I’ve highlighted in a previous article how to double your retirement income while not necessarily working any harder in retirement. In this article, I’ll discuss how one couple is planning to increase their retirement income, essentially adding $400,000 to their bank accounts over their lifetime.

Tom (born 1955) and Jess (born 1962) are a pretty normal American couple. Their wages have been fairly modest over the years with Tom making about $80,000 and Jess making in the mid-$40’s last year. Jess spent some time outside of the workforce to take care of their two children. Tom has pretty much been working every year with his wages rising steadily through the years with one blip during the Great Recession.

Here’s their asset breakdown:

Tom’s 410(k) balance – $260,000

Jess’s 403(b) balance – $60,000

Home – $200,000 w/ about $40K mortgage remaining

Savings – $27,000 cash

Debt – None except for the house and a $1,000 credit card balance soon to be paid off

Original Plan

Tom is turning 62 this year and was planning on pulling Social Security while his wife continues to work. He doesn’t want to work anymore because, well to put it bluntly, he hates his boss among other things. Tom would get $19,878 annually if he claimed Social Security at 62. His Social Security along with his wife’s employment income of $45,000 would get them by. They don’t want to just get by though. They want to thrive in retirement, having enough money to go on trips and buy things they want instead of just what they need.

They still have some assets and were planning to use those assets down the road, as they got closer to 70. They know about the required minimum distribution, which requires people start withdrawing from their tax-deferred accounts by April 1st of the year after they turn 70 1/2.

Their combined income of $64,878 annually or $5,407 monthly would give them enough money to pay all their bills and live comfortably but they want more than that. That’s where they turned to a retirement planner to do some research and come up with an optimal strategy to maximize their retirement income.

Optimized Plan

Tom and Jess did some research on optimizing their retirement income. They realized they could have more money if they rearranged the way they did things. Here’s their optimized retirement plan:

1) Maximized Social Security Benefits – Tom’s leaving work at 62 no matter what. But that doesn’t mean he has to claim Social Security right away. He’s in good health and plans to live a long time. He ran the numbers through a Social Security calculator and found that he and Jess would get an extra $261,000 over their lifetimes if they filed strategically to get the most. Here’s a chart of what their original Social Security numbers would look like compared to what their optimal Social Security numbers.

Social Security strategy

Instead of filing Social Security at 62, Tom’s going to delay until age 70. This means that from 62 to 70, he won’t have income from Social Security so he’ll have to figure out another way to get income. He still needs to pull something in after all.

2.) Income Structuring – Tom would’ve received about $20,000 a year from Social Security if he claimed at 62. He needs the money so he decided to pull some cash from his 401(k). He’s going to start withdrawing $1,667 per month, which is equivalent to the $20,000 per year that he needs to support his lifestyle. Remember, Tom’s 401(k) balance is $260,000 and it’s currently invested in Vanguard’s Target Date Retirement 2025 fund. He’s had a good run on this investment. It’s returned 9.6% annually over the last 5 years. He expects the returns to drop to 5% annually due to the fund’s investment mix.

Tom’s first year of 401(k) withdraws will look something like this:

401k withdraw

Notice the account balance only decreases by $4,283 in 2018 due to the assumed 5% annual growth rate of his portfolio.

There is a tax implication on pulling out money from a tax-deferred account as opposed to receiving Social Security income. Social Security income isn’t taxed as much as tax-deferred distributions. There’s no 10% penalty if you take a distribution after the age of 59 1/2 but it’s still taxed as normal income. Whereas, only a portion of your Social Security income is taxed and it’s based on your provisional income. We’ve accounted for taxes in the next step instead of pulling more money out of their tax-deferred accounts to make it an apples to apples comparison.

3.) Refinance Home – Tom and Jess are currently paying about $1,200 in P&I on their mortgage note. It’s a 15 year mortgage and they have about 4 years left to pay on it. To optimize their money in retirement, they decided to do a cash out refi and invest the proceeds in two ways. The first way is to contribute more to their emergency account and the second is to invest the remainder in a taxable brokerage account.

As a side note, most people think they should have a paid off mortgage in retirement. But in most cases the math says that you should carry a long term mortgage just before entering retirement. A lot of smart people are taking on mortgage debt at low rates to optimize their finances. Don’t just take my word for it.

Here’s how the numbers play out for Tom and Jess:

  • they’re currently in the process of refinancing for a $140,00 loan for 30 years at 4%
  • Tom’s going to stay at his job until after closing, then give his 2-week notice (he’ll stay for an extra month if they want him)
  • their loan balance on the old mortgage note will go to ZERO
  • they will have $100,000, which they will put into a taxable brokerage to start
  • Their new P&I payment will be $668, almost half of their previous payment
  • They can now deduct their interest on the loan from their taxable income. They couldn’t do this before because they were barely paying any actual interest because of amortization.

Their taxes will be a little lower because of the interest deduction and this will help offset the taxes due on Tom’s deferred account withdraws in point 2 above. They will itemized because their property tax, interest, and other deductions push them over the top.

4.) Consulting – Tom also thought about what he’d do in retirement. Instead of playing gold everyday and taking walks in the park, he would like to do some home-based consulting. His engineering background will be a good fit for consulting too. He’s going to work on his own terms and it will be very limited. He’s going to price his services at $50/hour to start and is thinking about getting a website to act as a business card.

Financial Impact

Social Security – Tom & Jess will get $261,000 more out of Social Security over their lifetimes. Instead of Tom getting $1,657 per month at 62, he’ll get $2,886 per month at 70. Jess will collect Social Security at 67 and she’ll get $1,762 per month at that time.

Deferred Asset Accounts – Tom’s 401(k) will take a hit earlier because he’s going to use it at 62. His account is still growing all the while he’s withdrawing in his 60’s. In fact, Tom’s account is forecast to have a balance of $196,218 when he’s 70. Thank you compounding growth! He’ll have the flexibility to withdraw more some months if he needs to.

Increased cash on hand – The cash out refi will allow Tom & Jess to have more flexibility. They’ll go from $27,000 in cash on hand to $127,000. Their plan is to leave this in the brokerage for a few months while deciding which conservative investments to allocate to. They’ll likely go with a CD Ladder or a Vanguard fund that’s suitable for their risk tolerance. Either way, this additional cash will grow as well. The flip side to this is that they’ll have more in total debt but they accept this alternative because it makes so much sense.

Lower expenses – The couple lowered their monthly expenses by over $500 by refinancing their mortgage. They also took on more debt for the long term. They are going to pay as agreed on their mortgage and not try to pay it off early.

Consulting – Tom will make his services available and may or may not make money in consulting. The great thing is he’s happy either way. He could make a few thousand extra a year and understands to put half of his money away for the tax man as a precaution.

If you’re nearing retirement and would like to share your finances anonymously on this site, please put your email in the box below and reply to my introductory email. We’re always looking for complicated scenarios to review to help both you and other folks.