Tax preparation is reactive, for the most part. Tax planning is proactive. Most people focus solely on tax preparation, which involves preparing necessary documents to file your taxes. Tax planning involves not only minimizing your tax liability today, but minimizing taxes when you start to draw on your investment assets and throughout your retirement years. We hope you enjoy this episode!
~Kevin
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You can start with our Retirement Readiness Questionnaire linked on our website so we can learn more about how we can help in your journey to and through retirement.
What is a blended family and why does it impact my retirement plan?
First, what is a blended family?
Simply put, a blended family involves a remarriage that comes with children from a previous marriage or relationship. Maybe you and your new spouse both have children from previous marriages. Or, perhaps you have children with an ex and a current spouse.
There are many varieties of blended families, and they are quite common. In fact, it is estimated that 40% of households with children in the United States are blended of some kind. Each blended family has unique circumstances, but retirement and estate planning strategies are more complex when it comes to dealing with blended families. I have been working with blended family retirement planning for over 13 years in our home base of Florida, as well as across the United States virtually, so let’s discuss some key issues to focus on.
How does having a blended family impact my retirement plan?
There are four major topics we will cover in this post. Keep in mind, there are other considerations you should address, and no two families are identical. You have to consider your own family dynamics, financial situation, and much more. However, this should get you started as you think about planning for retirement with a blended family.
When should you claim Social Security?
How will you approach your retirement income withdrawal strategies?
How will you pay for Long-term care costs?
Inter-generational Wealth Planning and Estate Planning
1. When should you claim Social Security?
Social Security is likely your largest source of guaranteed income in retirement. It represents 40% of all income for those 65 and older.
There is a possibility you and your spouse each have children you may want to leave assets to, and this could impact the surviving spouse’s retirement income plan. For example, if you have three children and a new spouse, you may decide to divide your estate into 1/4 for each beneficiary.
However, Social Security is one income stream that will always be available to the surviving spouse, no matter what. So, how can you maximize the lifetime benefits for you and your spouse?
If you and your spouse are both eligible for Social Security benefits, the surviving spouse will keep the larger benefit after the first spouse dies. If you have the opportunity to delay Social Security longer to maximize your benefit, this will also maximize your surviving spouse’s benefit if they were to outlive you. If you are able to delay until age 70, you will be eligible for your largest monthly benefit. If that benefit is larger than your spouse’s, it will help maximize their Social Security income in the event some of your assets were not left outright to your spouse.
Other blended family Social Security nuances....
Dependent benefits are also important.
22% of men and 18% of women have a 10 or more year age gap in a second or third marriage. Therefore, you may have remarried a younger spouse, with potentially dependent children. Or, you are remarried and had new children with your younger spouse. Nonetheless, if you are approaching retirement age, consider dependent benefits for Social Security! Dependents are defined as children under age 18 (or 19 if still in high school), or disabled before 22. These dependents could be eligible for a Social Security benefit when you start collecting yours! The benefit is equal to 50% of your primary insurance amount and is available for each dependent child and for your spouse, regardless of age!
There is a cap on the total amount paid based on your primary insurance amount, and it usually ranges between 150%-180% of your full retirement benefit. The caveat is you must begin claiming yourself in order to trigger the dependent benefits. This may result in you filing earlier than you had anticipated. Therefore, you have to run some calculations to see what is best for your situation.
Another consideration is determining your ability to collect Social Security on an ex-spouse. This will depend on how long the previous marriage lasted, and whether it ended in a divorce or premature death.
For example, if your first spouse passed away and you remarried after age 60, you could still qualify for survivor benefits on your former spouse. On the contrary, if you were remarried before 60, those former spouse’s survivor benefits will be forfeited.
For divorcees, ex-spousal benefits will be forfeited (in MOST cases) once you are remarried, but you would then be eligible for a spousal benefit from your new spouse. This is often a consideration on whether or not to legally remarry if your former spouse’s benefit would result in a significantly higher monthly benefit. But let’s be honest, if you want to marry your new partner, don’t let a few extra Social Security dollars prevent you from doing so!
2. What is a safe withdrawal strategy for retirement income?
There is a good chance you and your new spouse both had assets before you were remarried. Perhaps you and your spouse have Traditional IRAs, 401ks, Roth IRAs, and taxable brokerage accounts. However, those account values probably vary between the two of you. Furthermore, you may have slightly different estate planning goals involving children from your previous marriages.
The key is to come up with a safe withdrawal strategy from each bucket based on:
tax characteristics
risk tolerance
inter-generational wealth planning or estate planning goals
insurance coverage
other income sources like Social Security or a pension
If you plan to leave everything to your new spouse and simply divide it evenly between all of the remaining children, the withdrawal strategy is more straightforward. However, if your children will inherit assets upon your death, how does that impact your new spouse’s retirement income plan? Will they have enough to live on throughout their life expectancy? Remember, Social Security will be reduced after the death of the first spouse, as discussed earlier.
Also, let’s say each of you has children from a previous marriage. If you are burning through your assets more aggressively to support the retirement lifestyle, how does that impact your goal to leave money to your children?
The SECURE Act changed the game with inherited IRA's/401k's.
If your children are in a higher tax bracket, you might not want to leave them your IRA or 401k outright. Your surviving spouse will likely have more favorable withdrawal options and be able to stretch this account over their life expectancy. Conversely, leaving the 401k or IRA to your children will likely trigger the new 10-year rule from the SECURE Act of 2019. This would force them to liquidate the retirement accounts fully within 10 years, likely triggering a much higher tax consequence than had you left those assets to your spouse. This is especially true if you are a Florida resident without a state income tax, and your children are residents of a state with high-income taxes (California, New York etc.). In these situations, you may want to consider a slightly higher withdrawal rate on your 401ks or IRAs, and a slightly lower withdrawal rate on your taxable brokerage accounts or Roth accounts. This way, you maximize the tax friendly assets to your children, and also maintain the tax efficiency of traditional 401ks and IRAs by leaving them to your spouse first.
There is no one-size-fits-all solution to creating a withdrawal strategy, but starting with open conversations about each other’s legacy goals for both sets of children and getting on the same page about a plan is a great first step. Once the goals are set, a safe withdrawal rate should be established. I wrote an article about this and you can read it here. The basic formula I use is; Financial Goals – Income sources – Risk Intolerance = Safe Withdrawal Rate from investments. Noticed how I used risk intolerance instead of risk tolerance. The reason is that the less risk you are willing to tolerate (the higher your intolerance score), the lower your withdrawal rate would be to accommodate for lower expected investment returns.
Should I follow the 4% rule?
Bill Bengen created the 4% rule back in the 1990’s, which back tested rolling 30 year retirement periods from 1926 to 1976. He concluded that a 4% withdrawal rate resulted in money left over at the end of retirement in all of the tested periods. You could certainly use this as a starting point, but there is much more to consider. If you want to maximize the inheritance for your children, you might need to stay close to 4% or even below it! If you don’t have a huge desire to maximize your estate to children, you might be able to inch closer to a 5% or even 6% safe withdrawal rate.
If you are comfortable with more volatility in your investments in order to maximize returns, you could potentially have a slightly higher withdrawal rate than 4%, perhaps 5%-6%. On the other hand, if you cannot withstand any volatility, supporting a 3%-4% withdrawal rate is a more realistic goal.
Finally, guaranteed income sources play a role in determining your rate of withdrawal. If you have most of your expenses covered by Social Security and/or a Pension, your rate of withdrawal required might even be 0%! In this scenario, you could choose to simply reinvest your earnings, gift to your children or even your favorite charity. On the other hand, if guaranteed income is a very small portion of your required standard of living, your rate of withdrawal might be higher than average.
All of these factors; guaranteed income, risk intolerance, and financial goals; play a role in determining what withdrawal rate to use, so be careful with using a rule of thumb from a textbook.
Using the "Guardrail" approach to withdrawals...
The higher your withdrawal rate, the greater the uncertainty. If you are more aggressive with your investments, you could expect higher returns, and maybe for a period of time a 5% or even 6% rate of withdrawal works just fine. However, what happens when the first recession hits? Or the first bear market?
This is why we like to use Dynamic Withdrawals by way of a “Guardrail Approach.” This involves reducing the rate of withdrawal during a significant downturn in stocks. Conversely, our clients can increase spending when markets are performing well. In our modeling, we have concluded that this is the best way to maximize the safe withdrawal rate, but at the same time maintain flexibility based on current economic conditions. I also wrote more in-depth about this topic in this blog post.
Should I Buy An Annuity?
One final topic to consider is whether or not you will purchase an annuity to fund retirement. There are many flavors of annuities, but the general concept is to create an income stream that you cannot outlive, much like Social Security. These products also provide some peace of mind in that the income stream is typically guaranteed, and not tied to market volatility. If you don’t have a pension, this could be a nice supplement to Social Security. Furthermore, you can name your spouse as a joint annuitant to ensure that they will continue to receive the life income if they outlive you. These products can also be beneficial in that it could allow you to take more risk with your investment portfolio, as well as impact your safe withdrawal rate, knowing that a good portion of your expenses will be covered by guaranteed income.
Many consumers believe they will be sacrificing their intergenerational wealth planning goals for their children or grandchildren by purchasing an annuity. Based on research in the industry, this might be true if you were to die prematurely. However, if you were to live to or past your life expectancy, it could actually result in an increased amount of wealth transferred. The reason is because your investments were able to ride the ups and downs of the market without being tapped into during a recession or bear market. I always recommend seeing what’s out there and comparing the rates between several carriers as they do vary greatly.
Finally, interest rates have been on the rise so far in 2022, and that trend is expected to continue at the moment. Therefore, the payout rates have become quite attractive for new annuitants, so it’s prudent to do some due diligence as you approach retirement.
3. Long-term care planning
Long-term care planning is complicated enough to prepare for during retirement. For blended families, long-term care planning is even more complex. If you and your spouse both accumulated assets for retirement, how will one pay for Long-term care costs if they are needed? Do both of you have Long-term care insurance? Or, do you plan to self insure? Are your estate planning goals the same?
Chances are, we will all need some level of custodial care at some point in our lives. The question is, how extensive is the care? And, for how long is care needed? Genworth published their annual study that indicates there is a 70% probability of needing Long-term care costs for those 65 or older. If you have children from a previous marriage, and your spouse needs care, are you going to burn through your own assets to pay for it? If you are like me, you will do anything you can to take care of your spouse and give them the proper care they need. However, if you have goals to leave money to your children, is that a risk worth NOT planning for?
On the other hand, if your spouse has children from a previous marriage and you needed care, how would he/she pay for it? Would you expect your spouse to accelerate withdrawals on their accounts unnecessarily in order to provide you care?
Should I buy Long-term Care Insurance?
If you are still young enough and healthy enough, you could consider buying Long-term care insurance. The last time I checked, it’s very rare to find a company that will cover you if you are over age 75. The sweet spot is often between 50-60 years of age, as there is a much lower decline rate and premiums are still affordable. When you get into your 60s and 70s, the decline rate goes up substantially and your premiums are quite costly.
Long-term Care Insurance is a very clean way to dedicate specific resources for this major retirement risk. Of course, nobody has a crystal ball, and you might be in the 30% that never needs care, but it’s a gamble you may not want to take.
There are also hybrid Long-term Care and Life Insurance policies that will provide a death benefit if you never use the funds for Long-term Care. Or, a reduced death benefit if you only used a portion of the Long-term Care benefit. This can provide you with some peace of mind knowing that someone will benefit from the policy. These products are much more expensive, so be prepared to write some larger checks. Also, work with a broker that can represent multiple carriers to help you shop around.
What about an annuity with a Long-term Care rider?
If you or your spouse have health issues that might preclude you from getting traditional Long-term Care, consider an annuity with a Long-term Care rider. These products do require a certain level of funding, but they are a viable option if you have a nest egg you could allocate to protect against this risk. Even Suze Orman, who is typically anti life insurance, is an advocate for these types of hybrid policies!
What about “self-insuring?”
There is nothing wrong with self-insuring, just over half of my clients decide to go this route.
If you decide to self-insure, having that discussion with your spouse about what assets to use to pay for care is critical!
If you have accounts that are more tax favorable to leave to your heirs, you may not want that account aggressively spent down for your care!
Also, consider the state you live in relative to your beneficiaries. If you live in a state like Florida or Tennessee without a state income tax, you might consider using some of your 401k or IRA to pay for care. This is especially relevant if your children are in a higher tax bracket and/or live in a state with high income taxes.
Have a plan, communicate it with your spouse, your financial planner, and your other agents so they know what to do! I also wrote an entire article on Long-term Care planning if you want to check it out here.
4. Estate Planning Basics for Blended Families
We have touched on some of the estate planning and intergenerational wealth planning challenges throughout this article. Each spouse might bring a slightly different perspective on transferring wealth. However, the amount you leave or who you leave it to isn’t the only estate planning challenge for blended families. Here are some other key points to consider:
Who will step in to help make financial decisions as you get older?
What about healthcare decisions?
Who is going to be the executor of your estate, or successor trustee?
Do you have any special considerations for any of your beneficiaries? (special needs, spendthrift concerns, son/daughter-in-law concerns, or stepchildren that you may or may not want to include)
These individuals should know what their role is, and what it is not!We’ve all heard of horror stories when someone dies without a plan, and unfortunately impacts how that person is remembered.If you have ever watched the show “This is Us,” there is a scene in the last season where Rebecca calls a family meeting with her three adult children and her second husband.This is a textbook model on how a family meeting should be conducted!
If there are different sets of children involved, consider naming one child from each “side” to participate. If it’s a successor trustee role, perhaps you can name successor co-trustees to avoid any ill will.
I certainly would make sure that a successor trustee or successor financial power of attorney is financially savvy and responsible. This does make things a bit tricky if one “side” does not have a viable option. Instead, I’ve seen where families will name the successor trustee a corporation, also known as a corporate trustee, to serve in that capacity. This way, clients don’t have to worry about anyone’s feelings being hurt because they couldn’t be trusted.
Don’t worry about giving specific dollar amounts on what you are leaving.You certainly can, but it’s not the point.The point is proactive communication and agreement from the adult children and other beneficiaries.This can really protect their relationships long term, which is far more meaningful than the dollar amounts they each receive.
If you didn’t see the episode of This Is Us, check it out here!
Should you consider a trust for your blended family?
I spoke with my own attorney and friend in detail about this. His name is Ryan Ludwick and he’s an Estate Planning specialist with Fisher and Tousey law firm based in Florida. He told me some couples come in with the idea they want to simply leave everything to one another, and then whatever is left will be divided evenly to the children. This makes things very simple, almost like a traditional family estate plan.
However, certain blended family dynamics could be solved with a trust. For example, if you want your spouse to utilize the assets for retirement if they were to outlive you, but still guarantee the remaining assets are left to your children, you might consider a trust.
A trust would essentially be set up for the surviving spouse. When you pass away, the trust becomes irrevocable (nobody can change it), and your spouse can use the assets for their care. Once the second spouse dies, the remainder beneficiaries (presumably your children) will receive the trust assets.
A few reasons why a trust could make sense are:
The assets held in trust would not be up for grabs in the case of a remarriage.
Potential creditor protection benefits.
Oversight – meaning you could name a trustee to help manage the trust, in case your surviving spouse was incapacitated down the road, or if they don’t have the financial acumen.
And of course, the terms are your terms, and cannot be altered.
Ryan also made a great point to be careful with naming a trust as primary beneficiary of a retirement account (401k or IRA). There might be unfavorable tax results by doing so, and you should consult with your financial planner and estate attorney before making any changes.
Life Insurance
Life Insurance could also be a great tool for estate planning for blended families. You could set up a new policy, or change the beneficiary of an old policy, to satisfy certain estate planning goals.
For example, let’s you wanted to split your investment assets four ways at your death between children and your new spouse. Between your spouse losing one Social Security benefit and only receiving 25% of your estate, their ability to maintain financial independence could be at risk. Therefore, you could consider leaving your life insurance policy to your spouse to make them whole.
On the other hand, you may not want to leave those 401ks or IRAs to your children for reasons mentioned before. Therefore, you could elect to leave those assets to your spouse (outright or in a trust), and leave the life insurance policy to your children. The death benefit is always tax free, so this solves the issues related to inheriting retirement accounts with the new SECURE Act law.
Elective Share Rules
Ryan said to “be careful of the elective share rule for spouses.” In Florida, and many other states without community property laws, the spouse is entitled to a percentage of the estate, regardless of what your will says. For Florida, it’s 30%. So let’s say you only designate 10% to your spouse in your will, he or she could contest this in court, and would likely win.
There are legal ways to get around this by way of signing a prenuptial agreement, or having your spouse sign a waiver form. It’s just something to be mindful for, especially with blended family estate planning.
Final word
As you can see, blended families are unique in an of themselves, so cookie cutter retirement and estate planning advice doesn’t work.
There are other considerations for blended family retirement planning, and no two situations are created the equal, which is why we love helping people like you!
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Your kids might be financially independent, your mortgage is close to being paid off, and you are getting close to having what you need to retire comfortably. You might be wondering, “Should I own life insurance in retirement?” So, before you go and cancel that policy, read this post and see if you would be a good candidate to own some amount of life insurance for the long haul.
Basics of term and permanent insurance
Before we dive in, let’s go over the basics of the two primary types of life insurance. Term Insurance is just that, it’s for a specified term. This is a cost-effective solution for a temporary need. Let’s say you have young children, a mortgage, and another 20 years of earned income until retirement. The death benefit you will need, on average, will be at least 10-16x your gross income (according to the CFP board). So, if your income is $200,000/year, you will need approximately $2mm-$3.2mm of life insurance.
Depending on your health, this will only cost you pennies on the dollar (perhaps $1800-$3200/year). The reason it’s so cost effective is that only 1% of term policies ever pay a death claim, so term insurance is one of the most profitable products an insurance company can sell!
Permanent Insurance is of course, permanent (mind blown). There are many flavors out there; whole life (traditional), universal life, variable life, variable universal life, joint survivor universal life, and indexed universal life, to name a few. If you see the term variable, this means the policy performance is going to be tied to an underlying sub account that can be invested, like your 401k plan. If you don’t see the term variable, this means the performance is going to be tied to the performance of the insurance company’s general account, which is quite conservative. If you see indexed, this has a component of a fixed rate with potential upside of a targeted index, like the S&P 500. The difference between universal and traditional whole life is essentially the cost of insurance schedule. With traditional whole life, you have a fixed cost schedule at the time you start the policy, and it stays that way for the life of the plan. With universal, the cost of insurance goes up each year as you get older, but the premiums don’t necessarily go up each year. The schedule is flexible in that you can stop paying premiums one year (assuming you have enough cash value to support it), start again the next, pay half the premium another year and double the premium the year after. If you attempted this with traditional whole life, your policy would get cancelled, so don’t do that. I’m also not advocating you make premium payments to a universal policy like so, but it’s nice to have some flexibility.
I just want to emphasize how important it is, if you have a universal life policy, to review the performance at least annually. You can request an in-force illustration at any time to show how your policy has performed, and how it’s expected to perform based on fresh assumptions. I can’t tell you how many times I’ve looked at universal policies that people have paid into for decades that are on the verge of breaking.
The common theme for all permanent policies, if they are structured properly, is the death benefit should be in force for as long as you live. Additionally, there is a cash value component that you can access while you are living. This can be done through policy loans or partial surrenders.
So you might be wondering, why wouldn’t everyone buy permanent insurance and skip the term? The answer is simple, the premiums can range from 5-15 times more expensive! For this post, I will mainly discuss the argument of simply owning life insurance in retirement, whether it’s term or permanent is not the point. However, there are certain arguments I will make that ONLY permanent insurance can solve for. This is why it’s critical to begin with the end in mind and work backwards.
Reason #1: You are over the estate tax exemption limits (federal and/or state)
Currently, the federal estate exemption is $12.06mm/person (or $24.12mm for married couples). If your total estate is valued above the threshold and you die in 2022, you will pay tax on the amount ABOVE the threshold. The tax rates range from 18%-40%, depending on the size of your estate. Let’s say you had a total estate of $30mm and were married in 2022. If both you and your spouse passed away today under the current law, you would pay taxes on $5,880,000 at the federal level. There are also 17 states that have a “death tax,” so be careful where you live when you die as you might owe state AND federal estate taxes (and by “you,” I mean your beneficiaries)! For example, Massachusetts and Oregon tax estates in excess of $1mm! As you can see, living in an estate tax friendly state is a big decision point for many retirees.
This can become problematic for your heirs to pay these large sums of taxes. If you own a closely held business, a real estate portfolio, or a mix of stocks and bonds, you probably want your heirs to continue to enjoy the fruits of your labor and preserve those assets. Well, if your beneficiaries owe a seven figure tax bill, they might be forced to sell an extremely valuable asset in order to pay the taxes. This is where permanent life insurance can come into play. Life Insurance is a tax free payment of cash to your designated beneficiary. Therefore, instead of forcing your beneficiaries to sell that valuable asset, the life insurance death benefit could be used to pay the estate tax bill.
*The Tax Cuts and Jobs Act will sunset after the year 2025. The federal exemption is scheduled to revert back to the $5mm/person limit (plus some inflation adjustments). So, while you may not exceed the federal thresholds today, you certainly could exceed them in a few short years. Plan accordingly!
Reason #2: You Have a Dependent with Special Needs
Children with special needs often require permanent financial assistance. Meaning, their condition won’t make their life any easier as they get older. In fact, quite the opposite. The government provides some financial assistance for those they deem disabled in the form of Social Security Income, Medicare and Medicaid. However, you will likely want to provide additional financial support above and beyond the government assistance. While you are alive and working, you will do anything you can to provide that additional financial support. However, if something were to happen to you, how do you address that financial shortfall?
Owning a life insurance policy is a great solution to this problem. You can simply calculate the amount of annual income needed to support the beneficiary with special needs, and come up with an appropriate amount of life insurance to pay out to that beneficiary. These policies are often owned inside of what is called a Special Needs Trust. This special type of trust allows for the preservation of government support for the child, while at the same time receiving supplemental income from the trust. The longer you live, and the more assets you accumulate, might impact the amount of insurance that you need to own. Ideally you will want some amount of the insurance to be term and some permanent to accommodate the future accumulation of other assets.
Reason #3: To Replace Lost Retirement Income
You might be thinking life insurance is there to replace income when you are working, but how does it factor into retirement income? For starters, Social Security represents the largest pension fund in the world, and most retirees rely on it for some or most of their income in retirement. When one spouse dies, there is an automatic loss in Social Security income. The surviving spouse will elect to keep their own benefit, or the deceased’s benefit, whichever is higher. If a couple each had $24,000/year in social security benefits, this would result in $24,000/year in lost social security income upon the first spouse passing away. Additionally, after two tax years of filing as a qualifying widower, there could be a widow’s tax given they will have to transition over to a single filer, and potentially pay higher tax rates.
Furthermore, you might receive a pension from the military or government, or perhaps VA Disability income. The benefit might be cut in half, or even go to zero upon the annuitant passing away. Therefore, owning a life insurance policy through retirement can help replace lost social security or other pension income, making the surviving spouse whole and protecting their own longevity.
Reason #4: To Replenish Lost Assets from Long-term Care Costs
It’s estimated that medical costs in retirement will total about $300k for a couple that is 65 years old today, and that excludes Long-term care costs. The average cost of a nursing home in the US is north of $100k/year (in today’s dollars). If there was a need for long-term care at the end of the first spouse’s life, this could create a significant drain on retirement assets. This is especially true if the assets that were used to pay for long-term care came from retirement plans such as traditional IRAs or 401k plans, given the tax drag on withdrawals. Therefore, owning a life insurance policy can guarantee a cash infusion for the surviving spouse to protect their retirement lifestyle and their own longevity going forward. This could also be achieved with a life insurance policy with a Long-term care rider, which would allow funds from the policy to be paid in advance for long-term care costs, instead of waiting for the death benefit of the first spouse. Either way, utilizing some form of permanent life insurance in retirement is a great way to protect and/or replenish assets in the event long-term care becomes a financial drain.
Reason #5: To Guarantee a Financial Legacy
I often times hear from clients they have a strong desire to leave assets to their children, grandchildren or even their favorite charity. Ultimately what they are saying is they don’t want to burn through the assets they have accumulated, but they still want to ENJOY their retirement! These clients often times have a very difficult time spending their own money in retirement simply because of the fear of running out of money and being a burden on their loved ones. My clients that own permanent life insurance in retirement can sleep extremely well at night knowing that at least one asset is guaranteed to be there upon their death. This ends up liberating the client to spend more freely on travel, bucket list activities, charitable giving, and overall results in a more enjoyable retirement lifestyle.
BONUS Reason #6 – Owning Permanent Life Insurance in Retirement as a Fixed Income Alternative
Here is a fun concept, especially in light of today’s bond market! With the bond index down double digits year to date, many clients are asking about an alternative to bonds. A few come to mind including an individual bond ladder, fixed income annuities, or even a zero duration hedge strategy. However, the cash value in a traditional universal life or permanent life insurance policy can be extremely powerful, if structured properly. If you google “cash value life insurance,” you will see a mix bag of opinions. For the right client profile (maxing out qualified plans, maxing out Roth conversions, higher tax bracket etc.), there could be a very compelling argument to begin accumulating dollars within a permanent life insurance policy well before retirement. For starters, it will solve for all of the primary challenges we mentioned previously. Additionally, it will allow time for cash value to build up inside of the policy. If it’s structured properly, it can become a liquid asset to draw from during your retirement years.
You will likely experience anywhere from 4-6 bear markets during your retirement years. You’ve probably heard the concept, “buy low, sell high.” In retirement, this involves avoiding selling a depreciated asset for income. In a market like 2022, both stocks and bonds are down. If you have cash values built up in a fixed life insurance policy, it’s a viable hedge to allow your riskier assets to fully recover when the market turns around.
A few last words of advice
Life insurance does get more expensive as you get older, and you also have a greater risk of developing a medical condition that might make life insurance unobtainable. There is no one size fits all when it comes to retirement planning, especially when it comes to using life insurance in your retirement plan. The life insurance industry is quite complex with many carriers and many variations of permanent life insurance. Therefore, I highly recommend you consult with a fee-only financial planner who has expertise in this arena, like our firm! (Yes, I’m quite biased).
If you are interested in learning more about working with our firm, or would like to discuss your financial objectives, book a Mutual Fit meeting with the link below. Also, feel free to share this article with anyone that might find it useful.
Are you approaching retirement with the bulk of your next egg in tax deferred 401ks or IRAs? With so much uncertainty on where tax rates might head in the future, you might be wondering, “Should I take advantage of Roth conversions?” They are not for everybody, but in the right situation you could end up saving thousands, or even hundreds of thousands of dollars, in taxes during your lifetime. Additionally, your heirs will also benefit from a more tax efficient inheritance. I hope you enjoy this episode, which includes my interview with Kevin Geddings at WSOS 103.9 in St. Augustine!
Pay me now or pay me later applies to your retirement accounts. Let’s talk about when it makes sense to pay up now and minimize your tax liability during retirement.
Investment losses can be painful, but they often come with great opportunity. This includes not only buying equities at discounted prices, but significant tax benefits if you are opportunistic.
The number one thing I hear from clients is they don’t want to ever be a burden on their loved ones, and yet, I’ve seen a number of estate planning mistakes over the years. Fortunately, they never truly get exposed unless something unexpected happens. These 5 common estate planning mistakes can and should be addressed, and I always recommend seeking official legal counsel from a licensed attorney to do so! ~Kevin
Are you interested in working with me 1 on 1?
You can start with our Retirement Readiness Questionnaire linked on our website so we can learn more about how we can help in your journey to and through retirement.
Inflation is running hot, the market is volatile, and I-Bonds have become attractive. This article addresses the basics of I-Bonds and how you can assess if they are right for you.
Volatility is a healthy part of investing! If there was no risk to it, there would not be the upside potential the stock market has provided for decades! Inevitably when the stock market is volatile, I field a bunch of questions on “what to do next?!” Nobody is complaining when markets are flying up with no volatility, but once we see that 10% or 20% dip, people start to pay attention. I decided to record this episode to shed light into what our practice looks like and how we navigate the good and bad markets. I hope you enjoy it!
~Kevin
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In my nearly 14 years in this business, I’ve seen financial advice given by many different professionals. Insurance agents, stock brokers, bank representatives, real estate professionals, next door neighbors and the like. I’ve seen some great advice given, but also some terrible advice. This often times leads to the general public to think “are financial advisors worth it?” This is especially the case now given the lines are blurred between different segments of the “financial services” industry. Vanguard did a study called “Advisor’s Alpha” which I have found is the most helpful and accurate summary of value-added services a comprehensive financial advisor provides. I’ve referenced it to clients and other professionals since 2014 when it was originally published. To summarize it briefly, they outline seven areas of advice that add value to the client’s portfolio by way of net returns annually. They have assigned a percentage to each of the categories which amounts to approximately 3%/year in net returns! In this article, I will highlight some of the key components of their research, as well as put my own spin on it based on my thousands of hours working with clients directly.
What is comprehensive advice?
First things first, not all advisors are comprehensive (and that’s okay). However, this article is specifically for firm’s like mine that are focused on comprehensive advice and planning, and I would argue the 3%/year figure is on the low end. I will get into this more shortly.
Here is a breakdown of Vanguard value-added best practices that I mentioned previously:
The first thing that should jump out to you is that suitable asset allocation represents around 0%/year! This is given the belief that markets are fairly efficient in most areas, and it’s very difficult for an active fund manager to consistently beat their benchmarks. This is contrary to the belief of the general public in that a financial advisors “alpha” is generated through security selection and asset allocation! What’s also interesting is that the largest value add is “behavioral coaching!” I will get into more about what this means, but I would 100% agree with this. Sometimes, we are our own worst enemy, and this is definitely true when it comes to managing our own investments. It’s natural to have the fear of missing out, or to buy into the fear mongering the media portrays. So if you take nothing else away, the simple notion of having a disciplined process to follow as you approach and ultimately achieve financial independence will add 150% more value than trying to pick securities or funds that may or may not outpace their benchmarks!
Before I dive into my interpretation of their study, I want to note that I will be using five major categories instead of seven. Some of the above mentioned can be consolidated, and there are also some value added practices I, and many other comprehensive planners, incorporate that are not listed in their research.
What are the five value-added practices? I use the acronym “T-I-R-E-S”
Tax planning
Income Distribution Planning
Risk Management
Expense Management
Second set of eyes
Tax planning
There are four major components of tax planning a comprehensive financial advisor should provide. The first component is what we call “asset location.” The saying that comes to mind is “it’s not what you earn, it’s what you keep.” Well, taxes are a perfect example of not keeping all that you earn. However, some account types have preferential tax treatment, and therefore should be maximized through sound advice. Certain investments are better suited for these types of tax preferred accounts and other investments tend to have minimal tax impact, and therefore could be better suited OUTSIDE of those tax preferred accounts. A prime example is owning tax free municipal bonds inside of a taxable brokerage or trust account, and taxable bonds inside of your IRA or Roth IRA’s. Another example could be leveraging predominantly index ETF’s within a brokerage account to minimize turnover and capital gains, but owning a sleeve of actively managed investments in sectors like emerging markets, or small cap equities inside of your retirement accounts. According to the Vanguard study, this type of strategy can add up to 75 basis points (0.75%/year) in returns if done properly, which I would concur.
The second component is income distribution. This is often thought of much too late, usually within a few years of retirement. However, this should be well thought out years or decades in advance before actually drawing from your assets. One example I see often is when a prospective client who is on the brink of retiring wants a comprehensive financial plan. Often times they have saved a significant sum of money, but the majority of the assets are held inside of tax deferred vehicles like a 401k or IRA, and little to no assets in a tax free bucket (Roth). This type of scenario limits tax diversification in retirement. On the contrary, someone who has been advised on filling multiple buckets with different tax treatments at withdrawal will have many combinations of withdrawal strategies that can be deployed depending on the future tax code at the time. I have incorporated the rest of the income distribution value-added practice in the next section, but this practice as a whole is estimated to add up to 110 basis points (1.1%/year) in additional returns!
Legacy planning is the third component of tax planning that a comprehensive financial advisor should help with. This isn’t discussed in the Vanguard study, but it’s safe to say a comprehensive plan has to involve plans for your inevitable demise! You might have goals to leave assets to your heirs, especially if you are fortunate enough to have accumulated more than you will ever spend in your lifetime. With the SECURE Act, qualified retirement plans are now subject to the “10-year rule,” and therefore accelerating tax liabilities on your beneficiaries. However, if you incorporate other assets for legacy that can mitigate the tax impact on the next generation, this can save your beneficiaries hundreds of thousands, or even millions of dollars simply by leveraging the tax code properly.
Finally, navigating tax brackets appropriately can be another way a comprehensive advisor adds value. If a client is on the brink of a higher tax bracket, or perhaps they are in a period of enjoying a much lower tax bracket than normal, planning opportunities should arise. If you are in an unusually higher tax bracket than normal, you might benefit from certain savings or tax strategies that reduce their adjusted gross income (think HSA’s, pre-tax retirement account contributions, or charitable giving). If you find yourself in a lower tax bracket than normal, you might accelerate income via Roth conversions or spending down tax deferred assets to lessen the tax burden on those withdrawals. Additionally , considerations on the impact on Medicare premiums in retirement should also be taken into account when helping with tax planning.
As you can see, even though I am not a CPA and I’m not in the business of giving tax advice, helping you be strategic with your tax strategies is part of the comprehensive planning approach. All in, you should expect to increase your returns up to 1%/year (or more depending on complexity) by navigating the tax code effectively.
Income Distribution Strategy
In my personal practice, this ends up being a significant value add given the work I do with post-retirees. A systematic withdrawal strategy in retirement will involve a monthly distribution 12 times throughout the year. This reduces the risk of needing a sizeable distribution at the wrong time (similar to the concept of dollar cost averaging). For a 30 year retirement, this means 360 withdrawals! Most retirees have at least two different retirement accounts, so multiply 360 by 2 for 720 different income decisions to navigate. In my experience, the selling decisions are often what set investors back, especially if they are retired and don’t have the time to make it back. By putting a process in place to strategically withdrawal income from the proper investments at the right time, and maximize the tax efficiency of those withdrawals, this can add up to 1.1%/year in returns alone, according to Vanguard’s study! I’ve also had clients tell me they value their time more and more the older they get. Instead of spending their retirement managing income withdrawals each month, they would much rather travel, play golf, go fishing, spend time with their grandchildren etc. So yes, I would agree with the Vanguard study that 1.1%/year is appropriate for this category, but I would also argue the peace of mind of not needing to place trades while you are on an African Safari with your spouse is priceless! Yes, I did have a client who admitted to this, and no, his wife was not happy! That’s why they hired me!
Risk Management
The major risks you will see during your lifetime from a financial planning perspective are:
Bear market
Behavioral
Longevity
Inflation
Long-term care
Premature death
Incapacity or aging process
Vanguard’s study focuses mainly on the behavioral risk (value add up to 1.5%/year) and re-balancing (.26%/year). As I mentioned earlier, it’s fascinating they rank behavioral risk as the largest value add out of any category! What is behavioral risk? Let me tell you a quick story. A client of mine was getting ready to retire at the beginning of 2020, right as the pandemic reared it’s ugly head. He had 30+ years working in higher ed and climbed the ladder to ultimately become president of his college for the last 15 years. He is a brilliant man, and a savvy business person. When the pandemic hit us, he was terrified. Not only did he see his portfolio drop from $2.5mm to $2.25mm in four weeks, but he was worried this could lead to the next depression which his parents lived through. We had at least a dozen conversations during those weeks about how he was losing sleep every night, which of course was miserable for he and his wife. Finally, in our last discussion he informed me he wanted to sell out of his retirement investments and move to cash. I plead my case in that we had a well thought out diversified strategy, and looking at the math, we had enough resources in fixed income investments to pay his bills for the next ten years! However, I told him it was his money and I was ready to place the trades if that is what he wanted. He told me he would think on it for the next 24 hours. The next day, he called me and said I was right, we had a plan, and he wanted to proceed with sticking to the plan. Well, by the end of 2020 his account not only fully recovered, but it grew to $2.75mm! I am not pumping my chest on performance, but by being the behavioral coach he needed at that time earned him $500k of growth in his portfolio (a whopping 22%).
I can literally share a hundred of these stories not just from the pandemic, but stories from 2008/2009, the dot com bubble etc. The point is, having an advisor you trust that can help you navigate through the ups and downs of the market and tell you what you NEED to hear, not what you WANT to hear is invaluable. Furthermore, it can free up your time to focus on what matters in your life and have the professionals worry about the market for you!
So all in all, I would agree on the 1.5%/year value add for behavioral coaching and .26%/year to help re-balance the portfolio properly. However, Vanguard’s study doesn’t even take into consideration proper insurance planning and estate planning advice a comprehensive advisor gives to their clients which are also value-adds in and of themselves. In that sense, I would argue this category can add up to 2%/year in additional returns to a client.
Expense Management
This is oftentimes overlooked when working with a financial advisor. Much of the public believes working with an advisor will be more expensive! However, many of them are used to being sold high commission investment products or services that are overpriced. However, through due diligence and leveraging the proper research, Vanguard estimates clients should save on average 0.26%-0.34%/year on expenses. From my personal experience, this might even be on the low end. However, for arguments sake and given it’s their research, let’s say we agree with the value-added range set forth.
Second set of eyes
Vanguard doesn’t reference this in their study, but that objective point of view is sometimes necessary to drive positive change. I don’t have any specific data on how to quantify this, but I hear time and time again from clients that they so much appreciate having me as an accountability partner. Think about trying to get in tip top shape without a coach or personal trainer! You might do okay, but you certainly wouldn’t push yourself as hard as you could have if you had a coach or trainer. On the contrary, I often hear from new prospective clients how information overload and the fear of making a mistake has caused a whole lot of inaction, which can significantly hurt returns and performance. Think about a surgeon attempting to perform surgery on their own body! They simply wouldn’t. Not that I am comparing my occupation to a surgeon, but someone working to achieve financial independence would benefit substantially from a trusted third party to help navigate all of the different financial decisions they will encounter in their lifetime. This also could be true for married couples who might have differing views on finances. After all, financial reasons are the #1 cause for divorce in America. If I can help a married couple get on the same page with their financial vision, that is a win for them, no questions asked! Without specific data, I would have to say my gut feel is that objectivity should add an additional 0.5%/year in returns over the duration of a relationship, as well as more self confidence and peace of mind that you are on the right path.
If we tally up our TIRES acronym:
Tax planning = 1%/year
Income Distribution Planning – 1.1%/year
Risk Management – 2%/year
Expense Management – 0.26% – 0.34%/year
Second set of eyes – 0.5%/year
This gives us a total value add range of 4.86% – 4.94%/year in additional returns. My firm’s average fee is roughly 0.85%/year. This is why I get so excited to help new and existing clients. The value you receive, is far greater than the cost to pay me, creating a win-win situation. Now, not EVERY client will experience in additional 4-5% in additional value. Some might receive 2%/year, some might receive 10%/year! However, all of you who have yet to work with a comprehensive planner, or for those of you working with an advisor who may not be doing a comprehensive job, it might be time to reevaluate and see what holes you need to fill. If you are interested in learning how to work with me directly, you can schedule a mutual fit meeting with the button below. Or, you can visit my “Process” and “Fees” pages on my website.
