drops off in year eleven.

Other expenses may need to be added in. If your current vehicle is paid off, at some point, you’ll need another one. This expense needs to go in your timeline, as either a lump sum purchase, or a car payment that starts in approximately the year you when you think you’ll next be buying a car.

Health care spending is another item that may change as you near retirement. If you are currently covered by employer provided health care, but will have to pay your own premiums once retired, then be sure to add a line item for this expense in the year where it will begin.

The spending timeline is important because it becomes the basis for the lifestyle you want to have in retirement.

This is about creating a plan that lets you live comfortably for the rest of your life. To do that, “comfortable” has to have a number.

Your spending timeline helps you figure out what that number will be.

Wally and Sally start with what they spend now, which is about $62,000 a year. They also know they need to consider inflation. So they assume these expenses will go up by 3% a year. Remember, they want to be conservative – so they are intentionally assuming their living expense go up by 3% a year while their Social Security only goes up by 2% a year.

For living expenses, that means with inflation the first year they are retired they estimate they’ll need $64,000, and then in the second year $66,000, and so on.

Next, they realize they will be paying their own health insurance once retired. They add an estimated $12,000 a year for that.

Now, as things stand today, $12,000 a year may not be enough to cover health care premiums for both of them. Wally and Sally realize that later when they start doing more research. But again, this is version one of their plan.

They also realize they need to estimate taxes in retirement. Not knowing where to start, they ask their CPA to come up with an estimate. Their CPA tells them if they have $40,000 a year in Social Security, $5,000 a year in investment income, and $30,000 a year in IRA withdrawals, they will pay $8,000 in federal taxes and $1,500 in state taxes.

After adding in health care premiums and taxes, Wally and Sally calculate they’ll need a total of $85,000 their first year in retirement. With inflation, this goes to $88,000 in year two, $91,000 in year 3, and so on.

Wally and Sally project their Expense Timeline for 29 years, which as I mentioned, takes it out to Sally’s age 90.

Again, out of curiosity, they tally up all their expenses, including taxes, health care, and inflation, over 29 years. It adds up to just over $3.9 million. Yikes, they think… “We’ll have to work forever.”

Luckily for them, that turns out NOT to be true. Their planning is not yet done.

Next, they need a Deposit and Withdrawal Timeline.

A deposit and withdrawal timeline shows you the difference between what is coming in on your Income Timeline, and what is going out on your Expense Timeline.

Wally and Sally compare their income timeline to their expense timeline on a year-by-year basis.

Here’s how it works.

Once retired, the first year they have $38,000 of Social Security and $85,000 of expenses, that means they’ll need to withdraw $47,000 from savings and investments.

In year two, they’ll have $45,000 of Social Security and $88,000 of expenses, leaving $43,000 to come from investments.

Over 29 years, to cover all their expenses and keep up with inflation, their timeline shows they need to withdraw $2.4 million.

Once again, they feel discouraged, as Wally and Sally only have $1.2 million saved right now.

What are Wally and Sally forgetting?

They are forgetting that their savings and investments will earn something.

Sure, if they hide their savings and investments under the mattress, and it earns nothing, it is true, they would need $2.4 million in the bank right now for it to last 29 years.

But if their investments earn 4% a year, they only need $1.2 million saved now to support all the withdrawals they need for 29 years. If their investments earn 5% a year, they need just over $1 million saved.

Is a 4$ or 5% rate of return realistic? The short answer is yes, it can be realistic if you follow a specific investment plan. I provide all the details on this in Chapter 5 on investing.

Is there anything else Wally and Sally are forgetting? Yes, there is.

As I mentioned, health care expenses are likely to be higher than what they have projected in the first year or two of retirement when they are not yet age 65. At age 65, Medicare begins. Once both are on Medicare, they will still pay for a supplemental health plan, but it will not cost as much as it did before they were on Medicare. Basically, health care is likely to cost more than they had planned on for the first two years, then less in the following 27 years.

When they factor in these changes to their timelines, their projected lifetime spending goes down from $3.9 million to $3.7 million.

As Wally and Sally begin to talk more about retirement they realize what they’d really love to do is travel in their first five years of retirement while they feel they will be in their healthy and active years. They start to wonder if they could afford an extra $10,000 a year on travel, just for their first five years of retirement.

What do you think? Is funding their travel realistic? The answer becomes clear in Chapters 3 & 4.

In conclusion, using a set of basic schedules, Wally and Sally now have a 30,000 foot view of their potential retirement plan. It looks realistic to them, but they know they are not experts.

Now that they have a basic set of schedules in place, they also know they can begin to look at alternate solutions.

They decide to start reading every article about retirement they can find. Wally finds one about Social Security that makes him realize there might be a better way than their original plan.

Social Security and how Wally and Sally can use it to improve their plan, is the topic of Chapter 3.

Thanks for joining me for Chapter 2 of Control Your Retirement Destiny. To learn more, get a copy of the book on Amazon, or to work with a professional retirement planner to put together your own customized plan, visit us at SensibleMoney.com