The Thirteen-Word Retirement Plan

A Simple Roadmap for Joining the Top Ten Percent

By Stephen L. Nelson, CPA, MBA-finance, MS-taxation

Copyright © 2016 - 2019 by Stephen L. Nelson Inc

Table of Contents
Introduction ............................................................................................................................................ 1
Chapter 1 – Setting Expectations ............................................................................................................. 2
Taking a Bite of the Reality Sandwich ................................................................................................... 2
What $399,000 Looks Like in Retirement ............................................................................................. 3
What $542,000 Looks Like in Retirement ............................................................................................. 3
Three Quick Remarks Before We Move On .......................................................................................... 4
Chapter 2 – Understanding Why People Seem to Fail .............................................................................. 5
Retirement Plans That Are Too Complicated ........................................................................................ 5
Misunderstanding the Logic of Income Allocation ................................................................................ 5
Financial Grief and Retirement Savings ................................................................................................ 6
Final Point of Chapter - Don’t Get Bummed Out Yet............................................................................. 7
Chapter 3 – Using an IRA or 401(k) .......................................................................................................... 9
Take the Free Money ........................................................................................................................... 9
When You Can’t Get Free Money ....................................................................................................... 11
Using Tax Savings for 401(k) and IRA Contributions............................................................................ 11
Two Other Reasons You Want to Work with an IRA or 401(k) ............................................................ 12
Chapter 4: Please, Please Not a Roth ..................................................................................................... 13
The Attraction of a Roth-style Account .............................................................................................. 13
A Simple Example of When a Roth Account Fails ................................................................................ 13
Another Simple Example of Roth Weirdness ...................................................................................... 14
Compound Interest and a Roth Account ............................................................................................ 15
Roth-style Worst Case Scenarios ........................................................................................................ 15
Roth Worst-case Scenario #1: Savings Shortfall .............................................................................. 16
Roth Worst-case Scenario #2: Long-term Care Costs ...................................................................... 16
Roth Worst-case Scenario #3: Short or Shorter-than-expected Retirement .................................... 16
Tying Things Up with a Bow ........................................................................................................... 17
When a Roth Does Make Sense ......................................................................................................... 17
People Who Don’t Currently Pay Any (or Much) Income Tax .......................................................... 17
People Who Will Probably Always Pay the Top Tax Rate ................................................................ 18
 People Who Want to Tax-diversify ................................................................................................. 18
People with a Decimated Portfolio—Maybe .................................................................................. 18
Chapter 5: Cheap Really Matters ........................................................................................................... 20
Why You Can Go Cheap with Your Investing ...................................................................................... 20
The First Reason Cheap Matters a Lot ................................................................................................ 21
The Second Reason Cheap Matters a Lot ........................................................................................... 22
Two Final Comments About Cheap .................................................................................................... 22
Chapter 6 - Target Retirement Funds ..................................................................................................... 23
Choosing Your Investments is Easier than You Think .......................................................................... 23
Picking a Specific Target Retirement Fund.......................................................................................... 25
When No Target Retirement Fund Option Exists in a 401(k) ............................................................... 26
Criticisms of Target Retirement Funds ............................................................................................... 27
The Big Benefit Critics Ignore ............................................................................................................. 28
Chapter 7 – Playing with the Percentages .............................................................................................. 29
Setting the Right Percentage of Your Income to Save ......................................................................... 29
Choosing a Return on Investment Percentage.................................................................................... 31
Selecting a Small Safe Withdrawal Rate Percentage ........................................................................... 32
Criticizing a 4% Safe Withdrawal Rate ................................................................................................ 32
In the End, the Percentages Don’t Matter Much ................................................................................ 34
Chapter 8 – Tricks for Finding the Money to Save .................................................................................. 35
Trick #1: Free Money from an Employer ............................................................................................ 35
Trick #2: Free Money from the Government ...................................................................................... 35
Trick #3: Go Cheap on Investment Management Fees........................................................................ 35
Trick #4: Bump Your Working Years ................................................................................................... 35
Trick #5: Delay Social Security Benefits until Age 70 ........................................................................... 36
Trick #6: Cut Any Other Investment Expense Fees.............................................................................. 36
Trick #7: Prioritize Your Retirement Savings over Other Investments ................................................. 36
Trick #8: Save a Year of Time ............................................................................................................. 37
Trick #9: Get Smart about Any Inherited IRA or 401(k) Accounts ........................................................ 37
Trick #10: Save Any Unexpected Windfalls ......................................................................................... 38
Trick #11: Bump Your Earned Income ................................................................................................ 39
Trick #12: Get Frugal .......................................................................................................................... 40
Chapter 9 – Seven Awkward Questions.................................................................................................. 41
Can I Really Rely on Social Security?................................................................................................... 41
Can I Run The Thirteen Word Plan with Fewer than 30 Years? ........................................................... 41
What If My Household Wants to Accumulate More Money?.............................................................. 42
What If My Household Can’t Possibly Save $6,000 Annually? ............................................................. 42
Can I Run the Thirteen Word Plan For a Child Or Grandchild? ............................................................ 42
When Does a Target Retirement Fund Not Work Well?...................................................................... 43
Introduction
You can use a simple roadmap to achieve financial independence.

More specifically, you can use a simple, thirteen-word retirement plan to end up with retirement savings that
put you, roughly, at the 90th percentile as compared to other retirees.

You absolutely don’t need to do anything complicated or costly for this thirteen-word retirement plan—just so
you know that. In fact, complicated plans make preparing for retirement too hard. And costly plans usually
sabotage results.

This short book talks in detail about how the thirteen-word retirement plan works. And the short chapters that
follow give you all the information you’ll need to have in order to run the plan. But before we go any farther,
gosh, let me share the plan:

$6,000 annually into an IRA or 401(k) invested in cheap target retirement funds

We shouldn’t spend too much more time getting ready to talk about the thirteen-word retirement plan, but to
make your reading easy and fast let me share just a handful of quick tips.

First, I put as much of the nitty-gritty detail as I could fit into the footnotes. Accordingly, you can ignore those
if you don’t need to see things like how calculations work, sources, or technical clarifications.

Second, you can visit this page at my blog, http:evergreensmallbusiness.com/13wordretirementplan.htm to get

an Excel workbook that shows all the key calculation results in the chapters that follow.

Third, just so you know this from the very start, other than being a customer of one of the mutual fund
management companies, I have no financial relationship with any of the companies mentioned in the pages
that follow.

And now, let’s get started.

1
Chapter 1 – Setting Expectations
If you save $6,000 annually into an IRA or 401(k) and invest your money into cheap target retirement funds,
you can end up with a retirement nest egg of around half a million dollars.

More precisely, if you annually save $6,000 into your IRA or 401(k) or into any retirement plan option that
essentially works like an IRA or 401(k) account…

And you earn 5% annually…

And you save this amount for thirty years (so you make thirty $6,000 contributions) …

You end up with about $399,000. 1

If you save and invest for 35 years, you end up with about $542,000.

I’ve adjusted these future retirement account values for inflation. And I make this adjustment throughout the
book to keep the discussion apples to apples. If inflation occurs—surely it will—you should end up with
bigger balances.

I don’t know if that $399,000 or $542,000 figure sounds like a lot of money to you. But with those retirement
savings amounts, you should find yourself in great shape as long as you receive a Social Security benefit and
especially if you have economical housing.

But let me, if it’s okay, share some information so you know how good an outcome $399,000 or $542,000 is…

Taking a Bite of the Reality Sandwich

Slightly more than half of retirees and near-retirees hold zero retirement savings according to a recent Federal
Government study. 2 (Some of these people do report that they have pension benefits from a defined-benefit
pension plan.)

For the roughly 50% of the retirees and near-retirees that the same study says have retirement savings, the
averages run a little over $100,000 for people in the 55 to 64 age group and about $150,000 for the people in
the 65 to 74 age group.

Only about 14% of retirees and near retirees end up with $399,000 or more in their retirement savings. And
only about 10% of retirees and near retirees end up with $542,000 or more in their retirement savings.

Run the thirteen-word retirement plan over 30 years or 35 years, therefore, and you should end up either in or
nearly in the top 10%.

1
I use 5% as the adjusted-for-inflation rate of return your savings earn, as discussed in Chapter 6.
2
This report appears here http://www.gao.gov/assets/680/670153.pdf if you’re interested.

2
Clearly, ending up in the top 10% counts as a good deal. But a bit of detail brings the picture into focus.

What $399,000 Looks Like in Retirement

Let’s look at how your retirement works if you accumulate $399,000 and your household earned an average
salary (about $60,000 annually) over the years.

You can probably plan on about $25,000 of Social Security benefits if you’re single, or on about $37,500 if
you’re married. 3

You can probably draw nearly $16,000 annually from your nest egg.

Note: I assume that you can draw 4% annually from your retirement nest egg. If you accumulate $399,000, for
example, and draw 4%, that’s about $16,000 a year to start. Chapter 7 goes into detail about this percentage.

Your household income, once you combine your Social Security benefits with your retirement draw, maybe
runs from $41,000 to $53,500 depending on whether you’re single or not.

Again, note that per our example, you’ve been making (in current day dollars) about the national household
average of $60,000.

This $60,000 might seem like a long way from $41,000 or $53,500. But you’re closer than you may realize.

You won’t save for retirement once you’re retired. You won’t pay Social Security taxes once you’re retired.
You may see other living expenses decline, too, once you’re retired. What if you pay off a mortgage or
relocate to a less expensive area?

In short, if you averaged $60,000 in annual income over the years you work and you retire with $41,000 or
$53,500 in retirement income, you should be in great shape financially. In fact, if you made $60,000 while you
worked and then you retire with $53,500 in retirement income, you may notice a bump up in your lifestyle.

What $542,000 Looks Like in Retirement

If you save $6,000 a year for 35 years and earn 5%, you accumulate $542,000 in retirement savings.

Again, if you earned $60,000 over the years you were employed, you can probably plan on about $25,000 of
Social Security benefits if you’re single or about $37,500 if you’re married.

3
Social Security replaces about 90% of the first $11,000 of the wages earned, about 32% of the wages earned
between $11,000 and $67,000, and then about 10% of the wages earned between $67,000 and $133,000.
Someone averaging $60,000, then, receives roughly $25,000. Their spouse receives either their benefit or 50% of
the $25,000. To get the precise benefit formula, visit this page: https://www.ssa.gov/oact/cola/piaformula.html
3
And then with $542,000 of retirement savings, you should be able to draw about $22,000 a year from your nest
egg.

In this scenario, your combined retirement income equals either $47,000 or $59,500 depending on whether
you’re single or married. But note again, you’ll see your expenses drop substantially.

During retirement you won’t be spending $4,000 a year on Social Security taxes. During retirement you won’t
be squirreling away $6,000 a year for retirement savings.

In fact, if you run the thirteen-word retirement plan for 35 years, you probably end up with monthly spendable
income quite a bit bigger than you enjoyed during your working years.

Three Quick Remarks Before We Move On

Let me share three quick comments before we talk about how and where you find the $6,000.

First, notice the big bump you get if you can run your plan over thirty-five years instead of thirty-years. No,
don’t freak out. I am not suggesting you work five years longer in a job you hate. But you want to know that
stretching out your plan to thirty-five years makes a giant difference.

Second, remember that I’m adjusting all the dollar amounts for inflation. You can, therefore, forget about
inflation while you read this book. All the dollar amounts reflect current day dollars.

Third—and this is important—don’t worry if right now you have no idea where you get that $6,000 I keep
throwing out. In the pages that follow, I explain where you can get much of the money.

4
Chapter 2 – Understanding Why People Seem to Fail
If you accept that you need to start saving money for your retirement, skip this chapter. No seriously, go ahead.
Jump ahead to Chapter 3. You don’t need to read the stuff written here.

If you find yourself still unsure about whether or not you really need to save money, however, I want to share
with you my observations about why most people fail to prepare financially for retirement. I feel awkward
doing this. Some of what I say comes across as a little preachy. But we need to talk about the three roadblocks
to making a retirement plan work.

Retirement Plans That Are Too Complicated

A first roadblock you’re already heard about. Most retirement plans are too complex. And too expensive. And
I’m going to guess that part of the reason you maybe haven’t made the progress you wanted or maybe don’t
have the plan you want stems from this complexity and cost.

The good news? We’ve got that fixed, right? You can use the thirteen-word retirement plan described here.
We’re talking about $6,000 annually into your IRA or 401(k). We’re talking about you using a particular type
of cheap investment fund for those savings.

In the chapters that follow, I’ll talk more about all the details. But I promise you, the thirteen-word retirement
plan is simple enough to work easily. And the plan should deliver you a great result compared to any other
plan—including those that cost more and those that burden you with painful complexity.

Misunderstanding the Logic of Income Allocation

A second roadblock to talk about? People goof up the income allocation math. But let me explain.

Suppose, for sake of illustration, that you’re 30 years old, that you plan to retire at age 60, and that you
anticipate living to age 90.

In this situation, obviously, you earn an income for 30 years, but you spend for 60 years.

The roadblock is, then, acknowledging that you want to allocate your 30 years of income over 60 years.

The logic of income allocation hides some good news, fortunately. The situation works better than it looks.
You earn income on the chunk of your earnings you set aside and invest. 4

4
If you did not earn investment income and you needed to pay for 60 years of living with 30 years of earning, you
would need to save half your earnings. That makes sense, right? Without investment income, each year of working
would need to pay for two years of living.

5
In fact, the average household usually makes its retirement numbers work if the household saves about 10%
percent over about 30 years. The preceding chapter, for example, shows how saving $6,000 annually works
well for a household making $60,000.

Financial Grief and Retirement Savings

Okay, an observation about a common third roadblock: Some people react to their retirement finances in a way
that reflects the five stages of grief. I want to use the five stages of grief model here because if you’re stuck on
getting going, sometimes looking at the issue this way helps you get “unstuck.”

Stage 1 is denial, of course. Using the example of a cancer diagnosis, the reaction of denial leads to thinking
the doctor is wrong. Or that the medical test returned a false result. But retirement planning can provoke a
similar reaction. You or I can deny that the income we earn over our working years needs to pay for our living
expenses over all our life. Being in denial about this, we tell ourselves and others that we’ll never retire…

Stage 2 is anger. Again, a health-related worst-case scenario makes the similarities easy to spot. A patient or
the patient’s family gets angry at the doctor for a late diagnosis. Maybe at some other person who bears
responsibility. Maybe at God. And one can see the retirement planning equivalents of denial too. Wall Street
scoundrels stole our money. A financial planner behaved unethically if not worse. Or the politicians in
Washington D.C. broke the economy. The problem with denial? You and I still need to save a substantial
chunk of money each year while we work if we plan to not work for the last years of our lives.

Stage 3 is bargaining. Again, a worst-case scenario health crisis presents an easy way to see clearly bargaining.
Someone bargains with God or a doctor or an insurance company hoping that a healthier lifestyle or better
behavior or an experimental treatment can be traded for a cure or at least longer life. I think you see this stage
with people’s retirement planning too. People hope to bargain with employers or the government or the next
generation to compensate for previous mistakes or financial boo-boos.

Stage 4 is depression. You don’t need me to explain this. Probably you’re not depressed if you’re reading a
book about a common-sensed retirement plan approach. But lots of people do give up and then sink into
sadness. That’s a crummy way to live. Depression also stops and stalls someone from taking constructive
action.

Stage 5 is acceptance, as you probably remember. Hopefully, acceptance is where you are. Acceptance lets
you, and lets me, make good decisions and take practical steps. In terms of preparing for retirement, we need to
accept the reality of income allocation. And then we need make good decisions about our retirement plan.

Maybe I’ve laid it on a bit too thick with the five stages of grief stuff. And, no argument, the five stages of
grief model suffers from flaws even if you’re using it for traditional grief triggers like death and divorce. 5

5
You might find it interesting to peek at the Wikipedia article on the Five Stages of Grief, which appears here:
https://en.wikipedia.org/wiki/K%C3%BCbler-Ross_model

6
But you can see, hopefully, that a big chunk of the population responds to the issue of retirement savings in
ways that look very much like one of the first four stages of grief: denial or anger or bargaining or even
depression.

And that simply doesn’t work. What we all need to do is respond with acceptance. And then we need to get
going with regular annual contributions to something like an IRA. Or a 401(k). Using a cheap target retirement
fund.

Final Point of Chapter - Don’t Get Bummed Out Yet

Okay, I think I can guess what you’re thinking. This business about saving maybe 10% of your income is all
good in theory, but in practice, how do the numbers even work? And what planet did I come from to think that
the average household can save anywhere near 10% a year?

For the record, I hear you. So, let me share a handful of really important comments so you realize this isn’t as
hard or painful as you may think.

Some Free Money Is Available: The first thing to note, for example, is that some, and maybe even most, of the
money you need for your retirement can come from the federal and state government and, possibly, from your
employer. I describe how this math works in Chapter 3. But let me just point out now that if you need to save,
say, $6,000, you can often get a big chunk of this money from someone else. At this stage, you might want to
assume you can get half the money from other people.

You Already Know How to Do Something like This: Another thing to note… This business about the process
taking 30 years? Or even 35 years? You might think that’s too long to commit to any financial project. But you
actually are okay with big multi-decade financial commitments. I know you are. You may have already made a
two-decade-ish financial commitment by becoming a parent. Many people make a three-decade financial
commitment when they buy a home using a 30-year mortgage. In short, most of us already comfortably
shoulder multi-decade financial burdens. And we can handle this one too.

People Who Live on 90% or 95% of What You Make Do Fine: A quick point. I guarantee people you know
and respect live great lives earning an amount that’s equal to 90% or 95% of what you make. In other words, if
your family income equals the average household median income of roughly $60,000, saving 10% equals
$6,000 a year. And if this is your situation—and you know this is true—you have friends and family members
who live a great life on $54,000. Accordingly, you can do that too. And again, I need to emphasize, that some
of the money you need to save won’t come from your $60,000 income but from other people like the federal
and state government and possibly from employers.

You May Have More Flexibility Than You Realize: Yet another point to note is this. You do have wiggle
room. You can move the numbers around and get the same place in the end. You can, for example, trade a few
more years of saving for a slightly smaller annual savings amount. You can tweak your retirement plan in
some minor ways that will over time boost your results. You can also take advantage of some of the stuff

7
that’ll happen in your life (like that once in a blue moon windfall) to effectively catch up on your plan.
Summing things up, you can run your own slightly customized version of the thirteen-word retirement plan
and get a good result.

Note: I’ve been throwing out that $60,000 average household income figure a few times in the earlier
paragraphs. But remember that if you’re living in an area where living costs less than average or if your
household counts fewer members than average, the idea of saving 10% of a $60,000 salary may be higher than
is necessary. Further, if your household income is less than the average household’s, say because your
household has one person, you can often use a smaller percentage than 10%. (I’ll talk more about this in
Chapter 7).

What Other Choice Do You Have? And then a final, important point: You do need to plan for retirement if
you want to someday stop working.

I’m going stop here. And you may want to take a short break too. We’ve just covered the hardest (and really
the only difficult) part of the thirteen-word retirement plan.

Once you’re ready to start again, read Chapter 3, “Using an IRA or 401(k),” to get some information and
advice on how to smartly use an IRA or 401(k) to store your retirement savings. In Chapter 3, I also explain
how you may be able to get much of the money you need for retirement from your employer, the federal
government, and the state government.

8
Chapter 3 – Using an IRA or 401(k)
The thirteen-word retirement plan says you should use either a traditional Individual Retirement Account or an
employer-sponsored 401(k) account. You can also use some other option that works like an IRA or a 401(k).

You should use a traditional IRA or a 401(k) plan for two reasons.

First, your retirement account won’t pay any income taxes on the income it generates. By the way, you might
pay income taxes on the money you someday draw down, but that outcome is unlikely. Most people—even
people who end up with hundreds of thousands of dollars in their retirement accounts—don’t need to worry
about paying income taxes during retirement. 6

And then importantly a second reason exists for using an IRA or 401(k) for your retirement plan: If you use
one of these plans, you get free money you can use for some of your savings. With both IRA accounts and
401(k) accounts, the average household may create substantial tax savings. And with 401(k) accounts and
anything else that works like a 401(k) account—such as a Simple-IRA—an employer may throw in extra free
money.

By the way, note what we’ve just discussed: Some big chunk of the money you need for running the thirteen-
word retirement plan will come out of other people’s pockets—and not out of your family’s budget.

Let’s dig into the details…

Take the Free Money

A handful of employer-provided pension plans give you, in effect, free money. And almost always, you want
to take the free money.

You probably have encountered 401(k) plans. And these plans commonly provide an employer match equal to
some percentage of your income. The formulas employers use vary. But one common matching formula says
an employee who participates in the 401(k) plan gets a 4% contribution from the employer if employee
contributes 4% from wages.

Someone who earns $60,000, for example, might actually get $2,400 from employer matching.

And note that if you have two employed spouses who together earn $60,000—maybe one person works
fulltime and earns $40,000 and the other person works part-time and earns $20,000—the 4% matching can
work the same way. The higher earner may get a $1,600 match and the lower earner may get a $800 match.
But add the numbers together and the family gets the full $2,400.

6
An Evergreen Small Business blog post shows how most people don’t need to worry about income taxes in
their retirement:
http://evergreensmallbusiness.com/why-you-dont-need-to-worry-about-taxes-in-retirement/

9
Small businesses also regularly offer something called a Simple-IRA which works like a “lite” 401(k) plan and
offers a 3% match if the employee contributes at least 3%. If you make $60,000 in your job, 3% of your wages
equals $1,800. With a Simple-IRA, this means that if you contribute $1,800 or more to your IRA, your
employer will also contribute $1,800.

The actual limits on what you or an employer can contribute to a Simple-IRA or a 401(k) don’t really matter in
most cases. But here are the numbers as of 2019. An employee can typically contribute up to $13,000 to a
Simple-IRA, but can bump up that to $16,000 if aged 50 or older, and an employer can contribute a 3%
matching amount to a Simple-IRA account. An employee can typically contribute up to $19,000 to a 401(k),
but can bump that up to $25,000 if aged 50 or older, and an employer can contribute a matching amount equal
up to 25% of an employee’s wages to a 401(k).

The table that follows shows whose money (yours or someone else’s) gets saved with a 4%-matching 401(k)
plan or with a 3%-matching Simple-IRA plan when you want to save $6,000, when you annually earn $60,000,
and when you pay a 15% top combined federal and state income tax rate.

Where Money Comes From How a 401(k) Works How a Simple-IRA Works

Your money $3,060 $3,570

Money from tax savings 540 630

Employer matching 2,400 1,800

Total saved $6,000 $6,000

With something like a 401(k) plan, you solve about half of your savings challenge simply by taking the free
money. In the table that precedes this paragraph, for example, a 401(k) saver gets $540 of tax savings and
$2,400 of employer match money which they can use as part of the $6,000.

The Simple-IRA option delivers a huge chunk of the money you want, too. The table shown here suggests a
Simple-IRA saver who wanted to save $6,000 might get $630 of the money needed from tax savings and then
$1.800 of the money needed from the employer match.

That $6,000 problem you had in the last chapter? You chop that problem in half with a 401(k). And you chop
that problem by more than a third with a Simple-IRA.

And for this reason, if you can get free money, you want to take it.

10
When You Can’t Get Free Money
You are not going to always be able to tap into an employer’s free matching money for some year’s retirement
savings. But that’s okay. You can often get big tax savings—money you can also use indirectly for your IRA
contribution.

If your household’s top marginal tax rate equals 15%, for example, a $6,000 contribution to your IRA saves
you $900 in income taxes. You only therefore need to come up with $5,100 of your “own” money in order to
make a $6,000 contribution to your IRA. 7

If your household’s top marginal rate equals 25%, which might be the case if you’re an upper-middle-class
taxpayer hit with a 22% federal tax rate on your last dollars of income and a 3% state tax rate, a $6,000
contribution to your IRA saves you about $1,500 in income taxes and you only need to come up with $4,500 of
your “own” money.

With the IRA option, in other words, you can often get a big chunk of your $6,000 from tax savings.

Using Tax Savings for 401(k) and IRA Contributions

At this point, people sometimes ask how one gets the tax savings into your IRA or 401(k). So let’s talk about
that.

Using the 401(k) example from the table on the preceding page, if you tell your employer to withhold $3,600
from your pay checks over the year, your employer does withhold $3,600 for your 401(k) plan—which
decreases your paychecks. But your employer also automatically decreases your income tax withholdings by
$540 because of the 401(k) deduction—which increases your paychecks. 8 These two paycheck adjustments, in
combination, mean that you end up with your tax savings effectively “going into” your retirement account.

In the case of an IRA deduction, the accounting requires more effort. If you contribute $6,000 to your IRA and
this contribution reduces your taxes by $900 over the course of the year, you will need to ask your employer to
withhold $900 less income taxes over the year. You’d then use that extra $900 of take-home pay to make part
of your IRA contribution.

Let me issue a caution about this fiddling with your tax withholding for your IRA. You may need to
experiment a bit to get your withholding savings working just right. And do be careful about your numbers.
The mother of all battles, in the world of taxes, occurs when you find yourself surprised you owe a big bunch
of taxes on April 15th.

7
For 2019, you can contribute $6,000 to an IRA ($7,000 if you aged 50 or older) as long as you earn that amount.
8
If you combine a $3,600 401(k) deduction with $540 of tax saving, the net paycheck effect equals $3,060 a year.

11
Two Other Reasons You Want to Work with an IRA or 401(k)
As mentioned in the opening paragraphs of this short chapter, the big reasons that you and I want to use things
like IRAs and 401(k) accounts are (a) we avoid income taxes on our investment income and (b) we get free
money from the government or our employer.

However, two other good small reasons exist for using an IRA or 401(k), too:

Reason #1: You lock up your savings. Tax law penalizes you and me in a couple of ways when we withdraw
IRA or 401(k) money before we retire. First, we may pay an early withdrawal penalty that runs 10% to 25%
depending on the type of retirement account. Second, we may pay a pretty high tax rate on the money because
we get taxed at our top marginal rate on withdrawals and that rate might be high if we’re still working.
However, while that sounds bad, here’s the way I think we should see all this: These penalties are actually
good if the penalties help us stay disciplined about our retirement savings. Remember the logic of income
allocation as shared in Chapter 2. We all need to spread the three or four decades of earning we do over the six
or so decades of spending we do.

Reason #2: Your retirement savings are protected. A final reason to use something like an IRA or 401(k)?
Your retirement accounts receive protection from creditors that other savings and other assets don’t. In a
lawsuit or bankruptcy, for example, you could lose your non-retirement savings, your house, a business, and
lots of other stuff in a worst-case scenario. But the money you store in your retirement accounts, and especially
the money you’ve stored in any employer retirement plans which is what a 401(k) plan is, get really good
protection.

12
Chapter 4: Please, Please Not a Roth
If what you’ve read thus far sounds pretty good, but you’re wondering why in the world I haven’t talked about
using a Roth-style IRA or 401(k), we should take a slight detour and talk about the Roth options.

The reason for this is that some well-meaning people are going to tell you that you don’t want to use an IRA or
401(k)… that you instead want to use a Roth-IRA or Roth-401(k).

These people are almost always wrong. But let’s go over the facts.

By the way, if you’re not interested in a Roth? If you’re on-board with using a traditional IRA or regular
401(k) account (or anything that looks like either of these accounts)? Just skip this chapter.

The Attraction of a Roth-style Account

You probably know the attraction of a Roth-IRA or Roth-401(k), right?

Unlike a regular retirement account, you can withdraw money from a Roth-style account without paying
income taxes. So, whatever you accumulate inside your Roth-IRA or your Roth-401(k) you’ll be able to
withdraw without paying taxes.

This seemingly free lunch appeals to many people. But here’s the reality: You probably shouldn’t put your
retirement money into a Roth-IRA or Roth-401(k).

In this chapter, I explain the math behind this suggestion.

A Simple Example of When a Roth Account Fails

Let me start by sharing with you an example that shows the fundamental reality of the Roth option.

Say you have a $5,000 bonus to invest. And say you haven’t yet paid any taxes on this income because you
don’t know how you’ll invest the money.

But say you can invest the money into a regular traditional IRA account. And that’s attractive because then
you’ll get a $5,000 tax deduction on your tax return.

Or you can invest the money into a Roth-IRA account. That means you’ll need to pay taxes on the money
upfront. But on the leftover amount you’ll be able to invest, you’ll be able to earn a tax-free return.

For the sake of illustration, assume that you pay a 20% combined federal and state tax on your income. (I use
this tax rate because it makes the math easier to understand. Most people pay lower tax rate.)

Finally, just to keep things simple initially, assume that your money earns no return. The return on the
investment, in other words, equals zero. (I’ll make things more complicated and realistic in a minute, don’t
worry.)

13
Here’s what happens with a regular IRA. You put in the entire $5,000. So far so good. Then when you later
withdraw the money during retirement, you have to report the $5,000 withdrawal as income—which means
you pay $1,000 in taxes. Your net after-tax proceeds with the IRA option equal $4,000.

And here’s what happens with a Roth-IRA. You have to pay the $1,000 in 20% taxes upfront. So that’s
unfortunate. You put only $4,000 into the Roth account. But here’s the attraction: When you pull the money
out during retirement, you don’t pay any income taxes. You get the whole $4,000.

But see what happens? After you correctly account for the front-end or back-end taxes, the withdrawal
amounts equal each other.

And the reason is simple: The tax rates equal each other.

The take-away? If the rates are equal, a Roth-IRA and a regular IRA result in the same tax bill.

Another Simple Example of Roth Weirdness

Okay, so when would the regular IRA and Roth-IRA amounts differ? Well, only when the tax rates differ. So
let’s look at that next.

To keep things simple, let’s again assume the return on investment equals zero percent.

But now assume that while you work, your top tax rate equals 20% but that when you retire, your top tax rate
will equal 10%.

So, here’s what happens with a regular IRA. You put in the entire $5,000. And when you later withdraw the
money during retirement, you have to report the $5,000 withdrawal as income. At a 10% retirement tax rate,
you pay $500 in taxes which means your net after-tax proceeds with the IRA option equals $4,500.

Now compare that to what happens with a Roth-IRA. In this case, because the top tax rate during your working
years (according to our example) equals 20%, you have to pay the $1,000 in tax upfront and so put only $4,000
into the Roth account. But when you pull the money out during retirement, you don’t pay any income taxes.
You get the whole $4,000.

When you compare the net cash amount you get after the front-end or back-end taxes, the traditional IRA after-
taxes amount of $4,500 is better than the Roth-IRA amount of $4,000.

And the reason is pretty intuitive. You want to avoid the highest top tax rate. Instead, you want to pay lowest
top tax rate on the money. That means paying the 10% rate on withdrawals from the traditional IRA rather than
having to pay a 20% rate up front on the money you want to put into a Roth-IRA.

The big insight here? The decision to use or not use a Roth-style account rests almost entirely on the top tax
rate you pay today versus the top tax rate you will pay in retirement.

14
Furthermore, because we live in a society with pretty progressive tax rates and because most people enjoy
higher taxable incomes when they work as compared to when they’re retired, almost always, a Roth-style
account only costs an investor more taxes. Ouch. 9

Compound Interest and a Roth Account

Let me address the issue of compound interest and its effect on the math, because people understandably ask if
compound interest changes things.

To illustrate the effect of compound interest, let’s again assume that you’re thinking about how to invest a
$5,000 retirement savings contribution. You’re considering using a regular IRA or a Roth-IRA. Let’s again
assume that the top tax rate you pay now, and which you’ll pay in the future, equals 20%.

But let’s add this wrinkle. Let’s assume that that you’ll earn a 6% return on your money and that you’ll invest
the money for 12 years.

Note: A 6% interest rate over 12 years causes your money to double.

Here’s what happens with a regular IRA in this example. You put in the entire $5,000. Over twelve years, if
the money earns 6%, the account grows to $10,000. When you later withdraw the $10,000, you have to report
the withdrawal as income. With a 20% tax rate, you pay $2,000 in taxes which means your net after-tax
proceeds with the IRA option equal $8,000.

Here’s what happens with Roth-IRA. You have to pay the $1,000 in tax upfront and so you can put only
$4,000 into the Roth account. Over the twelve years you invest, the account grows to $8,000 if you annually
earn 6%. The good news here, so to speak: You don’t pay any income taxes when you withdraw the money.
You get the whole $8,000.

But look at the result: Compound interest doesn’t change things. If your top tax rate when you work equals the
top tax rate when you’re retired, the IRA and the Roth-IRA options deliver the same result.

Just to repeat this point, then, the big (massively big) insight one wants to keep in mind? The decision to use or
not use a Roth-style account rests almost entirely on the top tax rate you pay today versus the top tax rate you
will pay in retirement.

Roth-style Worst Case Scenarios

Just in case you’re still on the fence, I need to tell you that three common “worst-case” scenarios make the
Roth-style option even worse than suggested by the simple tax rate comparisons shared in the preceding
paragraphs. We ought to discuss these scenarios just to be thorough.

9
I made this point in Chapter 3, but very probably in retirement you will pay a very low marginal tax rate. Nearly
zero if you’re running a retirement plan like that proposed in this book. And, of course, as noted in the
Introduction, 90% of the population will fail to accumulate the sums you can accumulate with the thirteen word
retirement plan.
15
Roth Worst-case Scenario #1: Savings Shortfall
A first thing to consider: If you come up short on your retirement savings, you are really not going to need to
worry about paying taxes on the money that comes out of your IRA or 401(k).

Say, for example, that either a late start or adverse circumstances mean you and your spouse retire with annual
Social Security benefits of $30,000 and a $250,000 IRA nest egg from which you’ll draw $10,000 a year.

That is still a way better job than most people do. But in this scenario—and any that are less optimistic—you
definitely won’t pay any federal income taxes. And you probably won’t pay any state income taxes either.

Given this, you probably aren’t crazy to say to yourself, “Hey I’m first going to worry about stuffing as much
money into my IRA or 401(k) as I can, and I just hope I have the problem of paying income taxes in
retirement.”

Roth Worst-case Scenario #2: Long-term Care Costs

Let me point out another worst-case scenario that affects the Roth-style account versus a traditional IRA
account analysis: long-term and nursing home care.

Here’s the deal: Because long-term care costs count as an itemized deduction, if you or your spouse end up
requiring long-term care, funding that expense out of a traditional IRA or tax-deferred investment account
should be very tax efficient.

For example, say you accumulated a $1,000,000 IRA or 401(k) balance—so double the size suggested by the
thirteen-word retirement plan. 10 That sounds like a sure-fire recipe for a big tax hit if you need to start taking
big taxable distributions, right? But if you end up paying for lots of healthcare in the final years of your life,
those big itemized deductions further reduce the attractiveness of a Roth-style account too.

Note, too, you can also use most other big itemized deductions to shelter income from an IRA. For example, if
you make large charitable contributions, those donations effectively shelter IRA distribution income. If you
pay large property taxes, those taxes effectively shelter IRA distribution income. Ditto for mortgage interest
and other Schedule A itemized deductions, too.

Roth Worst-case Scenario #3: Short or Shorter-than-expected Retirement

A final worst case scenario to at least mention in passing. (Sorry.)

Any IRA balances you hold when you die are untaxed to you. So, you may be worrying about taxes you won’t
ever have to pay.

10
I think everything I’m saying here applies to people with IRA balances not just double the size provided by the
thirteen word retirement plan but also IRA balances quadruple the size provided by the thirteen word retirement
plan.
16
By the way, yes, your heirs may need to pay taxes on the balances. But you won’t. And you want to recognize
this.

The logic of you paying taxes so your heirs won’t? Not compelling…

Furthermore, an heir should be able to stretch out withdrawals from your IRA over a very long time. And that
means that the tax rate heirs ultimately pay will very possibly be very low.

I’m going to talk more about this in Chapter 5 when we discuss how to deal with any inherited retirement
accounts you receive. But a thirty-something heir who stretches out a $500,000 inherited IRA might, if the heir
has a mortgage and children or if the heir can redirect the inherited IRA’s funds into their own IRA, pay zero
income taxes on the annual distribution drawn from the inherited IRA. (This scenario would assume the heir
doesn’t have other income bumping them into higher tax brackets.)

Tying Things Up with a Bow

So let me tie up this “Why Roth accounts don’t make sense” discussion with nice little bow by suggesting the
following take-away: While a best-guess scenario concerning a Roth-style account is that the accounts don’t
make any financial sense, in common worst-case scenarios a Roth-style account really, really doesn’t make
sense.

And just to repeat a point because it’s so important: Most people enjoy higher taxable incomes when they work
as compared to when they’re retired, so almost always the Roth-style account only costs an investor more
taxes.

When a Roth Does Make Sense

Fairness requires me to tell you that in three or four situations taxpayers probably should consider a Roth-style
account rather than a traditional 401(k) or traditional IRA account. Let me identify and describe these
situations.

People Who Don’t Currently Pay Any (or Much) Income Tax
If someone doesn’t pay income taxes or doesn’t pay much income tax, a Roth-style account probably makes
good sense.

The reasoning here goes like this: If such a person uses a traditional IRA or 401(k), they don’t get any or much
tax savings because they don’t pay any or much tax. And the Roth-style account could save them taxes in the
future.

For example, anyone with a below-median income, a mortgage or children usually doesn’t pay any federal
income tax and very possibly doesn’t pay state income tax. This investor should, given the choice, use a Roth-
style account rather than a traditional IRA or 401(k).

17
People Who Will Probably Always Pay the Top Tax Rate
This next idea probably matters to no readers of this little book, but let me share it anyway…

Remember that the optimal choice when picking between Roth-style and traditional retirement accounts comes
down to the top tax rates. And what someone wants to do is “pay the fiddler” when the tax rate is lowest.
Usually that’s during retirement.

However, if you’re someone who will always pay at the top tax rate, you may as well pay your taxes now by
using a Roth-style account. You don’t know for sure that you’ll save income taxes by doing this.

But you will by using a Roth-style account “lock in” your tax rate, in effect protecting yourself against future
tax rate increases. You will also reduce or eliminate the need to take required minimum distributions from your
retirement accounts. (Probably this isn’t you if you’re reading this book… but who knows.)

By the way, you probably don’t need to start thinking you’ll always be in the top tax rate until you accumulate
$10,000,000 or more in investments and these investments produce annual income something in excess of
$500,000.

People Who Want to Tax-diversify

Okay, this is maybe a little far-fetched, but you will sometimes hear pretty smart people talk about using Roth-
IRAs and Roth-401(k)s as a way to diversify the tax risks connected to your investments.

As a tax accountant, I am not a fan of trying to guess what Congress will do.

That said, this tax diversification angle is probably a semi-decent idea for people with multi-million-dollar IRA
or 401(k) balances. Say over $2,000,000? Again, this probably isn’t you. And just so you know, I don’t think
this is a great idea. I think it’s an okay idea.

But, gosh, who knows what Congress might do in the future with regard to retirement accounts (including both
traditional IRA and 401(k) accounts and also Roth-style accounts).

Accordingly, if you want to be super-cautious, it’s probably not crazy to spend at least a few minutes thinking
this way—especially if you’re doing a good job saving for retirement. Very possibly, Roth-style
accounts might be treated differently in any re-writing of pension tax laws. And if that were the case, you
might benefit from having your money sprinkled among a few different types of retirement accounts.

People with a Decimated Portfolio—Maybe

One final category of investor may want to consider using a Roth-style account: someone with a massively
beat-up IRA account balance and money outside of tax-deferred accounts to pay for a conversion. This applies
to almost no one, but words are free in an e-book so let me describe this final rationale for using a Roth-style
account with an example.

18
Suppose that you have a growing IRA balance and that you also know by the time you retire this money will
have doubled. Or even quadrupled. Further suppose that (perhaps due to some financial system meltdown like
the one experienced in 2008) that the IRA balance declines by half. So, boom, a $100,000 balance becomes a
$50,000 balance. And now another assumption: Also assume that you know in retirement you will pay
significant income taxes. (Most people won’t, as I’ve said several times, but we’re assuming you will for
purposes of this example.)

In this situation, it’s probably not crazy to consider converting the $50,000 IRA to a Roth-IRA. Yes, you’ll pay
a hefty tax rate on this conversion. Perhaps 30% of the $50,000, so $15,000?

But assuming the stock market rebounds and that your IRA balance continues to grow, you may (in effect)
lock in your tax bill at a low level due to the temporarily depressed account balance.

Note: People who did this during the “2008 Great Recession,” ended up really well obviously… and though
risky what they were betting implicitly was that their 401(k) and IRA accounts really had not been halved in
value no matter what the statements from the mutual fund company or their investment adviser said… Rather,
these people assumed that the craziness in the stock markets only made it seem that way.

We’ve now talked more than enough about Roth-style accounts. Let’s get back to the details of running the
thirteen word retirement plan. Because the next thing we want to talk about is how to save money on your
investment management costs.

19
Chapter 5: Cheap Really Matters
Lots of times, when you buy some important product or service, you don’t go cheap. I mean, sure, you
probably always consider price. But price isn’t the only or the dominant factor.

If you need heart surgery, for example, you don’t shop on price.

But with investment advisory and management services, I think you do want to shop based almost entirely on
price.

In fact, you want to find the cheapest widely-diversified mutual fund you can.

Note: A mutual fund goes out and buys the bunch of stocks and bonds that you want as your investments and
then does the record-keeping for your share of the fund.

Accordingly, in this chapter, I want to talk about why you can “go cheap” and why “going cheap” makes such
a huge difference in your outcome.

Why You Can Go Cheap with Your Investing

In a word, “computers.”

Computers, specifically, do two really important things for you if you’re an investor. First, a computer cheaply
assembles and does the record-keeping for a giant, richly diversified portfolio of high-quality stocks or bonds.
This doesn’t surprise you, I’m sure. But this work is important. And the work improves your returns as long as
the computer’s efficiency creates cost savings for you.

But computers also do (and have for more than a couple of decades done) something else that’s really
important and also more than a little weird. The computers have made it really easy to see how well a clever
investment advisor does as compared the stock market’s averages. And here’s where things get awkward…

It turns out the emperor has no clothes.

More specifically, computers pretty much irrefutably prove that investment gurus don’t “beat the averages”
over time. If the stock market over ten years delivers a 5% annual return, nearly all of the investment gurus
who run things like mutual funds will earn less than a 5% return. 11

I know. This hardly makes sense. But it means you have two choices.

11
It turns out that economists and financial experts have long suspected this result. If you’re interested in dipping
your toes into this topic, you might want to start by reading the Wikipedia entry on the efficient market
hypothesis, which appears here: https://en.wikipedia.org/wiki/Efficient-market_hypothesis

20
You can let a computer cheaply and easily assemble a giant portfolio of stocks and bonds. You will only earn
the average return if you do this. But you pay almost nothing for the work the computer does. People call this
approach “index investing” or “passive investing.”

Alternatively, you can let some investment guru assemble a portfolio of stocks and bonds that you (and the
guru) hope will beat the market. The guru will charge you a large fee for this effort. Though some years the
guru will beat the averages, the effort will almost surely fail over the long run. And then because you’ll be
paying the investment advisor handsomely for his efforts, your investment returns will fall short of the market
averages. People call this approach “active investing.”

Just so you know, other than people trying to sell you investment guru services, basically no one thinks “active
investing” mutual funds and managers can over time beat a computer doing “index investing.” Warren Buffet,
for example, thinks you ought to index. 12 13David Swensen, the fabulously successful active investor who ran
the giant Yale University endowment fund thinks you ought to index. 14 Robert Shiller, the Noble prize
winning economist who warned everybody about the housing bubble thinks you ought to index. 15 John Bogle,
the founder of the Vanguard Group (the world’s largest mutual fund company) thinks you should index.
Charles Schwab thinks you should almost surely index. 16 And the list goes on and on.

The First Reason Cheap Matters a Lot

I’m hoping I’ve got you on board with the notion that you can use index investing for your retirement plan—
which is, as noted, basically the same thing as saying you are comfortable to just let the computer cheaply
assemble a basket of essentially all the stocks and bonds in an index.

And so now let me discuss why this approach matters hugely for your retirement plan.

If you use index investing, your annual investment management costs (in a sense, your share of the computer)
run maybe .15% of your assets if you use something like a Vanguard Group target retirement fund. Your first-
year investment expenses, if you save $6,000 because you’re running this book’s the thirteen-word retirement
plan, might equal $9.

12
http://www.npr.org/2016/03/10/469897691/armed-with-an-index-fund-warren-buffett-is-on-track-to-win-
hedge-fund-bet

13
http://www.marketwatch.com/story/why-warren-buffett-is-giving-bad-advice-to-disciplined-investors-2015-03-
02

14
http://www.npr.org/2015/10/17/436993646/three-investment-gurus-share-their-model-portfolios

http://articles.chicagotribune.com/2013-10-14/business/ct-biz-1015-gail-20131015_1_index-funds-stock-
15
21
market-apple-stock

16
http://blogs.marketwatch.com/thetell/2014/05/22/charles-schwab-himself-is-a-big-fan-of-index-funds/
If you use an active investment fund or collection of active funds where behind the scenes some investment
guru picks stocks, you’ll probably pay .8%. That’s the average per a recent study from Morningstar, and works
out to $48 for the year on a $6,000 investment. 17

Now maybe that little, itty-bitty .65% difference doesn’t seem that bad. But you want to look at the impact of
the extra cost on both your future retirement savings and on your future retirement income. And when you do
that, the extra expense really adds up.

With a higher expense ratio, you lose tens of thousands of dollars of savings. (Instead of saving for 35 years
and ending up with $542,000, for example, you might save for 35 years and end up with $475,000.)

The Second Reason Cheap Matters a Lot

But financial math becomes downright tragic after you retire.

When you combine lower retirement savings at the start of retirement with higher investment expenses each
year during retirement, you shave more than $6,000 off your retirement income if you don’t use a cheap target
retirement fund. This is just brutal math. 18

Two Final Comments About Cheap

I hope I’ve convinced you of the power of keeping your retirement plan really economical. You really do want
to go cheap—something you’ll do by using index funds.

But before we end this chapter, let me share two final comments about the importance of cheap.

First, you should know that while the average actively managed investment fund charges .8%, you can in many
situations find yourself paying quite a bit more. 19 Obviously, half of the actively managed investment funds
charge more than .8% annually, so that’s a piece of the puzzle.20 And then it turns out that actively managed
funds may also have additional costs they tend to incur, too, such as trading costs. The point here? You need to
be careful because things can get a lot worse that the .8% annual charge.

And a second comment: In addition to your investment fund fees, you may also be paying investment advisor
fees. I ignored these fees in the discussion here. But if you feel like you have to pay them for managing your
money, these fees (which can cost you another .5% annually) sabotage your retirement plan finances.

Quite bluntly: I think you can probably skip having an investment advisor if you’re okay and comfortable
running with the thirteen word retirement plan.

17
Here’s the actual Morningstar study: https://news.morningstar.com/pdfs/2015_fee_study.pdf
18
To forecast the effect of paying .65% more in fees, this e-book assumes you pay them out of your draw.
19
Morningstar asset-weights their calculation. Without that adjustment, the average expense ratio equals 1.19%.
20
The average expense ratio charged by one large payroll service company’s 401(k) plan runs about 1%.
22
Chapter 6 - Target Retirement Funds
I will guess that you think the $6,000 annual savings amount suggested by the thirteen word retirement plan
makes sense. And that the thirty- or thirty-five-year timeline makes sense.

Furthermore, I bet you already knew to use something like an economical 401(k) account or an IRA. One
doesn’t need to be a financial genius to see that free money is free money. Or that saving taxes is good.

I also, however, can guess that you still have some questions about picking the actual investments you’ll use.
In fact, I’ll bet you’re more than a little nervous. Over time, your portfolio should grow very large. And one
wants to be smart…

Choosing Your Investments is Easier than You Think

Here’s the surprising thing, though: Once you buy into the plan where you’re going to use index investing, you
don’t pick your investments. Rather, you pick an asset allocation formula.

This sounds complicated. But it really isn’t. All people mean when they use the phrase “asset allocation” is a
set of percentages for splitting your savings between different types of investments.

The traditional asset allocation, for example, says you put 60% of your money into stocks and 40% of your
money into bonds. People who think a lot about such things like the 60%/40% approach because it gives you
almost as good a result as a 100% stocks approach but with considerably less of a rollercoaster ride.

If you use cheap index funds to mimic this formula, you could therefore put 60% of your money into a cheap
stock index fund and 40% of your money into a cheap bond index fund. But in practice, asset allocation works
even easier than that. If an asset allocation formula becomes popular, you’ll probably also have the option of
buying a single index fund that uses the asset allocation formula you want. If you wanted to go with a 60%
stocks and 40% bonds allocation, you could buy a single cheap index fund that invests 60% in stocks and 40%
in bonds. People often call these funds “balanced funds.” 21

Here’s the next thing you want to know. People who think a lot about such things have come up with a bunch
of different asset allocations, but if you look closely, these formulas mostly resemble the 60% stocks and 40%
bonds allocation that we’ve just started talking about.

Warren Buffet has reportedly suggested his wife use a 90% stocks and 10% short-term treasury bonds asset
allocation. (Mr. Buffet is very smart but also very rich and what makes sense for his heirs probably doesn’t
make sense for you or for me.)

21
The largest balanced index fund is the Vanguard Balanced Index Fund. It invests 60% of its money into the US
stock market and 40% into high-quality taxable bonds using index funds. The Vanguard Balanced Fund charges as
little as .07% annually, or $7 on every $10,000 invested.
23
John Bogle, the founder of the mutual fund giant the Vanguard Group, suggested that people invest their “age”
or maybe a little bit less in bonds and then the rest in stocks. Someone who is age 50, for example, would
invest 40% to 50% in a bond fund and then 50% to 60% in one or more stock funds.

More than one financial writer has suggested splitting one’s savings into thirds and then investing in an
inflation-protected US Treasury bonds fund, a total US stock market fund, and then a total international stock
market fund.

Taylor Larimore, an author and thought leader at the popular boglehead.org wiki and online discussion forum,
has suggested something very similar, where one splits one’s saving into three chunks: A total U.S. stock
market index fund; a total International stock market index fund and a total bond market index fund.

Other smart people have come up with asset allocations that use a larger number of index funds to smooth the
rollercoaster ride and hopefully juice up the portfolio’s returns… but these allocations still often boil down to a
60% stocks and 40% bonds formula.

Bill Schultheis, an investment advisor and author, has suggested a variation on the 60%/40% asset allocation
where the 60% that’s in “stocks” is spread evenly across six, more specialized stock categories including a real
estate investment index fund (also known as a REIT index fund), an international stock fund, and then the
remainder into both big US company stocks and small US company stocks.

Former Yale University endowment fund manager David Swensen has suggested a 70% stocks /30% bonds
asset allocation where you put (essentially) 30% into bonds but use high quality US treasury bonds and then
70% into stocks from not just the US but also from stock markets outside the US.

Physician, author, and investment advisor William Bernstein has suggested using a nine category asset
allocation formula which basically atomizes the 60% stocks and 40% bonds components by using smaller,
even more specialized investment classes.

Note: The Bogleheads.org wiki has a good summary of these asset allocation formulas as well as several
others. I provide the URL to the webpage in the footnote. 22

The number and the percentages of all these different asset allocation formulas can make your head spin. But
really you only need to know four things to make a smart decision about which one you should use.

Thing #1: All of these asset allocations (with the exception of Mr. Buffet’s which is really only for someone
very very wealthy) split the savings between stocks and bonds (often 60% stocks and 40% bonds) to dampen
the fluctuations in value that come from stock prices and bond interest rates yoyo-ing. That’s a good and smart
thing according to all of these people—and you and I should take their cue.

22
Here’s the link in case you’re interested: https://www.bogleheads.org/wiki/Lazy_portfolios

24
Thing #2: One of these asset allocations will, in fact, be best for your retirement savings program—but the
problem is you and I can’t know looking forward which one. And neither can anyone else.

Thing #3: All of these asset allocations will do a pretty good job if you or I stick with the allocation over the
decades we save and invest. We need to not freak out, for example, when stocks or bonds lose a bunch of their
value. This has happened before. It will surely happen again.

Thing #4: The one thing you and I need to do if we use any of these asset allocation formulas is periodically
adjust (or “rebalance”) our holdings to match our asset allocation percentages. For example, if we choose the
60% stocks and 40% bonds asset allocation formula, a rise in stock prices may put our actual allocations at
65% stocks and 35% bonds. And in this case, we then need to sell some of our stock investments and buy
some more bond investments to bring things to back to that preselected 60% stocks and 40% bonds level. 23 Or
if we don’t want to do this, someone else needs to do it for us, which brings up my next point.

Thing #5: You can buy a cheap target retirement fund, which will have been designed by investment experts,
and then not worry about any of this. With a cheap target retirement fund, essentially what happens is that a
big mutual fund company picks a pretty good asset allocation for you based on the number of years of saving
you have left. Over time, they change your asset allocation so it’s less risky and they also do any rebalancing.
This isn’t precisely what happens, but you can think about the target retirement funds this way. If you’re forty
years from retirement, they might use an asset allocation like Warren Buffet’s suggestion for his heirs so 90%
of your money goes into stocks and then 10% goes into bonds. But then over time, the asset allocation
percentages change so that two or three years before retirement you have 60% invested in stocks and 40% in
bonds. After retirement, by the way, these percentages might continue to adjust until you hold 30% in stocks
and 70% in bonds. 24

Picking a Specific Target Retirement Fund

You see where this is going, right? You can just use a target retirement fund. You don’t need to fiddle with
some slightly customized version of that 60% stocks and 40% bonds asset allocation formula. Nor do you need
to do any rebalancing.

We simply want a good, cheap target retirement fund. Any target retirement fund from a big mutual fund
company will do this. Though as noted in Chapter 5, cheaper really is better. But a target retirement fund is
what works just fine, thank you.

Really, the only thing you need to decide with a target retirement fund is when you want to retire. The year you
want to retire lets you pick the right fund.

23
This adjustment process not only keeps your investment risks level, it tends to slightly bump up your investment
performance. David Swensen in his wonderful book “Unconventional Success” suggests that daily rebalancing at
the Yale University Endowment Fund adds about half a percent annually to the fund’s return.
24
Taylor Larimore, when he read a draft version of this e-book, made this useful comment too
25
If it’s 2020 and you plan to retire in 30 years in 2050, for example, you choose the fund that specifically “asset
allocates” for people who will retire in 2050.

Generally, mutual fund companies use the anticipated retirement year in the fund name. Here are the names
(and expense ratios) of the target retirement funds from Vanguard, Fidelity, and Charles Schwab, for example:

• Vanguard Target Retirement 2050 (expense ratio .15%)

• Fidelity Freedom 2050 (expense ratio .75%)

• Schwab Target 2050 (expense ratio .8%)

Not to keep beating the same drum, but make sure you appreciate how big a difference it makes to pay a .15%
expense ratio instead of a .75% or .8% ratio. If you’re not sure, peek again at Chapter 5.

Note: If you work someplace where your employer doesn’t offer a cheap target retirement fund, print out
Chapter 5, highlight appropriate portions and then hand-deliver it to your employer’s human resources
department.

When No Target Retirement Fund Option Exists in a 401(k)

If you’re saving money for retirement using an IRA, you absolutely will be able to find a cheap target
retirement fund. Vanguard will probably be your cheapest option, by the way, as indicated in the earlier
paragraphs.

However, if you will use an employer’s 401(k) plan for your retirement plan because it’s providing free
matching money, you may not have a target retirement fund option.

In this case, you can as a temporary solution construct your own “target retirement fund” using the logic and
formulas I’ve provided here.

You already know from your reading here, for example, that if you’re a long way from retirement, these target
retirement funds often use asset allocations that put 90% into stocks and 10% into bonds. So, you might be
able to do something similar given the other investment choices in your employer’s 401(k).

Using similar thinking, if you’re closer to retirement, you might simply use that 60% stocks and 40% bonds
asset allocation. In this case, you might be able to tell your human resources or the payroll department that you
want 60% of your money going into a cheap stock index fund and then 40% of your money going into a cheap
bond index fund.

And another thought: If this fiddling with percentages is exactly what you want to avoid, you probably do have
another option. No matter what, your employer’s 401(k) plan should provide you with an economical balanced
fund which probably automatically invests 60% in stocks and 40% in bonds.

26
If you’re a long way from retirement, yes, conventional wisdom says you should be more adventurous than
this… but who knows… you may actually beat the professionals with “60% in US stocks” and “40% in taxable
US bonds.” Feel free, and clever, to go with this simple approach, too.

And again, just to say this, do-it-yourself asset allocation works just fine as a temporary solution. Eventually,
you’ll get the money into a cheap target retirement fund where someone like Vanguard deals with the
management and record-keeping.

Criticisms of Target Retirement Funds

Before moving on, we should talk about the criticisms that some people level at the target retirement funds.
Let’s do that here. You and I can quickly discuss these points.

Okay, if you Google or Bing on the search term “disadvantages target retirement fund,” you get pages of
website articles that argue against target retirement funds. Mostly, the arguments boil down to three general
criticisms:

1. Some of the target retirement funds aren’t that economical.

2. A more complicated asset allocation might give you better results.

3. You might want a different asset allocation than the “default” used by a target retirement fund for
someone in your age group.

These are great points to consider. Let’s address them one by one.

First, the point about some target retirement funds being uneconomical? Absolutely correct. That’s why the
thirteen word retirement plan suggests you use cheap target retirement funds. Go cheap, and you’ll be in good
shape. You don’t, as discussed in the last chapter, want to waste money on investment management expenses.
Waste money and you just get totally beat up with regard to your retirement income.

Note: Just to remind you about this, paying .8% rather than .15% might cut your retirement income by about a
quarter. Someone who goes cheap, in other words, might get $22,000 a year in retirement income from the
thirteen word retirement plan and someone who doesn’t go cheap may be looking $16,000 a year.

The second criticism is that a more complicated asset allocation might give you better results. Or maybe what
someone promises is that a more complicated asset allocation will give you better results.

In any case, this criticism suffers from two big weaknesses. As a first weakness, you and I probably can’t
ahead of time identify which more complicated asset allocation will work better. (Surely, most won’t.) As a
second weakness, you and I don’t just need a more complicated asset allocation plan to work better, we need it
to work enough better to pay for any extra fees or risks we bear. This is very unlikely, financial history
suggests. Accordingly, this second criticism, given its weaknesses, seems impractical and unfair to me.

27
The third and final common criticism of target retirement funds is that you or I might want a different asset
allocation than the default formula for our age group. This criticism, I think, rests on quite solid ground. But
I’m not sure it’s a reason to avoid target retirement funds. Rather, this criticism means maybe (if you’re willing
and able) you should look at buying a target retirement fund for someone who’s actually in a different age
group. For example, if you want to bear less risk, maybe you to pretend you’re ten years older than in fact you
are. Or, if you want to bear more risk, maybe you pretend you’re ten years younger.

The Big Benefit Critics Ignore

One other point should be made during any discussion of the disadvantages of a target retirement fund.

The automatic, systemized nature of a target retirement fund becomes a powerful advantage as you and I age
and for a surviving spouse or domestic partner. We want to recognize that—even if the critics of target
retirement funds often don’t.

The “automatic and systematized” benefit shows up in a couple of areas.

First of all, as you and I age, we may well lose our ability to effortlessly rebalance and adjust a portfolio. A
complicated or customized asset allocation formula therefore possibly becomes a headache at some point. And
by the way, even if you think, well, when I can’t handle this, I’ll assign the job to a talented ethical investment
advisor, how do you know you’ll be able to do that when the time comes? You see the problem.

And then there’s another aspect of this “automatic and systemized” approach, too. If something happens to you
or me and we’re married or domestically partnered with someone, how will our surviving spouses or partners
deal with this more complicated or more customized plan? Are they up to the task in the days and months and
years after they become a single person? They won’t have any problem “handling” the situation if we’ve been
using a target retirement fund. But heaven help them if we’ve been doing something clever but complicated.

Summing up, a cheap target retirement fund provides an awfully good way to invest retirement savings.
Perfect in every situation? No, but good. Darn good.

28
Chapter 7 – Playing with the Percentages
The earlier chapters of this little e-book, almost casually, toss out three percentages.

Early in the book, for example, after noting that the average household income earns $60,000 annually, I say
that what makes sense is for this family to save $6,000, or 10% of their income.

In more than one chapter, I talk about you earning a 5% return on the money you save over the decades you
run your thirteen word retirement plan.

And then, at several points through this book, and frankly without much explanation, I talk about you annually
spending 4% of your retirement nest egg once you quit working full-time.

Each of these percentages—10%, 5% and 4%—deserves a bit of discussion. Though they look like numbers I
simply pulled out of the air, they aren’t.

Setting the Right Percentage of Your Income to Save

Let’s talk first about the percentage of your income that you ought to save.

This book makes a big point that you can end up with a great retirement planning result—better than nine out
of ten people—if you just save $6,000 annually and you continue saving for three decades or so.

I also point out in a bunch of places that the average household makes about $60,000 a year, which means
implicitly the thirteen-word retirement plan suggests the average person save about 10% annually.

But let me just clarify a couple of things so we aren’t misunderstanding each other.

First, if your household income varies from that $60,000 median value, then while you definitely can still use
the $6,000 value, you maybe want to consider adjusting your annual savings. Moreover, while you might be
inclined to calculate a new number using that 10% figure, you may also want to adjust your savings percentage
up or down for the realities of the way Social Security benefits work.

I’ve got a blog post at Evergreen Small Business 25 that goes into the weeds on this topic. That post includes an
Excel workbook you can download and use to come up with a savings percentage that works for a given set of
circumstances. But when I play with the numbers, the savings rates and amounts appropriate for different
income levels probably look something like what follows:

Income Savings Percentage Annual Amount Saved

$10,000 0% $0

Here’s the link to the actual post: http://evergreensmallbusiness.com/income-allocation-versus-asset-allocation-

25

why-income-allocation-is-more-important/

29
 $20,000 4% $800

$30,000 7% $2,100

$40,000 8% $3,200

$50,000 9% $4,500

$60,000 10% $6,000

$70,000 11% $7,700

$80,000 12% $9,600

$90,000 13% $11,700

$100,000 14% $14,000

What’s going on in the preceding table is simple: The Social Security Benefits formula replaces a big
percentage of the first dollars of income a person earns. But then as the person’s income grows, the
replacement percentage drops.

Because less of your retirement income comes from Social Security the more your income grows, the more
your income grows, the bigger percentage you need to save. If your household income equals $30,000, for
example, maybe you shoot for a savings percentage of 7%. If your household income equals $70,000, maybe
you shoot for 11%.

Note: Remember that 3% or 4% of your savings percentage will probably come from an employer. You may
also be able to pick up 1% or even more from federal and state income tax savings.

Let me also make another quick observation. While a traditional Individual Retirement Account lets someone
save up to $6,000 a year ($7,000 a year if aged 50 or older) in 2019, if your household wants to save more than
$6,000, you need to get a little creative.

For example, if you’re married and want to exceed that $6,000 threshold, you may want to double-up on your
IRA contributions by doing IRA contributions for both spouses. Even if only one spouse works in a wage-
paying job, the family can probably deduct two contributions to an IRA. 26

26
You and your spouse can contribute to a traditional IRA if you aren’t covered by an employer’s qualified
retirement plan. If one of you works outside the home and the other doesn’t, the nonworking spouse can
contribute to a traditional IRA if the family’s income falls below a specified limit. That limit in 2019 equals
$193,000.
30
If your household can’t make an IRA work because you’re covered by a qualified retirement plan at the place
where one spouse works, that may mean you can’t use a traditional IRA as the container for your savings. But
that should be okay because your employer’s qualified retirement plan should give you enough space to
contribute what you want.

A Simple-IRA retirement plan in 2019, for example, provides for a $13,000 annual employee contribution
($16,000 if the employee is 50 or older) plus an employer contribution equal to 3% of the employee’s annual
wages. Work out the math and you’re probably talking enough space to allow for nearly $20,000 of annual
savings.

A 401(k) retirement plan in 2019 provides for an $19,000 annual employer contribution ($25,000 if the
employee is 50 or older) plus a possible employer contribution that might commonly equal 4% of the
employee’s annual wages. Work out the math in this case and you’re probably talking enough space to allow
for $25,000 to $30,000 of annual savings.

Choosing a Return on Investment Percentage

We should talk briefly about the 5% return on investment percentage, which I’ve referenced several places
already in this book.

On the face of it, this 5% figure seems way too high. Or at least it will to some people who carefully watch the
stock markets and the economy. But I do believe that you can plan on a real return of 5% over the years you
run your thirteen-word retirement plan.

The math behind this assumption goes like this: I figure that over the first decade (when your account balances
are relatively modest), you’re going to get pretty poor returns. For example, even though you’re going to be
investing mostly in stocks if you’re using a target retirement fund and paying essentially zero investment
expenses, I assume you will earn a real return of 3%. 27

Then, I assume in the second and third decade of the accumulation phase of your retirement plan that you’ll
enjoy 5.25% annual returns, which are (once you adjust for modest expenses) pretty close to the long-run
historical averages produced by the asset allocations employed by target retirement funds. 28

When you average a first decade of 3% returns with two final decades of 5.25% returns and you round, you get
a 5% real rate of return. And note that if this seems weird, you want to remember that the decade of low

27
You can estimate long-term real returns by combining the dividends rate, the growth in the company earnings,
and inflation. I get to 3% by saying dividends equal 2%, earnings growth equals 3%, and inflation equals 2%.
28
Long run stock returns average maybe 9%. If one subtracts 3.5% inflation and .25% expenses, that leaves a 5.25%
real return. For more details on returns of balanced portfolios, see this article:
http://web.archive.org/web/20061214061904/http://dfmadvisors.com/pdf/Bernstein6040.pdf
31
returns is also the decade of pretty small account balances. So those years when your investments only earn 3%
don’t matter that much.

That’s probably enough chattering away about real rates of return.

Selecting a Small Safe Withdrawal Rate Percentage

The math behind the statements that you can withdraw annually 4% of your savings after you retire deserve a
bit of discussion, too.

For example, in earlier chapters of this little book, I say that with a 4% withdrawal rate and $400,000 in
retirement savings, you can draw $16,000 annually because 4% of $400,000 equals $16,000.

A first thing to note about this math: The 4% safe withdrawal rate assumes that you bump up your annual
withdrawals over time for inflation. If inflation runs 2% some year, for example, you bump up your next year’s
withdrawals by that same 2%. If in year one, you withdrew $16,000, a 2% inflation adjustment would mean in
year 2 you should withdraw $16,000 plus an extra $320, or 2%. And you would continue to annually adjust
your withdrawal amount for changes in the consumer price index over the years you spend.

A second thing to note: With a 4% withdrawal rate, most years you draw less money than you earn if your
retirement savings are “stock heavy.” But that will not always be the case—some years your portfolio will lose
money and then your draw will shrink the portfolio even further. That reality points out an unlikely but still
real worst-case scenario: Running out of money if you experience several bad years in a row. Now, again, this
worst-case scenario is unlikely. Probably, your heirs will end up with a bunch of money. But if you begin
retirement and your first few years of retirement occur when the stock market performs terribly and then you
live a really long time, in some scenarios a 4% safe withdrawal rate approach may mean you come up short. 29

Criticizing a 4% Safe Withdrawal Rate

People who understand the math of spending down your retirement savings point to several very legitimate
flaws in something like the 4% safe withdrawal rate. But what you need to understand is that while these flaws
matter if you’re at the doorstop of retirement, the flaws don’t matter much if you’re simply trying to plan your
retirement.

Nevertheless, let’s briefly identify and discuss the most talked about flaws.

Flaw #1: Rigidity of Withdrawals: For the actual withdrawals, critics point out that the 4% safe withdrawal
rate is too rigid. It doesn’t reflect your actual spending, for one thing, which is a problem because retirees tend
not to spend the same amount each year of retirement. (They often spend less over time.) And it doesn’t
provide a way for you to tighten your belt if the stock markets sag or crash and you want to economize. I
agree, and probably you should too. The “rigidity” thing is real in theory. However, very frankly, I think we

29
Technically, if your last few years of work occur when the stock market does very poorly, you can also find
yourself coming up short in terms of your retirement savings. As a “real” worst case scenario, however, you can
probably plan to fix this by working a year or two longer than you hope.
32
can still use the 4% safe withdrawal rate for planning. We just all need to remember that when we do retire, we
shouldn’t mechanically and unthinkingly spend some ever-inflating “safe withdrawal rate” amount. You and I
both need to apply some common sense.

Flaw #2: Large Unspent Balances: Another flaw critics point to is that by drawing out an amount that means
you probably never run out of money, you probably never spend all the money you’ve saved. Most of the
people using a 4% safe withdrawal rate, in other words, leave money for their heirs. And some critics view that
as problem. Okay, no doubt, this criticism reflects financial reality. But I’m not sure you and I have practical
responses. We really do want to avoid running out of money. And I’m not sure about you, but I’d like to leave
some money for my kids. Finally, some of the people most aggressively pointing out this flaw conclude that
what we therefore need to do is buy annuities with our retirement savings. An annuity (which is a contract with
an insurance company where they pay you monthly for the rest of your life) lets you spend all your money and
end life with no retirement savings. That approach definitely lets us spend more. But an annuity also lets the
annuity salesperson earn a commission and forces you or me to bear risk related to the insurance company’s
solvency. You should make up your own mind on this issue, but I’m not going to worry if I leave large unspent
balances. In fact, I hope I do.

Flaw #3: Assumes Unrealistically High Returns for Today’s Markets: A third criticism you hear most
often from recent retirees and their advisors. It goes like this: In today’s economy with its low stock market
returns and low interest rates, you simply can’t look at long-term historical averages and assume you’ll be
okay as a new retiree. Again, I agree with this criticism, but if you’re starting out with a retirement savings
plan, you don’t need to worry about the next few years of stock market returns or interest rates. Yes, the next
few years do look bleak. But they don’t really matter to you. (If you want to worry about something, worry
about those first ten years after you retire.)

Two final comments you might find useful and comforting: First, if you’re interested in how safely you might
draw down your anticipated future nest egg, visit the www.firecalc.com website. It provides a simple tool that
you can use to test how something like a $16,000 retirement draw would have worked with $400,000 of
savings had you retired at any point in recent history. 30

A second comment: In my own retirement planning, just so you know, I plan to draw 4.25% annually (based
on simulations just like those provided by calculators like the www.firecalc.com tool I just mentioned.) With a
nearly 30 year period of retirement, the simulators suggest my wife and I have about 90% probability of not
outlasting our savings. And if the economy looks to be in rough shape at the point I actually do retire, I’ll deal
with that by working a bit longer or by spending a chunk less.

30
The www.firecalc.com calculator shows that a $16,000 starting draw from a $400,000 nest egg works about
97% of the time. That success rate is probably higher than you need because two unlikely things need to
happen in order for you to run out of money. First, you live a long time. Second, you experience a really bad
patch of returns early in retirement. The chance that both unlikely scenarios occur together is very low.
33
In the End, the Percentages Don’t Matter Much
Let me end with one final comment about the percentages discussed in this chapter.

For the most part, you probably don’t need to worry too much about anything other than getting good about
your saving.

In other words, don’t worry too much about the return on investment percentage. Don’t wring your hands too
much about the safe withdrawal rate. Heck, I wouldn’t even worry about whether you’re saving 10% of your
income or some other percentage.

Rather, focus on getting going with a disciplined annual savings program where you save some meaningful
amount. I’ve suggested $6,000 a year because that works well for the average household. But you can pick
some other number based on your income and your specific situation.

The main thing—and sorry to keep saying this—the main thing is you need to save.

In the next chapter, therefore, I talk about where to find this money.

34
Chapter 8 – Tricks for Finding the Money to Save
This chapter summarizes the best ways I know of that you can find the money and time you need for your
thirteen word retirement plan. Specifically, I provide a dozen tips for finding either money or time. Remember
you need both to make your retirement plan work.

Note: The first half of the list below repeats stuff discussed in earlier chapters, but I figure that it’s okay to
review.

Trick #1: Free Money from an Employer

You want to take any free money offered by an employer.

Chapter 4 goes on and on about this point, talking about how an employer may contribute 3% or 4% of your
salary to something like a 401(k) plan or a Simple-IRA. You can refer to that chapter if you want more
information or want help understanding the math and your options.

But let me just say this: An employer match provides a lot of the money you need for your annual savings.
You really could be talking around $2,000 a year from this source.

Trick #2: Free Money from the Government

You want to take any upfront tax savings offered by the federal government and state government—which
simply means you want to use a traditional IRA, an employer’s 401(k) plan, or an employer’s Simple-IRA
plan.

For the typical family, the tax savings you get from making a tax-deductible contribution to an IRA or 401(k)
is probably worth nearly $1,000 if you’re saving $6,000 annually.

Trick #3: Go Cheap on Investment Management Fees

I talked in Chapter 5 about the importance of being cheap. But let me repeat that suggestion here.

If you use a cheap target retirement fund—one where you’re paying peanuts to the mutual fund management
company—those savings really add up over time.

Remember something pointed out in Chapter 5: If you don’t watch your costs, you may be giving up about a
quarter of your retirement income. Rather than $22,000 a year of income, for example, you may be looking at
less than $16,000 a year of income.

Trick #4: Bump Your Working Years

You understand already that if you work a few more years, those extra years of work and saving really bump
your retirement savings and income.

Can I suggest a possibility, however? You may be underestimating how powerful working a few more years is.

35
Two things happen when you work a few more years. First, you end up with more money. And sometimes a
surprising chunk more. And, second, you spend down the savings over a shorter time frame.

The precise “bump” you get depends, but simulations often show you get nearly a 50% bump in the amount
you can safely draw each year from your retirement savings if you work an extra five years.

Trick #5: Delay Social Security Benefits until Age 70

This idea maybe doesn’t sound very good, but if you really can’t make the numbers work any other way, you
may want to work and delay drawing Social Security benefits until you hit age 70.

Do this and, as just noted, you fiddle with the income allocation formula in a manner that bumps your income.

But something else neat happens, too. If you delay drawing Social Security by a couple-three years, your
monthly benefit bumps up nicely. A three-year delay, for example, might bump the annual benefit up by
roughly 20%. If you would have received $25,000 at age 67, you might get $30,000 at age 70.

Trick #6: Cut Any Other Investment Expense Fees

A quick point: If you’ve been spending money on investment advisors or magazines or newsletters to help you
with your investments, consider cutting those costs out of your budget.

Saving $50 or $100 a year (or more?) doesn’t provide a bunch of the money you need. But it provides a little
bit of the money. And staying away from the crowd that touts complex, high-cost investment options probably
keeps you out of trouble.

By the way, saving a .5% investment advisory fee will provide a bunch of money. And I don’t know why, if
you’re using cheap target retirement funds, you would need an investment advisor.

Trick #7: Prioritize Your Retirement Savings over Other Investments

Can I also say this? You ought to make your retirement savings a priority over any other investments.

Let me point to an example of what I mean by this: college costs for children.

If you’ve got children and find yourself trying to squirrel away a bit of money for college or some other
educational expense in their future? That’s great, but your retirement is clearly a higher priority.

This little e-book isn’t a book about saving and paying for college. But kids and grandkids have ways to go to
college even if parents don’t save money. Some states provide free community college to high schoolers, for
example. Some employers provide massive support for college costs of their employees. Scholarships do exist
and can be substantial if you think ahead.

If you look, you can also find very economical options for attending college. Finally, if none of these options
work, a student always has the option of borrowing money and then repaying any loans with the higher wages
a smart investment in education usually pays.

36
In comparison, no states let people retire for free. No “retirement scholarships” exist. No banks loan money for
retirement.

Just so you won’t think I’m an ogre, I think education represents a great investment if students show common
sense about their studies. But your kids’ and grandkids’ educations shouldn’t be a higher priority than your
retirement.

Trick #8: Save a Year of Time

Another quick, minor suggestion if you’re using an IRA: Make your contribution early.

In other words, make this year’s contribution on January 1 and not next year on April 15. Making your
contribution fifteen months early means that every contribution you make earns an extra fifteen months of
investment income.

This has the effect of slightly but rather easily bumping up your starting retirement account balance by 5% or
6%.

Trick #9: Get Smart about Any Inherited IRA or 401(k) Accounts
You or your spouse may have a parent or grandparent name you as the beneficiary of an IRA or 401(k)
account. If this occurs, you probably will at some point inherit an IRA or 401(k) balance. Should this occur,
consider using this money to jumpstart or catchup your retirement plan.

But let’s discuss how this works using the example where you inherit an IRA with $50,000.

If you want, you will be able to take the entire $50,000 out all at once and without penalty. Boom.

But if you do that, you’ll typically get hit pretty hard with taxes. You might lose 25% or even 30% in taxes
because the IRA withdrawal will be income added to your other income from wages and salaries.

However, as an alternative, what you can nearly always do is draw down an inherited IRA or 401(k) over time
based on your life expectancy.

If your life expectancy is 50 more years, you would need to draw out a $50,000 IRA at roughly the rate of
$1,000 a year.31

Here’s how this connects to you funding your IRA. What you can do is draw money out of the IRA—for
example, draw out $6,000—and then immediately deposit this money back into your own IRA. The money
you withdraw from the inherited IRA counts as income, and the money you deposit into your own IRA counts

31
Required minimum distributions (RMDs) get complicated. What really happens is, each year you need to
withdraw the RMD reported on the Form 5498 you receive in the spring. Form 5498 calculates the RMD by dividing
the account balance at the start of the year by your remaining life expectancy. A $50,000 balance and a 50-year life
expectancy, for example, means a $1,000 RMD. Furthermore, over time account balances grow and life expectancy
decreases which means an ever larger RMD. 37
as a deduction. Done right, you should be able to move the money out of one IRA and then into another IRA
without paying income taxes.

And now let me point out a couple of wrinkles related to using an inherited IRA for your own retirement plan.

First, inherited IRAs are not quite as protected or safe as regular IRAs, so you want to move the money as
quickly as you can.

For example, if you’re married, you might decide to do a spousal IRA and so move $12,000 out of the
inherited IRA, and then $6,000 into your IRA and then $6,000 into your spouse’s IRA.

Here’s a second wrinkle that can really jack your retirement savings. If you or a spouse has an employer
pension plan that provides a matching amount, you may want to withdraw money from an inherited IRA and
then recontribute the money into the employer plan that provides the matching.

Let’s say, for example, that your annual household income equals exactly $60,000 (my estimate of the national
average), that you or your spouse work someplace where your employer provides a 401(k) plan with 4%
matching, and that you want to take $6,000 from an inherited IRA and put this money into your retirement
account.

What you ought to consider doing in this case is drawing $6,000 from the inherited IRA and then asking your
employer to use $6,000 of your wages for your 401(k) contribution.

This shouldn’t hurt your family cash flow at all. The $6,000 withdrawal from the inherited IRA draw and the
$6,000 extra contribution to your 401(k) cancel each other out. 32

But look what happens: Your $6,000 401(k) contribution probably means your employer is now kicking in
$2,400 a year matching contribution into your 401(k). In effect, you’re actually using a $6,000 draw from the
inherited IRA to make a $8,400 annual contribution to your 401(k). Beautiful, right?

Run this trick over the years it takes to move an inherited IRA’s money into your 401(k) and you should see a
great result.

Trick #10: Save Any Unexpected Windfalls

While we’re on the subject of inheritances, let’s talk about a related subject: windfalls.

Now you can’t count on windfalls obviously. That’s why people call them windfalls.

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One weird thing could happen if you’re not careful here. If you tell your employee to redirect $6,000 of your
wages into your 401(k) plan, your employer will reduce your income taxes withheld by about $900 a year. But you
don’t want them to do that. You want your employer to keep on withholding income taxes at the same rate as
before.
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But it’s very possible, maybe even likely, that you or your spouse will over the years you work receive a
windfall or two. Maybe an inheritance or gift from a family member or friend. Perhaps a bonus from an
employer. Maybe you unexpectedly convert some valuable item you own into a small pile of cash.

Think about using these amounts for your retirement plan. And by the way, note that my suggestion does not
mean that you don’t enjoy the windfall. You will. But saving the windfall into your retirement account will
mean you essentially spread the financial benefit of the windfall over decades.

One other thing to note about some windfalls. In many cases, windfalls may be tax-free to you.

This tax-free-ness means you can amplify your retirement contribution with tax savings and possibly employer
matching, as discussed repeatedly in the pages of this book.

Assume, for example, that you inherit $4,000 of cash. If your top tax rate is 20%, you can actually use this
$4000 to make a $5000 IRA contribution. This works because if your tax rate is 20% and you contribute
$5,000 to an IRA, you get a $1,000 reduction in your federal and state income taxes. If you combine this
$1,000 of tax savings with the $4,000 you received as a gift, voila, you have the $5,000 of cash needed to
make a $5,000 contribution.

Or, another even better approach: If you make $60,000 a year and have an unused employer match of 3% or
4%, you might decide to skip the IRA and use the employer’s pension plan to save the $5,000. If you do this,
you might add another $1,800 or $2,400 of employer matching money to the $5,000. That pushes your total
contribution to around $7,000.

That’s a pretty good result from a $4,000 gift or inheritance.

And note this: If you received not $4,000 but, say, $40,000, you wouldn’t run this gambit for a single year…
you might run this gambit for ten years in a row.

Trick #11: Bump Your Earned Income

The preceding paragraphs describe tactics you can use to get chunks of the money you need to fund your
retirement.

If those tactics prove inadequate, however, you really have only two other options left: bumping your income
and cutting your expenses.

I am not going to try to give you some clever idea about how you bump your income by the $1 or $2 an hour
required to have the money needed to run your thirteen word retirement plan.

If you have this option, you already know it. If you don’t have this option, you know that too.

All I’m going to say here is that whatever ideas and options you have for bumping your income? Well, maybe
you want to reconsider all that stuff if you’re now serious about working the thirteen word retirement plan.

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If you can’t bump your income and you can’t make any of the other ideas described previously work, you
really only have one option left. And we’ll briefly describe that next.

Trick #12: Get Frugal

If nothing I’ve said in the earlier paragraphs of this little e-book works, you have only a single option left. You
need to cut your expenses enough to provide for some retirement savings.

I have only two (hopefully useful) comments to make about this cost-cutting. First, if you start looking for
cost-cutting ideas, you’ll find tons of interesting advice, crazy tricks, and sometimes bizarre encouragement in
books and in online forums. Because it’s free, I would start by looking at the www.mrmoneymustache.com
blog and in the related forums.

By the way, some people go just crazy about the frugality stuff. And maybe you’ll end up doing the same
thing. No kidding, I remember once reading in a forum how someone said you could totally cut back on
buying toilet paper. That you could instead use a banana… (More on this in a minute.)

But just so we’re clear here, you don’t need to go this extreme. You just need to find some clever ways to cut
your costs by enough to fund your thirteen word retirement plan. This brings me to a second comment:

You don’t need to find the cost savings you need tonight. Or over the coming weekend. Or even over the next
few months. You have a bit of time to work this out. What you do need to do—if getting frugal is the only
remaining option you have that’s practical—is steadily work toward finding some savings that can be paired
with tax savings and then take your cost savings and your tax savings and multiply them with some employer
matching.

A little bit here, a little bit there, and pretty soon you’ll be talking real money. Then, keep your investment
costs really low by going with a cheap retirement fund. You’ll soon find yourself on the path to something like
“half-millionaire” status.

Oh yeah, I need to tell you about the banana thing… As I continued to read the advice about cutting toilet
paper costs, it become apparent that the person making this suggestion to use a banana had misspelled the
word bandana. Which I still think is more frugal than you need to be…

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Chapter 9 – Seven Awkward Questions
The thirteen word retirement plan raises several awkward questions—or at least it does if you read the plan and
then spend three minutes thinking about it. I want therefore to quickly ask and suggest answers for the most
awkward questions I’m guessing you’ll probably have.

Can I Really Rely on Social Security?

For the most part, I think you can. But let’s talk briefly about the financial problem this question hints at.

The Social Security Administration Trustees report 33 each year summarizes the current financial condition of
the trust fund. And each year, the report paints the same basic picture. At some point in the not too distant
future (the year 2034 in the 2019 report), the trust fund goes to zero and at that point, Social Security taxes
only cover a percentage of the Social Security benefits being paid out (the percentage is 80% in the 2019
report).

Nobody who wants to be re-elected wants to talk about what needs to happen to deal with the shortfall. And to
be fair, we voters penalize candidates who bring this subject up.

But at some point in the future, Congress will surely raise more taxes, bump the retirement age and dial back
on the benefits rather than cut benefits by, for example, 20%.

Can I Run The Thirteen Word Plan with Fewer than 30 Years?
You and I need to view preparing for retirement as a 30 year or 35 year project.

But that said, you can run a watered-down version of the thirteen-word retirement plan if you start at age 50
and save the “catchup” IRA amount, $7,000, for 20 years until age 70. You accumulate about $230,000 if your
investment returns equal 5% a year and that should allow you to draw about $12,000 a year with nearly a 90%
historical success rate. This bigger 5% safe withdrawal works because you’ve got fewer years of retirement to
support with income from your savings.

Note: See my discussion of expected returns on investments in Chapter 7, though. The next decade’s returns
look pretty bleak to me.

The one other thing that makes this plan look better than you might expect is this: As long as you delay taking
Social Security until you reach age 70, you’ll get a big 20%-ish bump in your benefits. If you had been slated
to get $25,000 you’ll now be looking at $30,000. Or, if you and a spouse had been slated to get $33,000, you’ll
now be looking at nearly $39,000.

The obvious trick to getting this option to work is having a reasonably fun job you can work at for a few more
years.

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Here’s a link to the 2019 report: https://www.ssa.gov/OACT/TR/2019/tr2019.pdf

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For what it’s worth, I think the idea of working longer makes tons of sense—and not just for financial reasons.
Jobs and work can enrich our lives.

What If My Household Wants to Accumulate More Money?

You need to save more than that $6,000 a year if you want to accumulate more than half a million dollars.

If you want to double the nest egg you start your retirement with, for example, you probably need to double
your IRA contributions.

If you want to triple or quadruple your starting retirement, you need to use an employer-sponsored retirement
plan such as a Simple-IRA or 401(k) plan which will let you triple or quadruple your annual savings amounts
(including both your money and your employer’s money).

For what it’s worth, it’s pretty difficult to accumulate much more than $1,000,000 in an IRA, more than about
$2,500,000 in a Simple-IRA and more than about $4,000,000 in 401(k). 34

What If My Household Can’t Possibly Save $6,000 Annually?

I would try to get a job with an employer that offers a nice match. (A 401(k) will work best, probably.) And
then I’d try to do whatever I could to get the match.

If your household income equals $30,000, for example, maybe you can get 4% from your employer and
through tax savings. So that equals $1,200 a year. And then if you can somehow come up with another 3% or
$900 a year, you’re sitting at a $2,100 a year retirement savings amount.

That $2,100 annual savings amount, made over 35 years, grows to a $190,000 nest egg by the time you start
retirement. That’s nearly $8,000 a year of draw. You also get around $16,000 a year of Social Security income
at age 67 in this situation—and about $19,000 if you wait until age 70. And you will be fine with that outcome
if you live someplace where the cost of living isn’t high.

Remember too that accumulating a $190,000 nest egg means you’ve done a way, way better job that most
people at saving for retirement.

Can I Run the Thirteen Word Plan For a Child Or Grandchild?

Yes, if the child or grandchild has earned income equal to or in excess of the amount you want to save.

For example, if a kid makes $2,500 a year in part-time jobs, you can contribute $2,500 a year.

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I did a blog post about the myth of a $10,000,000 IRA and that post explains the absolute best-case scenarios for
retirement accounts. You can see the post here: http://evergreensmallbusiness.com/ten-million-dollar-ira-
accounts/

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By the way—and this is probably something you already know and maybe the very reason you’re interested—
but the aspect of this that works really well is that you get so much compounding of interest over 50 years.

Save $2,500 a year for 50 years, for example, and you also hit the half million-dollar mark by the time you get
to the end of the accumulation phase.

With a kid or grandkid paying no income taxes, by the way, you probably do want to use a Roth-style IRA
account. A traditional IRA generates no tax savings in this situation, and the Roth-IRA might save a kid or
grandkid taxes in the future.

When Does a Target Retirement Fund Not Work Well?

Good question. And here’s my answer…

Target retirement funds work really well in most situations. They work great for the average household, for
example. And they work really well for the 90th percentile people who accumulate retirement savings similar
to the amounts anticipated by the thirteen word retirement plan.

But Taylor Larimore, who I mentioned in Chapter 6, read a prepublication draft of this e-book. And he
reminded me of an important exception.

Though Mr. Larimore is a strong advocate of expertly-designed, low-cost target retirement funds, he pointed
out that if you have some of your money stored outside of a tax-deferred account and some of your money
stored inside a tax deferred account, the target retirement fund approach doesn’t necessarily work as well
because of taxes.

This is a topic beyond the scope of this book, but if you find yourself in this situation, and you have a
substantial sum saved outside of your tax-deferred accounts, you will probably want to use the taxable
component of your retirement savings for investing in a cheap stock index fund. Then, you will use the tax-
deferred component of your retirement savings (the chunk inside your IRA, for example) for investing in a
cheap bond index fund. 35

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If you want information about how to do this, consider one of the books Larimore co-authored like “The
Bogleheads Guide to Investing” or “The Bogleheads Guide to Retirement Planning.”

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