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!

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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 [email protected]

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:

Ongoing retirement planning, tax optimization, and investment management. We serve those who are close to retirement, or have recently retired and need help with their retirement income plan, Roth conversion strategy, investment management, and estate planning strategies. The majority of our clients end up in this engagement as they prefer to live their best lives in retirement instead of spending time in the weeds of personal finance.
One-time engagements. This offering is best suited for those who prefer to implement their retirement income and investment strategy on their own, but want a professional second set of eyes to reveal any opportunities or blind spots. Alternatively, this could serve as a great way to experience our value proposition before signing up for ongoing planning.

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 financial planner 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

4 Retirement and Estate Planning Strategies for Blended Families in Florida

What is a blended family and why does it impact my retirement plan?

First, what is a blended family?

Simply put, a blended family involves a remarriage that comes with children from a previous marriage or relationship. Maybe you and your new spouse both have children from previous marriages. Or, perhaps you have children with an ex and a current spouse.

There are many varieties of blended families, and they are quite common. In fact, it is estimated that 40% of households with children in the United States are blended of some kind. Each blended family has unique circumstances, but retirement and estate planning strategies are more complex when it comes to dealing with blended families. I have been working with blended family retirement planning for over 13 years in our home base of Florida, as well as across the United States virtually, so let’s discuss some key issues to focus on.

How does having a blended family impact my retirement plan?

There are four major topics we will cover in this post. Keep in mind, there are other considerations you should address, and no two families are identical. You have to consider your own family dynamics, financial situation, and much more. However, this should get you started as you think about planning for retirement with a blended family.

When should you claim Social Security?
How will you approach your retirement income withdrawal strategies?
How will you pay for Long-term care costs?
Inter-generational Wealth Planning and Estate Planning

1. When should you claim Social Security?

Social Security is likely your largest source of guaranteed income in retirement. It represents 40% of all income for those 65 and older.

There is a possibility you and your spouse each have children you may want to leave assets to, and this could impact the surviving spouse’s retirement income plan. For example, if you have three children and a new spouse, you may decide to divide your estate into 1/4 for each beneficiary.

However, Social Security is one income stream that will always be available to the surviving spouse, no matter what. So, how can you maximize the lifetime benefits for you and your spouse?

If you and your spouse are both eligible for Social Security benefits, the surviving spouse will keep the larger benefit after the first spouse dies. If you have the opportunity to delay Social Security longer to maximize your benefit, this will also maximize your surviving spouse’s benefit if they were to outlive you. If you are able to delay until age 70, you will be eligible for your largest monthly benefit. If that benefit is larger than your spouse’s, it will help maximize their Social Security income in the event some of your assets were not left outright to your spouse.

Other blended family Social Security nuances....

Dependent benefits are also important.

22% of men and 18% of women have a 10 or more year age gap in a second or third marriage. Therefore, you may have remarried a younger spouse, with potentially dependent children. Or, you are remarried and had new children with your younger spouse. Nonetheless, if you are approaching retirement age, consider dependent benefits for Social Security! Dependents are defined as children under age 18 (or 19 if still in high school), or disabled before 22. These dependents could be eligible for a Social Security benefit when you start collecting yours! The benefit is equal to 50% of your primary insurance amount and is available for each dependent child and for your spouse, regardless of age!

There is a cap on the total amount paid based on your primary insurance amount, and it usually ranges between 150%-180% of your full retirement benefit. The caveat is you must begin claiming yourself in order to trigger the dependent benefits. This may result in you filing earlier than you had anticipated. Therefore, you have to run some calculations to see what is best for your situation.

Another consideration is determining your ability to collect Social Security on an ex-spouse. This will depend on how long the previous marriage lasted, and whether it ended in a divorce or premature death.

For example, if your first spouse passed away and you remarried after age 60, you could still qualify for survivor benefits on your former spouse. On the contrary, if you were remarried before 60, those former spouse’s survivor benefits will be forfeited.

For divorcees, ex-spousal benefits will be forfeited (in MOST cases) once you are remarried, but you would then be eligible for a spousal benefit from your new spouse. This is often a consideration on whether or not to legally remarry if your former spouse’s benefit would result in a significantly higher monthly benefit. But let’s be honest, if you want to marry your new partner, don’t let a few extra Social Security dollars prevent you from doing so!

2. What is a safe withdrawal strategy for retirement income?

There is a good chance you and your new spouse both had assets before you were remarried. Perhaps you and your spouse have Traditional IRAs, 401ks, Roth IRAs, and taxable brokerage accounts. However, those account values probably vary between the two of you. Furthermore, you may have slightly different estate planning goals involving children from your previous marriages.

The key is to come up with a safe withdrawal strategy from each bucket based on:

tax characteristics
risk tolerance
inter-generational wealth planning or estate planning goals
insurance coverage
other income sources like Social Security or a pension

If you plan to leave everything to your new spouse and simply divide it evenly between all of the remaining children, the withdrawal strategy is more straightforward. However, if your children will inherit assets upon your death, how does that impact your new spouse’s retirement income plan? Will they have enough to live on throughout their life expectancy? Remember, Social Security will be reduced after the death of the first spouse, as discussed earlier.

Also, let’s say each of you has children from a previous marriage. If you are burning through your assets more aggressively to support the retirement lifestyle, how does that impact your goal to leave money to your children?

The SECURE Act changed the game with inherited IRA's/401k's.

If your children are in a higher tax bracket, you might not want to leave them your IRA or 401k outright. Your surviving spouse will likely have more favorable withdrawal options and be able to stretch this account over their life expectancy. Conversely, leaving the 401k or IRA to your children will likely trigger the new 10-year rule from the SECURE Act of 2019. This would force them to liquidate the retirement accounts fully within 10 years, likely triggering a much higher tax consequence than had you left those assets to your spouse. This is especially true if you are a Florida resident without a state income tax, and your children are residents of a state with high-income taxes (California, New York etc.). In these situations, you may want to consider a slightly higher withdrawal rate on your 401ks or IRAs, and a slightly lower withdrawal rate on your taxable brokerage accounts or Roth accounts. This way, you maximize the tax friendly assets to your children, and also maintain the tax efficiency of traditional 401ks and IRAs by leaving them to your spouse first.

There is no one-size-fits-all solution to creating a withdrawal strategy, but starting with open conversations about each other’s legacy goals for both sets of children and getting on the same page about a plan is a great first step. Once the goals are set, a safe withdrawal rate should be established. I wrote an article about this and you can read it here. The basic formula I use is; Financial Goals – Income sources – Risk Intolerance = Safe Withdrawal Rate from investments. Noticed how I used risk intolerance instead of risk tolerance. The reason is that the less risk you are willing to tolerate (the higher your intolerance score), the lower your withdrawal rate would be to accommodate for lower expected investment returns.

Should I follow the 4% rule?

Bill Bengen created the 4% rule back in the 1990’s, which back tested rolling 30 year retirement periods from 1926 to 1976. He concluded that a 4% withdrawal rate resulted in money left over at the end of retirement in all of the tested periods. You could certainly use this as a starting point, but there is much more to consider. If you want to maximize the inheritance for your children, you might need to stay close to 4% or even below it! If you don’t have a huge desire to maximize your estate to children, you might be able to inch closer to a 5% or even 6% safe withdrawal rate.

If you are comfortable with more volatility in your investments in order to maximize returns, you could potentially have a slightly higher withdrawal rate than 4%, perhaps 5%-6%. On the other hand, if you cannot withstand any volatility, supporting a 3%-4% withdrawal rate is a more realistic goal.

Finally, guaranteed income sources play a role in determining your rate of withdrawal. If you have most of your expenses covered by Social Security and/or a Pension, your rate of withdrawal required might even be 0%! In this scenario, you could choose to simply reinvest your earnings, gift to your children or even your favorite charity. On the other hand, if guaranteed income is a very small portion of your required standard of living, your rate of withdrawal might be higher than average.

All of these factors; guaranteed income, risk intolerance, and financial goals; play a role in determining what withdrawal rate to use, so be careful with using a rule of thumb from a textbook.

Using the "Guardrail" approach to withdrawals...

The higher your withdrawal rate, the greater the uncertainty. If you are more aggressive with your investments, you could expect higher returns, and maybe for a period of time a 5% or even 6% rate of withdrawal works just fine. However, what happens when the first recession hits? Or the first bear market?

This is why we like to use Dynamic Withdrawals by way of a “Guardrail Approach.” This involves reducing the rate of withdrawal during a significant downturn in stocks. Conversely, our clients can increase spending when markets are performing well. In our modeling, we have concluded that this is the best way to maximize the safe withdrawal rate, but at the same time maintain flexibility based on current economic conditions. I also wrote more in-depth about this topic in this blog post.

Should I Buy An Annuity?

One final topic to consider is whether or not you will purchase an annuity to fund retirement. There are many flavors of annuities, but the general concept is to create an income stream that you cannot outlive, much like Social Security. These products also provide some peace of mind in that the income stream is typically guaranteed, and not tied to market volatility. If you don’t have a pension, this could be a nice supplement to Social Security. Furthermore, you can name your spouse as a joint annuitant to ensure that they will continue to receive the life income if they outlive you. These products can also be beneficial in that it could allow you to take more risk with your investment portfolio, as well as impact your safe withdrawal rate, knowing that a good portion of your expenses will be covered by guaranteed income.

Many consumers believe they will be sacrificing their intergenerational wealth planning goals for their children or grandchildren by purchasing an annuity. Based on research in the industry, this might be true if you were to die prematurely. However, if you were to live to or past your life expectancy, it could actually result in an increased amount of wealth transferred. The reason is because your investments were able to ride the ups and downs of the market without being tapped into during a recession or bear market. I always recommend seeing what’s out there and comparing the rates between several carriers as they do vary greatly.

Finally, interest rates have been on the rise so far in 2022, and that trend is expected to continue at the moment. Therefore, the payout rates have become quite attractive for new annuitants, so it’s prudent to do some due diligence as you approach retirement.

3. Long-term care planning

Long-term care planning is complicated enough to prepare for during retirement. For blended families, long-term care planning is even more complex. If you and your spouse both accumulated assets for retirement, how will one pay for Long-term care costs if they are needed? Do both of you have Long-term care insurance? Or, do you plan to self insure? Are your estate planning goals the same?

Chances are, we will all need some level of custodial care at some point in our lives. The question is, how extensive is the care? And, for how long is care needed? Genworth published their annual study that indicates there is a 70% probability of needing Long-term care costs for those 65 or older. If you have children from a previous marriage, and your spouse needs care, are you going to burn through your own assets to pay for it? If you are like me, you will do anything you can to take care of your spouse and give them the proper care they need. However, if you have goals to leave money to your children, is that a risk worth NOT planning for?

On the other hand, if your spouse has children from a previous marriage and you needed care, how would he/she pay for it? Would you expect your spouse to accelerate withdrawals on their accounts unnecessarily in order to provide you care?

Should I buy Long-term Care Insurance?

If you are still young enough and healthy enough, you could consider buying Long-term care insurance. The last time I checked, it’s very rare to find a company that will cover you if you are over age 75. The sweet spot is often between 50-60 years of age, as there is a much lower decline rate and premiums are still affordable. When you get into your 60s and 70s, the decline rate goes up substantially and your premiums are quite costly.

Long-term Care Insurance is a very clean way to dedicate specific resources for this major retirement risk. Of course, nobody has a crystal ball, and you might be in the 30% that never needs care, but it’s a gamble you may not want to take.

There are also hybrid Long-term Care and Life Insurance policies that will provide a death benefit if you never use the funds for Long-term Care. Or, a reduced death benefit if you only used a portion of the Long-term Care benefit. This can provide you with some peace of mind knowing that someone will benefit from the policy. These products are much more expensive, so be prepared to write some larger checks. Also, work with a broker that can represent multiple carriers to help you shop around.

What about an annuity with a Long-term Care rider?

If you or your spouse have health issues that might preclude you from getting traditional Long-term Care, consider an annuity with a Long-term Care rider. These products do require a certain level of funding, but they are a viable option if you have a nest egg you could allocate to protect against this risk. Even Suze Orman, who is typically anti life insurance, is an advocate for these types of hybrid policies!

What about “self-insuring?”

There is nothing wrong with self-insuring, just over half of my clients decide to go this route.

If you decide to self-insure, having that discussion with your spouse about what assets to use to pay for care is critical!

If you have accounts that are more tax favorable to leave to your heirs, you may not want that account aggressively spent down for your care!

Also, consider the state you live in relative to your beneficiaries. If you live in a state like Florida or Tennessee without a state income tax, you might consider using some of your 401k or IRA to pay for care. This is especially relevant if your children are in a higher tax bracket and/or live in a state with high income taxes.

Have a plan, communicate it with your spouse, your financial planner, and your other agents so they know what to do! I also wrote an entire article on Long-term Care planning if you want to check it out here.

4. Estate Planning Basics for Blended Families

We have touched on some of the estate planning and intergenerational wealth planning challenges throughout this article. Each spouse might bring a slightly different perspective on transferring wealth. However, the amount you leave or who you leave it to isn’t the only estate planning challenge for blended families. Here are some other key points to consider:

Who will step in to help make financial decisions as you get older?
What about healthcare decisions?
Who is going to be the executor of your estate, or successor trustee?
Do you have any special considerations for any of your beneficiaries? (special needs, spendthrift concerns, son/daughter-in-law concerns, or stepchildren that you may or may not want to include)

These individuals should know what their role is, and what it is not! We’ve all heard of horror stories when someone dies without a plan, and unfortunately impacts how that person is remembered. If you have ever watched the show “This is Us,” there is a scene in the last season where Rebecca calls a family meeting with her three adult children and her second husband. This is a textbook model on how a family meeting should be conducted!

If there are different sets of children involved, consider naming one child from each “side” to participate. If it’s a successor trustee role, perhaps you can name successor co-trustees to avoid any ill will.

I certainly would make sure that a successor trustee or successor financial power of attorney is financially savvy and responsible. This does make things a bit tricky if one “side” does not have a viable option. Instead, I’ve seen where families will name the successor trustee a corporation, also known as a corporate trustee, to serve in that capacity. This way, clients don’t have to worry about anyone’s feelings being hurt because they couldn’t be trusted.

Don’t worry about giving specific dollar amounts on what you are leaving. You certainly can, but it’s not the point. The point is proactive communication and agreement from the adult children and other beneficiaries. This can really protect their relationships long term, which is far more meaningful than the dollar amounts they each receive.

If you didn’t see the episode of This Is Us, check it out here!

Should you consider a trust for your blended family?

I spoke with my own attorney and friend in detail about this. His name is Ryan Ludwick and he’s an Estate Planning specialist with Fisher and Tousey law firm based in Florida. He told me some couples come in with the idea they want to simply leave everything to one another, and then whatever is left will be divided evenly to the children. This makes things very simple, almost like a traditional family estate plan.

However, certain blended family dynamics could be solved with a trust. For example, if you want your spouse to utilize the assets for retirement if they were to outlive you, but still guarantee the remaining assets are left to your children, you might consider a trust.

A trust would essentially be set up for the surviving spouse. When you pass away, the trust becomes irrevocable (nobody can change it), and your spouse can use the assets for their care. Once the second spouse dies, the remainder beneficiaries (presumably your children) will receive the trust assets.

A few reasons why a trust could make sense are:

The assets held in trust would not be up for grabs in the case of a remarriage.
Potential creditor protection benefits.
Oversight – meaning you could name a trustee to help manage the trust, in case your surviving spouse was incapacitated down the road, or if they don’t have the financial acumen.
And of course, the terms are your terms, and cannot be altered.

Ryan also made a great point to be careful with naming a trust as primary beneficiary of a retirement account (401k or IRA). There might be unfavorable tax results by doing so, and you should consult with your financial planner and estate attorney before making any changes.

Life Insurance

Life Insurance could also be a great tool for estate planning for blended families. You could set up a new policy, or change the beneficiary of an old policy, to satisfy certain estate planning goals.

For example, let’s you wanted to split your investment assets four ways at your death between children and your new spouse. Between your spouse losing one Social Security benefit and only receiving 25% of your estate, their ability to maintain financial independence could be at risk. Therefore, you could consider leaving your life insurance policy to your spouse to make them whole.

On the other hand, you may not want to leave those 401ks or IRAs to your children for reasons mentioned before. Therefore, you could elect to leave those assets to your spouse (outright or in a trust), and leave the life insurance policy to your children. The death benefit is always tax free, so this solves the issues related to inheriting retirement accounts with the new SECURE Act law.

Elective Share Rules

Ryan said to “be careful of the elective share rule for spouses.” In Florida, and many other states without community property laws, the spouse is entitled to a percentage of the estate, regardless of what your will says. For Florida, it’s 30%. So let’s say you only designate 10% to your spouse in your will, he or she could contest this in court, and would likely win.

There are legal ways to get around this by way of signing a prenuptial agreement, or having your spouse sign a waiver form. It’s just something to be mindful for, especially with blended family estate planning.

Final word

As you can see, blended families are unique in an of themselves, so cookie cutter retirement and estate planning advice doesn’t work.

There are other considerations for blended family retirement planning, and no two situations are created the equal, which is why we love helping people like you!

Book a call with us!

If you have questions or want to discuss your situation, feel free to book a 30 minute Zoom call and we would be happy to connect with you.

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Kevin Lao

July 6, 2022

5 Reasons To Own Life Insurance In Retirement

"Should I own life insurance in retirement?"

Your kids might be financially independent, your mortgage is close to being paid off, and you are getting close to having what you need to retire comfortably. You might be wondering, “Should I own life insurance in retirement?” So, before you go and cancel that policy, read this post and see if you would be a good candidate to own some amount of life insurance for the long haul.

Basics of term and permanent insurance

Before we dive in, let’s go over the basics of the two primary types of life insurance. Term Insurance is just that, it’s for a specified term. This is a cost-effective solution for a temporary need. Let’s say you have young children, a mortgage, and another 20 years of earned income until retirement. The death benefit you will need, on average, will be at least 10-16x your gross income (according to the CFP board). So, if your income is $200,000/year, you will need approximately $2mm-$3.2mm of life insurance.

Depending on your health, this will only cost you pennies on the dollar (perhaps $1800-$3200/year). The reason it’s so cost effective is that only 1% of term policies ever pay a death claim, so term insurance is one of the most profitable products an insurance company can sell!

Permanent Insurance is of course, permanent (mind blown). There are many flavors out there; whole life (traditional), universal life, variable life, variable universal life, joint survivor universal life, and indexed universal life, to name a few. If you see the term variable, this means the policy performance is going to be tied to an underlying sub account that can be invested, like your 401k plan. If you don’t see the term variable, this means the performance is going to be tied to the performance of the insurance company’s general account, which is quite conservative. If you see indexed, this has a component of a fixed rate with potential upside of a targeted index, like the S&P 500. The difference between universal and traditional whole life is essentially the cost of insurance schedule. With traditional whole life, you have a fixed cost schedule at the time you start the policy, and it stays that way for the life of the plan. With universal, the cost of insurance goes up each year as you get older, but the premiums don’t necessarily go up each year. The schedule is flexible in that you can stop paying premiums one year (assuming you have enough cash value to support it), start again the next, pay half the premium another year and double the premium the year after. If you attempted this with traditional whole life, your policy would get cancelled, so don’t do that. I’m also not advocating you make premium payments to a universal policy like so, but it’s nice to have some flexibility.

I just want to emphasize how important it is, if you have a universal life policy, to review the performance at least annually. You can request an in-force illustration at any time to show how your policy has performed, and how it’s expected to perform based on fresh assumptions. I can’t tell you how many times I’ve looked at universal policies that people have paid into for decades that are on the verge of breaking.

The common theme for all permanent policies, if they are structured properly, is the death benefit should be in force for as long as you live. Additionally, there is a cash value component that you can access while you are living. This can be done through policy loans or partial surrenders.

So you might be wondering, why wouldn’t everyone buy permanent insurance and skip the term? The answer is simple, the premiums can range from 5-15 times more expensive! For this post, I will mainly discuss the argument of simply owning life insurance in retirement, whether it’s term or permanent is not the point. However, there are certain arguments I will make that ONLY permanent insurance can solve for. This is why it’s critical to begin with the end in mind and work backwards.

Reason #1: You are over the estate tax exemption limits (federal and/or state)

Currently, the federal estate exemption is $12.06mm/person (or $24.12mm for married couples). If your total estate is valued above the threshold and you die in 2022, you will pay tax on the amount ABOVE the threshold. The tax rates range from 18%-40%, depending on the size of your estate. Let’s say you had a total estate of $30mm and were married in 2022. If both you and your spouse passed away today under the current law, you would pay taxes on $5,880,000 at the federal level. There are also 17 states that have a “death tax,” so be careful where you live when you die as you might owe state AND federal estate taxes (and by “you,” I mean your beneficiaries)! For example, Massachusetts and Oregon tax estates in excess of $1mm! As you can see, living in an estate tax friendly state is a big decision point for many retirees.

This can become problematic for your heirs to pay these large sums of taxes. If you own a closely held business, a real estate portfolio, or a mix of stocks and bonds, you probably want your heirs to continue to enjoy the fruits of your labor and preserve those assets. Well, if your beneficiaries owe a seven figure tax bill, they might be forced to sell an extremely valuable asset in order to pay the taxes. This is where permanent life insurance can come into play. Life Insurance is a tax free payment of cash to your designated beneficiary. Therefore, instead of forcing your beneficiaries to sell that valuable asset, the life insurance death benefit could be used to pay the estate tax bill.

*The Tax Cuts and Jobs Act will sunset after the year 2025. The federal exemption is scheduled to revert back to the $5mm/person limit (plus some inflation adjustments). So, while you may not exceed the federal thresholds today, you certainly could exceed them in a few short years. Plan accordingly!

Reason #2: You Have a Dependent with Special Needs

Children with special needs often require permanent financial assistance. Meaning, their condition won’t make their life any easier as they get older. In fact, quite the opposite. The government provides some financial assistance for those they deem disabled in the form of Social Security Income, Medicare and Medicaid. However, you will likely want to provide additional financial support above and beyond the government assistance. While you are alive and working, you will do anything you can to provide that additional financial support. However, if something were to happen to you, how do you address that financial shortfall?

Owning a life insurance policy is a great solution to this problem. You can simply calculate the amount of annual income needed to support the beneficiary with special needs, and come up with an appropriate amount of life insurance to pay out to that beneficiary. These policies are often owned inside of what is called a Special Needs Trust. This special type of trust allows for the preservation of government support for the child, while at the same time receiving supplemental income from the trust. The longer you live, and the more assets you accumulate, might impact the amount of insurance that you need to own. Ideally you will want some amount of the insurance to be term and some permanent to accommodate the future accumulation of other assets.

Reason #3: To Replace Lost Retirement Income

You might be thinking life insurance is there to replace income when you are working, but how does it factor into retirement income? For starters, Social Security represents the largest pension fund in the world, and most retirees rely on it for some or most of their income in retirement. When one spouse dies, there is an automatic loss in Social Security income. The surviving spouse will elect to keep their own benefit, or the deceased’s benefit, whichever is higher. If a couple each had $24,000/year in social security benefits, this would result in $24,000/year in lost social security income upon the first spouse passing away. Additionally, after two tax years of filing as a qualifying widower, there could be a widow’s tax given they will have to transition over to a single filer, and potentially pay higher tax rates.

Furthermore, you might receive a pension from the military or government, or perhaps VA Disability income. The benefit might be cut in half, or even go to zero upon the annuitant passing away. Therefore, owning a life insurance policy through retirement can help replace lost social security or other pension income, making the surviving spouse whole and protecting their own longevity.

Reason #4: To Replenish Lost Assets from Long-term Care Costs

It’s estimated that medical costs in retirement will total about $300k for a couple that is 65 years old today, and that excludes Long-term care costs. The average cost of a nursing home in the US is north of $100k/year (in today’s dollars). If there was a need for long-term care at the end of the first spouse’s life, this could create a significant drain on retirement assets. This is especially true if the assets that were used to pay for long-term care came from retirement plans such as traditional IRAs or 401k plans, given the tax drag on withdrawals. Therefore, owning a life insurance policy can guarantee a cash infusion for the surviving spouse to protect their retirement lifestyle and their own longevity going forward. This could also be achieved with a life insurance policy with a Long-term care rider, which would allow funds from the policy to be paid in advance for long-term care costs, instead of waiting for the death benefit of the first spouse. Either way, utilizing some form of permanent life insurance in retirement is a great way to protect and/or replenish assets in the event long-term care becomes a financial drain.

Reason #5: To Guarantee a Financial Legacy

I often times hear from clients they have a strong desire to leave assets to their children, grandchildren or even their favorite charity. Ultimately what they are saying is they don’t want to burn through the assets they have accumulated, but they still want to ENJOY their retirement! These clients often times have a very difficult time spending their own money in retirement simply because of the fear of running out of money and being a burden on their loved ones. My clients that own permanent life insurance in retirement can sleep extremely well at night knowing that at least one asset is guaranteed to be there upon their death. This ends up liberating the client to spend more freely on travel, bucket list activities, charitable giving, and overall results in a more enjoyable retirement lifestyle.

BONUS Reason #6 – Owning Permanent Life Insurance in Retirement as a Fixed Income Alternative

Here is a fun concept, especially in light of today’s bond market! With the bond index down double digits year to date, many clients are asking about an alternative to bonds. A few come to mind including an individual bond ladder, fixed income annuities, or even a zero duration hedge strategy. However, the cash value in a traditional universal life or permanent life insurance policy can be extremely powerful, if structured properly. If you google “cash value life insurance,” you will see a mix bag of opinions. For the right client profile (maxing out qualified plans, maxing out Roth conversions, higher tax bracket etc.), there could be a very compelling argument to begin accumulating dollars within a permanent life insurance policy well before retirement. For starters, it will solve for all of the primary challenges we mentioned previously. Additionally, it will allow time for cash value to build up inside of the policy. If it’s structured properly, it can become a liquid asset to draw from during your retirement years.

You will likely experience anywhere from 4-6 bear markets during your retirement years. You’ve probably heard the concept, “buy low, sell high.” In retirement, this involves avoiding selling a depreciated asset for income. In a market like 2022, both stocks and bonds are down. If you have cash values built up in a fixed life insurance policy, it’s a viable hedge to allow your riskier assets to fully recover when the market turns around.

A few last words of advice

Life insurance does get more expensive as you get older, and you also have a greater risk of developing a medical condition that might make life insurance unobtainable. There is no one size fits all when it comes to retirement planning, especially when it comes to using life insurance in your retirement plan. The life insurance industry is quite complex with many carriers and many variations of permanent life insurance. Therefore, I highly recommend you consult with a fee-only financial planner who has expertise in this arena, like our firm! (Yes, I’m quite biased).

If you are interested in learning more about working with our firm, or would like to discuss your financial objectives, book a Mutual Fit meeting with the link below. Also, feel free to share this article with anyone that might find it useful.

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Kevin Lao

June 23, 2022

Six Reasons To Take Advantage of Roth Conversions

Pay me now or pay me later applies to your retirement accounts. Let’s talk about when it makes sense to pay up now and minimize your tax liability during retirement.

Kevin Lao

May 27, 2022

Tax-Loss Harvesting

Investment losses can be painful, but they often come with great opportunity. This includes not only buying equities at discounted prices, but significant tax benefits if you are opportunistic.

Kevin Lao

May 13, 2022

Should I purchase I-Bonds?

Inflation is running hot, the market is volatile, and I-Bonds have become attractive. This article addresses the basics of I-Bonds and how you can assess if they are right for you.

Kevin Lao

April 19, 2022

Are Financial Advisors Worth It?

"How do fiduciary financial advisors add value?"

In my nearly 14 years in this business, I’ve seen financial advice given by many different professionals. Insurance agents, stock brokers, bank representatives, real estate professionals, next door neighbors and the like. I’ve seen some great advice given, but also some terrible advice. This often times leads to the general public to think “are financial advisors worth it?” This is especially the case now given the lines are blurred between different segments of the “financial services” industry. Vanguard did a study called “Advisor’s Alpha” which I have found is the most helpful and accurate summary of value-added services a comprehensive financial advisor provides. I’ve referenced it to clients and other professionals since 2014 when it was originally published. To summarize it briefly, they outline seven areas of advice that add value to the client’s portfolio by way of net returns annually. They have assigned a percentage to each of the categories which amounts to approximately 3%/year in net returns! In this article, I will highlight some of the key components of their research, as well as put my own spin on it based on my thousands of hours working with clients directly.

What is comprehensive advice?

First things first, not all advisors are comprehensive (and that’s okay). However, this article is specifically for firm’s like mine that are focused on comprehensive advice and planning, and I would argue the 3%/year figure is on the low end. I will get into this more shortly.

Here is a breakdown of Vanguard value-added best practices that I mentioned previously:

The first thing that should jump out to you is that suitable asset allocation represents around 0%/year! This is given the belief that markets are fairly efficient in most areas, and it’s very difficult for an active fund manager to consistently beat their benchmarks. This is contrary to the belief of the general public in that a financial advisors “alpha” is generated through security selection and asset allocation! What’s also interesting is that the largest value add is “behavioral coaching!” I will get into more about what this means, but I would 100% agree with this. Sometimes, we are our own worst enemy, and this is definitely true when it comes to managing our own investments. It’s natural to have the fear of missing out, or to buy into the fear mongering the media portrays. So if you take nothing else away, the simple notion of having a disciplined process to follow as you approach and ultimately achieve financial independence will add 150% more value than trying to pick securities or funds that may or may not outpace their benchmarks!

Before I dive into my interpretation of their study, I want to note that I will be using five major categories instead of seven. Some of the above mentioned can be consolidated, and there are also some value added practices I, and many other comprehensive planners, incorporate that are not listed in their research.

What are the five value-added practices? I use the acronym “T-I-R-E-S”

Tax planning
Income Distribution Planning
Risk Management
Expense Management
Second set of eyes

Tax planning

There are four major components of tax planning a comprehensive financial advisor should provide. The first component is what we call “asset location.” The saying that comes to mind is “it’s not what you earn, it’s what you keep.” Well, taxes are a perfect example of not keeping all that you earn. However, some account types have preferential tax treatment, and therefore should be maximized through sound advice. Certain investments are better suited for these types of tax preferred accounts and other investments tend to have minimal tax impact, and therefore could be better suited OUTSIDE of those tax preferred accounts. A prime example is owning tax free municipal bonds inside of a taxable brokerage or trust account, and taxable bonds inside of your IRA or Roth IRA’s. Another example could be leveraging predominantly index ETF’s within a brokerage account to minimize turnover and capital gains, but owning a sleeve of actively managed investments in sectors like emerging markets, or small cap equities inside of your retirement accounts. According to the Vanguard study, this type of strategy can add up to 75 basis points (0.75%/year) in returns if done properly, which I would concur.

The second component is income distribution. This is often thought of much too late, usually within a few years of retirement. However, this should be well thought out years or decades in advance before actually drawing from your assets. One example I see often is when a prospective client who is on the brink of retiring wants a comprehensive financial plan. Often times they have saved a significant sum of money, but the majority of the assets are held inside of tax deferred vehicles like a 401k or IRA, and little to no assets in a tax free bucket (Roth). This type of scenario limits tax diversification in retirement. On the contrary, someone who has been advised on filling multiple buckets with different tax treatments at withdrawal will have many combinations of withdrawal strategies that can be deployed depending on the future tax code at the time. I have incorporated the rest of the income distribution value-added practice in the next section, but this practice as a whole is estimated to add up to 110 basis points (1.1%/year) in additional returns!

Legacy planning is the third component of tax planning that a comprehensive financial advisor should help with. This isn’t discussed in the Vanguard study, but it’s safe to say a comprehensive plan has to involve plans for your inevitable demise! You might have goals to leave assets to your heirs, especially if you are fortunate enough to have accumulated more than you will ever spend in your lifetime. With the SECURE Act, qualified retirement plans are now subject to the “10-year rule,” and therefore accelerating tax liabilities on your beneficiaries. However, if you incorporate other assets for legacy that can mitigate the tax impact on the next generation, this can save your beneficiaries hundreds of thousands, or even millions of dollars simply by leveraging the tax code properly.

Finally, navigating tax brackets appropriately can be another way a comprehensive advisor adds value. If a client is on the brink of a higher tax bracket, or perhaps they are in a period of enjoying a much lower tax bracket than normal, planning opportunities should arise. If you are in an unusually higher tax bracket than normal, you might benefit from certain savings or tax strategies that reduce their adjusted gross income (think HSA’s, pre-tax retirement account contributions, or charitable giving). If you find yourself in a lower tax bracket than normal, you might accelerate income via Roth conversions or spending down tax deferred assets to lessen the tax burden on those withdrawals. Additionally , considerations on the impact on Medicare premiums in retirement should also be taken into account when helping with tax planning.

As you can see, even though I am not a CPA and I’m not in the business of giving tax advice, helping you be strategic with your tax strategies is part of the comprehensive planning approach. All in, you should expect to increase your returns up to 1%/year (or more depending on complexity) by navigating the tax code effectively.

Income Distribution Strategy

In my personal practice, this ends up being a significant value add given the work I do with post-retirees. A systematic withdrawal strategy in retirement will involve a monthly distribution 12 times throughout the year. This reduces the risk of needing a sizeable distribution at the wrong time (similar to the concept of dollar cost averaging). For a 30 year retirement, this means 360 withdrawals! Most retirees have at least two different retirement accounts, so multiply 360 by 2 for 720 different income decisions to navigate. In my experience, the selling decisions are often what set investors back, especially if they are retired and don’t have the time to make it back. By putting a process in place to strategically withdrawal income from the proper investments at the right time, and maximize the tax efficiency of those withdrawals, this can add up to 1.1%/year in returns alone, according to Vanguard’s study! I’ve also had clients tell me they value their time more and more the older they get. Instead of spending their retirement managing income withdrawals each month, they would much rather travel, play golf, go fishing, spend time with their grandchildren etc. So yes, I would agree with the Vanguard study that 1.1%/year is appropriate for this category, but I would also argue the peace of mind of not needing to place trades while you are on an African Safari with your spouse is priceless! Yes, I did have a client who admitted to this, and no, his wife was not happy! That’s why they hired me!

Risk Management

The major risks you will see during your lifetime from a financial planning perspective are:

Bear market
Behavioral
Longevity
Inflation
Long-term care
Premature death
Incapacity or aging process

Vanguard’s study focuses mainly on the behavioral risk (value add up to 1.5%/year) and re-balancing (.26%/year). As I mentioned earlier, it’s fascinating they rank behavioral risk as the largest value add out of any category! What is behavioral risk? Let me tell you a quick story. A client of mine was getting ready to retire at the beginning of 2020, right as the pandemic reared it’s ugly head. He had 30+ years working in higher ed and climbed the ladder to ultimately become president of his college for the last 15 years. He is a brilliant man, and a savvy business person. When the pandemic hit us, he was terrified. Not only did he see his portfolio drop from $2.5mm to $2.25mm in four weeks, but he was worried this could lead to the next depression which his parents lived through. We had at least a dozen conversations during those weeks about how he was losing sleep every night, which of course was miserable for he and his wife. Finally, in our last discussion he informed me he wanted to sell out of his retirement investments and move to cash. I plead my case in that we had a well thought out diversified strategy, and looking at the math, we had enough resources in fixed income investments to pay his bills for the next ten years! However, I told him it was his money and I was ready to place the trades if that is what he wanted. He told me he would think on it for the next 24 hours. The next day, he called me and said I was right, we had a plan, and he wanted to proceed with sticking to the plan. Well, by the end of 2020 his account not only fully recovered, but it grew to $2.75mm! I am not pumping my chest on performance, but by being the behavioral coach he needed at that time earned him $500k of growth in his portfolio (a whopping 22%).

I can literally share a hundred of these stories not just from the pandemic, but stories from 2008/2009, the dot com bubble etc. The point is, having an advisor you trust that can help you navigate through the ups and downs of the market and tell you what you NEED to hear, not what you WANT to hear is invaluable. Furthermore, it can free up your time to focus on what matters in your life and have the professionals worry about the market for you!

So all in all, I would agree on the 1.5%/year value add for behavioral coaching and .26%/year to help re-balance the portfolio properly. However, Vanguard’s study doesn’t even take into consideration proper insurance planning and estate planning advice a comprehensive advisor gives to their clients which are also value-adds in and of themselves. In that sense, I would argue this category can add up to 2%/year in additional returns to a client.

Expense Management

This is oftentimes overlooked when working with a financial advisor. Much of the public believes working with an advisor will be more expensive! However, many of them are used to being sold high commission investment products or services that are overpriced. However, through due diligence and leveraging the proper research, Vanguard estimates clients should save on average 0.26%-0.34%/year on expenses. From my personal experience, this might even be on the low end. However, for arguments sake and given it’s their research, let’s say we agree with the value-added range set forth.

Second set of eyes

Vanguard doesn’t reference this in their study, but that objective point of view is sometimes necessary to drive positive change. I don’t have any specific data on how to quantify this, but I hear time and time again from clients that they so much appreciate having me as an accountability partner. Think about trying to get in tip top shape without a coach or personal trainer! You might do okay, but you certainly wouldn’t push yourself as hard as you could have if you had a coach or trainer. On the contrary, I often hear from new prospective clients how information overload and the fear of making a mistake has caused a whole lot of inaction, which can significantly hurt returns and performance. Think about a surgeon attempting to perform surgery on their own body! They simply wouldn’t. Not that I am comparing my occupation to a surgeon, but someone working to achieve financial independence would benefit substantially from a trusted third party to help navigate all of the different financial decisions they will encounter in their lifetime. This also could be true for married couples who might have differing views on finances. After all, financial reasons are the #1 cause for divorce in America. If I can help a married couple get on the same page with their financial vision, that is a win for them, no questions asked! Without specific data, I would have to say my gut feel is that objectivity should add an additional 0.5%/year in returns over the duration of a relationship, as well as more self confidence and peace of mind that you are on the right path.

If we tally up our TIRES acronym:

Tax planning = 1%/year
Income Distribution Planning – 1.1%/year
Risk Management – 2%/year
Expense Management – 0.26% – 0.34%/year
Second set of eyes – 0.5%/year

This gives us a total value add range of 4.86% – 4.94%/year in additional returns. My firm’s average fee is roughly 0.85%/year. This is why I get so excited to help new and existing clients. The value you receive, is far greater than the cost to pay me, creating a win-win situation. Now, not EVERY client will experience in additional 4-5% in additional value. Some might receive 2%/year, some might receive 10%/year! However, all of you who have yet to work with a comprehensive planner, or for those of you working with an advisor who may not be doing a comprehensive job, it might be time to reevaluate and see what holes you need to fill. If you are interested in learning how to work with me directly, you can schedule a mutual fit meeting with the button below. Or, you can visit my “Process” and “Fees” pages on my website.

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CFP fiduciary financialplanning retirement

Kevin Lao

January 21, 2022