Financial Planning Archives

What can Retirees learn from Silicon Valley Bank’s failure?

Easy money policy beginning in 2009 led to a historical run in tech companies. Companies that rely on leverage to aggressively grow were borrowing money for next to nothing! Investors weren’t even concerned with cash flows, or healthy balance sheets. If the idea seemed like it could stick, they would take their bets. Some paid off, and some flopped. But the overall sentiment was “risk-on.”
These policies led to the success of Silicon Valley Bank, or SVB. Out of all of the start-ups in the US, SVB provides banking services to nearly half of them. Whether it was providing them loans or deposits, they were the go-to Bank for start-ups.

But what happens to these tech companies (with no positive cash flows) when rates go up?

Instead of borrowing “free money,” they begin to use their own cash (really their investor’s cash) for operations. Why would they borrow for 8% or 9% when their cash is only earning 1% or 2%? At some point, the interest on debt isn’t sustainable.

So, they go to their bank and pull funds for their operations. After all, they still have payroll and other overhead to keep the business going.

Remember the run-on banks in “It’s a Wonderful Life?” No, they don’t keep your money in the bank! It’s invested somewhere!

In SVB’s case, over half of their assets were invested in bonds! What’s more is that the majority of these bonds had long-term maturities, over 10 years, instead of shorter-term maturities.

We talked about interest rate risk in several of our market commentaries over the last couple of years, and SVB completely missed the mark on hedging interest rate risk. Maybe they should’ve been reading our blog!

So how did they raise cash to give to their depositors?
They had to sell their bonds…

What happens to bond prices when interest rates rise?

They go down, simple as that. Think about it. If you bought a 10-year treasury 3 years ago, it was yielding less than 1%. Today, new issues of 10-year Treasuries are yielding 3.7%! So, for anybody to want to buy your bond, you would need to discount it significantly. Otherwise, they will just buy a new issue for almost 4x the interest!

So, instead of SVB holding their bonds to maturity, as they intended to, they needed to sell (at a significant loss) to meet their obligations. The loss realized was $15b, which was equivalent to nearly all of its tangible capital. This led to their ultimate collapse and is the second-largest bank failure in US history (second to Washington Mutual in 2008).

Why didn’t SVB hedge interest rate risk?

I’m not putting the blame on one individual, but it’s no coincidence that the CFO of Lehman Brothers (who left Lehman right before their bankruptcy in 08) is now an executive at SVB. Additionally, the Chief Risk Officer of SVB worked for Deutsche Bank during the subprime-mortgage crisis in 2008.

Some banks are more conservative. They lend to small businesses or individuals. SVB, on the other hand, catered to start-ups in Silicon Valley. These tech start-ups have significantly more risk than the bakery shop next door. Additionally, their deposits were padded over the last two years because of the easy money policy over the last decade coupled with record amounts of stimulus.

The bottom line is that SVB got greedy. Instead of looking at the interest rate environment as a risk, they ignored it. They sought higher yields in longer-term bonds without hedging the need for short-term cash flows. They never expected a “run on the bank.”

So what does this mean for SVB’s deposit holders?

The Federal Deposit Insurance Commission, or FDIC, officially announced on Friday that SVB was closed. This led to a selloff in stocks and of course, those holding SVB stock will lose their investment.

But what about the deposit holders and borrowers? The FDIC typically protects balances up to $250k per entity/bank. In SVB’s case, most of their customers had significantly more than the FDIC limit. After all, these are big wigs out in Silicon Valley. Not surprisingly, here comes the Government to “bail them out.” But they aren’t calling it a bailout, as we saw in 2008/2009, because they say that stock and bondholders in SVB are not protected. However, they are using “emergency-lending authorities” to make funds available to meet bank withdrawals, even those that exceed FDIC limits! In fact, 85% of the bank’s deposits were uninsured! And you can’t argue their customers don’t understand FDIC. These are some of the supposed best and brightest innovators in our country. This is absolutely a bailout; they just aren’t calling it one.

What are the lessons we can learn from SVB’s failure?

After all, SVB is an investor, just like you and me. The principles they failed to adhere to can also lead to an investor running out of money during retirement. The only difference is the Government has no interest in bailing YOU out. So, it’s important to have a plan and process while you are navigating a potential 30+ year retirement!

Lesson #1: Diversification

This is a basic principle of “Investments 101” – Don’t put all of your eggs in one basket! Diversify! In SVB’s case, they put all of their eggs in the tech start-up basket, and they had quite a run-up until 2022.

Coincidently, when I review prospective client portfolios, technology is by far the most concentrated sector. I’m not going to argue the merits of tech companies, but most banks tend to diversify their clientele. This provides less risk of one industry going through hard times.

Oftentimes people bury their heads in the sand in hopes that “things work out.” Well, if you haven’t done anything with your portfolio in a while, there is a good chance you’re overexposed to assets that are overpriced.

SVB chose not to diversify. They decided to stick with their niche, and ultimately the Fed’s aggressive rate hikes put pressure on their customers leading to the run on their bank.

Lesson #2: Match retirement cash flows with YOUR time horizon!

When you are planning for retirement, there are two types of expenses:

Known expenses
Unknown expenses

For your “Known expenses,” wouldn’t it make sense to match those up with “known cash flows” and not “unknown cash flows”? Well, SVB decided to keep their bond portfolio LONG term. The longer the term of the bond, the more interest rate risk it has. It’s important to not chase rates. Just because a bond is paying a higher coupon, doesn’t mean it aligns with YOUR portfolio goals.

This is why I am a big fan of individual bonds for the “core” bond portfolio. With individual bonds, you can hold them to maturity for the “known expenses.” Sure, there is a time and place for bond mutual funds or bond etfs, but those funds have redemption risk, similar to what SVB experienced. In their minds, they wanted to hold their bonds to maturity to match up with later cash flow needs, but their customers wanted cash now.

With bond funds, what if OTHER investors who own that fund want their cash before you do? Well, these are known as redemptions and ultimately the fund may have to sell at an inopportune time, just like SVB! In essence, you lose one of the most important characteristics of a bond, the maturity date!

So, if you have a bond portfolio and are planning for retirement, you must absolutely match your bond portfolio up with YOUR time horizon and YOUR cash flow needs! This eliminates interest rate risk as much as possible. And for retirees, risk management is the name of the game.

Lesson #3: Have a contingency plan

Ok, that’s a great plan for the “known expenses,” but what about the “unknown expenses?” In retirement, things ALWAYS come up. We just don’t know what they will be, and how much they will set us back.

This is why I advocate for an emergency fund OUTSIDE of the retirement portfolio. With high-yield savings accounts offering north of 3% interest, cash can at least earn something while sitting idle. Of course, stick within FDIC limits, but anywhere from 1-2 years worth of FIXED expenses is appropriate for a retiree’s emergency fund. Unlike an investor who is still working and has time to get a new job or allow the portfolio to recover, retirees don’t have those luxuries. Sure, you could beg for your old job back, but that might not be what you WANT to do. Instead, if you have 1-2 years of fixed expenses, this will help preserve your investment portfolio from a larger-than-anticipated withdrawal.

For some, you may not want so much cash sitting around for that “what-if” scenarios, so here are a couple of compliments to a cash reserve fund:

Home Equity Line of Credit
Life Insurance Cash Values

Home Equity Lines of Credit, or HELOCs, are a great way to limit how much you keep in cash. Most people use these for home improvements, but having a HELOC can also help with your emergency fund. Let’s say 1 year of fixed expenses is $100,000. Instead of having $100k-$200k in high-yield savings, you might keep $50,000 in cash, and have a $150k HELOC for the JUST-in-case scenario. That way, your savings account can be your first line of defense. And only if needed, the HELOC can come in as a backup.

Cash Value Life Insurance is probably my favorite emergency fund vehicle in retirement. Unlike term insurance, it can act as a pool of funds available when you really need it.

And unlike a bond which can decline in value based on interest rates, cash values have a minimum guaranteed rate, so the cash can never go down. Think about the power of this tool in the market we are in now where bond prices are down over 15%!

And I’m not talking about Indexed Universal Life policies or Variable Life Policies, I’m talking about a traditional fixed product. If you build up enough cash value over time, you may only need 3-6 months of fixed expenses in cash given the rest of your cash buffer is inside of your life insurance policy. I’m going to write another article on Cash Value Life Insurance later, but it’s a great tool for the right person. But for the wrong person, it’s one of the worst products you can buy!

For what it’s worth, our firm does not sell any insurance products and we have no skin in the game. These products should also be gone over with a fine-tooth comb as they can be extremely complex.

Bonus Lesson #4: Don’t chase the shiny new toy

As I began writing this piece, Signature Bank became the next casualty of the run on banks Sunday, March 12^th. Their Bank was also focused on a niche, commercial real estate. However, in 2018, they decided to chase the shiny new toy, cryptocurrency, or digital assets. As concerns arose from the failure of FTX as well as SVB, customers started to pull their funds from Signature, leading to what is now the 3^rd largest Bank to fail in US History.

I repeat, don’t chase the shiny new toy!

What does this mean for the markets?

It was interesting because the stock market rallied on Monday after both SVB and Signature closed their operations. WHY??

Well, it seems that investors feel the Fed might slow their rate increases in light of the casualties it caused. Slower rate hikes mean potentially less pressure on profits and ultimately earnings. However, I don’t think we’ve seen the end of this narrative. Starting with FTX’s collapse last fall, and now these two large banks failing, other companies that are overweight in speculative investments will continue to unravel. The magnitude of these rate hikes cannot be overstated and this type of carnage has been what we’ve been concerned about since the beginning of 2022.

The story we are very interested in is the impact on small “moms-and-pops” businesses. After all, many of the customers SVB serves provides service to everyday businesses. Whether it’s payroll, cloud services, or other technology, small businesses across the US rely on tech. And if these tech companies are beginning to falter, what does that do to the economic system as a whole? Also, is this going to lead customers of other regional banks to panic? Will they take their money and put it at a larger bank or under the mattress or in cryptocurrency? This could put significant pressure on banks all over the US, which would have a trickle effect on the economy.

In the end, the Fed may not get the soft landing it wanted, but a recession may not be fully priced into the market at this point.

The one silver lining is that inflation does continue to ease, and that’s good news when it comes to what the Fed does next.

For those of you who are close to, or already retired, I have 5 major takeaways for you.

1. Are you overweight in speculative investments?

Tech, consumer discretionary, digital assets, or even speculative real estate. These assets have certainly appreciated significantly over the last decade, but things tend to fall in and out of favor. Therefore, it’s important to review and re-balance your portfolio on an ongoing basis to reduce risk. Even if your portfolio consists of several mutual funds or ETFs, it’s also very possible they are concentrated in certain sectors with higher risk.

2. What does your bond portfolio consist of?

Are the time horizons of your bond portfolio consistent with your personal retirement goals and objectives? If you need help reviewing this, consult a professional (we can help you!).

3. What major unexpected expenses might you run into during retirement?

Sure, we may not have a “run-on-your-retirement” as we had with SVB. However, I can guarantee there will be significant unknown expenses during a multiple-decade retirement. One, in particular, I can think of is the need for long-term care. This is perhaps the largest unknown expense for retirees, and the cost can drain a retirement portfolio much sooner than desired. It’s important to have a contingency plan to protect and preserve the retirement portfolio if the need for care arises.

4. Where do you bank?

The notion of FDIC has come back into play with the collapse of SVB. Are you over the $250k FDIC limit with your bank? While the Fed announced it’s going to make customers of SVB and Signature whole, that may not be the case with smaller regional banks, so it’s important to keep your safe money safe.

5. Don’t be reactive, be proactive.

News like this is never good for the markets. We have been talking about the Fed’s rate hikes for over a year and how certain sectors are going to take a hit. Now, the impact is beginning to rear its ugly head, and we might have a few more quarters of continued bad news. However, you are investing for retirement. Retirement is not just a few quarters, it’s a few decades! As long as your portfolio is aligned with your retirement goals, there is no need to make a knee-jerk reaction to the bad news. After all, if you’ve learned from the lessons SVB’s failure taught us, you can implement a successful retirement plan for “all seasons.”

If you have questions about how these lessons can be implemented into your retirement plan, we would love to meet you and learn more about you.

And finally, make sure to subscribe to our newsletter to stay up to date with all of our latest retirement planning content.

Until next time, thanks for reading.

Sources

https://www.wsj.com/articles/the-silicon-valley-bank-bailout-chorus-yellen-treasury-fed-fdic-deposit-limit-dodd-frank-run-cc80761e?mod=hp_opin_pos_1

https://www.wsj.com/articles/federal-reserve-rolls-out-emergency-measures-to-prevent-banking-crisis-ba4d7f98?mod=economy_lead_pos1

https://www.wsj.com/articles/companies-with-deposits-trapped-in-silicon-valley-bank-9034f33b?mod=article_inline

https://finance.yahoo.com/news/silicon-valley-bank-exec-lehman-000556735.html

https://www.barrons.com/articles/svb-silicon-valley-bank-rates-securities-693c931c

Kevin Lao

March 14, 2023

What are the rules for Required Minimum Distributions?

Congratulations! Lots of blood, sweat, and tears went into a successful career, and you have saved enough to start thinking about when to retire. If you’ve been saving into a 401k, 403b, or another retirement plan through work, you’ve probably heard of Required Minimum Distributions or “RMDs.” You might be wondering;
“What are the rules for required minimum distributions?”
“How do RMDs impact my taxes?
Or, “What can I do now to prepare for RMDs?”

This article is for you! We’ll unpack all of this and provide REAL-LIFE action items to help you plan for RMDs and save in taxes!

What are RMDs and when do they start?

Simply put, RMDs are the IRS’s way of saying, “the party is over.” Or in this case, the tax party is over!

When you contributed to your 401k, IRA, or 403b, you likely took advantage of a generous tax deduction up front and have never paid taxes year over year on earnings. Pretty powerful, right?

The IRS has been patiently waiting for you to start withdrawals, and RMDs are their way of starting to collect their tax revenue.

Starting in 2023, the RMD age, or “beginning date,” is the year in which you turn 73 (for individuals born before 1960). For those born in 1960 or later, the beginning date is the year you turn 75.

Just a few short years ago, the beginning date was the year you turned 70 ½. The SECURE Act of 2019 pushed the RMD age back to 72, and the SECURE Act 2.0 (just passed in December 2022) pushed it back even further. With many retirees living well into their 90s, that’s potentially 20+ years of RMDs!

These qualified plans have such powerful tax advantages because the growth year over year is not taxable! This allows for compounding interest to avoid tax drags altogether, which is unique in the investment world. However, there is a reason why our clients’ largest expense during retirement is TAXES! Our job is to minimize taxes, legally, as much as possible. Part of that job is to minimize the tax impact of RMDs in retirement.+

How are RMDs calculated?

The IRS has life expectancy tables that are updated (not so frequently), and each age has an assigned “life expectancy factor.” Once you reach your beginning date, the account balance at the previous year’s close (December 31^st) is divided by the life expectancy factor in the IRS tables.

Example:

You have a $1,000,000 IRA balance as of December 31^st of 2022.

Assuming you turn 75 in 2023 and you use the Uniform Lifetime Table (more on this in a moment), your life expectancy factor would be 24.6.

To calculate the RMD for 2023, you would divide $1,000,000 by 24.6, which would equate to $40,650.40.

There are three types of life expectancy tables. The Uniform Life Expectancy table (used above) is for single or married account owners. However, if you are married, your spouse is the sole beneficiary of your account, AND is more than 10 years younger than you, you can use the Joint Life and Last Survivor Life Expectancy Table.

The “Single Life” expectancy is for beneficiaries of IRAs that were not the spouse and inherited the account before January 1^st of 2020. For account owners who have inherited IRAs or other retirement accounts beginning in 2020, the new 10-year rule applies, which we will discuss shortly.

The older you get the higher the rate of withdrawal gets. By the time you reach 80, the distribution percentage is close to 5%/year! At 85, it’s 6.25%!

An RMD for a $1,000,000 IRA at age 85 is $62,500!

If you add in Social Security income, perhaps a pension, and other investment income, you can see how this could create a tax burden during the RMD phase. The IRS does not care if you need the income, they just want their tax revenue. And not only will your taxable income in retirement go up, but could impact how much Social Security is taxed and how much you are paying for Medicare premiums!

If you miss an RMD, there are penalties. The SECURE Act 2.0 changed the penalty to 25% from 50%, and that applies to the amount you failed to withdraw. Using our example above with a $40,650.40 RMD, a 25% penalty would equate to $10,162.60 assuming you withdrew nothing!

Needless to say, make sure you satisfy this important rule for required minimum distributions or pay the price.

The first RMD can be delayed until April 1st of the following year!

RMDs need to be satisfied by December 31^st each year. Some of our clients elect to take the RMD monthly in 12 equal payments; others elect quarterly. And some take it as a lump sum. The decision is cash flow driven and how much you need the RMD for income (or not). There is one exception that applies to your FIRST RMD. The first required minimum distribution can be delayed until April 1^st of the following year.

Let’s say you turn 73 in the year 2024, which would make 2024 your beginning date. However, you also plan to retire in 2024 and might still have high wages to report for that tax year. In 2025, you will be fully retired and will have ZERO wages, so you decide you want to take advantage of delaying the first RMD until 2025. In this scenario, you would take the 2024 distribution by April 1^st (of 2025) and of course the 2025 distribution by December 31^st! In this scenario, you have two RMDs on your 2025 tax return, but your overall income perhaps is still lower because of no W2!

Are there RMDs on my current employer plan?

If you are still actively employed and have a qualified plan you are participating in, you can avoid RMDs from those plans only. Let’s say you plan to work until 75, and you have a large 401k with your current employer and an IRA from previous retirement plans. You will still be required to make an RMD from your IRA, but you can avoid the RMD on your 401k altogether. Once you are officially separated from service, that will trigger the “beginning date” for that 401k plan.

It’s also important to note that separation from service triggers the “beginning date” for that 401k. So, assuming you deferred RMDs in your current 401k plan, and retire at 75, you can still take advantage of deferring the first RMD until April 1st following the year you separated from service.

Finally, this rule does NOT apply to Solo 401ks or SEP IRAs. These plans are for self-employed individuals, and RMDs can’t be delayed simply because they are still working.

Can I aggregate my RMDs into one plan?

You might be wondering if you have multiple retirement plans, can you just pull the RMDs from one account?

My favorite answer is, “it depends.”

If the multiple retirement plans have identical plan types (perhaps they are all 401ks or all 403bs), then “yes, you can aggregate the RMDs.” If there are different plan types, like one IRA and one 401k, those plans each have their own RMD and must be satisfied separately. Let’s look at two examples:

Scenario 1: Joe has two IRAs, each with RMDs:

IRA RMD #1: $10,000

IRA RMD #2: $25,000

Total IRA RMD = $35,000

He can satisfy the entire $35,000 from either or both accounts.

Scenario 2: Joe has one IRA and one 401k each with RMDs:

IRA RMD #1: $10,000

401k RMD #2: $20,000

Each RMD would need to be satisfied separately because they are not identical account types.

SECURE Act’s elimination of the Stretch IRA for (MOST) beneficiaries

In January 2020, the SECURE Act of 2019 went into law. Part of the plan to pay for the bill was to accelerate distributions for beneficiaries of IRAs and 401k plans.

Under the previous law, a beneficiary other than the spouse could “stretch” the IRA based on THEIR life expectancy. Assuming the non-spouse beneficiary was much younger (like an adult child), the RMD would be reduced significantly after the original owner’s death. This is when the Single Life Expectancy table is used, as we alluded to earlier.

Let’s look at an example:

An original account holder has a $1mm IRA and is 80 years old. Their RMD would be $1,000,000 / 20.2 = $44,504.96. Before 2020, if that account owner passed away and their 55-year-old daughter inherited the account, her RMD would be $31,645.57. That’s a reduction of almost $13,000 of taxable income! In essence, it allowed the new owner to “stretch out” the distributions over a much longer period of time and thus preserving the tax-deferred status for longer.

The SECURE Act of 2019 eliminated the stretch IRA for MOST beneficiaries. I wrote about this in a previous post, “The Tax Trap of Traditional 401ks and IRAs,” but most beneficiaries other than the spouse will follow the “10-year rule.”

What is the 10-year rule?

The 10-year rule states that a retirement account must be fully liquidated by the end of the 10^th year following the owner’s death. The exception to the 10-year rule is for those who are “eligible designated beneficiaries.” These individuals are essentially a spouse, a beneficiary who is disabled or chronically ill, or a beneficiary who is fewer than 10 years younger than the IRA owner.

Everyone else will follow the 10-year rule.

If the IRA owner passed away on or after the beginning date, RMDs must continue during years 1-9, and then the full balance must be liquidated in year 10. If the IRA owner passed away before their beginning date, there are no RMDs until year 10, when the account needs to be fully liquidated.

It might be tempting to stretch the 10-year rule until the 10^th year, but this would result in significant taxes owed that year. Instead, you might consider taking somewhat equal distributions in years 1-9 and distributing the remaining account balance in year 10 to avoid a huge tax bill.

As you can see by the (overly simplified) chart below, this has significantly increased the size of distributions required after the account owner’s death and ultimately results in higher taxes.

What can you do to minimize the tax impact of RMDs?

If you are like many of our clients, the bulk of your retirement savings might be in tax-deferred 401ks or IRAs. However, newer plans like Roth IRAs and other Roth retirement plans have NO RMDs! Therefore, one way to minimize the RMD impact is to increase the proportion of Roth accounts on your balance sheet. There are two ways to do this:

If you are still working, change the contribution allocation to Roth vs. Traditional (401ks, 403bs, TSPs, etc). If your employer does not have a Roth option, you might consider a Roth IRA.
If you are retired or perhaps not contributing to a retirement plan, you could consider Roth conversions. This allows for money to be moved from tax-deferred accounts to tax-free accounts by paying taxes on the amount converted.

Why would I want to pay more taxes now?

Perhaps you believe your tax bracket will go up due to RMDs. Maybe you saved diligently into 401ks and IRAs and your RMD will be high enough to push you into the next tax bracket.

Also, healthcare is a big expense in retirement! Many people don’t realize that your Modified Adjusted Gross Income (“MAGI”) will impact how much you pay in Medicare Part B and D premiums (known as “IRMAA”)! The base premium for Medicare Part B is $164.90, but this can increase as high as $560.50 depending on your MAGI! Multiply this by 2 for Married Couples and we are talking over $12k/year in premiums alone!

Therefore, you might consider taking small bites at the apple now (pay some additional taxes now), so you don’t have a huge tax drag when RMDs kick in.

Consider taking advantage of "Qualified Charitable Distributions" or QCDs

This is perhaps my favorite tax strategy for retirees. QCDs allow for up to $100,000 to be donated to a qualified charity from your IRA. You have to be at least 70.5 years old, and it has to come from YOUR IRA (not an inherited IRA). This also means you cannot use 401ks or 403bs for QCDs!

While you can start this strategy at 70.5, this has the most impact on those already taking RMDs.

Because of the increase in the standard deduction, the majority of taxpayers are NOT itemizing deductions. If you’re not itemizing deductions, the gift you made to your favorite charity is NOT deductible! Instead of donating cash, a QCD will allow you to use some (or all) of your RMD to contribute to your favorite charity (or charities). The best part; is there is NO impact on itemizing or using the standard deduction! The amount donated via QCD reduces your RMD dollar for dollar (up to $100,000), which is in essence BETTER than a tax deduction! Let’s look at how this works.

Bill’s RMD for 2023 is $50,000.

Bill loves donating to his local animal shelter which is a qualified 501(c)(3). He typically sends a check for $5,000, but he does not have enough deductions to itemize on his tax return. Instead of sending a check, Bill fills out a QCD form with Charles Schwab (where his IRA is) and tells them to send $5k from his IRA directly to the shelter. The QCD is processed, and now Bill’s remaining RMD is only $45,000 for 2023! See, better than a tax deduction!

It’s important to note that the charity has to be a US 501(c)(3) to be eligible for a QCD, and this excludes Donor Advised Funds and certain charities.

Action Items

RMDs will likely always be a part of our tax code. As you can see, however, the rules are changing frequently! Instead of being reactive, begin planning for how to deal with your RMDs well before you start them!

Here are some action items and questions to consider:

1. Run a projection for what your RMD will be at your beginning date

2. Does your RMD provide a surplus of income? Or, do you need your RMD to maintain your retirement lifestyle?

3. If your RMD provides a surplus of income, consider increasing Roth contributions and reducing Pre-tax contributions. Or, consider converting some of your pre-tax balance to Roth when the timing is right. Typically a great time to look at this is when you retire and have a window of time (let’s say 4-5 years) before starting RMDs!

4. If you are already taking RMDs, determine if QCDs are a viable option for you to consider

5. If leaving a financial legacy is important, consider the tax implications of leaving retirement accounts to the next generation. Are your children in higher tax brackets? If so, you might want to consider the impact the 10-year rule will have on their tax bill.

6. Do you believe your tax rate (or perhaps tax rates in general) will be higher or lower in the future?

It’s important to have a plan and consult with a financial professional who understands taxes in retirement! If you have questions about how to address your RMD strategy, reach out to us and schedule an initial “Zoom” meeting! We would love to get to know you and learn how we can help with your retirement journey.

And as always, make sure to subscribe to our newsletter to stay up to date with all of our latest retirement planning content!

Until next time, thanks for reading!

Kevin Lao

February 27, 2023

Using the Guardrail Withdrawal Strategy to Increase Retirement Income

What is a safe withdrawal rate for retirement?

There will be ongoing debates on what a safe withdrawal rate is for retirees. It’s the Holy Grail of retirement planning. After all, wouldn’t it be nice to know EXACTLY how much you could withdraw from your portfolio, and most importantly, for how long? Unfortunately, there isn’t a one-size-fits-all solution. The most popular research in this arena is Bill Bengen’s “Determining Withdrawal Rates Using Historical Data,” which coined the “4% Rule.” However, what if you need more than 4%/year to enjoy retirement? Or, what if you want to spend more early in retirement while you still can? Or, perhaps you can make other adjustments over time to improve outcomes. This is where the Guardrail Withdrawal Strategy, or a dynamic spending plan, really helps retirees’ incomes.

In Michael Stein’s book, “The Prosperous Retirement,” he categorizes retirement into the following three phases:

“Go-go years”
“Slow-go years”
“No-go years”

The idea is that spending tends to go up in the first phase of retirement, and then continues to go down as we age. Sure, healthcare costs could go up later in retirement, but not at the same rate that discretionary spending goes down.

Another example where adjustments to spending occur is during a recession or bear market, like in 2020. Spending was down significantly due to global lockdowns, and for retirees, this meant a significant drop in travel expenses.

On the other hand, some years might require higher spending because of unexpected medical expenses or home repairs.

The point is, life isn’t a linear path, so why should your retirement income plan be?

Justin Fitzpatrick, the co-founder of Income Lab, and I talked about retirees’ spending powers in “Episode 14 of The Planning for Retirement Podcast.” Those of us who specialize in retirement income are familiar with the Guardrail Withdrawal Strategy. This involves setting a specified rate of withdrawal but understanding when to pivot during good and bad times.

In this article, we will discuss the background of the 4% rule and its impact on retirement planning. We will also review some of the drawbacks of the 4% rule when implementing it in practice. And finally, we will discuss the Guardrail Withdrawal Strategy, and how it can improve retirement income by simply allowing for fluidity in withdrawals.

Let’s dive in!

The 4% rule

Bill Bengen was a rocket scientist who received his BS from MIT in aeronautics and astronautics. After 17 years of working for his family-owned business, he moved to California and began as a fee-only financial planner. He couldn’t find any meaningful studies to showcase what a safe withdrawal rate in retirement would be. So, he began his own research and discovered the 4% rule, or “SAFEMAX” rule.

He looked at historical rates of return and calculated how long a portfolio would last given a specified withdrawal rate and portfolio asset allocation. In layman’s terms, he figured out how much could reasonably be withdrawn from a portfolio, and for how long. This helped solve the #1 burning question for pre-retirees; “Will I outlive the money? Or, will the money outlive me?”

The Findings

There is a ton of amazing detail in Bill’s research, the most famous being the 4% rule. The main takeaway is if a portfolio withdrawal rate was 4% in the first year and adjusted for inflation each year thereafter, the worst-case scenario was a portfolio that lasted 33 years. This worst-case scenario was a retiree who began withdrawals in the year 1968, right before two recessions and hyperinflation. This confirms that the timing of retirement is important but completely uncontrollable!

The hypothetical portfolio within the 4% rule consisted of a 50% allocation in US Large Cap Stocks and 50% in US Treasuries.

Bill later acknowledged that adding more asset classes and increasing stock exposure would increase the SAFEMAX rates. For example, adding small-cap and micro-cap stocks increases the SAFEMAX to 4.7%!

The downsides of using the 4% rule in practice

First and foremost, I must first acknowledge that Bill Bengen’s research has made a huge impact on the retirement planning industry, and certainly in my practice personally. Every planner who focuses on retirement knows who Bill Bengen is and knows about the 4% rule.

One common mistake is most people assume the 4% rule means multiplying the portfolio each year by 4%, thus providing the withdrawal rate. Instead, 4% is the FIRST year’s rate of withdrawal. Each subsequent year, the dollars taken out of the portfolio will adjust for that year’s inflation rate. Let’s look at an example.

Let’s say you have $1mm saved. If we used the 4% rule, your first withdrawal would be $40k (4% x $1mm). In year 2, assuming inflation was 3%, the withdrawal would be $41,200 ($40k + 3% or $40k x 1.03). Well, what if year 2 involved a steep drop in your portfolio value? If you retired in 2008, and your portfolio dropped by 35%, the rate of withdrawal in year 2 would equal 6.33% ($41,200/$650k).

What about the mix of stocks and bonds?

Some clients are more risk-averse than others. However, most people assume the entire study was based on a 50/50 stock and bond allocation. This is TRUE for the 4% rule, or SAFEMAX, but he also ran scenarios based on all types of allocations. He discovered that 50% is the minimum optimal exposure to stocks. However, he found that the closer you get to 75%, the more it will increase your SAFEMAX. So, in addition to adding more asset classes, as mentioned above, increasing your percentage of stock ownership could also increase the safe withdrawal rate.

Word of caution: increasing your stock exposure could certainly increase your rate of withdrawal, but it will also increase the volatility and the risk of loss in your portfolio.

This is where “risk capacity” comes into play. The more risk capacity you have, the more inclined you might be to take on more risk. The inverse is also true.

The 4% rule is also based on the worst-case scenario of historical rates of return and inflation.

The majority of the time, stocks have positive returns (80% of the time). But, what if you pick the worst year to retire, like 1968? This was a perfect storm of bear market stock performance combined with high inflation (sound familiar?). So, does that mean you should plan for the worst-case scenario? If you do, in most of the trials within Bengen’s research, the portfolios lasted well beyond 50 years resulting in a significant surplus in assets at death.

In fact, he cited that many investors did very well with a 7% withdrawal rate! My goal is to encourage my clients to ENJOY retirement, not worry about the worst that could happen!

How much of your retirement income are you willing to sacrifice just to prepare for the worst-case scenario? After all, $70,000/year is a heck of a lot more than $40,000/year from the same $1mm portfolio.

What about the impact of tax planning?

Bill Bengen’s study assumed the entire portfolio was invested in a tax-deferred IRA or 401k plan. This means that all income coming out of the portfolio was taxed at ordinary income rates! But what about those who have brokerage accounts with favorable capital gains treatment? Or better yet, what about Health Savings Accounts or Roth IRAs? These accounts have TAX-FREE withdrawals assuming they are qualified!

If smart tax planning is implemented, this could also enhance retirement income!

If you are like many of the clients we work with, the majority of your retirement savings likely consists of pre-tax 401ks and IRAs (aka “tax deferred” accounts). You might be wondering if you should take advantage of the Roth conversion strategy to improve tax efficiency during retirement. You can read more about that topic in a previous post (link here).

Sometimes, if you have a period of time with very low taxes (typically in the first 5-10 years of retirement), you can be aggressive with this strategy and significantly save on taxes in retirement and Medicare surcharges (aka “IRMAA”).

Do retirees' expenses increase with inflation?

Another challenge of the 4% rule is the assumption that spending continues to increase at the pace of inflation each year. But what about later in retirement when travel slows down? Or, perhaps you sell the RV after years of exploring the national parks. Wouldn’t discretionary spending go down, thus resulting in a lower rate of withdrawal?

According to Michael Stein and his research, he cites that retirees go through three life stages

Go-go years
Slow-go years
No-go years

In the Go-go years, spending may actually go up slightly due to the simple fact that you have more free time! You’re able to take several big trips a year, visit the grandkids often, and so on.

In the Slow-go years, expenses go down a bit and also tend to increase at a slower pace than the consumer price index. During this phase, spending can drop up to 25% and increase at a slower pace than the Consumer Price Index.

In the No-go years, spending continues to drop with the exception of the healthcare category. Healthcare expenses tend to increase in the No-go years, but proper planning can help mitigate these costs.

If we assume a static spending level and therefore a reduced SAFEMAX, this could mean clients would potentially miss out on more spending in the “Go-go years” in order to have a surplus of available spending later in retirement!

Of course, we need to have a plan to address longevity and inflation risk, as well as a plan for unexpected healthcare expenses, such as Long-term care. However, if we have those contingencies in place, I’m all for spending more early in retirement while good health is on your side.

Social Security and other income sources aren't counted

Finally, the 4% rule never accounted for a reduction of portfolio withdrawals due to claiming Social Security or other retirement income.

Let’s say you plan to retire at age 60 and delay Social Security until 70 in order to collect the largest possible benefit. Your portfolio withdrawals in the first 10 years might be 30% or even 40% higher until you begin collecting Social Security!

The 4% rule does not account for those adjustments, and therefore will result in far less spending early on.

Word of caution. Accommodating for a higher than optimal withdrawal rate for an extended period of time, like 10 years, requires significant due diligence and risk management! A downturn during this period puts your portfolio at much greater risk, so ensure proper contingencies are in place if we go through a “Black Swan” event.

What is the Guardrail Withdrawal Strategy?

At a high level, the Guardrail Withdrawal Strategy allows for adjustments based on economic and market conditions. For simplicity purposes, this means reducing or increasing spending ONLY if a withdrawal rate guardrail is passed.

If you picture a railroad track, the initial target is the dead center of the track. We will then set “guardrails” on each side (positive and negative) to ensure we stay on track and make an adjustment to spending ONLY if we cross over the guardrail.

The guardrails we like to use involve an increase or decrease in the rate of withdrawal by 20% before a change needs to be made. If the rate of withdrawal crosses over the 20% threshold, either spending goes down 10% (Capital Preservation Rule) or up 10% (Prosperity Rule).

Let’s say we started with a rate of withdrawal of 5%; the lower guardrail would be 4% and the upper guardrail would be 6%. Due to market conditions outlined earlier in 2008, let’s say that caused us to pass the upper guardrail of 6%.

This would result would trigger the Capital Preservation Rule and the client would reduce their spending by 10% during that year.

Conversely, let’s say in 2021 the lower guardrail was hit given the extreme overperformance by stocks. This would result in the Prosperity Rule and spending increasing by 10% the following year.

This research was back-tested for a retiree who began withdrawals in 1973, which hit the perfect storm of high inflation and bear market returns. Despite these challenges, the maximum initial rate of withdrawal for a retiree that year was 5.8%! (assuming the portfolio was allocated to 65% in equities and 35% in fixed income). Increasing the stock exposure to 80% increased the initial rate of withdrawal to 6.2%!

Key factors to consider when implementing the guardrail withdrawal strategy

Risk tolerance

A client’s tolerance for risk will impact the “tightness” of the guardrails as well as exposure to stocks in the portfolio.

If a client is extremely risk-averse, perhaps you set “tighter” guardrails. This will increase the number of adjustments needed over time, but it could provide some peace of mind to the client. Additionally, reducing the stock exposure close to 50% (or in some cases lower) reduces volatility in the portfolio, but will also reduce the initial rate of withdrawal.

Conversely, if a client wants to achieve a higher rate of withdrawal (or income) and is comfortable with volatility in the market, up to 80% exposure to stocks could very well be appropriate. Additionally, you could widen the guardrails in order to limit the number of adjustments in spending.

What is the desire to leave a financial legacy?

The desire to leave a financial legacy is one of the major factors when considering the initial rate of withdrawal. If this is a high-priority goal, reducing the initial withdrawal rate could certainly improve the ultimate legacy amount.

On the other hand, if leaving a financial legacy isn’t a big priority, allowing for a much higher initial withdrawal rate is a viable option.

This is also where certain insurance products could be considered. For many, using a well-diversified investment portfolio with systematic withdrawals is more than appropriate. Fixed income would be used to protect withdrawals in a bear market, and stocks would be used as income during bull markets.

However, maybe having a guaranteed income stream is important to a client. In that case, consider purchasing a fixed annuity. One positive to rates increasing is that these annuity payout rates have also increased. I’ve seen quotes recently between 6%-8%/year. Many of the rate quotes, however, will not adjust for inflation. But if structured properly, this could be a nice solution to create an “income floor” over and above Social Security income.

For those of you who have a strong desire to leave a financial legacy, perhaps purchasing a life insurance policy could solve this challenge. In essence, this creates a legacy floor that can free you up to enjoy your retirement assets!

Finally, for those who have major concerns about Long-term care expenses down the road, purchasing Long-term Care Insurance could create some peace of mind. That way, the retirement income for the surviving spouse and/or legacy goals aren’t completely destroyed by a Long-term Care event.

Key takeaways and final word

There is no one size fits all retirement income plan. The 4% rule, the Guardrail Strategy, and the spending stages, all tie in differently based on your personal goals, risk tolerance, and financial situation.

Here are some key takeaways:

The 4% rule is a sound benchmark, but following it may result in a significant surplus of unspent retirement capital over a normal life expectancy
Retirement spending isn’t static, and using the Guardrail Withdrawal Strategy can ultimately improve your retirement income by allowing for flexibility in spending
Successful withdrawal rates have ranged anywhere from 4%/year to 7%/year
Risk tolerance and risk capacity drive the guardrail ranges as well as the exposure to equities in the portfolio
Personal goals and risk factors further determine what the initial safe withdrawal rate should be
Insurance products can help increase peace of mind and protect retirement income streams

We hope you enjoyed this article!

If you are curious about how you might incorporate guardrails into your retirement withdrawal strategy, we’d love to hear from you! You can use the button below to schedule a “Mutual Fit” meeting directly with me.

Make sure to subscribe to our newsletter so you don’t miss out on any of our retirement planning content.

Last but not least, share this with someone you know who is approaching retirement!

Thanks for reading!

Kevin Lao

February 7, 2023

2022 Market Recap and Opportunities for 2023

As we start 2023, it’s important for us to take some time to reflect on this past year before turning the page.
That way, we can bring in the new year with a fresh perspective on where the opportunities are.
In addition to investment opportunities, the SECURE Act 2.0 passed in December, which brings about some exciting tax and retirement planning strategies.
Let’s start with a recap of 2022!

2022 Was a Tough Year for Investors

We started out 2022 with record-high inflation at 7.5%, but the Fed Funds rate was still at 0%. In order to respond to the COVID-19 pandemic in 2020, the Feds not only cut interest rates but also injected mass amounts of stimulus into the economy. The more money in people’s hands, the more inflation you get. Additionally, unemployment skyrocketed in the short-term following temporary layoffs in 2020, but those workers were largely seasonal and got their jobs back later in 2020 and early 2021. Many worked remotely and never skipped a beat. As a result of record stimulus coupled with historically low unemployment, inflation began to persist in the summer of 2021. Instead of the Fed acting at that point (potentially increasing rates and/or reducing their balance sheet), they insisted that inflation was transitory and that it would be short-lived. After several months of PERSISTENT inflation, the Fed announced its strategy for 2022: Rate Hikes and Quantitative Tightening (reducing the assets on the Fed’s balance sheet).

Meanwhile, Russia invades Ukraine, which is of course a tragedy simply due to the unnecessary loss of life. Financially, this sent an energy shortage throughout Europe and Asia that impacted the global economy (and fuels MORE inflation).

And finally, the second largest economy in the world, China, continued its improbable journey to a zero-tolerance policy for COVID-19.

In essence, the biggest global economies in the world each had their own economic headwinds to deal with, which has now led us to where we are today.

After raising rates by 4.25% in 2022, the Fed feels like its work is starting to pay off. However, Jay Powell believes more work needs to be done and needs “substantially more evidence” that inflation is abating. Therefore, we should expect to see more rate hikes this year, but not as steep. This year, the market is pricing in two 25 basis point rate hikes which will bring the Fed funds target to nearly 5%.

The ongoing conflict in Ukraine as well as China’s rocky start to “reopening” will not help the fight against inflation. Additionally, unemployment FELL in December to 3.5% from 3.6% in November. Wage growth also remains above historical averages at 5.8% given the tight labor market.

Therefore, despite further rate hikes, inflation might remain above the Fed’s goal of 2% for quite some time.

For some positive news of 2022, let’s remember that the pandemic has brought about a tough 2 1/2 years. But finally, it looks like everyone is moving forward into the new “post-pandemic normal.”

Asset Class Returns 2008 - 2022

Here is a summary of the asset class returns from 2008 – 2022. For your reference, here is some clarification on some of the acronyms:

“Comdty.” = commodities
“EM Equity” = emerging markets
“DM Equity” – developed markets (excluding US)
“Asset Alloc.” = 60% equity / 40% fixed income portfolio

2022 was a tough year. All of the major asset classes were negative, and mostly by double digits. However, looking at the past 15 years since 2008, a 60/40 portfolio (“asset alloc.”) returned 6.1%/year, and Large Cap US Stocks returned close to 9%/year! I would argue the last 15 years the market has outperformed its historical average, so it’s not unreasonable to think we might have a down year (or two). After all, when we have a long-term investment strategy, we are signing for up occasional volatility. However, the only way to guarantee not getting to your destination is by bailing out of your long-term plan.

Despite these factors, here are the opportunities we see for 2023 and beyond. Additionally, the SECURE Act 2.0 passed in December of 2022 and brings about new tax planning opportunities for retirees and pre-retirees. We’ll discuss all of this below.

Yield is Back in Fixed Income

Since 2008, we have seen rate cuts to historic lows, which remained unnecessarily low for too long. As a result, yields on bonds were paying next to nothing, unless you were willing to take on substantial risk. As a result, you were lucky to earn 2% on an investment-grade portfolio over the last decade. Now that rates have skyrocketed, we are seeing yields on bonds push past the 4% and even the 5% range! At the beginning of 2022, I talked about the risk of rate hikes on existing bond portfolios. For this reason (among others), we elected to stay short term in duration within the fixed income positions for our clients. This didn’t eliminate the volatility within bonds, but it reduced the price risk substantially and paid off well. Now that these bonds are maturing, we have an opportunity to reinvest at the highest rates we’ve seen since before the global financial crisis in 2008.

For retirees out there, this is a great opportunity to take advantage of purchasing bonds that can not only act as a stabilizer from equity volatility but provide meaningful returns for retirement income. After all, inflation is expected to abate, which could lead to an intermediate to long-term term bond strategy outpacing inflation by 2% or even 3% per year!

I wrote about 4 bear market income strategies in my last article where I also discussed the value of a bond ladder as part of a retirement income plan. Given the expectation that rates are likely not to remain this high for very long, the next 1-3 years will be a great opportunity to add duration and yield to your fixed-income portfolios.

I might add that shorter-term bonds are yielding higher coupon payments than longer-term bonds. As of today, the 2-year treasury is yielding 4.157%, compared to the 10-year treasury yielding only 3.449%. This means that the market is pricing in rate decreases over the next few years. As we mentioned earlier, bond prices go down when rates go up. The opposite is true when rates go down, bond prices go up. This means that fixed-income investors will not only benefit from higher yields but might also benefit from potential appreciation if/when bond prices do go up.

Value Stocks vs. Growth Stocks

With all of the talk about how great yields are on bonds and how poorly stocks did in 2022, we love the outlook for stocks over the next 5 years. The question is, what kind of stocks will outperform? Well, being an advocate for a well-diversified portfolio, we won’t be taking any big bets on any one asset class. However, we talked about overweighting toward value stocks in 2022, and we think the same for 2023.

Companies that rely on leverage for growth typically reap the rewards of the low-rate environment we saw since the Great Recession. Therefore, the “growth” sectors within equities outperformed for much of the last decade. Towards the end of 2021, we talked about the risk of being overexposed to growth-oriented stocks (tech stocks, consumer cyclical stocks) during a rising rate environment. Just think about it; the more expensive debt becomes, the tougher it is for these companies to borrow at the pace they need for growth.

Instead, we liked value stocks to be overweight in the portfolio, as investors would flock to safety during volatile times (think dividend-oriented, cash-flow healthy companies).

Growth stocks took the biggest hit in 2022 and lost about 30%. Some of the biggest names in tech were down even more.

Google (GOOG): -39.1%
Amazon (AMZN): -49.6%
Tesla (TSLA): -65%
Facebook (META): – 65%
Netflix (NFLX): -50%

On the contrary, value stocks were down only 6% in 2022.

We do believe there is more volatility ahead, as corporate earnings might disappoint in the first half of 2023. However, when stocks take a big hit like this, it’s a buying opportunity, NOT a selling opportunity. As we re-balanced portfolios in 2022 and at the beginning of 2023, we were buying stocks, not selling! And if history is an indicator, after we hit bear markets, the performance of stocks tends to be very promising in the years ahead. After all, bear markets typically experience a -37% decline, but bull markets experience a 209% increase, on average!

Don't ignore International Stocks!

International stocks have been underperforming relative to US stocks for over a decade. However, international companies have looked relatively cheap for quite some time now. These stocks were set to outperform in 2020 until COVID-19 shut down the global economy. International stocks have taken a bigger hit since the pandemic but outperformed US stocks in the second half of 2022. With cheap valuations, a stronger outlook for growth relative to the US, and a strong dollar, it’s important NOT to ignore international exposure within your portfolio. For our clients, we are focusing on quality companies with steady cash flows and strong balance sheets, very similar to the story for the US sectors. Additionally, we are limiting our exposure to companies that are owned by foreign governments, as they create additional geopolitical risk.

Of course, there are still significant risks with China’s reopening, as well as the Russian invasion of Ukraine. These factors could certainly create lots of volatility for the asset class, which is why US stocks will continue to remain the majority asset class within our equity portfolios.

For you historians out there, the chart below shows international stocks outperformed much of the 70s and 80s during hyperinflation. I’m not suggesting this will be the same story, but a prudent investment strategy will certainly incorporate international stocks going forward.

Bottom Line

Stocks and bonds both declining at a double-digit pace is unprecedented. However, staying diversified and disciplined served our clients well in 2022 and will serve them even better when things begin to recover.

It’s important to always start with “why.” Why are you investing?

For our clients, it starts with a financial plan which includes their personalized goals, risk tolerance, and financial assets.

Each investment strategy is tailored to its goals and involves a process to stay on track for those goals. It’s extremely dangerous to try to guess or time the market, as it’s virtually impossible to do consistently over time.

SECURE Act 2.0 Highlights

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed in 2019 and went into effect on January 1^st of 2020. The SECURE Act 2.0 was officially passed in December 2022. Some aspects go into effect in 2023, whereas others will go into effect in the years to come. We will focus on the SECURE Act 2.0 and the major changes we believe will impact retirees and pre-retirees.

Changes in Required Minimum Distributions

Required Minimum Distributions, or RMDs, is the amount required to be taken out of a qualified retirement plan once the beginning date starts. Before the SECURE Act of 2019 was passed, the RMD beginning date was the year in which you turned 70 1/2 . However, for those who had not yet turned 70 ½ as of January 1^st 2020, the new RMD beginning date was the year in which you turned 72.

The SECURE Act 2.0 now pushes the beginning date back further. The table below illustrates the beginning date based on your year of birth.

The amount required for the distribution is based on the IRS life expectancy table. For most participants, the Uniform Lifetime Table will be used. If your spouse is more than 10 years younger, you can use what is called the “Joint Life Expectancy Table.” There is also a single life expectancy for stretch IRAs (no longer allowed after 2020).

For illustrative purposes, let’s take a look at the Uniform Lifetime Table below, which also shows the corresponding percentage and dollar amount required to be taken from a $1,000,000 retirement account.

As you can see, for a 72-year-old, the account balance is divided by 27.4 (the divisor balance), which is equal to $36,496.35 (or roughly 3.65% of the account balance).

You will notice the RMD goes up over time. This is because there are fewer years of life expectancy remaining. By the time a retiree reaches 80, the RMD is approximately 5% of the portfolio.

Uniform Lifetime Table
Age	Divisor Balance	% of Account	RMD for a $1,000,000 retirement account
70	29.1	3.44%	$ 34,364.26
71	28.2	3.55%	$ 35,460.99
72	27.4	3.65%	$ 36,496.35
73	26.5	3.78%	$ 37,735.85
74	25.5	3.93%	$ 39,215.69
75	24.6	4.07%	$ 40,650.41
76	23.7	4.22%	$ 42,194.09
77	22.9	4.37%	$ 43,668.12
78	22	4.55%	$ 45,454.55
79	21.1	4.74%	$ 47,393.36
80	20.2	4.96%	$ 49,504.95
81	19.4	5.16%	$ 51,546.39
82	18.5	5.41%	$ 54,054.05
83	17.7	5.65%	$ 56,497.18
84	16.8	5.96%	$ 59,523.81
85	16	6.25%	$ 62,500.00
86	15.2	6.58%	$ 65,789.47
87	14.4	6.95%	$ 69,444.44
88	13.7	7.30%	$ 72,992.70
89	12.9	7.76%	$ 77,519.38
90	12.2	8.20%	$ 81,967.21

For those of you turning 72 in 2023, you were probably planning to have your beginning date start this year. However, this new legislation is in effect NOW, so your beginning date is 2024 when you turn 73! Happy Birthday to those born in 1951!

The next group of individuals born in 1960 or later will have a beginning date of the year they turn 75.

For the first RMD only, you can delay the distribution until April 1^st of the following year.

For example, you turn 73 in 2024 (born in 1951). You can either take your first RMD in the calendar year of 2024 OR take that RMD by April 1^st of 2025. Just remember, if you decide to delay until April 1^st, you will have TWO RMD’s for 2025 (one for 2024, and one for 2025). However, this is helpful if your taxable income will drop substantially after your beginning date due to retirement or other reasons.

Planning opportunities for RMDs

First and foremost, SECURE Act 2.0 gives account owners more time until they are required to start taking RMDs. For many of you, you might be dreading RMDs as you might not NEED those distributions for income. Perhaps your Social Security, Pension, and other investment income is more than enough to live your lifestyle. Therefore, RMDs are more of a tax liability than anything else.

For some, considering a Roth conversion strategy could be advantageous.

Consider someone who is retiring at 62, and their earned income goes to 0. Perhaps they plan to live on their investment assets until reaching 70 (their Latest Retirement Age for maximum Social Security benefits). Assuming the beginning date is the year in which they turn 75, they have 13 years of potentially low income.

Therefore, instead of continuing to defer their retirement account balances until 75, one might consider converting portions of those existing tax-deferred account balances for the next 13 years. Yes, a Roth conversion would trigger taxes now based on the amount converted, but this also reduces the calculation for the RMD each year. Roth IRAs do not have RMDs, and distributions from Roth IRAs are tax-free (assuming they are qualified). Therefore, this could result in tax savings beginning at age 75, and could potentially last for 20+ years based on one’s life expectancy. I wrote an article on Roth conversions and if you should consider them that you can read here.

Another positive change is the elimination of the RMD from Roth 401ks and other Roth-qualified retirement plans. In the past, ONLY Roth IRAs were excluded from RMD calculations. Beginning in 2024, qualified plans with Roth balances will NOT be required to take an RMD.

Qualified Charitable Distributions (QCDs)

QCDs are a great tool for those over the age of 70 ½ and are charitably minded. For 2023, the limit for a QCD is still $100,000, which means you can gift up to that amount from your Traditional IRA to a charity without paying taxes. However, this limit will begin to index with inflation beginning in 2024 (finally!). The initial $100,000 limit was set in 2001, so it’s about time they began to increase the amount allowed.

This works extremely well if you are already taking RMDs, as that income is not counted towards your Adjusted Gross Income. Instead, it’s an above-the-line deduction regardless if you itemize or take the standard deduction.

Example: Susan typically donates $10,000/year to her favorite animal shelter, which operates as a 501(c)3 charity. However, her total itemized deductions don’t exceed the standard deduction for her and her spouse, which is $27,700 for 2023. Therefore, she technically does not receive any tax incentive for donating the $10,000. Last year, she turned 72, so she now has an RMD of $50,000 in 2023. Instead of taking the $50,000 as income, paying taxes, and writing a $10k check to the animal shelter, she elects to do a $10k QCD. The QCD form is filled out through the custodian, and the custodian will write the check directly to the charity. Now, her RMD is only $40,000 (instead of the full $50k). The net result is a reduction in taxable income of $10,000, and the standard deduction is still in effect! Win-win!

There is a provision in SECURE Act 2.0 that allows for a $50,000 one-time contribution to fund a Charitable Remainder Trust (CRUT or CRAT). Most individuals funding Charitable Remainder Trusts are funding them with much larger increments, as essentially you are giving away those assets to a charity, in exchange for a lifetime income and a generous tax deduction. In most cases, $50,000 is not going to provide very much in the way of lifetime income, and that asset is no longer available on the balance sheet.

Therefore, QCDs are mostly unchanged with the exception of inflation adjustments, but keep in mind the Charitable Trust strategy as it could come into play for some charitably minded individuals.

Roth SIMPLE IRAs and Roth SEP IRAs

Traditionally, these small business retirement plans could only be funded with pre-tax dollars. With the SECURE Act 2.0, these businesses can now allow for Roth contributions for both SIMPLE IRAs and SEP IRAs. This will be effective immediately starting in 2023. However, I’m expecting some challenges and delays from the custodians of these accounts given the need to update forms, processes, and procedures.

Just remember, a ROTH contribution into a SEP or SIMPLE IRA is non deductible, but can benefit from tax-free growth. A Traditional (pre-tax) contribution into a SEP or SIMPLE IRA is deductible and grows tax deferred.

The driver of what kind of contribution to make is based on what your current tax bracket is vs. what it might be in retirement (any crystal balls?). If you are in a high tax bracket today and don’t plan to be during retirement, you might benefit from Traditional SEP contributions that are deductible. If you are tax neutral or you might be in a higher tax bracket in retirement, you might benefit from tax-free growth (Roth contributions).

If you have no idea, perhaps you should consider contacting a fiduciary financial planner and/or tax professional. (or just split it 50/50!)

529 Rollovers to a Roth IRA

Yes, you read this correctly! Parents tell me all the time that they are worried about overfunding their child’s 529 because their kid is going to be the next Mark Zuckerberg, drop out of college and become a billionaire. So, what about those dollars that are left inside the 529?

Most parents (and grandparents) will just liquidate the account and pay taxes and/or penalties, or simply let the account sit there indefinitely. Beginning in 2024, 529 plans that have unused funds can be rolled over into a Roth IRA. However, it’s NOT too good to be true as there are hoops you need to jump through.

The Roth IRA receiving the rollover must be the same beneficiary as the 529 plan
The 529 plan must be open for at least 15 years
Contributions to the 529 within the last 5 years, and earnings on those contributions, are ineligible for rollover
The annual limit for how much can be moved to the Roth IRA is the same as Roth IRA contribution limits (not including contributions directly made to the Roth IRA)
The lifetime maximum that can be moved from a 529 plan to a Roth IRA is $35,000

If your child is the beneficiary, this would mean you would have to rollover their 529 balance to a Roth IRA in THEIR name. However, could the rule allow for a change of beneficiary to name either you or your spouse, then proceed with a rollover to a Roth IRA in one of your names? And if so, does that reset the 15-year clock?

The law is unclear about this, but it should be addressed by the IRS before it comes into effect in 2024. Until then, just know there is a potential solution for these unused 529 funds over time, and is perhaps one of the most interesting developments with the SECURE Act 2.0!

Spouses who inherit IRAs

The current law allows spouses to;

Rollover the IRA into their own IRA
Elect to treat the decedent’s IRA as their own
Or simply remain as the beneficiary of the IRA

Beginning in 2024, the SECURE Act 2.0 will now allow for the surviving spouse to essentially treat the IRA as if they were the deceased spouse.

This could be beneficial if the surviving spouse is older than the deceased spouse, as they could potentially delay RMDs for longer. Additionally, if the surviving spouse passes away before the initial owner would have reached RMD age, their beneficiary would have some flexibility with the 10-year rule.

IRA and 401k Plan Catch-up Contributions

When you are over the age of 50, you are eligible for “catch-up” contributions. IRA catch-up contributions have been $1,000 for 15 years! Finally, they will be indexed for inflation, I guess in response to record-high inflation all around. Makes sense to me!

This will begin in 2024, and adjustments will be made in increments of $100.

Starting in 2025, SECURE Act 2.0 will allow for additional catch-up contributions for certain qualified plan participants. Those who are 60-63 have their plan catch-up contribution limit increased to the greater of $10,000, or 150% of the regular catch-up contribution. This limit applies to plans like 401ks, 403bs, 457bs, and TSP accounts.

SIMPLE IRA participants ages 60-63 also have their catch-up contributions increased to $5,000 or 150% of the regular catch-up contribution.

Catch up contributions for high income earners

Starting in 2024, catch-up contributions for workers with wages over $145,000 during the previous year will be automatically characterized as Roth contributions, not traditional. There are several key planning considerations with this change.

There are income phaseouts that ultimately eliminate participation in a Roth IRA for individuals (for 2023, a single filer is phased out at $153,000, and married filing jointly at $228,000). Given 401k catch up contributions have NO income phaseouts, this is a BENEFIT to some 401k/403b participants who prefer Roth contributions over Traditional
1. If a participant between the age of 60-63 prefers Roth contributions, they could in essence max out approximately $41,250 into Roth accounts starting in 2025!
  1. $22,500 for Roth 401k/403b (regular deferral max)
  2. +$11,250 catch up contribution for ages 60-63 (new catch up limit beginning in 2025)
  3. +$7,500 Roth IRA contribution or backdoor Roth IRA contribution (if done properly)
If the plan does NOT allow for Roth contributions (which are becoming less and less common), then the catch-up contributions will be pre-tax instead.

Some higher income earners might actually PREFER traditional (pre-tax) contributions, especially those who believe their tax bracket will go down in retirement.

We still need clarity on a few provisions within this section, so stay tuned as we get closer to 2024!

Final word

There are many investment and tax planning opportunities in the years ahead, it makes me excited to serve our clients!

It has been a tough couple of years, and many of you might be wondering if you should be making adjustments to your portfolio. Or, perhaps you have an advisor that focuses mostly on investments and not retirement and/or tax planning.

We will be accepting 12 more clients for 2023, and we would be more than happy to see if you are a good fit to work with us (and vice versa). Feel free to schedule a “Mutual Fit” Zoom Call using the link below.

Also, make sure to subscribe to our newsletter to get our latest insights delivered to your inbox.

Until next time!

Sources:

https://www.schwab.com/learn/story/fixed-income-outlook

https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/economic-and-market-update/

https://www.schwabassetmanagement.com/content/quarterly-chartbook-video?segment=advisor&mkt_tok=MTUzLUhSWS0xOTQAAAGJRvqWZCYGXBuEWVz_t_XSlK7BQxQAOMXvT6fTv83rV-gsKVFRoHkDUz6kKLN0Dr2XVP1hu2NGVBA_byzsRl-MbS8BpR9k0N0DAYvWLe_g5pFg

https://www.kitces.com/blog/secure-act-2-omnibus-2022-hr-2954-rmd-75-529-roth-rollover-increase-qcd-student-loan-match/

https://www.finance.senate.gov/download/retirement-section-by-section-

Kevin Lao

January 17, 2023

4 Bear Market Retirement Income Strategies

The 2022 bear market hits retirees the hardest

As we prepare to close out 2022, retirees and pre-retirees are facing the worst possible scenario, a triple bear market. US stocks, along with international stocks will likely be down double digits. US bonds will close in the red 10%+ year to date. And cash, although yields have risen, are experiencing negative returns net of inflation. All in all, the traditional 60/40 investment portfolio model for retirees has many questioning whether this strategy is still viable.

Many of you will need to take a distribution to satisfy your RMD (“Required Minimum Distribution”) for 2022 and 2023, or simply need income to live on during retirement.

But, you have probably heard the old saying, “Buy Low and Sell High.”

Well, how do you implement a retirement income strategy during a bear market, particularly one in which both stocks and bonds are experiencing record losses?

Here are 4 retirement income strategies to consider during times like these. Let’s not forget that bear markets, on average, happen every 5 years. So, in a potential 30 year retirement time horizon, you will experience roughly 6 bear markets!

Let’s dive in.

#1: Asset Dedication

One way to hedge bear market risk involves what is called the “Asset Dedication Strategy.” This strategy incorporates aligning a CD or individual bond ladder with specific cash flows, in this case retirement income. Let’s say your RMD is estimated to be $50,000 in 2023. A basic example would be to purchase a high quality bond or CD for $50,000 (or a combination), that will mature at the time the cash flow is needed. This is my personal favorite when working with clients because it eliminates the uncertainty of where interest rates might go in the future. In general, when interest rates rise (like in today’s market), the value of bonds go down. If you own an individual bond and hold it to maturity, the par value is redeemed in addition to the interest payments you received. Therefore, who cares what the price fluctuation was along the way?

The challenge for bond mutual funds or ETFs is they have to deal with redemptions (other investors selling), which will inevitably impact the price of that particular fund, and ultimately its performance.

Depending on your time horizon and risk tolerance, we would create a bond and/or CD ladder to satisfy 2-10 years of those expected distributions.

If done properly, you will never have to sell your stocks when markets are down. As your bonds mature and are paid to you as retirement income, you would then re-balance your portfolio (sell some of the winners) to add the next “rung to your ladder.”

The frequency of the re-balance will depend on market conditions and how well your other investments are performing. So, if markets rise rapidly, you might find yourself adding several rungs to the fixed income ladder by taking gains off the table. That way, when markets are down, you have plenty of wiggle room to wait until things recover.

If the strategy involves a taxable account (non-retirement), you might consider municipal bonds, depending on your tax rate. These interest payments are exempt from federal income taxes, and could also be exempt from state income taxes depending on the bond you purchase. If the strategy involves a tax free or tax deferred account, investing in corporate bonds and/or government issuers will work just fine, as taxes are not a concern.

BONUS Strategy

I have to add a bonus strategy as not all bond mutual funds and ETF’s have done poorly in 2022. In late 2021, with the help of our friends at Wisdom Tree Asset Management, we added the ticker AGZD as a core bond holding for all client accounts. The more conservative the account, the more exposure to AGZD. This strategy involves using traditional fixed income securities coupled with derivatives within the treasury market to hedge against interest rate increases.

Sound complicated? Well, it is somewhat. But in essence, when interest rates do rise (like in 2022), this strategy helps preserve principal unlike your traditional bond mutual fund or ETF.

Year to date this strategy has returned a positive return of 0.63%! Compare that to the average bond mutual fund at -12.79%, wow! This strategy, coupled with individual bonds, has allowed our clients to protect their retirement income during this particular bear market.

#2: “Income Flooring”

“Income Flooring” with annuities is another strategy that works extremely well during volatile markets. This involves purchasing an annuity to generate an income floor that can be relied upon regardless of market fluctuations. Social Security might represent a portion of your fixed income needs in retirement, but what makes up the gap? If you are relying solely on securities that have price fluctuations, what do you do in a market like 2022?

An income floor will invariably reduce the amount of cash needed from a distribution, and therefore will allow your riskier assets to recover during a downturn.

The beauty of this strategy in today’s market is that interest rates have risen sharply. Therefore, insurance companies have been able to increase their payout rates, thus making income flooring much more attractive than it was 3-4 years ago.

I like to compare this to purchasing an investment property designed to pay a fixed income stream. The difference is there are no repairs, unexpected maintenance costs, or tenant vacancy gaps.

On the flip side, it’s not an asset you can “sell back” to anyone to recoup your principal. Additionally, there is no price appreciation like you would expect from buying real estate.

For the most part, these annuities are not liquid and should not be relied upon for an unexpected expense or emergency fund. Therefore, I typically would not recommend exchanging a large majority of your investible assets for these contracts given the lack of flexibility.

However, if structured properly, it can serve as a compliment to Social Security and other guaranteed income streams.

A good rule of thumb is to calculate your non discretionary expenses, and compare that to your projected fixed income payments (Social Security and Pensions). If there is a shortfall, you might consider backing into how much money would need to be exchanged into an annuity to fill that gap.

If you have yet to claim Social Security, this strategy can be even more powerful so you avoid tapping into longer term investments for current fixed income needs.

Caution

These contracts are complex and not all annuities are created equal. It’s important to consult with a fiduciary financial advisor who can work with you and multiple insurance carriers to select the most appropriate product. Caring.com has a great article on annuities that you can read here.

#3: Cash Value Life Insurance

Cash Value Life Insurance is one of the highly debated products in the financial services industry. Insurance companies tend to “sell the sizzle” and often fall short on fully educating the consumer.

On the other hand, most investment advisors tend to default to the advice of “buy term and invest the difference.”

I started my career at a large insurance company, and now run my own fee only financial advisor firm, so I have sat at both sides of the table.

I wrote an article titled “5 reasons to own life insurance in retirement” that I would recommend reading to get my insights on the topic. For this article, I want to focus on using the cash value as an income strategy to hedge a bear market.

Here are the basics:

Cash values within a fixed life insurance policy have a guaranteed interest rate + a non guaranteed interest rate. They are paid to the policy owner in the form of annual dividends that can be used to purchase more life insurance, increase the cash value (or both), and pay premiums.
Cash values can be surrendered, at which point taxes will be due on any gains (if applicable)
Cash values can also be borrowed tax free while also keeping the policy in force

Example: Let’s say you have a policy with $100k in cash value. You are also retired (or planning to retire) and need $50,000/year from your investment portfolio to supplement other income sources. In a market like 2022, you might find it difficult to take a distribution from your investment portfolio, unless you implemented strategy #1 or #2 as previously mentioned. Therefore, instead of selling a stock or bond at a loss, you might consider borrowing $50k from your $100k cash value on a tax free basis. The loan will be charged interest, but there is still interest credited to you on the loan. My personal policy with Northwestern Mutual has a net charge of 3%, which isn’t bad in today’s market.

Let’s say you borrowed from the policy and avoided selling your longer term investments. Now what?

You have two options.

One, you can let the loan ride, and simply ensure that the policy doesn’t run into issues down the road. This involves reviewing your policy on an annual basis using an “In Force Illustration.”

When you pass away, the loan proceeds will be subtracted from the death benefit paid to your beneficiaries.

Or two, pay the loan back once the market recovers.

I prefer option two if you plan to utilize this strategy again in the future. At some point, this market will recover, and we will set new market highs. Who knows if that will be in 2023, 2024, or even 2025. But at some point, you might experience substantial gains within your stock portfolio that you are comfortable with taking $50k off the table and paying back that policy loan.

In essence, you are using the cash value as a re-balancing tool in lieu of other fixed income assets.

Here’s the challenge.

You need to have the cash value in the policy to take advantage of the strategy in the first place. This involves buying life insurance and funding the policy adequately to build up adequate cash value.

Therefore, this strategy is best suited for those of you approaching retirement that have adequate recourses to fund a policy for at least 5 years, and you’re healthy enough to buy it. If it’s designed properly, this will give the policy time to work properly and set you up for this defensive hedge that you may need 4-5 times throughout an average retirement time horizon.

Caution

Much like annuity contracts, life insurance policies are also not created equal. The design of the policy is key and will impact the viability of policy loans as well as the tax implications of using the cash value.

Furthermore, this strategy works best if you have a legacy goal of transferring assets to the next generation, and the cash value is more of an ancillary benefit.

Consult with a fiduciary advisor and licensed agent to create an optimal strategy best suited for you!

#4: Tap into Home Equity

Leveraging a HELOC (Home Equity Line of Credit) or Reverse Mortgage to access home equity is my fourth and final strategy.

With home values shooting up the last few years, you might find yourself with a large chunk of cash available to tap into via a home equity line of credit or reverse mortgage. This should be done carefully as it involves leveraging one of your most important assets, your home. However, if done properly, it could create an infusion of cash while letting your longer term investments recover.

A reverse mortgage could be tapped into as a form of life income payments, a line of credit, or both. At death, the loan amount would be offset by the sale of the home. For a HELOC, the loan would generally need to be repaid within a specified term. With rates increasing, you might be hard-pressed to find a HELOC for less than 6.5%. However, some of you might already have a HELOC established at a lower rate and can tap into the funds cost effectively.

Also, the challenge with reverse mortgages is that a higher interest rate will result in a more expensive loan and thus a lower payment. However, if you are in a bind, it’s worth consulting with your financial advisor and mortgage specialist to see if it’s a viable option.

In Summary

2022 has brought unique challenges to retirees. However, a well thought out retirement income plan is critical to weather this storm, and future storms during a 20-30 year retirement time horizon.

If you have questions about your retirement income plan, or are wondering how this bear market has impacted your long term goals, feel free to book a 30 minute initial conversation with me by clicking on the Schedule Now button below.

Also, make sure to subscribe to our email newsletter below so you don’t miss out on any of our future insights!

Retirement planning = reduce stress and worry less!

Kevin Lao

December 2, 2022

Blended Families – You Need a Long-term Care Plan!

Don't have a Long-term care plan? You are not alone!

Nobody likes to think about the possibility of a family member caring for them later in life. However, the number one concern I hear from my clients is “I don’t want to be a burden on my children.” When I ask about how a long-term care event would impact the family, most people have never thought about it. Or, they’ve thought about it but have yet to create an actual game plan.

Now, what about long-term care for blended families? If there are adult children from previous marriages, how does that impact the actual long-term care plan for Mom/Dad?

In this article, we will dive into the facts about Long-term Care planning, the challenges for blended families, and the top solutions to consider!

The basics

Despite the fact there is a 70% chance you will need long-term care later in life, less than half of retirees over 65 have Long-term Care insurance. Furthermore, 70% of caregivers are NON paid family members. So what does this mean?

Even though the probability of needing care is high, people simply ignore long-term care planning. Or, they simply assume buying insurance is too expensive or they will simply pay out of pocket.

And despite not wanting to burden their loved ones, they many end up doing just that. In fact, more than 60% of caregivers have other full time jobs in addition to being the primary caregiver!

Many people believe Medicare or Medicaid will cover Long-term Care expenses.

Medicare does not pay for custodial care after 100 days. Sure, if you are in a rehab facility and expect to improve, you can rely on Medicare to help subsidize those costs for a very short period of time. Medicaid, on the other hand, does pay for custodial care. However, most of you will probably not qualify for Medicaid given the financial requirements of income and assets. And sure, you might assume that your family members will hire help, but the reality is they are NOT hiring help. Perhaps they believe they can’t afford it, or they are afraid they will burn through assets too quickly and won’t be able to maintain financial independence for themselves. Both of these are legitimate concerns.

Long-term Care Planning Challenges for Blended Families

Blended families are becoming much more common nowadays. In fact, 40% of weddings today will form a blended family! For blended families planning for retirement with adult children, this can provide challenges in three ways:

Who’s assets will be used to pay for long-term care expenses?
How does a long-term care need for your spouse impact your ability to maintain financial independence?
Who’s children will be available to coordinate care?

Who’s assets will be used to pay for long-term care expenses?

What if you remarried and brought a much larger pool of assets to the marriage than your spouse? You might have the goal of passing on a financial legacy to your children, but at the same time making sure your spouse is taken care of for life.

As I discussed in my previous article, 4 Retirement and Estate Planning Strategies for Blended Families, the functionality of a trust for blended families is important. A trust would allow for you to pass on assets to your spouse, but making sure the next beneficiary is your children once your spouse passes away.

But what if your spouse needs long-term care later in life? Perhaps they don’t have their own pool of funds to pay for that care. Inevitably your trust will have to be invaded to pay for those long-term care costs. The question is, how does this impact your intergenerational wealth planning goals?

What about your financial independence?

If your spouse needs care and you spent down a large chunk of your assets to pay for it, how does this impact your ability to maintain financial independence after your spouse dies?

When your spouses passes away, the household will automatically have a reduction in Social Security income. There could also be a reduction in pension and annuity income, on top of assets being spent down for long-term care.

If you were cruising along and on track to meet your retirement and estate planning goals, how does a long-term care event impact your ability to maintain those goals?

As we illuded to earlier, most of the time the spouse will care for the other. Remember, 70% of long-term care is provided by unpaid caregivers. This means you might forgo hiring professional help in efforts to save your financial resources, but this could negatively impact your mental and physical health. We’ve seen caregivers get sick after their spouse passes away, simply because they took on the lion’s share of caregiving and are flat out worn out.

Who’s children will be available to coordinate care?

This is the most difficult part of the equation. Sure you might have enough resources to pay for care. But, like Jean Ausman shared in our retirement readiness checklist, “a checkbook is not a long-term care plan.”

Who is going to manage the care?

Who is physically going to provide the care? What if that person is a stepchild?

Who is going to manage the financials and decide which accounts to tap into for care?

These are all touchy subjects, especially with a blended family where the adult child handling these issues isn’t the biological child of the one needing care.

What is a Long-term Care Plan?

As I discussed in a previous article, Long-term Care Planning, I mentioned the fact that 40% of retirement aged clients have long-term care insurance. If you read that article, you understand that I am agnostic as to what the solution is, but we need to have a plan.

These are some questions to get you started:

Where will care be provided? If care is provided at home, you will likely have family providing the bulk of the care. On top of this, you might hire some professional help to give relief for the family members. If you need specialized care in a nursing home or memory care, the price tag goes up substantially. Check out Genworth’s stats on this below.

What assets will be used to pay for care? Different accounts will have different tax consequences. Additionally, certain accounts are better to spend during your lifetime instead of leaving to your children. Make sure you designate which accounts (in order) should be spent down first if there is a long-term care need. Take a look at our article on how to divide assets in a blended family.

What’s the strategy to mitigate the tax impact of accelerated withdrawals? You might have multiple accounts to draw from, and accelerated withdrawals on certain accounts like 401ks or IRA’s might push you into a higher tax bracket. Additionally, it could result in higher Medicare premiums as a result of “IRMAA” (income related monthly adjustment amount). Therefore, you might work with a fiduciary financial planner who also does tax planning to ensure you are making tax efficient withdrawals.

Who is the caregiver coordinator? This job can feel like a full time job, even if the individual isn’t the one providing the care. The ongoing hiring, firing, financing, and other issues can result in major headaches for the coordinator. For blended families, what if that coordinator isn’t your biological child? Or, what if your biological child is the coordinator for your new spouse (their step parent)? These are touchy issues and can cause a divide amongst the family. It’s very important to be proactive with all of the children on who is responsible for what. You also might consider hosting a family meeting so all of the children are on the same page.

Who is going to manage the assets? If you plan to hire professionals to provide the care, some additional asset management will need to be considered. Which investments are being sold when? How does selling those investments impact the long term viability of the portfolio? What’s the tax consequence of selling an investment to pay for care? How does selling an asset impact your legacy goals?

For traditional families with shared estate planning goals, it can be perfectly acceptable to “self-insure,” as long as the plan is laid out for the decision makers.

With blended families, particularly those with separate estate planning goals, I highly recommend Long-term Care Insurance.

The potential challenges for the adult children and your spouse are endless depending on the relationship dynamics, and insurance removes them from the equation (for the most part).

The benefits of Long-term Care Insurance for Blended Families

Caregiver Coordinator benefit

Immediately after a triggering event, a Long-term Care policy will most likely have a caregiver coordinator benefit. This allows for the client to call the carrier, and request a specialist to come out to the home. This specialist will help create a plan to provide care within the framework of the insurance policy’s terms and budget. Additionally, they can help make recommendations on home modifications to suit the needs of the family. From there, if there is additional care needed, the family will then decide if they will pay out of pocket or coordinate efforts to provide care. Nonetheless, the family will have an objective third party to help them with these major decisions.

A long-term care benefit pool

Some policies provide for reimbursement, some provide cash benefits immediately upon the triggering event. Either way, there is a defined pool of dollars that are specifically meant for long-term care needs. In addition, the payouts are income tax free, which will eliminate unnecessary tax increases from accelerated retirement account withdrawals. Why do you think ultra high net worth individuals own Long-term Care Insurance? Of course they could “self insure,” but they would rather keep their long term investments on their balance sheet instead of liquidating them for care.

The best part is, having a defined pool of assets will eliminate the question of “do I hire help or provide care myself?” Instead of putting your spouse or adult children at risk of carrying the weight of caregiving, the insurance essentially forces the family to hire professional help. You can’t put a price tag on preventing that burden.

Hybrid policies

Over the years, I’ve had clients bring up the concern of “what if I never need care?” Statistically speaking, there’s a good chance you’ll need care. In fact Genworth estimates 70% of those 65 or older will need care at some point in life. But the question is valid. What if you don’t?

Hybrid policies were designed to address this issue. The gist is there is a life insurance benefit with a long-term care benefit. Some policies are life insurance focused with a long-term care rider. Others are long-term care focused with life insurance rider. Either way, if long-term care is not needed. Or, if only a portion of the benefit pool is used, there will be a death benefit when you pass away that can be left to your beneficiaries. These policies are certainly more expensive, but you get what you pay for. What’s also nice is all of the policies I am familiar with are guaranteed to not increase in premiums. This has been another pain point for the long-term care industry and these policies were also designed to eliminate that concern.

For those that are interested in leaving a financial legacy to their children, these hybrid policies are a great solution!

Final thoughts

All in all, if you are a blended family with adult children, you must absolutely have a long-term care plan. If you are similar to a traditional family in the sense of having shared estate planning goals, long-term care insurance might be optional for you. However, the tax benefits and having a dedicated plan for care makes insurance extremely appealing for all families.

For blended families with different estate planning goals, long-term care insurance is the top solution! It’s important to consult with a fiduciary financial advisor that specializes in retirement planning and specifically long-term care planning to create a plan that’s right for you. An objective third party who can review your goals and balance sheet is invaluable.

If you are interested in discussing your long-term care plan, feel free to start with a no obligation Zoom call with us! (see the link below)

Make sure to subscribe to our blog and join our Facebook group to get the latest retirement planning insights delivered to you!

Kevin Lao

October 18, 2022

The 7 Most Tax Efficient Retirement Income Strategies

Tax efficiency maximizes retirement income!

When I started my first job as a soccer referee at 12 years old, my Mom used to tell me; “it’s not what you earn, it’s what you keep!”

I’m not sure if working at 12 years of age is legal any longer, but I’ve had a job ever since. My Mom instilled in me the value of forced savings and paying yourself first. (thanks, Mom!)

I’ve been practicing financial planning now for over 14 years, and I find this quote is highly relevant for taxes.

Tax inefficiency of retirement income is one of the biggest drags on returns. In fact, taxes are likely the largest expense for retirees, even more so than healthcare costs!

While we can’t control the stock market, we can control our taxable income (to a certain extent).

This article will outline the 7 most tax efficient retirement income withdrawal strategies so you can maximize spending on your lifestyle, not the IRS.

1. Roth IRAs + other Roth Accounts

As you know, this is one of my favorite tax efficient income strategies for retirement. Sure, you will forgo the tax deduction for contributions, but in exchange for a lifetime of tax free (“qualified”) withdrawals. I’ll take that tradeoff any day!

Here is the nuts and bolts of how these accounts work:

You make a contribution (whether it’s payroll deductions with work or IRA contributions).
You invest the money according to your goals and risk tolerance.
Enjoy tax free withdrawals, assuming they are “qualified”:
- The account is at least 5 years old (for an IRA)
- You are 59 ½ or older

Your contributions in these accounts are always tax and penalty free, but you might have taxes and penalties on earnings if your withdrawal is “nonqualified.”

There are some exceptions like for first time home purchases, educations expenses, etc. But if you are reading this, these will likely not be of interest to you anyhow! Why would you cash in your most tax efficient retirement vehicle for anything other than retirement?

There are some limitations on these accounts.

Contributions:

For Roth IRAs – the max contribution for 2022 is $6,000/year (if you are over 50, you can contribute $7,000/year)
For a Roth 401k/403b – the max contribution for 2022 is $20,500 (if you are over 50, you can contribute $27,000/year)

These contribution limits are per person. If you are married, your spouse has their own limits to take advantage of.

Income phaseouts:

If you are over a certain income threshold, you might be phased out completely from a Roth IRA contribution (don’t worry, there may be a loophole).

Roth 401ks/403bs etc. are NOT subject to income phaseouts. You can make $1million/year and still max out a Roth 401k. Check out your 401k plan rules to see if there is a Roth option in lieu of the traditional.

Enter the backdoor and mega backdoor Roth contributions

In 2012, the IRS lifted the income limits for “Roth conversions.” A Roth conversion simply means you convert all or a portion of your Traditional IRA to your Roth IRA. You will then be responsible for any taxes due at that time. However, you may find this compelling based on your expectations on where taxes might go in the future.

Here’s the loophole…there is no income cap for non deductible IRA contributions. Therefore, savvy tax planners can make non deductible IRA contributions, and immediately convert those dollars into their Roth IRA! This is known as a backdoor Roth contribution!

Pro tip – be careful of the IRA aggregation rule or your conversion may not be tax free!

Now, companies are starting to allow for “Mega Roth 401k/403b conversions!” Depending on your plan rules, you can not only contribute the maximum to a Roth 401k, but you can make an additional non deductible contribution up to the 402g limit. That non deductible contribution can then be converted to your Roth 401k to enjoy tax free growth!

Sound too good to be true? Well, lawmakers are looking to shut this down ASAP, so take advantage while you can and read your plan rules to see if it’s allowed.

2. Health Savings Accounts (HSA)

Healthcare will likely be one of your largest expenses in retirement, so why not pay with tax free income?

In order to participate in an HSA, you must have a high deductible healthcare plan. Talk to your HR team about which plans allow for these accounts.

In general, if you are going to the doctor frequently or have higher than average medical bills, a high deductible health care plan may not be right for you. However, if you are pretty healthy and don’t go to the doctor often, you might consider it so you can take advantage of the tax free HSA.

HSA’s have a triple tax benefit:

Tax deductible contributions
Tax free growth
Tax free distributions (if used for qualified medical expenses)

This triple tax benefit is the reason it’s one of the most tax efficient retirement income strategies!

You can also use an HSA to help pay for long-term care costs or even pay long-term care insurance premiums tax free.

Try not to tap into this account early

You might be tempted to reimburse yourself the year you have a major surgery or other medical bill. If you can pay out of pocket, do that instead! As your account grows, you can even invest it according to your risk tolerance and time horizon. This helps amplify the benefit of tax free compounding!

Save your medical bill receipts

There is no time limit on when you reimburse yourself. You could have surgery in 2022, and reimburse yourself anytime in retirement tax free!

Planning a major trip in retirement? Take a look at some medical bills you paid 20 years ago and reimburse yourself from the HSA…now you have more money to enjoy that trip instead of paying Uncle Sam!

Don’t leave this as a legacy

Your beneficiaries (other than a spouse) will have to liquidate the HSA the year you pass away, which could create an unnecessary tax bill for your heirs. Spend it while you can, name your spouse as beneficiary, and enjoy this triple tax advantaged account!

3. Life Insurance

Life Insurance is an often misunderstood, misrepresented, and misused financial tool for retirement. However, it can be used as a tax efficient retirement income strategy, or a tax efficient intergenerational wealth strategy (dual purpose!).

I started out with a life insurance company and am so thankful I did. First and foremost, I was taught to load up on life insurance while I was young and healthy (even before needing it), to lock in my insurability and health profile.

Secondly, I was taught the benefits of permanent insurance and loaded up on this as well. Again, before having any insurance needs at all!

Over time, the cash values have grown, and I’ve been able to tap into this asset class at opportune times when other asset classes were temporarily at a discount!

Ever hear of the concept “buy low, sell high?” Well, how do you buy low if all of your assets are down at the same time?

As we’ve seen with the market in 2022, bonds are not immune to significant drops in performance. Life insurance keeps on keeping on!

Long term, my plan is to keep the insurance as a tax free legacy for my three boys (and hopefully grandbabies!). There is no other financial vehicle that provides an amplified tax free death benefit like life insurance.

Which type of insurance should I own?

Raising children is expensive. Inflation has made it even more difficult! If you are strapped for cash and are worried about making rent or your mortgage on time, you should buy some inexpensive term insurance and protect your family.

Pro tips:

Buy lots of coverage – a rule of thumb is 10x – 16x your gross income, but some insurance companies allow you to buy 25x your gross income!
Make it portable. If you are healthy, buy a policy NOT tied to your workplace, as you never know how long you will stay there.
Make sure it’s convertible. Even though you may not be a good candidate for permanent insurance today, that may change over time. Perhaps when your kids are out of the house, or your mortgage is paid off, or your income has skyrocketed. Being able to convert to a permanent policy without medical underwriting is extremely helpful.

For those of you comfortably maxing your tax advantaged retirement plans and HSA’s (as discussed previously), overfunding a permanent life insurance policy can be a great supplemental savings tool.

There are multiple flavors of permanent life insurance that we won’t go into detail on in this article. But in general, you can invest in fixed products or variable products. This feature will impact the performance of your cash value, and potentially your death benefit.

You can also add a long-term care rider on some policies to kill two birds with one stone. That way, if you are someone who never needs long-term care, your family will still receive the death benefit.

What I have found is that the intention might be to use this cash value as a tax efficient retirement income strategy, more often it’s used for the death benefit. All of you diligent savers will accumulate assets in your 401ks/IRAs, taxable brokerage, HSA’s etc., and you might realize that this amplified death benefit is best used to enhance your intergenerational wealth objectives. Plus, it gives you a license to spend down your other assets in retirement “guilt free.”

Don’t worry about making that decision today, but just know this asset can be a flexible vehicle throughout your lifetime.

4. Taxable Brokerage Accounts

This bucket is one of my favorite tax efficient retirement income strategies for three reasons:

There is no income restriction on who can contribute
There is no cap on contributions
There is no early withdrawal penalty

The title of this account sometimes leads people to believe it’s not tax efficient.

And this can be true if you invest in certain securities within the taxable brokerage account.

However, if you are strategic with your security selection, you can have minimal tax liability during the accumulation phase.

In retirement, you can then use losses to offset gains, sell certain blocks of securities with limited capital gains, and use tax free income as cash flow by investing in municipal bonds (if appropriate).

I find this tool is great to maintain flexibility for funding college, saving for retirement, or any other major expenditures along the way.

Intergenerational Wealth Planning

Certain assets are better used during your lifetime instead of passing on to your heirs, as we discussed with the HSA. However, taxable brokerage accounts are extremely tax efficient for intergenerational wealth planning.

When you pass away, your beneficiaries will get a “step up in cost basis” which will limit their tax liability if/when they sell that asset themselves.

All in all, this can be a great multi functioning tool for retirement income, legacy, or any other major opportunity that comes along!

5. Non Qualified Annuities

I find consumers have a negative connotation associated with the term annuity. And, rightfully so. These products, like life insurance, are often oversold or inappropriately utilized.

In it’s purest form, annuities are used to provide a guaranteed income stream in retirement. Think Social Security or a Pension.

Creating a “retirement income floor” is one of the most powerful things you can do for yourself. Believe me, when the markets go south, you don’t want to be worried about how to fund your basic living expenses in retirement.

However, if Social Security + Pension + Annuity income covers your basic necessities, you can avoid losing sleep at night when the markets do take a dive (which they will!).

The tax efficiency components are twofold:

Tax deferred growth, much like a traditional 401k or IRA
Exclusion ratio for lifetime annuity income

For you high income earners, you will want to limit tax drags on your savings. However, once you are maxed out of your qualified retirement plans, you’re going to be wondering where to go next. One of the benefits for annuities is the tax deferred growth. You won’t receive a 1099 until you start the income payments in retirement!

In retirement, instead of the gains being withdrawn first (“LIFO”), you can take advantage of the exclusion ratio. This allows for a portion of your retirement income to be a return of basis, and a portion to be taxable income. Therefore, it’s a great way to spread the tax liability over your lifetime.

In retirement, if you decide you don’t need this income stream, you can flip on the switch to fund other tax efficient vehicles like life insurance or long-term care insurance.

Intergenerational Wealth Planning

In years past, annuities were a terrible way to leave a legacy for your children. Beneficiaries were often forced to take a lump sum distribution or take payments over a short period of time. Now, some annuity contracts allow for the children to turn their inherited annuities into a life income stream. This can also help spread out the tax liability over a much longer period.

I still recommend using these accounts during YOUR retirement phase and leave other assets to your children. Having your beneficiaries deal with the death claim department within annuity companies can be a nightmare!

6. Reverse Mortgage

One of the largest, if not the largest, asset on your balance sheet over time will be home equity. However, many retirees don’t maximize their home equity as an income tool, which could be a mistake.

In simple terms, a reverse mortgage allows the homeowner to stay in their home as long as they live. These products essentially flip your home equity into an income stream. The income stream now becomes a loan with your home as collateral.

Because it’s a loan, the income is not taxable to the borrower!

Instead, the loan will be repaid from the home sale proceeds when you move, sell your home, or pass away.

Creating this essentially tax free income stream can allow you to preserve other liquid assets on your balance sheet, like the ones mentioned above.

It can also be a part of the “retirement income floor” concept that we mentioned previously.

7. Real Estate Income

You often hear of real estate investors paying little to no taxes. The basic reason is the ability to deduct ongoing expenses from the income.

mortgage payments
taxes
insurance
maintenance
property management fees
And the “BIG D” – Depreciation!

This depreciation expense is the real wildcard as it can essentially wipe out any taxable income you would otherwise have to report. Depending on the property type, this can amount to approximately 3.6% of the cost basis year after year! There is some “true up” at the end when you go to sell the property, but it’s a huge advantage to minimize taxable income while your property still cash flows!

And once you sell the property, you can even take advantage of a 1031 tax free exchange and buy another investment property that better suits your overall financial goals.

Investing in real estate is not for everyone. And it’s certainly not a passive activity, even if you have a property manager. Studying your market, analyzing trends, upgrading your property and dealing with bad tenants are ongoing challenges.

However, if you do it right, this can be an extremely tax efficient retirement income strategy.

Final word

Minimizing taxes in retirement is one of the most impactful ways to maximize your cash flow!

However, most people don’t think about taxes in retirement…until they are about to retire!

These strategies only work if you begin building the framework 10, 20 or even 30 years before you quit your day job. Furthermore, not all of the strategies discussed will make sense given your goals and financial circumstances.

It’s important to consult with a fiduciary financial advisor that can take a comprehensive look at your financial plans.

If you are interested in scheduling a call, feel free to use the calendar link below for a 30 minute “Mutual Fit” meeting over Zoom.

Also, make sure to subscribe to our mailing list so you don’t miss out on any retirement planning insights!

Until next time, thanks for reading.

-Kevin

Kevin Lao

September 9, 2022

How to divide assets in a blended family

Benjamin Franklin said “the only two certainties in life are death and taxes.”

As a fiduciary financial advisor, one of the most important topics to address is how to divide assets in a blended family.

If something were to happen to you, how do things play out? How do you divide an estate with step children? How do you protect your assets from stepchildren? What about the effects of an unequal inheritance? What about estate planning for a blended family with adult children?

Each situation is unique. Take what applies to you, and make a plan!

How to divide your estate with stepchildren?

The reality is that blended families are almost as common as a traditional family. A blended family is a marriage that involves children from a previous marriage or relationship.

It’s important to consider your own family dynamics when dealing with retirement and estate planning issues.

A remarriage when children are young is very different than becoming a blended family when the children are adults.

You might think if the children are young, it’s more likely you will handle your estate planning and wealth transfer strategies like your “traditional family.” And that may be correct in the sense that you want to divide your assets equally to your biological children and stepchildren.

One potential hurdle to look out for is guardianship issues of your minor children. If something unexpected happened to you and your spouse, it’s possible that an ex-spouse might have guardianship rights over your child or stepchild. Additionally, if your children are minors, the guardian will take custody of their assets until they are age of majority.

You probably want to avoid your ex spouse taking custody over your children’s inheritance. Instead, consider setting up a trust and naming a successor trustee (someone other than your ex of course).

How to protect assets from stepchildren

The most basic form of an estate plan is a will. A will allows you to name specific beneficiaries that will inherit your assets when you die (among other important decisions). You could name your spouse, children from your previous marriage, and even perhaps your stepchildren. You can also exclude anyone you wish within certain limitations.

The issue with having a basic will is that if you do predecease your spouse, all of the assets you leave to your new spouse will be his/her property outright. This means that after his/her death, the remaining estate will be property of their beneficiaries, likely their children (your stepchildren).

This could be problematic if your ultimate goal was to leave your remaining estate to your children, not your stepchildren.

The way to get around this issue is to set up some sort of marital trust, the most common being a Marital Bypass Trust. This can allow you to name the trust as beneficiary of your assets. The trust could be the beneficiary of all, or a portion of your estate.

First and foremost, this type of trust will ensure your spouse is taken care of for their lifetime.

Once your spouse passes away, the remaining trust proceeds will then be left to your children (or other remaining designated beneficiaries). This will prevent any other “unwanted beneficiaries” from receiving your estate.

If you have an existing trust, make sure it’s been reviewed and updated in accordance with the SECURE Act rules. Otherwise, there could be some unfavorable tax consequences for your beneficiaries.

What about adult children in a blended family?

If you are a blended family with adult children, it’s possible one or more of the following might apply:

An age gap with your new spouse
You or your spouse have accumulated substantial assets before your remarriage
You and your new spouse might have children together and separately
Your new spouse might be closer in age to your adult children

If there is an age gap in the remarriage, it’s likely that you will have two separate estate planning and wealth transfer strategies.

Take care of your spouse for their lifetime
Leave a financial legacy to your children

As discussed earlier, the likely solution here is to set up a trust that allows for your spouse to benefit, and then ultimately your children.

However, you may consider leaving some or all of your assets to your adult children if:

your spouse is financially independent
you don’t want your children to wait until your spouse dies to receive their inheritance

If this is appealing, you must be aware of the elective share rules in your state.

Elective Share

For community property states, assets accumulated jointly are assumed to be owned by both parties. However, in non-community property states you can own assets separately despite being married. You can leave those assets to another beneficiary other than your spouse, as long as you leave your spouse a certain % of your total estate (this is known as the Elective Share).

Florida, for example, has an Elective Share rule stating 30% of your assets must be left to your spouse, regardless of what your estate plan says. Additionally, there is no requirement for how long that new marriage lasted!

Even if you set up a trust, certain trusts might fail the elective share test. Therefore, be careful if you have goals to leave a larger portion of your estate to your children instead of your spouse.

If you and your spouse are financially independent, you might consider signing a prenup or a postnup. This will ensure that you have the legal right to “disinherit” your spouse and overrides the elective share rules.

Consider Life Insurance

Life Insurance is a great tool if you have multiple estate planning and wealth transfer goals.

Here’s an example:

Let’s say the bulk of your assets are inside of a 401k or IRA and you get remarried.

Let’s say your adult children are on their own, building their careers and growing their families.

Because of this, you’d like to leave your kids money when you die, but you also want to make sure your new spouse is taken care of during retirement.

First, you may consider setting up a trust for the benefit of your spouse and naming that trust the beneficiary of your 401k or IRA. Your children would be the contingent beneficiary of the new trust. This will protect against any stepchildren or new spouses from inheriting your assets.

If the trust is set up properly, your spouse can maintain favorable life expectancy rules when it comes to required minimum distributions.

Now that your spouse is covered, you buy a new life insurance policy with your children as primary beneficiaries. This way, they aren’t waiting for stepmom/stepdad to pass away to receive their inheritance. If you already have life insurance, you could make sure it’s structured properly and simply name your children as primary beneficiaries.

This also gets around the issue of the elective share. The calculation for the elective share will typically not include death benefits from life insurance. However, it might count cash value, so make sure you structure the policy properly in accordance with your state’s rules.

If the goal is to own the policy throughout retirement, you will want to make sure it’s a permanent policy, not term. Term insurance is more likely to expire before it pays the death claim, and you don’t want to be shopping for permanent insurance when you’re 70.

Effects of an unequal inheritance

If you have multiple sets of beneficiaries, you might be thinking of the effects of an unequal inheritance.

Let’s say you have adult children that are well off financially. However, you also have children with your new spouse that are still 100% dependents.

In this scenario, you might consider leaving a larger percentage of your estate to the side of the family that needs it most.

If you consider this strategy, I highly recommend setting up a trust. This will reduce the likelihood of issues being contested in court, and the terms of the trust remain private. Additionally, it’s likely your dependent children are minors and would need someone to oversee their inheritance (a trustee) until they are responsible adults.

Another consideration for an unequal inheritance is the impact of income sources that will be lost for the surviving spouse. This could include Social Security, pensions, annuities, distributions from IRA’s and investment accounts.

Upon the first spouse passing away, the surviving spouse is entitled to the larger of the two Social Security benefits. However, this still results in a reduction of Social Security income for the survivor.

If you have a pension or annuity that stops at your death, you also need to consider the impact of this lost income.

If your IRAs or 401ks are left to your children instead of your spouse, could your surviving spouse maintain their standard of living for years or even decades to come?

Additionally, would your surviving spouse be able to pay for long-term care if a large portion of your estate was left to your children?

These are all issues you should think through to help divide your assets within your blended family.

One final thought on this topic is that it’s not just about how much you leave, but how you are remembered.

The act of making things easy to manage for your loved ones is a big part of how you will be remembered! Leaving a big mess to clean up won’t help that cause, regardless of how much money you leave behind.

Tax Considerations

The types of assets that are left to children, your spouse or a trust are all important from a tax standpoint.

Qualified Retirement Accounts

Leaving your qualified retirement accounts to your spouse outright will create the optimal tax benefits. These include IRAs, 401ks, 403bs, 457bs, TSPs etc.

On the other hand, leaving qualified assets to your children will likely trigger the new 10-year rule. With the SECURE Act coming into effect in 2019, these accounts can no longer be stretched according to the child’s life expectancy. This will likely result in an acceleration of taxes that could have been minimized had these accounts been left to a spouse.

Naming a trust as beneficiary of a qualified plan also presents some challenges. Tax brackets are significantly higher for trusts versus an individual.

In 2022, a Married Filing Joint taxpayer would have to earn over $647,850 in taxable income to cross the highest tax bracket at 37%.

For trusts, the highest tax bracket threshold is only $13,450!

If you name a trust as beneficiary of a retirement plan, make sure your attorney has revised or drafted the documents to align with the SECURE Act rules. This could mitigate unnecessary tax implications.

Taxable Investments

Investments including stocks, bonds, mutual funds, ETFs, real estate, tangible property and even crypto assets would fall under this category. This assumes these investments are held outside of an IRA, 401k or other qualified retirement plan.

The major tax benefit for these assets is the step up in cost basis after death.

How does the step up in cost basis rule work?

Let’s say you bought $100k of Apple in 2000 and it’s now worth $500k. If you sold $500k worth of Apple, your capital gain would be $400k (500k – 100k).

If you die before selling it, your beneficiary gets a “step up in the cost basis.” Instead of your beneficiary paying taxes on the gain of $400k, their new cost basis is now $500k. If they sold the stock immediately thereafter, they would have little to no capital gains taxes due!

For married couples, there are some additional rules that are based upon the state you live in. For community property states, assets are assumed to be owned jointly, and therefore only ½ of the basis is assumed to be stepped up upon the death of the first owner. Upon the death of the second owner, than the full step up rule is applied.

In non-community property states, you could in fact own assets separately from your spouse so they can take advantage of the FULL step up at your death. This could be accomplished with a revocable living trust in your name only, OR perhaps individual ownership with your spouse as beneficiary (via TOD or POD designations).

Make sure you consider your estate planning and wealth transfer goals before making any changes to your asset titling!

Life Insurance

We’ve already discussed the functionality of leveraging life insurance to take care of one or more of your wealth transfer objectives.

From a tax standpoint, this is one of the most tax efficient assets to leave a beneficiary. It’s 100% income tax free and probate free! Additionally, you can structure this strategy to pass outside of your estate by way of an Irrevocable Life Insurance Trust (ILIT).

If you have a beneficiary with special needs, you could also fund their “Special Needs Trust” with life insurance.

Action Items

Your estate planning and wealth transfer strategies should be personal to you!

Make sure you are taking care of your loved ones the way you intend to.

Make sure you have the proper documents in place that align with your intentions.

Make sure you update and revise all of your beneficiary designations.

Make sure your financial plan is coordinated with your estate plan and wealth transfer goals.

And finally, do your best to make things simple for your loved ones. Communication and clarity are critical to avoid unnecessary conflict. You don’t want your loved ones to question “why” things were set up a certain way.

I hope you found this information valuable!

Make sure to SUBSCRIBE so you don’t miss out on any of our retirement planning insights!

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Kevin Lao

August 19, 2022

Retirement Readiness Checklist

You are in the final stretch of your career!

Congratulations on a successful career! You’re in the proverbial 7th inning stretch, ready to finish strong and start the next chapter. Along with all of the excitement is a bit of uncertainty about the unknown. Use our updated “Retirement Readiness Checklist” to help you prepare for whatever is next!

Step 1: What is your vision for "retirement?"

The word retirement means different things to different people. Maybe you want to travel the world for the next 10 years. Perhaps you want to spend more time with loved ones. Or, you might have a business venture you’ve always wanted to pursue.

This is the most exciting part about retirement planning. You define what success means during this next chapter, not your current or former boss.

Write down your biggest hopes and dreams you wish to experience. If you are married, you and your spouse should sit down together to craft your vision. You will be surprised at how much you learn about one another! My wife and I do this on an annual basis, and I’m always learning new things about what’s on her heart and mind.

You should also decide whether you will work in any capacity during retirement. You might find yourself wanting to work part-time for the same company, or perhaps pursuing opportunities with a different firm.

This is also known as a phased retirement, where you “try it out” before fully retiring.

This is perfectly acceptable as it might be tough to quit your job cold turkey. It also provides some financial incentives including; delaying retirement account withdrawals, deferring Social Security, and continuation of group benefits.

You might decide not to work at all, and that’s okay too!

Perhaps you dedicate your time volunteering for a passion project that excites you!

Whatever it is, this is your time to create your ideal schedule, which brings us to step 2.

Step 2: Create an ideal day/week

Many people don’t realize that depression is more common than you think in your retirement years.

According to Web MD, over 6 million people over 65 are impacted by depression. However, only 10% receive treatment. One of the reasons is the feeling of embarrassment. Why would one feel depressed if they achieved financial independence?

Upon retiring, most people want to check off things on their bucket list. It might be a dream vacation, or moving into their forever home, buying a boat, etc. This can cause a spike in excitement in the early years which we call the “Go-Go Years.” However, as you enter the “Slow-Go” and “No-Go” years in retirement, that excitement fades and depression can begin to set in.

If routines or structure aren’t in place with how you are spending your time, and with whom, the feeling of losing purpose can have a negative impact on mental health.

Also, it’s more likely you have experienced the loss of a loved one or close friends.

How do you solve this issue?

Create an ideal day or week and decide:

Who do you want to spend your time with?
What are you spending time doing?
Where are you living and whom are you living close to?
Where are you traveling?
What are some new hobbies you wish to start?
What do you want to learn?
What activities can you eliminate from your schedule? (preferably ones that are draining your energy)

This will help maximize your fulfillment in retirement and avoid that feeling of loneliness or isolation.

Step 3: Make a Budget

Stay with me on this one!

I know, nobody likes to make a budget. However, I find this exercise creates a ton of excitement around an otherwise mundane topic.

Make a list of anything that will cost money, but divide them into three separate categories:

- Needs

- Wants

- Wishes

Examples of NEEDS are:

Housing
Utilities
Food
Clothing
Transportation
Insurance
Healthcare needs

A Quick "Aside" on The Housing Decision

Once you have decided on where you will be living in retirement, you will need to discuss whether or not you want to pay off your mortgage.

Having a mortgage in retirement isn’t necessarily a bad thing. It’s all about personal risk tolerance and liquidity needs.

If you are comfortable with taking on some risk with your investment portfolio, you could earn a higher return relative to the interest rate on your mortgage. All while keeping your investments liquid.

If you decide to pay off your home with a lump sum, how does that impact your liquidity needs? Sure, you could take out a home equity line of credit or cash out refinance, but your home is not truly a liquid asset.

As interest rates have been creeping higher, this debate has begun to lean slightly more in favor with paying off the mortgage. However, you might be locked into a 3.5% (or even better) interest rate, so keeping your funds liquid and investing in other asset classes could pay off in the long run.

With all that being said, there is a legitimate argument that having no debt in retirement provides a psychological benefit. I’m all about helping people with peace of mind, and if paying off the mortgage can help with that, let’s do it (forget the math)!

Aside from the mortgage issue, you are likely going to consider whether or not to stay in your current home, downsize, or even move to a new city. The conventional wisdom has been to downsize in retirement.

However, I have found that not having enough space in the home might limit your adult children and grandchildren’s ability to visit (if that’s important to you)! In other circumstances, I’ve had clients downsize and absolutely love the reduced maintenance and upkeep…but usually after the period of de-cluttering, selling, or giving away “stuff.”

Additionally, moving to a new city might sounds appealing given a lower cost of living or more favorable tax advantages, but it’s a big decision that should not be taken lightly.

If you do decide to either downsize or move to a new market, you will need to factor in how this will impact you financially in this first category of “needs.”

Examples of WANTS are:

Travel
Home Improvement
Major Purchase (Boat, RV, Pool, Hot Tub etc.)
Education funding (children or grandchildren)
New Home
Wedding

“Wants” could be reduced or even eliminated, if needed, during a period of unfavorable financial circumstances or as you begin to slow down.

Examples of WISHES are:

Leaving a financial legacy
Major gifting/donations
Dream vacation home

“Wishes” are things you would love to accomplish as long as your needs and wants are covered throughout retirement.

Enjoy this exercise and make it fun and interactive!

Estimate each cost

I find most people know what their “needs” cost on a monthly or annual basis. However, certain expenditures in the “wants” or “wishes” categories might be more difficult to estimate.

Do your best. Remember, you can always revisit these on an annual or semi-annual basis, as we will discuss in Step 10.

And finally, tally up each category for your projected retirement income goal!

Step 4: How much of your retirement income will come from fixed sources?

The first pillar of your retirement income is your guaranteed or fixed income. These resources may include:

Social Security
Pension
Annuities
Employment Income

These sources are immune to market fluctuations, and you can rely on them for either a fixed period, or for life.

Social Security represents over 40% of retirement income for those over 65. Therefore, it’s important to make the right Social Security decisions. Some of the factors you might consider when choosing when to begin taking Social Security are:

Age at retirement
- The earlier you retire, the longer you will need to wait until your full retirement age (between 65-67)

Life expectancy
- If you have longevity in your family and are in good health, you might decide to delay Social Security past full retirement age. Age 70 is the latest retirement age where your benefit will be the highest.
- Another consideration if you are married is your spouse’s life expectancy. Even if you are not in great health, delaying benefits could help maximize the survivor benefit to your spouse.

Other assets/income sources
- If you have other assets or income to draw upon early in retirement, you might consider delaying Social Security for the reasons mentioned above.
- However, if you need the income sooner to avoid draining your investment accounts, you might consider taking the benefit earlier (or working longer)

There is no “one size fits all” answer to taking Social Security. I wrote another article on Social Security considerations that you can read here, but I also recommend speaking to a qualified fiduciary financial planner to address this important issue. Of course, we can help with this 😊!

Step 5: Determine your income gap

What is a safe withdrawal rate for retirement?

Once you have calculated your total expenditures for your needs, wants and wishes, and have tallied up all your fixed income sources, it’s time for some basic math.

The first part to the equation is how much of your “needs” are covered by guaranteed income? If the answer is 100%, you are in great shape!

If it’s less than 100%, you will need to make the decision on how to draw income from your other assets like 401ks, IRAs, brokerage accounts etc., to fill the income gap.

It’s okay if your guaranteed income does not cover 100% of your needs. Most of my clients will draw income from investments to cover the income gap.

However, this brings about the question, “what is a safe and reasonable rate of withdrawal in retirement?”

A reasonable withdrawal rate is relative to your goals and risk tolerance, but anywhere from 3% – 7%/year could be reasonable. The higher the rate of withdrawal, however, the more risk of your plan failing. The lower the rate of withdrawal, the lower the risk of your plan failing.

Step 6: Make the decision on how your investments will be managed

Once you have determined the income gap, you will need to decide on the process of how investments will be managed. If you are a “do-it-yourselfer,” make sure you have a process in writing! This includes:

What is your optimal asset allocation?
Which investments will you use to create your optimal asset allocation?
How often will you re-balance and monitor your accounts?
How much will you withdrawal each month, quarter, or year?
Which accounts will you withdrawal from first?
The tax impact of withdrawals
A process to determine which investments to liquidate and when

For the “do-it-yourselfers” out there. If something ever happened to you:

Death
Disability
Incapacity

What is the contingency plan? Who is stepping in to fill that role? Is it a spouse? Adult child? Sibling?

Do they have the ability, AND the availability to step in as the new “investment manager?”

One of the primary reasons I find clients hire my firm or another fiduciary financial advisor is because they are the investment guru, but their spouse/son/daughter/sibling is not! Or, their children don’t have the time to take on this role given they are busy with their own family and career!

Therefore, my “do-it-yourselfers” want to be involved in the process of hiring a fiduciary financial advisor to help manage the affairs if/when something does happen to the them.

For those of you who have no interest or capacity, make sure you hire a fiduciary! A fiduciary is someone who looks out for your best interests, always! And yes, we can help you with this! Our firm specializes in retirement planning including investment management.

Step 7: What to do with your old 401k and employer benefits?

When you are implementing your investment strategy and income strategy, you will need to decide on how to best consolidate accounts.

Perhaps you have several 401ks or 403b plans. Maybe you have multiple brokerage accounts with different institutions.

You might consider consolidating accounts to simplify your balance sheet. I find most retirees want to avoid complexity!

By doing so, it will make managing your investments easier during retirement, particularly when it comes to making withdrawals.

It will also help clean things up for your beneficiaries or powers of attorney, and we will discuss this topic more in Step 8.

The argument against doing a 401k rollover might include:

– Plans to work past 72 and defer required minimum distributions

– Certain proprietary investments within an employer plan that are not offered elsewhere (fixed annuities etc.)

Otherwise, rolling over those plans into one consolidated IRA will open the door for more investment options and diversification. Additionally, you have more control over liquidity and fees within the investments you select.

Other Benefits to Consider

Life Insurance
401k Contributions + Catch Up
Health Insurance
Legal Benefits
HSA (Health Savings Account)

Reviewing the checklist of benefits you will lose is an important exercise when gauging your retirement readiness.

You should begin to think about how you will replace these benefits when you retire, and maximize these benefits while you are still employed.

For Life Insurance, consider whether you will want to own some life insurance in retirement. If so, purchase an individual policy that is portable after you retire. If you can’t buy an individual policy, see if you can extend coverage with the group for a period of time.

401k’s and 403b plans allow for catch up contributions after you turn 50. Take advantage of these catch up contributions while you can!

Here are the limits for 2022 on certain qualified plans:

401k/403b/457: $20,500/year + $6,500/year catch up
SIMPLE IRA: $14,000/year + $3,000/year catch up
IRA/Roth IRA: $6,000/year + $1,000/year catch up
HSA: $3,650/year (single), $7,300/year (family) + $1,000/year catch up (age 55+)

In that final stretch of planning for retirement, your children might be done with school and you finally have some extra cash flow. Take advantage of this final decade as it can pay huge dividends in your later years when healthcare costs tend to rise!

For legal plans, you might consider having your estate documents reviewed and updated before you officially retire. These legal plans often have an estate planning benefit that can save you thousands of dollars while you are still employed.

Finally, consider health insurance options. If you are retiring and are eligible for Medicare, compare the Original Medicare with Medicare Advantage. Shop for plans, use a broker to help find you the best deal based on your medical needs.

If you are retiring before you are Medicare eligible, consider your options for health insurance. Perhaps your spouse will continue to work, or you may work during the early phase of retirement.

Otherwise, you may need to buy an individual policy on the exchange (healthcare.gov). These policy premiums are based on your income, so there could be some planning opportunities to keep your income low until you reach age 65 and qualify for Medicare.

Step 8: Update your Estate Plan, and keep it up to date!

How will your assets transfer to your loved ones? Who will step in to make decisions if you are unable to? How are your assets titled? What is the tax impact of the assets transferred to your beneficiaries? These are all questions that you need to consider for your Retirement Readiness Checklist!

The basic estate planning package that everyone needs includes:

A Will
Financial Power of Attorney
Medical Power of Attorney
Living Will/Advanced Medical Directive

Others might need to supplement these documents with a revocable living trust, an irrevocable trust, a special needs trust, or a marital bypass trust. Speak to a qualified attorney who specializes in estate planning in your state!

An Estate Plan, however, is not simply what documents you have drafted!

Do you have three IRAs and two 401ks that can be consolidated into one? Do you have physical stock certificates in a safe that can be moved to electronic custody?
Do your beneficiaries know where all of your life insurance policies are, or which financial institutions you have accounts with?
What about passwords?

An estate plan is also about making things simple for your loved ones!

Keep key decision-makers in the loop as to what their roles are (and are not)!
If you name one adult child as Power of Attorney, have that discussion with them.
If you have other children, make them aware also.
It could be difficult, but you need to be the one to speak up on “why” you made certain decisions. Otherwise, it could impact how you were remembered and/or the relationships between your children.
Finally, keep an “important document list” that outlines where your accounts are and at least one point of contact for each institution. (I have a template you can use, and I’d be happy to share it if you send me a Linkedin connection request asking for it!)

Step 9: Medicare or Healthcare Decisions

Are you 65 or older and eligible for Medicare? Well, make sure you take advantage of the special enrollment periods! That way, you can avoid penalties and unnecessary medical underwriting.

If you are eligible for Medicare, the primary decision is whether or not you will go with “Original Medicare” or Medicare Advantage.

Original Medicare is great because there is no “network” or managed care. You can pick and choose whatever specialists you want to see without worrying about a referral. The deductible is also extremely low (less than $300/year)! You will need to buy supplemental policies to cover prescriptions as well as gaps in Medicare part A and part B. Either way, it’s a great way to plan for how much your healthcare expenses might be.

Medicare Advantage has been growing in popularity, but sometimes people are misled into thinking it’s the less expensive route. If you are going to the doctor frequently, or have special medications, you might find yourself paying more for Medicare Advantage despite premiums being lower. Also, be sure to check out the network of providers as you may find your doctors don’t take certain insurance policies. If you are a snowbird, make sure the network is robust in both areas that you live.

There are some great independent Medicare advisors out there that I would recommend speaking with:

I interviewed the lead advisor for Chapter, Ari Parker, on one of my podcast episodes. Give it a listen for his insight on the topic:

Episode 13: Planning for Healthcare Costs in Retirement

If you are younger than 65 and not Medicare eligible, you are going to buy private coverage through the exchange. There are a variety of plans to choose from. The online marketplace is a great place to go to search for plans and screen for what features are most important to you.

Healthcare.gov

Step 10: Make a Long-term Care Plan

I discussed this topic with Jean Wilke-Ausman, the Director of Long-term Care Solutions at Stewardship Advisory Group; she gave a phenomenal headline to kick this topic off.

“Why a checkbook is not a plan for long-term care.”

Just because you have the means financially to pay for long-term care expenses, does not mean you have a plan. Furthermore, just because you have insurance doesn’t mean your plan is complete.

Medicare doesn’t cover custodial care, so you will ether pay out of pocket, buy insurance, or some combination of the two.

Some considerations if you decide to self-insure:

If you needed care, how would it impact your surviving spouse?
How would it impact your financial legacy goals?

Jean also added these issues to consider when self-insuring:

“Who is going to manage the liquidation of assets?”
“What about considering market fluctuations while managing withdrawals for care?”
“Who is going to manage the caregivers providing the custodial care?”
“What about changes in the real estate market”
“What about navigating taxes when liquidating certain assets?”

Perhaps your spouse has been managing your care for months or even years, and it’s now time to hire a caregiver. “Having insurance provides that liquidity need,” added Jean. “Having insurance can avoid you having untimely withdrawals from investments that have other purposes.”

Partner up with experts like a fiduciary financial advisor who understands long-term care planning, and someone like Jean who can be a quarterback to finding the right coverage.

There is no one-size-fits all with long-term care planning, but being proactive will help prevent you from becoming a burden on your loved ones later in life.

Step 11: Communication and Ongoing Review

Life will change! Your family will evolve! You will welcome new family members, and unfortunately say goodbye to others.

Make sure you continue to revise your plan. Keep your plan flexible.

Communication is important in all aspects of life, but particularly when it comes to dealing with issues in retirement. Active communication with your spouse, children, grandchildren, friends, work colleagues, neighbors, and other acquaintances, will help you stay connected during your retirement years.

It’s easy to unplug after retirement but staying involved with relationships can help you enhance your legacy well beyond how much you leave behind financially.

In the event of an unforeseen circumstance, it’s best for your loved ones to know who is in charge of what, and there is no question what your intentions are!

Nobody wants to leave a mess for their family to clean up, so keeping open lines of communication is paramount as we all go through the aging process.

Final word

I hope you found this information helpful.

Just remember, you are likely feeling a ton of excitement mixed with uncertainty. This is completely normal.

Our clients that have successfully retired started by planning early! If you aren’t technically starting to plan early, it’s okay too. My Mom loves to say, “better late than never!”

And guess what, planning doesn’t end the day you retire. Your plans will evolve and become more clear once you have more time and energy to think about the future. Therefore, continue to adapt and adjust based on what life throws at you.

Control what you can control, and the rest will fall into place.

Make sure to subscribe below so you never miss our retirement insights!

If you would like to schedule a Zoom with me to ask specific questions, you can access my calendar below.

Thanks for reading and I look forward to hearing your feedback along with suggestions for future topics! You can drop me a line at kevin@imaginefinancialsecurity.com

Kevin Lao

August 12, 2022

What is a flat fee financial planner?

Primary service models for financial advisors

There are so many different terms for “financial advisor,” it could make your head spin! Financial advisor, financial planner, fiduciary financial advisor, wealth management advisor, financial consultant, flat fee financial advisor, financial therapist, and the list goes on.

To make things simple, professionals providing financial advice can be categorized into one of three ways:

1. Broker/Commission Based Advisor: These advisors sell products to the consumer for a commission paid by the insurance or investment company they are representing.

2. Fee-Based Advisor: These advisors can sell products for a commission and provide investment and financial planning advice for a fee. The fee is typically a percentage of assets under management, and the commissions vary widely depending on the product.

3. Fee-Only Financial Advisor: These advisors don’t receive any compensation from an insurance or investment company, and work directly for the client within the scope of their financial planning and investment advisory agreements. There is a sub category within the Fee-Only space known as a Flat Fee Financial Advisor or Flat Fee Financial Planner.

I will cover all of these definitions later in the post.

There are also professional designations like Certified Financial Planner (CFP), that consumers might believe is a type of financial advisor. The reality is, not all CFPs are created equal, and they can work under any of the three primary service models listed previously. A designation, like a CFP, is meant to describe the education and experience an advisor has within the industry.

While the CFP is the mostly widely recognized and respected from a consumer standpoint, there are other designations that are well respected within the industry.

Just to name a few:

Retirement Income Certified Professional (RICP) designation is for those who specialize in retirement income planning.

Chartered Life Underwriter (CLU) is for those who have an in-depth knowledge around life insurance.

Chartered Financial Analysit (CFA) is for those specializing in investment analysis and portfolio management.

These designations are of course helpful when determining if a prospective advisor can serve your needs.

Just remember, the designation doesn’t describe the service model, and ultimately how the advisor is compensated, which are both important factors when choosing who to hire.

Broker, or Commission Based Advisor

If you’ve ever seen movies like Boiler Room or Wolf of Wall Street, brokers portrayed in them give financial professionals a bad reputation.

Stocks can now be traded for zero commissions, and the traditional/old school brokers are becoming less and less sought after by the consumer given the distrust.

Nowadays, the most popular products that are sold for commissions are mutual funds, annuities and insurance. I would argue that annuities and/or insurance products should be used in the majority of financial plans.

Commission based mutual funds, however, are being phased out with the rise of no sales load ETFs and no load mutual funds. These products perform just as well, if not better, for a fraction of the cost. However, there are still brokers and even fee-based advisors that sell these types of loaded mutual funds.

One of the most important factors to note is that a broker is not a fiduciary. The fiduciary standard requires that the advisor always puts the client’s interests ahead of their own. In the case of a broker, he or she is representing the firm they sell the product for, not the client.

Some of these brokers will engage in limited financial planning, but most don’t.

Another issue at hand is that the Broker/Dealer might limit which products they can or cannot sell. Additionally, certain products might pay a higher commission than others, even if the products are identical.

These are just a few of the reasons why consumers look to other service models if they wish to engage in a long term, mutually beneficial relationship.

Fee-Based Financial Advisors

Fee-based advisors can charge both commissions and advisor fees for investments and/or financial planning. This language is often misconstrued with the term “fee-only financial advisor,” which I will explain next. Fee-based advisors oftentimes charge a percentage of the assets their firm is managing, hence the term “fee-based.” Additionally, they can sell insurance, annuities or other investment products for commissions paid by their broker/dealer.

The cost will typically range anywhere from 0.75% – 2% for the assets under management fee, and anywhere from 3%-12% for commissions on other products.

Some of these advisors do comprehensive financial planning extremely well. However, many do not do financial planning at all, given their fee is technically for managing the investment assets only.

Here is the confusing part.

Fee-based advisors act as a fiduciary…sometimes. When providing advice for assets their firm is managing, they are a fiduciary. However, other services in which they engage through their broker/dealer are not part of the fiduciary standard.

Oftentimes, you might hear these advisors claim they are fiduciaries, but really they are a fiduciary “sometimes.”

This makes it extremely difficult for the client who thinks they have hired someone to look out for their best interests, when in reality they are representing a third party instead.

Fee-Only Financial Advisor

Fee-Only Financial Advisors are fiduciaries throughout the entire relationship, period. There are three ways these advisors can charge clients:

Percentage of Assets Under Management (anywhere from 0.75%-2%/year)
Ongoing retainer fee or flat fee (monthly or quarterly) ranging anywhere from $100/month – $2,000/month
One-time financial planning arrangement (ranging from $1,000 – $10,000)

These advisors are often much more comprehensive when it comes to the financial planning relationship than a fee-based advisor or broker. The reason is because the fee they charge is for financial planning and investment management, not for selling a product for a third party. Here are some examples of services fee-only financial planners provide that fee-based advisors and commission based advisors typically do not:

In Depth Retirement Planning Analysis
Income Distribution Planning
Social Security Optimization
Tax Optimization
Objective Long-Term Care and Life Insurance Review
Roth Conversion Analysis
Charitable Giving
Medicare Planning
Pension Maximization
Required Minimum Distribution Planning
Major Asset Purchase or Sale
Estate Planning Coordination
Debt and Cash Flow Analysis
Mortgage Review

Clients appreciate this dynamic because if they need a certain product that requires paying a commission, such as life insurance or long-term care insurance, their advisor’s compensation is not tied to the product! It creates a relationship where they decide what they need together, as opposed to a cliche’ sales pitch.

Many clients who are doing their research are gravitating towards these types of planners, and they can be found on third party association websites like:

These advisors are not affiliated with any broker dealer, wall street company or insurance company, and therefore no compensation is received by anyone other than the client.

They will typically sign a fiduciary oath where if breached, they could be penalized monetarily or lose their license to practice as such.

Flat Fee Financial Advisor, Flat Fee Financial Planner

A flat fee financial planner is a type of fee-only financial planner. The difference is the fee is not based on a percentage of assets the firm is managing.

Many of these firms charge based on what their hourly rate is, or based on your financial complexity. This method of compensation is gaining a lot of traction.

The reason is simple. If you have two similar prospective clients. One has $1 million of assets and the other has $2 million of assets. The question is, are you doing twice the work for the client who has $2 million?

The response from flat fee financial planners is a simple “no.” In fact, the workload is likely the same for both of those clients, so how can the fee be justifiably twice the amount?

Some flat fee financial advisors do not manage investments, and these are known as advice-only planners. They simply give you a second set of eyes on your situation, or help you create a roadmap on how to get where you want to go. The client is presumably comfortable with the implementation and maintenance of those recommendations on a go forward basis.

There are other flat fee financial advisors that will manage investment assets, but it’s inclusive of the overall flat annual/quarterly fee that is charged. Unlike the asset-based advisor’s fee, as your investment account grows, your fee doesn’t go up because of it. Conversely, if your investment account goes down, your fee doesn’t go down either.

This keeps the focus on financial planning and doing what is right for the client, regardless of the amount of assets under management.

Why did we choose to be a flat fee financial planner?

After starting in the broker world and moving to fee-based, I decided the best way to serve my clients was as a flat fee financial planner/flat fee financial advisor.

My firm, Imagine Financial Security, is a flat fee financial planning firm that includes investment management.

We have two separate offerings:

We serve those who are close to retirement, or have already retired, that need help with their retirement income plan, tax efficiency, long-term care planning and estate planning strategies.
We also serve younger professionals (generation X and Y) who are aggressively saving to retire early, also known as the FIRE (Financial Independence Retire Early) movement.

In addition to serving “traditional families” planning for retirement, we also have a niche that serves blended families planning for retirement. These families have children from previous marriages, assets accumulated before marriage, wider age gaps, and other challenges that make the financial picture slightly more complex.

I find the flat fee model allows our firm to focus on comprehensive financial planning without conflicts of interest that are inherent with other service models.

Resources to find a flat fee financial advisor or financial planner

I’ve compiled a few links below that include other flat fee financial planners who are doing great work in the financial planning community.

Tenon Financial has a list of flat fee financial planners who specialize in retirement planning and investment management.

7 Saturdays Financial has a list of flat fee financial planners who specialize in working with younger accumulators.

Wealthtender has an article about flat fee financial advisors.

Sara Grillo interviewed Andy Panko on the flat fee financial advisor movement.

Measure Twice Financial has a list of advice only financial advisors who do not provide ongoing investment management.

In summary

Your situation is unique, so hiring an advisor who specializes in working with others with your profile is extremely important. Additionally, understanding how advisors are compensated should help you determine how you want to be served.

There are good and bad players in every industry, and financial services is no different.

There are also good and bad advisors in each fee model, and simply hiring an advisor solely based on their fee structure may not be prudent.

There are high quality advisors doing great work in each category, even the commission-based world.

However, we recommend hiring someone who has a deep understanding of how to serve people like you, and who can always look out for your best interests.

Here are three simple questions (among others) you should ask a potential advisor:

Which service model do you fall under?
What credentials/designations do you currently hold, or are currently pursuing?
What is your firm’s niche?

Here is a link for the CFP Board’s 10 sample questions to ask a prospective financial planner.

I hope you found this information valuable as you look for the right partner to help you achieve financial independence.

If you have any questions or want to schedule a call with me, click the link below to coordinate our schedules.

Make sure to subscribe to our blog below to get our latest insights on retirement, tax and financial planning!

Kevin Lao

August 2, 2022