2.3. Sample Plan: Confident Investing with > $100,000

Goal of this lesson: A look at a sample plan for someone investing with over $100,000.

Ok, time of the last – and most confusing – potential plan.

A great philosopher once put this lesson into context when they stated “Mo money mo problems”. That’s the world we’ll get into this with this lesson.

To be honest though, if you have hundreds of thousands of dollars and are starting to invest, I’d HIGHLY recommend you work with a fee-only, fiduciary financial advisor before jumping into your actual investments. You’ll probably also want to work with an accountant or a CPA BEFORE you make major changes in your investments.

In the investing world, there’s nothing worse than thinking you’re doing awesome only to be hit by a massive tax bill at the end of the year.

In other words: GET FEEDBACK FROM A PROFESSIONAL ON YOUR PLAN. It’s awesome – amazing even – to be able to invest for yourself, but the more money you have in the market there is more room for a big issue down the line. I’ll mention a few areas in this lesson that should be red flags that you’ll want to talk to an expert (or at least take pause to dig deep) about your specific scenario before jumping in.

Luckily, it’s possible to have a very large portfolio and self-manage it with ease! If you had $1,000,000 in a 401(k) today and your retirement is still many years off you don’t need a financial advisor today if you can pick out your own asset allocation and rebalance it on your own. 

We’ll mix things up with our scenario to make sure it’s not the easy path:

Starting Point for Our Over $100,000 Plan

Who?

This lesson will follow our made up investors Pam and Chuck (also my favorite couple on the new Harley Quinn animated show – watch it if you like inappropriate violence in your comic books). 

Pam and Chuck are 42 years old with a 16-year-old daughter getting ready for college. They make a combined $150,000 a year after taxes ($175k before) and spend about $90,000 of it on their upscale lifestyle – leaving them about $60,000 a year to invest.

Pam and Chuck would like to pay for their daughters’ college and retire eventually – but they’re in no immediate rush.

Debts?

Pam and Chuck bought a nice house a decade ago during the great recession. They still have 20 years left on the mortgage and owe $300,000 more on it. They have two car loans with a few years left on them too.

Assets?

They’ve been putting money aside for their daughters’ college in a 529 plan for 16 years and it’s now grown to $150,000. We’ll skip talking about investing this money since it should be mostly in cash by now since their daughter is getting near college age.

Aside from that, they have a combined $600,000 in their 401(k) accounts! They’ve rolled all 401(k) accounts from previous employers into their current one, so they have no Traditional IRA rollovers. They’ve been following the same advice we’ve given Robert and Stacy and have been maxing BOTH of their 401(k) accounts for over a decade. $40,000 a year saved up grows very fast – especially since they had the bull market of the 2010’s helping them out. 

They also both opened up Roth IRA accounts in their late 20s and began investing there each year. The combined value of these Roth IRA accounts has grown to $150,000 during this time.

Lastly, Pam and Chuck have been putting some money aside in an after-tax brokerage account each year. They know this is their last line of investment after maxing out all other accounts. It’s still grown to $200,000 though! They’ve been investing with a financial advisor that charges 1% fees and has put them completely into an “American Funds American Balanced A” $ABALX fund. Their advisor says this is the best fund for someone like Pam and Chuck. It’s grown a lot over the years too, so they haven’t complained.

Our Problem: Pam and Chuck have a lot of assets. Between their 401(k), Roth IRA and brokerage account, they’re sitting on $950,000! On top of that, they’re saving $38,000 each year in their 401(k)s, $12,000 a year in their Roth IRAs, and another $12,000 in their brokerage accounts. What should they invest these in?

With their current spending, Pam and Chuck could reach financial independence by age 51 years old. At that point, they’ve had 25x their annual spending in all of their investment accounts. There’s a problem though. A lot of their money is in their 401(k), which means they’d need to pay taxes on it. 

We have a few problems we’ll need to solve for Pam & Chuck:

  • Create an asset allocation 
  • Determine how to spread this allocation across all of their accounts.
  • Come up with a reasonable estimate of how much they’ll need to retire.
  • Make a plan for moving away from their financial advisor.
  • Create a withdraw strategy for retirement that minimizes taxes down the line

Let’s take these one by one.

Making A Plan for Pam & Chuck

Unlike the previous examples with Robert and Stacy, Pam & Chuck already have their current investments on autopilot. They’ve paid off debts and are maxing out their investments.

Their problem is different: they want to optimize their investments. Let’s start there.

Create an asset allocation across all of their accounts

To review, here’s what Pam and Chuck have to invest in.

  • 401(k): $600,000 (+$40,000/yr)
  • Roth IRA: $150,000 (+$12,000/yr)
  • Brokerage: $200,000 (+$12,000/yr)

Based on the graph above, they’re roughly 8 years from reaching financial independence. That opens up a big question for the couple: when would they ideally like to stop working?

This is important to know right away because we’d want to create an asset allocation that takes that into account.

After sitting down and talking with Pam and Chuck, we finally settled on age 55 as their target date for retirement. This isn’t a sure thing – but it’s their plan for now.

Setting their retirement date at 55 years old has another major advantage as well: if you leave an employer when you’re 55 years old, you can begin withdrawing from the 401(k) at the company you left without paying the early withdrawal penalty!

Based on all of the math, it looks like they could potentially retire a few years earlier – which could still happen. At 55 years old, they might have saved up more than $3.4 million at their current pace. If their spending continued to rise with inflation, that would be around $115,000 a year – making this about 30x savings.

If they retired even a year earlier at 54, things get much more confusing. They wouldn’t be able to access their 401(k) accounts without paying a 10% early withdrawal penalty. There is one option for withdrawing from a 401(k) early that they could try. It involves rolling over part of their 401(k) to an IRA, then to a Roth IRA. In order for that to work, they’d need to have a 401(k) that allowed for “in-service distributions” – which means you can transfer some money out of your 401(k) while you’re still working. Pair that with a Roth IRA conversion and you have what’s known as a “Roth IRA Ladder” – a strategy for accessing 401(k) funds early.

To keep things easy, they decide to retire at 55. (whew) With that in mind we can create an asset allocation for them:

  • Age 42:
    • 50% US Funds: 
    • 25% International Funds:
    • 25% Bond Funds
  • Age 55:
    • 33% US Funds
    • 17% International Funds
    • 50% Bond Funds

This asset allocation starts slightly conservative based on their timeframe. Over the next 13 years, they’ll move more money away from equities and into bonds so that by the time they retire they’ll be 50% equities and 50% bonds.

The amount of bonds in their portfolio wouldn’t need to get higher than that. Actually, they could even start adding more equities so that by the time they’re 65 they’re back to 60% equities and 40% bonds. Historically, this has been more than safe. Since the mid-2000s, bonds have returned far fewer returns than they did in the 1900s. Because of that, they can’t rely on bonds to return the high rates their parents and grandparents enjoyed. The solution is simple though: move more into stocks.

Determine how to spread this allocation across all of their accounts

Now that we have an asset allocation, let’s figure out how to optimize this for taxes in their accounts. 

There is one red flag first though: they are investing with a financial advisor who charges a 1% fee. They have $200,000 in that account, so they’re effectively paying them $2,000 a year to invest in one single fund.

That fund has an expense ratio of 0.59% – MUCH higher than the 0.04% expense ratio of some other funds. That fund – $ABALX also isn’t just a US equity fund. It’s 50% US Equities and 33% “Fixed Income”, which just means bonds. It has a turnover of 104% and about a 2% dividend each year – meaning that they’ll likely have to pay taxes on those dividends each year.

They could sell this fund and be rid of it. Their “cost basis” is $120,000, which means that if they sold $200,000 that they bought over a year ago, they’d need to pay taxes on $80,000 at 15% = $12,000. They may also need to pay state taxes on this as well. Let’s say taxes total about $15,000.

Should they sell it and take the $15,000 hit? Or should they keep it around? In this case, I’d say keep around – but transfer it away from the financial advisor. It’s still an OK fund, and we can use this as part of their portfolio. My recommendation for them would be:

  • Transfer this money away from your financial advisor – likely to wherever they have their Roth IRA accounts.
  • Change the dividend setting on this fund to “cash”, or reinvest in another fund – like $VTSAX instead.

By changing the dividend to no longer reinvesting and no longer contributing anything else, this investment will continue to grow, but with most of their efforts elsewhere

  • Age 42:
    • 401(k): $600,000 (+$40,000/yr)
      • $200,000 in a Total Bond Market Fund (~21% of their total portfolio)
      • $240,000 in an International Fund (~25%)
      • $160,000 in a US Total Market Fund (~17%)
      • New Investments: Split between all 3.
    • Roth IRA: $150,000 (+$12,000/yr)
      • $150,000 in a US Total Market Fund (~15%)
      • New Investments: $VTSAX or a total US Market Fund
    • Brokerage: $200,000 (+$12,000/yr)
      • $200,000 still in $ABALX
        • Effectively $140,000 in a US Total Market (~16%)
        • Effectively $60,000 in a Bond Market Fund (6%)
      • New investments: $VTSAX or a total US Market Fund

With this mix, we’re reaching our target of 25% Bonds, 25% International, and 50% US Stocks. We’ll be paying some additional tax on the dividends from $ABALX each year, but it’ll still end up being less than the taxes if we sold it all today.

Side note: If Pam and Chuck started investing on their own earlier, there would be less growth in $ABALX. That would enable them to sell all of it and pay less in taxes!

Come up with a reasonable estimate of how much they’ll need to retire

The most dependable way to know how much you’ll need to retire is to track your spending over multiple years. If it’s rising more than inflation then you have a problem: you haven’t found your retirement spending amount yet.

This is incredibly tough to do! Large one-time purchases and throw a wrench in a good budget. A broken A/C unit in your house, replacing the transmission on your car, or an unexpected medical bill can easily throw your spending out of whack for an entire year.

There’s an activity I recommend people go through to understand their actual spending in retirement: calculator your financial independence with options number.

For Chuck and Pam, their entire financial picture will change between now and retirement. They’ll be closer to paying off their house, their daughter will be through college and on her own (well, hopefully), and they’ll almost surely make more money each year. Because of that, they figure they can actually revise their $90,000 spending number up only slightly to $100,000 a year. This will be their target spending with every luxury they want in retirement.

At 25x using the 4% rule, they’d need at least $2,500,000 in that case.

But that doesn’t take into account taxes. If they were to withdraw $100,000 from their portfolio, what would that look like? It might look something like this in their first year

  • $70,000 from a 401(k)
  • $30,000 from a brokerage account

If that was the case, then they’d pay taxes on the $70,000 at their ordinary income rate, and capital gains taxes on the gains from the $30,000 withdrawal. They’d pay no taxes on the capital gains due to the level of their income – which is awesome. They would, however, pay about $9,000 in federal taxes, or close to 10%. With state taxes that raise their total to 12%.

In other words, if they retired with only 25x their spending ($2,500,000), they’d still need another 12% to make the math work.

Side note: They might be able to make it work by withdrawing more from their Roth in some years and lowering their taxes slightly. They’d still eventually need to pay some taxes due to how much of their portfolio is in their 401(k).

If they save an additional 12% they’d feel a lot safer. Bringing their FI target up to $2,800,000.

Make a plan for moving away from their financial advisor

Leaving a financial advisor is a big decision. There’s paperwork to fill out, you have to break up with someone, and they usually try to sell you on why you should stay with them.

If you’ve already made up your mind to self-manage your investments, and that the 1% advisor fee isn’t worth it to you, there are a lot of ways to leave. The next course in the Minafi Investor Bootcamp is entirely focused on this topic: Ditch Your Financial Advisor.

For Pam and Chuck though, they could leave the money with a financial advisor for now if they wanted, and start investing on their own in a new brokerage account. They would effectively be paying $2,000 a year for nothing though. That’s a vacation every year given away!

Create a withdraw strategy for retirement that minimizes taxes down the line

Ok, this is the last thing we wanted to do for Pam and Chuck. Let’s take a look at what their investments may look like at age 55 when they retire.

  • $3,400,000
    • $2,200,000 in a 401(k)
    • $550,000 in a Roth IRA
    • $650,000 in a Brokerage account

If they wanted to pay $0 in taxes, they could withdraw $100,000 and do it:

  • $0 in Federal taxes
    • $24,400 from a 401(k)
    • $75,600 from their Roth IRA and brokerage account

This takes advantage of the “standard deduction” for taxes. That writes off the first $24,400 in income – making it tax-free. The capital gains rate is 0% all the way up to $78,000 – meaning that even if all of the brokerage accounts withdraw were gains (which it’s not) it would still be tax-free.

As a matter of fact, they could withdraw a LOT more from their brokerage account if they wanted, then reinvest it back in. This is called tax gain harvesting and is a way to pay taxes (in this case 0% taxes) then reinvest it.

Pam and Chuck would still need to pay some taxes on this due to the American Fund they have in their brokerage account that’s giving them some dividends. All of these tax rates are progressive though, so having a little more in dividends just means a little more in taxes – it doesn’t push them past some threshold that increases their taxes wildly.

You can probably already see the problem with this approach. If they withdraw $75,600 from their Roth and brokerage every year, it’s going to run out way before their 401(k) runs out.

The solution? Be OK paying some taxes now. The less they can withdraw from their 401(k) the better, but that shouldn’t stop them from tapping it every year. 

Pam and Chuck are in an excellent place financially. They’ve saved up a ton, and are on track to retire by 55. Less than 1% of the US population retires that early! That’s amazing!

55 was a conservative estimate for Pam and Chuck too. If they take a good look at their lifestyle and can lower their expenses, they may be able to retire even sooner.

This lesson:

Next up:

A few ways to get feedback on your investment plan before jumping in.

3.1: Get Feedback On Your Plan