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Category: Financial Planning

7 Reasons Not to Do a Roth Conversion

I’ve never met anyone who wants to overpay the IRS. As a result, one of the number one topics we discuss with clients is how to reduce their lifetime tax bill. More specifically, whether or not they should consider a Roth Conversion with some of their IRA dollars.

Before we talk about the seven reasons that might cause you to delay, reduce, or reconsider doing a Roth conversion, let’s look at some big news brewing in Washington related to taxes on Social Security.

Social Security has a complicated formula to determine how much of your benefit will be included in your taxable income. On the low end, your entire benefit could be tax-free (0% included in taxable income). On the high end, up to 85% of your Social Security benefit could be taxable.

Senior Citizens Tax Elimination Act

Congressman Thomas Massey from Kentucky, along with 29 Republican co-sponsors, has introduced the Senior Citizens Tax Elimination Act. To provide some context, prior to 1986, Social Security benefits weren’t taxable at all. In 1986, Social Security implemented revisions and created the provisional income formula that determines how much of your benefit is included in taxable income.

Massey’s bill would essentially repeal the inclusion of Social Security benefits in taxable income altogether. This would also include tier one railroad benefits (pensions from working at the railroad). The bill was first introduced last year, but now it’s legitimate. It’s in the House and seems to have a decent chance of passing.

However, there are costs associated with implementing this bill. According to the Committee for Responsible Government, this is estimated to cost taxpayers about $1.8 trillion over the next decade. When we couple this with Social Security’s projected insolvency date of around 2033-2034, it raises questions about funding.

Currently, 80% of Social Security benefits are funded by payroll taxes from current workers. The Social Security trust fund supplements the remaining 20%. If benefits become tax-free, this could accelerate the insolvency date.

So, how will they pay for this bill? My crystal ball says taxes will increase in some way to fund the deficits projected for Social Security and Medicare.

Why is this relevant to our Roth conversion discussion? Because, while we know what taxes look like today, it’s virtually impossible to be 100% certain about future tax rates.

What is a Roth Conversion?

A Roth conversion involves moving or converting funds from a tax-deferred vehicle (like a traditional IRA, 401(k), 403(b), or TSP plan) into a tax-free vehicle. In exchange for doing this, you elect to pay the taxes now.

Why would you do this? At one point, you believed deferring taxes was the way to go, or maybe you didn’t have access to a Roth account. This is pretty common—15-20 years ago, many employers didn’t offer Roth 401(k) plans. But now you have the ability to convert some of those assets to Roth.

The benefit of a Roth account is tax-free growth going forward, as opposed to tax-deferred growth. But there are situations where converting might not be the best strategy.

1. You’re in a Higher Tax Bracket Today Than You Will Be in the Future

The first reason to reconsider a Roth conversion is if you’re currently in a higher tax bracket than you expect to be in the future. There are several scenarios where this might happen:

When you retire, your W-2 income or self-employment income disappears. Your only income might be capital gain distributions, dividends, interest, a small pension, or IRA distributions. If your tax bracket will drop substantially in retirement, it might make sense to wait until you enter what we call the “Roth conversion window.” This window is after retirement, but before you start taking Required Minimum Distributions (RMDs) and/or Social Security.

Your income might be temporarily high due to things like

  • Selling a business, stock, or rental property
  • Receiving a large bonus
  • Inheriting money

Doing a Roth conversion during these high-income years could push you into an unnecessarily higher tax bracket.

You might believe taxes will decrease in the future due to legislative changes, making it beneficial to wait for potential tax cuts before converting.

In short, if you expect your income bracket to drop at some point, it might be worth evaluating conversions at that time instead of now.

2. You’re Leaving a High-Income Tax State for a Low or No-Income Tax State

According to the Tax Foundation, state income taxes significantly influence net migration in the U.S. The top third of states with positive net migration have an average state income tax of about 3.5%. The bottom third average nearly double that at 6.7%.

I don’t believe you should move to a state in retirement solely because of taxes. However, if you’re planning to move from a high-tax state like New Jersey, New York, or California to a low or no-income tax state, you might consider waiting to do Roth conversions until after your move.

You could potentially benefit from both a lower federal bracket at retirement and little to no state income tax, maximizing your tax savings on the conversion.

It will be interesting to see how migration patterns evolve as companies bring employees back to in-person work. For retirees with the flexibility to move anywhere, taxes will likely remain an important consideration.

3. Your Heirs Are in Lower Tax Brackets

The SECURE Act, passed at the end of 2019, eliminated the “stretch IRA” for most beneficiaries. Previously, individuals who inherited an IRA could stretch distributions over their life expectancy. Now, most non-spouse beneficiaries must liquidate the account within 10 years.

This applies to both traditional IRAs and Roth accounts. The key difference is that Roth account distributions during those 10 years are tax-free to beneficiaries, while traditional IRA distributions are fully taxable.

If your beneficiaries are in a very low tax bracket, while you are in a higher tax bracket, there could be an argument for not converting. For example, if you’re in the 24% or 32% bracket due to Social Security, a pension, and investment income, while your children are in the 10% or 12% bracket, it might make more sense to leave those assets to your heirs and let them pay taxes at their lower rate.

The challenge with this approach is that it requires knowing exactly when you’ll pass away and what tax bracket your children will be in at that time. Your 25-year-old child who’s currently in graduate school with no income might eventually have high earning potential or start a successful business, putting them in a higher tax bracket than you.

Additionally, even if your beneficiaries are in a relatively low tax bracket, inheriting a large IRA could push them into a higher bracket during the 10-year distribution period. For example, if your IRA is worth $2 million, your beneficiaries would need to distribute about $200,000 annually over 10 years, potentially pushing them into a much higher tax bracket regardless of their current income.

You should also consider the distribution of your assets between taxable, tax-deferred, and tax-free accounts when making this decision.

4. Hidden Taxes Could Reduce the Benefit of Converting

Any Roth conversion will increase your taxable income in the year you do the conversion, even though it doesn’t put cash in your bank account. This can trigger various “hidden taxes” based on calculations like modified adjusted gross income (MAGI), taxable income, or provisional income.

Here are some examples:

IRMAA Surcharge: The Income-Related Monthly Adjustment Amount applies once you’re Medicare eligible. While Medicare Part A is free, Part B has a premium (about $185 for 2025). Part D depends on your chosen drug plan. If your income exceeds certain thresholds, you’ll pay additional surcharges for both Part B and Part D. These surcharges can range from $1,000 to over $6,000 per year per person.

ACA Premium Tax Credits: If you retire before 65 and use the Affordable Care Act for health insurance, you might be eligible for premium tax credits based on your modified adjusted gross income. Roth conversions could reduce these credits.

Net Investment Income Tax: If your MAGI exceeds $250,000 (married filing jointly) or $200,000 (single), there’s an additional 3.8% tax on investment income like dividends, interest, and rental income.

Capital Gains Taxes: If you’re married filing jointly and your taxable income is below $96,700 for 2025, you don’t pay any tax on long-term capital gains. A Roth conversion could push you above this threshold.

Social Security Taxation: As mentioned earlier, between 0% and 85% of your Social Security benefits could be taxable depending on your provisional income. Roth conversions can increase this percentage.

While these hidden taxes aren’t necessarily reasons to avoid Roth conversions entirely, they should factor into your decision about timing and amount.

5. You’re Planning to Donate to Charity During Your Lifetime or at Death

Traditional IRAs are some of the best accounts to donate to charity. If you convert all your tax-deferred assets to Roth, you lose this potential tax benefit.

One powerful strategy is the Qualified Charitable Distribution (QCD). Once you turn 70½, you can donate up to $107,000 (in 2025) directly from your IRA to charity without recognizing an taxable income. What makes this even more powerful is that once you begin taking Required Minimum Distributions (RMDs), you can reduce your RMD dollar-for-dollar up to that cap.

For example, if your RMD is $50,000 and you typically donate $30,000 to charity, you could do a $30,000 QCD directly from your IRA. This would reduce your RMD to $20,000, essentially making that $30,000 completely tax-exempt—even better than a tax deduction.

Similarly, if you’re planning to leave money to charity at death, your traditional IRA is a great asset to use. While your non-spousal beneficiaries (typically children or nieces/nephews) will have to pay taxes as they withdraw from the inherited IRA over the 10-year period, charities don’t pay any taxes on these distributions.

This doesn’t mean you shouldn’t convert at all, but you might consider not converting as much or as aggressively if charitable giving is part of your plan.

6. You’re Planning to Self-Fund for Long-Term Care Costs

Long-term care is one of the most significant risks retirees face today. The uncertainty lies in whether you’ll need care, and if so, for how long—six months or ten years? The costs can be substantial, often exceeding six figures annually.

Some people buy long-term care insurance, while others plan to use their own assets. If you’re in the latter group, there’s an interesting tax angle to consider. While IRA distributions are taxable, there’s a deduction if your medical costs exceed 7.5% of your adjusted gross income. These expenses can be added to your itemized deductions.

If you need long-term care later in life, it’s almost certain your expenses will exceed that 7.5% threshold, given the high costs involved. If you have an IRA you can tap into to pay for care, you might be able to deduct some of those distributions because of the medical expense deduction.

While this deduction may not offset the entire tax on the distribution, it can be significant enough to argue against converting all of your IRA to Roth.

7. You Don’t Have the Cash to Pay the Taxes

The traditional approach to paying for Roth conversion taxes is to use cash on hand from a savings or checking account, or to increase withholding from sources like Social Security or a pension to offset the additional taxes.

If these aren’t options—if you don’t have the cash or need your income from other sources—you may have to use funds from your IRA to pay the tax. If you’re younger than 59½, this isn’t advisable because you’ll face a 10% early withdrawal penalty.

Even if you’re over 59½, using money from your IRA to pay the taxes leaves less money invested that could otherwise grow tax-deferred. This may not be ideal depending on your time horizon and the breakeven point of the Roth conversion.

Your plan should strongly favor Roth conversions for it to make sense to pay the tax out of the IRA. While there are cases where this works (I have a client for whom we’re doing exactly this), if you don’t have the cash and the case for Roth conversion isn’t compelling, you might want to pause or avoid the conversion altogether.

Final Thoughts on Roth Conversion Decisions

Understanding when a Roth conversion makes sense requires careful analysis of your current situation, future expectations, and overall financial goals. While Roth conversions can be powerful tools for retirement planning, they aren’t right for everyone in every situation.

Remember that tax laws and personal circumstances change over time, so regularly reviewing your retirement and tax planning strategy is essential for long-term success.

If you’re approaching retirement and wondering if you should do a Roth Conversion, check out Episode 66 of The Planning for Retirement Podcast. Consider working with a financial advisor who specializes in retirement income planning. They can help you analyze your specific situation and develop a claiming strategy that aligns with your overall financial goals.

At Imagine Financial Security, we help individuals over 50 with at least a million dollars saved navigate these complex retirement decisions.

If you are looking to maximize your retirement spending, minimize your lifetime tax bill, and worry less about money, you can start with our Retirement Readiness Questionnaire linked on our website at www.imaginefinancialsecurity.com. Click the “Start Now” button to learn more about our process and how we might be able to help you achieve a more confident retirement.

Not quite ready to take the questionnaire, but want helpful tips and resources? Sign up for our monthly newsletter and/or subscribe to our YouTube channel.

This is for general education purposes only and should not be considered as tax, legal or investment advice.




9 Reasons to Consider Delaying Social Security Benefits

You’ve probably heard financial experts advising people to claim Social Security as early as possible. They say things like:

  • “You don’t know how long you’ll live.”
  • “Take it now while you’re young and healthy.”
  • “Social Security might go bankrupt.”

But what if I told you that for high-net-worth retirees, claiming early could cost you several hundred thousand dollars in lost income and negatively impact your investment portfolio over time?

In this article, we’re going to dive into nine compelling reasons why you might consider delaying your Social Security benefits as long as possible. This advice is particularly relevant for individuals over 50 who have accumulated at least a million dollars in retirement savings.

The Current Economic Context

Before we dive into our main topic, it’s important to note some significant economic developments that could impact retirement planning. As of July 2025, all three major credit rating agencies have downgraded US credit from AAA to AA. This downgrade stems from rising national debt (currently at $36 trillion), large annual deficits, and higher borrowing costs for the government.

For retirees, this has several implications:

  1. Bond yields have increased, offering higher interest income on new issues
  2. Existing bonds may have decreased in value
  3. There’s increased volatility in fixed-income investments

These factors make your Social Security claiming strategy even more critical as part of your overall retirement plan.

Social Security Basics: What You Need to Know

Before discussing claiming strategies, let’s review some Social Security fundamentals:

  • Eligibility: You need 40 credits (typically achieved by working for 10 years) to qualify
  • Primary Insurance Amount (PIA): The benefit you’ll receive at full retirement age
  • Full Retirement Age: For most people born after 1960, this is age 67
  • Early Claiming: You can claim as early as 62, but with a reduction of up to 35% from your PIA
  • Delayed Claiming: For each year you delay beyond full retirement age (up to age 70), your benefit increases by 8%

In 2025, the average monthly Social Security benefit is about $1,840 across all recipients, with retirees receiving slightly more at around $1,900 per month. However, if you’ve had above-average earnings throughout your career, your benefits could be significantly higher.

The maximum possible monthly benefit at full retirement age is over $4,000. If claimed early at 62, the maximum is about $2,800, while delaying until 70 could provide up to $5,100 per month. For a married couple with two high earners, this could mean a combined monthly benefit of $8,000 to $10,000, a substantial fixed income stream.

Nine Reasons to Consider Delaying Social Security

1. You or Your Spouse Are Still Working

If you or your spouse continues working, whether part-time or full-time, this income might cover your basic necessities. You can supplement this with portfolio withdrawals if needed.

Additionally, if you claim Social Security while still working before reaching full retirement age, you’ll be subject to the retirement earnings test. This means Social Security will reduce your benefits if your wages exceed certain thresholds. While these reductions aren’t permanent (you’ll receive adjustments later), delaying benefits while working can simplify your financial situation.

2. Higher Guaranteed Monthly Benefit

This is perhaps the most obvious reason to delay. By waiting until age 70 instead of claiming at 62, you can increase your monthly benefit by approximately 77% (avoiding the 35% reduction at 62 and gaining 24% from delayed retirement credits between 67 and 70).

Example

If your primary benefit amount at 67 is $3,000, claiming it at 62 would reduce it to approximately $1,950, while waiting until 70 would increase it to approximately $3,720 per month. That’s a difference of $1,770 per month or $21,240 per year!

Of course, by delaying, you will be forgoing benefits for several years. The break-even point—where the cumulative benefits from delaying surpass what you would have received by claiming earlier—typically occurs around age 83. If you live beyond this age, delaying will have provided greater lifetime benefits.

3. Longevity Insurance

Social Security functions similarly to an annuity, providing guaranteed income for life. This “longevity insurance” becomes increasingly valuable the longer you live.

According to Social Security’s actuarial tables, a 60-year-old male today has a life expectancy of 80.4 years, while a female has a life expectancy of 83.5 years. However, many high-net-worth individuals have access to better healthcare and tend to live longer than these averages.

By delaying Social Security, you’re essentially purchasing a larger “annuity” that increases with inflation each year through cost-of-living adjustments (COLAs). Unlike private annuities, which may not include inflation protection, Social Security benefits are adjusted annually to keep pace with the Consumer Price Index.

4. Spousal and Survivor Benefits

For married couples, delaying benefits can significantly impact the financial security of both spouses.

While spousal benefits (up to 50% of the primary earner’s benefit at full retirement age) cannot be increased by delaying beyond full retirement age, survivor benefits can be. If the higher-earning spouse delays claiming until 70 and then passes away, the surviving spouse can step up to that higher benefit amount.

Example

Let’s say that Jack’s benefit at full retirement age is $4,000 per month, and Jill’s is $2,500. Jack decides to delay receiving benefits until age 70, which increases his benefit to $5,000 per month. When Jack passes away, Jill will receive $5,000 instead of $4,000. This provides significant additional income protection for the surviving spouse.

5. Tax Efficiency

Social Security benefits may be partially taxable depending on your “combined income” (adjusted gross income + tax-exempt income + half of your Social Security benefits):

For single filers:

  • Below $25,000: 0% taxable
  • $25,000-$34,000: Up to 50% taxable
  • Above $34,000: Up to 85% taxable

For married filing jointly:

  • Below $32,000: 0% taxable
  • $32,000-$44,000: Up to 50% taxable
  • Above $44,000: Up to 85% taxable

By delaying Social Security and strategically managing your income during the “Roth conversion window” (the period between retirement and Required Minimum Distribution age), you might be able to convert traditional IRA assets to Roth while keeping your tax bracket lower. Then, when you start Social Security at 70, a smaller portion (or potentially none) of your benefits might be subject to taxation.

6. Maximizing Legacy

While claiming early and investing those benefits might seem like a good strategy for maximizing your legacy, delaying can actually be more effective if you live a long life.

Yes, delaying Social Security means higher portfolio withdrawals in the short term. However, once you start receiving the higher benefit amount, your lifetime withdrawal rate decreases. Over a 15-25 year retirement, this can result in greater portfolio preservation and a larger inheritance for your heirs.

In one case study, a client with a $1 million portfolio who delayed claiming Social Security saw their portfolio initially dip but then recover significantly. By year 22 (around age 84), their portfolio value exceeded what it would have been had they claimed early, ultimately leaving a larger legacy.

7. Peace of Mind

The simple psychological benefit of having a higher guaranteed income stream shouldn’t be underestimated. Many retirees sleep better knowing they have a substantial, inflation-protected income source that isn’t dependent on market performance.

This peace of mind factor is why many people work longer than financially necessary—they want to maximize their guaranteed income in retirement.

8. Health Savings Account (HSA) Eligibility

This is a more technical consideration, but essential for those with HSAs. Once you enroll in Medicare at 65, you can no longer contribute to an HSA, even if you’re still working and covered by a qualified employer plan.

When you begin collecting Social Security after 65, you’re automatically enrolled in Medicare. If you plan to work past 65 and want to continue contributing to an HSA, delaying Social Security is necessary.

9. Flexibility

Deciding to delay Social Security doesn’t lock you in permanently. If you initially plan to delay until 70 but retire into a market downturn, you can start benefits earlier than planned to reduce pressure on your investment portfolio.

This flexibility allows you to adjust your strategy according to changing market conditions, health developments, or other life circumstances.

Real-World Impact: A Case Study

Let’s look at a real example of how different claiming strategies affect lifetime benefits. For a couple we’ll call Jack and Jill, we analyzed three scenarios:

  • Both claiming at 62
  • Both claiming at full retirement age (67)
  • Both claiming at 70

Assuming Jack lives to 85 and Jill to 90, with a 2% annual cost-of-living adjustment:

  • Claiming at 70: $2.3 million in lifetime benefits
  • Claiming at 62: $1.8 million in lifetime benefits

That’s a $500,000 difference in favor of delaying!

Making Your Decision

Every Social Security claiming decision is unique. There’s no one-size-fits-all approach, and hundreds of different claiming scenarios exist based on your specific circumstances.

Don’t let emotions or pessimistic assumptions about the system drive your decision. While concerns about Social Security’s future are valid, making claiming decisions based on fear rather than analysis could cost you hundreds of thousands of dollars.

Your Social Security strategy should be coordinated with other aspects of your retirement plan, including:

  • Your investment portfolio strategy
  • Tax planning
  • Healthcare costs
  • Spousal considerations
  • Legacy goals

For high-net-worth individuals, the decision is particularly nuanced. While you may not “need” Social Security to survive, optimizing this benefit can significantly enhance your retirement security and legacy planning.

Next Steps

If you’re approaching retirement and wondering if you should delay Social Security, check out Episode 79 of The Planning for Retirement Podcast.

At Imagine Financial Security, we help individuals over 50 with at least a million dollars saved navigate these complex retirement decisions.

If you are looking to maximize your retirement spending, minimize your lifetime tax bill, and worry less about money, you can start with our Retirement Readiness Questionnaire linked on our website at www.imaginefinancialsecurity.com. Click the “Start Now” button to learn more about our process and how we might be able to help you achieve a more confident retirement.

Not quite ready to take the questionnaire, but want helpful tips and resources? Sign up for our monthly newsletter and/or subscribe to our YouTube channel.

This is for general education purposes only and should not be considered as tax, legal or investment advice.

9 Reasons to Consider Claiming Social Security Benefits Early

The conventional wisdom about Social Security has long been clear: delay claiming as long as possible to maximize your lifetime benefits. Financial calculators, planning tools, and many advisors default to this recommendation. But what if this one-size-fits-all approach isn’t actually the best strategy for you?

As a financial planner, I look beyond the standard advice to consider each client’s unique circumstances. While delaying until age 70 maximizes the monthly benefit amount, there are numerous scenarios where claiming earlier might better serve your financial and personal goals.

In this article, we’ll explore nine compelling reasons why you might want to claim Social Security benefits earlier than conventional wisdom suggests. Let’s start with some basics.

Understanding the 2025 Social Security Landscape

Before diving into claiming strategies, let’s review the current Social Security environment in 2025:

  • A 2.5% Cost-of-Living Adjustment (COLA) has been implemented
  • The average monthly retirement benefit has increased to $1,976
  • The earnings test threshold has been raised to $23,400
  • The worker-to-beneficiary ratio stands at 2.7 workers per beneficiary
  • Trust fund depletion is projected for 2033 without legislative changes

With these updates in mind, let’s examine when claiming Social Security early might make sense for you.

1. Limited Life Expectancy

Social security claiming age considerations should include health status and family longevity.

The default assumption in most financial planning tools is longevity. These tools often project to age 90, 95, or beyond. However, if your life expectancy is shorter due to health conditions or family history, claiming earlier often makes mathematical sense.

The breakeven point between claiming at 70 versus claiming earlier typically falls between ages 78 and 82. If your life expectancy doesn’t suggest you will reach that age, you may collect more total benefits by claiming earlier. This isn’t about being pessimistic—it’s about being realistic and maximizing the total benefit based on individual circumstances.

2. Immediate Cash Flow Needs

Deciding when to claim social security benefits should factor in immediate cash flow requirements. Simply put, some people need the income now. While creating a comprehensive retirement income plan is ideal, Social Security can provide a reliable income stream when you lack other liquid assets or don’t want to draw down your investment portfolios too quickly.

Social Security essentially functions as an annuity, providing a guaranteed income. If you are concerned about market volatility or need predictable income, starting benefits early can create financial stability and peace of mind.

3. The Start-Stop Strategy Advantage

Many clients are unaware that they can claim Social Security benefits early and then suspend them when they reach full retirement age (currently between 66 and 67). This “start-stop” approach allows you to:

  • Begin receiving benefits during an unexpected early retirement
  • Test the waters of retirement without fully committing
  • Suspend benefits if you return to work
  • Earn delayed retirement credits of 8% annually from suspension until age 70

This strategy provides flexibility if your work and retirement plans are in flux, allowing you to adapt your claiming strategy as your situation evolves.

4. Legacy Planning Considerations

If leaving a financial legacy is a priority for you, the analysis must go beyond just cumulative Social Security benefits. Many online calculators only consider the breakeven point of lifetime Social Security payments, missing a crucial factor: portfolio preservation.

Consider this scenario:

A client who delays Social Security until 70 might need to withdraw 8-9% annually from their portfolio during those delay years. Conversely, a client who claims at 65 might only need to withdraw 4-5% annually. The lower withdrawal rate gives the portfolio a better chance to grow, potentially preserving more wealth for heirs.

The proper analysis should examine not just when Social Security benefits break even, but when the investment portfolio recovers from the higher early withdrawals. In some cases, this portfolio preservation aspect often tilts the scales in favor of earlier claiming. 

5. Market Volatility Protection

Market conditions significantly influence the decision of when to claim Social Security benefits. Claiming early may provide stability during market downturns.

Imagine retiring during a bear market, such as 2008, 2020, or 2022. Your portfolio has already taken a hit, and now you need to start withdrawals.

If you’re delaying Social Security, you might need to withdraw 8% or more from a diminished portfolio, potentially causing permanent damage to your retirement sustainability. Claiming Social Security during market volatility can reduce pressure on the investment portfolio, allowing it time to recover.

This strategy can be particularly effective when combined with the start-stop approach mentioned earlier. Clients can claim benefits during market downturns, then suspend when markets recover and they reach full retirement age.

6. No Spousal Benefit Concerns

For married couples, it’s generally advisable to delay the higher earner’s benefit, especially if longevity is expected. This maximizes the survivor benefit, as the surviving spouse will receive the higher of the two benefits upon the death of their spouse.

However, if you have the lower benefit or are single, this consideration doesn’t apply. In these cases, claiming earlier might be more sensible, especially if other factors, such as portfolio preservation or immediate income needs, come into play.

7. Hedging Against Future Benefit Changes

Some people are worried about potential future cuts to Social Security benefits. The Social Security trust fund is projected to be depleted by 2034. At this point, only about 80% of projected benefits would be covered by ongoing payroll taxes if no changes are made.

Over 50% of retirees depend on Social Security for a significant portion of their income. This means that it’s highly unlikely the Social Security benefits program will be eliminated entirely. Likely solutions to the funding gap include increasing the Social Security wage base cap (currently around $176,000) or slightly raising the payroll tax rate.

Still, some people prefer to “get theirs” now, while benefit payouts are certain. This is more of an emotional reaction than a mathematical decision. However, if you are concerned about potential means testing or benefit reductions, claiming earlier can be a reasonable hedge.

8. Self-Investment Opportunity

Some financially savvy people prefer to claim Social Security benefits early and invest those payments themselves. This approach can make sense if you:

  • Have aggressive investment strategies
  • Are comfortable with market volatility
  • Have specific investment opportunities with potential for higher returns
  • Value liquidity and control over their assets

By claiming early and investing the proceeds, you build assets on your own balance sheet rather than waiting for potentially higher future payments. These self-directed investments can be passed on to heirs, unlike Social Security benefits, which generally terminate upon the death of the surviving spouse.

9. Unlocking Benefits for Dependents or Spouses

An often-overlooked reason to claim Social Security benefits earlier involves dependent or spousal benefits. Your spouse cannot claim spousal benefits until you claim your own benefit. This is particularly important if:

  • Your spouse has limited or no Social Security credits of their own
  • You have dependent children under 18 (or still in high school)
  • Your spouse is caring for dependent children

Dependent children can receive up to 50% of the primary amount (the benefit at full retirement age), but only once the primary earner claims their benefit. For clients with younger children or those in second marriages later in life, this consideration can be particularly significant.

Strategic Considerations for Couples

Social security break-even analysis should include portfolio effects, not just lifetime benefit totals. For married couples, coordinated claiming strategies are essential. Here are a few key approaches to consider:

  1. Lower-earner claims early, higher-earner delays: This provides immediate income while maximizing the eventual survivor benefit.
  2. Survivor benefit optimization: If one spouse passes away, the survivor can receive the higher of the two benefits. Delaying the higher earner’s benefit increases the survivor’s benefit.
  3. Spousal benefit coordination: A spouse can receive up to 50% of their partner’s primary insurance amount at full retirement age (less if claimed early).

Remember that the “file and suspend” and “restricted application” strategies were largely eliminated by the Bipartisan Budget Act of 2015, but coordinated claiming strategies remain valuable for married couples.

Key Factors:

Developing effective social security claiming strategies requires understanding your unique situation. When deciding whether to claim Social Security benefits early, consider these essential elements:

  1. Health status and family longevity: Be realistic about life expectancy based on health conditions and family history.
  2. Financial need: Assess immediate income requirements versus long-term maximization.
  3. Employment status: Consider whether continued work is likely or possible.
  4. Marital status: Evaluate spousal and survivor benefit implications.
  5. Other retirement resources: Analyze how portfolio withdrawals interact with Social Security timing.
  6. Market conditions: Factor in current and expected market performance.
  7. Legacy goals: Consider the impact on wealth transfer objectives.
  8. Risk tolerance: Assess comfort with market volatility versus guaranteed income.

The most important advice? Don’t analyze Social Security claiming in isolation. It must be evaluated within the context of a comprehensive retirement income plan that considers all aspects of your financial situation.

Personalized Strategies Win

The “right” Social Security claiming strategy isn’t universal—it’s personal. While delaying benefits works mathematically for those with longevity, many real-world factors can make earlier claiming the optimal choice for you. For a deeper dive into claiming Social Security benefits early, check out Episode 68 of The Planning for Retirement Podcast.

Are you approaching retirement and feeling overwhelmed by the decision of when to claim Social Security? You don’t have to navigate the Social Security landscape alone.

At Imagine Financial Security, we help individuals over 50 with at least a million dollars saved navigate these complex retirement decisions.

If you are looking to maximize your retirement spending, minimize your lifetime tax bill, and worry less about money, you can start with our Retirement Readiness Questionnaire linked on our website at www.imaginefinancialsecurity.com. Click the “Start Now” button to learn more about our process and how we might be able to help you achieve a more confident retirement.

Not quite ready to take the questionnaire, but want helpful tips and resources? Sign up for our monthly newsletter and/or subscribe to our YouTube channel.

This is for general education purposes only and should not be considered as tax, legal or investment advice.

What is a fiduciary financial advisor?

Just because a financial advisor is technically a fiduciary, does it mean they are automatically superior to other financial advisors? 

What is a fiduciary financial advisor in the first place?  

Are fiduciaries always fiduciaries?  

What are the limitations of a fiduciary financial advisor?  

How do fiduciary financial advisors charge?

Let’s unpack the jargon and dive into what really matters when hiring a financial professional to assist with your financial goals.    

So, what is the definition of a fiduciary financial advisor?

How about a definition from good ole’ ChatGPT?!  

“A fiduciary financial advisor is a financial professional who is legally and ethically obligated to act in the best interests of their clients. This means they are required to put their clients’ financial well-being ahead of their own profits or interests. The fiduciary duty is a higher standard of care than the suitability standard that some financial professionals adhere to.” – OpenAI

Overall, I’m okay with the definition!  I might add that a fiduciary financial advisor also has the responsibility of ensuring the recommendations continue to be in the client’s best interests.  Whereas the suitability standard only requires that the recommendation (or product) is “suitable” at the time of sale.

What happens when life changes?  Or the markets change?  Is your financial strategy still in your best interest?  

A fiduciary financial advisor/planner would be required to ensure this is the case on an ongoing basis, as long as you are working with that individual or team.

Are fiduciary financial advisors always fiduciaries?

fiduciary financial advisor always a fiduciary

Let’s first talk about how you will know if your financial advisor is a fiduciary.  

The easiest way is to review their client engagement contracts.  Here is a snippet from mine:

“IFS hereby accepts appointment and fiduciary duty of utmost good faith to act solely in the best interest of each Client pursuant to the terms and conditions set forth in this Agreement and to comply with impartial conduct standards.”  

It’s pretty cut and dry.  My firm is registered as an RIA, or Registered Investment Advisor.  RIA’s are always fiduciaries, period.  

However, some firms operate as a “hybrid.”  This means they act on behalf of an RIA and a broker/dealer.  This is where things become clear as mud.  

A broker/dealer is a firm that sells products like insurance, annuities, mutual funds, or other investment products.  These products pay commissions to the selling agent or broker.  In this arrangement, the agent or broker is not a fiduciary, but oftentimes they put themselves out to be a fiduciary.  

I’m not saying these products are all bad.  However, much of the abuse in the financial services industry comes from the broker/dealer model.  Have you heard the sales pitch for a life insurance policy with juiced-up cash value?  Or the annuity that has upside potential with downside protection?  In this model, your compensation is dependent on how much you sell, not on the quality of the advice you provide.  

Here’s another confusing issue.  The CFP Board (CERTIFIED FINANCIAL PLANNER), claims that CFPs act as fiduciaries.  However, CFPs are not required to work for a Registered Investment Advisor.  Many of them work for brokers or hybrid firms.  This means you could say you are a fiduciary because you hold the CFP marks, but you may only act as a fiduciary “sometimes.”  

 

Professional woman holding laptop and notebook

What are the limitations of a fiduciary financial advisor?

Here is the other side of the coin.  Because full-go fiduciaries don’t sell insurance and annuities, they often don’t understand how these products work.  After all, the model of RIA firms is to charge advice fees, whether it be a % of assets under management or a flat fee.  Herein lies the conflict of interest with the fiduciary financial advisor model!  

I was having a conversation with another fee-only financial advisor at a conference recently about permanent life insurance.  He was telling me about a case he’s dealing with where he recommended his client surrender a 10-year-old whole-life policy in exchange for term insurance.  If you listened to episode 26 of our podcast, you know there are 7 reasons to own permanent life insurance in retirement! 

I stayed curious and asked about the facts of the client.  It turns out, this is a business owner with a large estate and is only in his 40s!  There is a good chance he will be over the estate tax exemption by the time he passes away.  Thus, permanent life insurance could be a great tool to help his beneficiaries pay the federal estate taxes without having to go through a fire sale of his business.

The other advisor was like a deer in headlights.  

I don’t bring this up to poke fun at other advisors, I was very fortunate to have spent my first 12 years working for broker/dealer firms to get an understanding of how these products can fit.

However, many fee-only fiduciary financial advisors don’t have that luxury.  Many of them started in the fee-only space.  Or, they are career changers who were dissatisfied with the abuse from commission-based advisors and decided to become one themselves to make the industry better.

And believe me, the industry is in a much better place than it was when I first started in 2008!  

With that being said, many clients who work with fee-only, fiduciary financial advisors may not get the advice they need when it comes to purchasing life insurance, long-term care insurance, and/or annuity products.  And for the right client, these products are great fits!  

This is the exact reason I’ve created a service offering for those who are interested in a comprehensive financial planning process that removes biases regarding buying insurance and annuities!  

How do fiduciary financial advisors charge?

flat fee fiduciary financial advisor fee structures

To keep it simple for this post, fiduciary financial advisors can charge in three ways:

  1.  % of assets under management
  2. Flat fee 
  3. Hourly or project-based

The % of assets model is by far the most popular, as many of the larger RIA’s have been operating in this arrangement for decades.  Simply put, the fee is calculated based on the portfolio size.  

Flat fee advisors charge a monthly, quarterly or annual “subscription fee” based on complexity.  These fees can range anywhere from $1k – $25k per year.  This is a newer model that is gaining in popularity, particularly for folks who don’t have liquidity for the advisor to manage.  Perhaps they work in big tech and all of their assets are in company stock.  Or, perhaps they are a business owner or real estate investor who’s net worth is tied up in their illiquid assets.  This is a great model for those types of clients that have some unique circumstances and complexities.  

And finally, you have hourly or project-based advisors.  These advisors just give advice, they don’t touch your investment portfolio!  This is a very important distinction as this is a great opportunity for advisors to add value to people who otherwise wouldn’t be able to hire an advisor.  

Or, perhaps you are just getting started in your career and don’t have the asset size to hire a traditional “AUM” advisor.  

Final thoughts

There is a lot to digest here, but just know that there is no right or wrong fee model!  Furthermore, just because a financial advisor can say they are a fiduciary, doesn’t mean you should hire them!  

Here are a few tips for those planning for retirement and looking to hire an advisor:

  1.  Of course, make sure you hire a fiduciary who is always a fiduciary!
  2. Make sure they have professional designations!  The CFP is the general financial planning designation, but the RICP is the Retirement Income Certified Professional!  These individuals have deep knowledge of all things retirement planning.
  3. Decide what role you want to play in the relationship.  If you want to continue to DIY your investments, you could hire an advisor for a one-time engagement or hourly work.  If you don’t want to deal with the headache of managing investments and portfolio withdrawals, or you have more important things to spend your time on, I would suggest hiring a flat-fee financial advisor or even an “AUM” based advisor who can help with retirement planning and investment management!  
  4. Regardless of the “fee model,” make sure the advisor has experience serving others like you!  You can either ask for references, look at reviews on Google, or ask them to share their experiences working with your “client profile.”  
  5. Make sure the advisor communicates with how you like to receive communication!  if you want to see how the watch works, make sure the advisor is comfortable communicating with showing you their work.  If you want to stay high level, make sure that the advisor isn’t diving deep into spreadsheets every time you have a meeting.
  6. Get a feel for what questions they are asking you!  To truly do comprehensive planning, they should be asking about your relationship with money, your family history, your family background, relationships that are important in your life, worries that are keeping you up at night, etc.  (not just the financial statements).  
  7. And finally, if you fall into the camp of being a worrier with a very low-risk tolerance, you need to consult with a fiduciary who also deals with insurance and risk management! 

I hope this helps!  If it did, make sure to subscribe to my newsletter below where I put out all of the retirement planning content in one consolidated email (monthly-ish).  

If you are interested in learning more about how we can serve you, make sure to fill out our Retirement Readiness Questionnaire to get started.

Thanks for reading!

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How to self insure for long term care

The numbers don't add up...

These three statistics don’t add up to me!

1.  70% of Americans over 65 will need long-term care during their lives.

2.  Fewer than half of you over the age of 65 own insurance to pay for long-term care.  Essentially, you are planning to self-insure for long term care.

3.  This is the crazy part. 70% of the care being provided is done by unpaid caregivers!  Aka. family members…🤔

I wrote about long-term care planning before, but my convictions on this have only increased over the years.  

In my previous article, I talked about considerations on whether or not you should purchase insurance. 

We also just finished recording a three-part series on The Planning for Retirement Podcast (PFR) about how to fund long-term care costs.  Episodes 22 and 23 were about using long-term care insurance and episode 24 was about how to self fund long-term care. 

So why do these statistics bother me?

If the majority of retirees will need care, and they are intentionally not buying insurance, that means they plan to self fund for long term care (by default).  However, why are family members providing the majority of long term care and not hired help!?    

The answer:  because there was no real plan to begin with.  In reality, it was a decision that was never addressed, or perhaps in their mind they decided to “self fund.”  However, that decision was never communicated to their loved ones.  

Let me ask you.  If you are in the majority that plans to self fund, what conversations have you had with your spouse?  Your power(s) of attorney?  Your trustee(s)?  Do they know how much you’ve set aside if long term care was ever needed?  Do they know which accounts they should “tap into” to pay for long-term care?  

The chances are “no,” because I’ve never met a client who did this proactively on their own.  Ever.  And I’ve been doing this for 15 years.  

So, this article is for you if you are planning to bypass the insurance route and use your own assets to “self fund long-term care.”  I believe this is one of the most important decisions you can make when planning for retirement because it can save how you are remembered. 

How much should I set aside to self insure long term care?

how much to set aside to self fund long term care?

It is impossible to pinpoint the exact number YOU will need for care.  But let’s pretend your long-term care need will fall within the range of averages.  

On average, men need care 2.2 years and women 3.7 years.

The 2021 cost of care study by Genworth found that private room nursing homes cost $108,405/year.  Assisted living facilities cost $54,000/year.   These are national averages, and the cost of care varies drastically based on where you live.

So let’s use this ballpark figure of $118,800 – $238,491 for men, and $199,800 – $401,098 for women (2.2x the averages for men and 3.7x  the averages for women). 

The major flaw in using this math is that most people have some sort of guaranteed income flowing into their bank accounts.

  • Social Security Income
  • Pensions
  • Required Minimum Distributions 

Of course, not all of that income could be repurposed, especially if you are married.  However, perhaps 25%, 50% or 75% of that income could be repurposed for caregivers.

Let’s say you are bringing in $100k/year between Social Security, Pension, and Required Minimum Distributions.  Let’s say you are married, and all of a sudden need long term care.  For simplicity’s sake, your spouse needs $50k for the household expenses.  The other $50k could be repositioned to pay for long-term care.  After all, if you need care, you probably are not traveling any longer, or golfing 5 days/week.  This unused cash flow can now be dedicated to hiring professional help and protecting your spouse from mental and physical exhaustion.  

If we assume the high-end range for men of $238,491, but we assume that $110,000 could come from cash flow (2.2 years x $50k of income), then only $128,491 of your assets need to be earmarked to self fund long term care.

Hopefully, that’s a helpful framework and reassurance that trying to come up with the perfect number is virtually impossible.  After all, you may never need care.  Or, perhaps you will need care for 5+ years because of Alzheimer’s.  

My key point in this article is to address this challenge early (before you turn 60), and communicate your plan to your loved ones.  

What accounts are the best to self insure long term care?

which bucket to tap into

My personal favorite is the Health Savings Account, or HSA.  I wrote in detail about HSA’s in another blog post that you can read here.

Here’s a brief summary:

  • You can qualify to contribute to an HSA if you have a high-deductible health plan.
  • The contributions are “pre-tax.”
  • Earnings and growth are tax-free (you can invest the unused HSA funds like a 401k or other retirement plan).
  • Distributions can also be tax-free if they are used for “qualified healthcare costs.”

What is a qualified healthcare cost?

Look up IRS publication 502 here, which is updated annually.

One of the categories for qualified healthcare costs is in fact long-term care!  This means you can essentially have a triple tax-advantaged account that can be used to self insure long-term care in retirement.

However, you need to build this account up before you retire and go on Medicare.  Medicare is not a high-deductible health plan!

But, if you have 5+ years to open and fund an HSA, it can be a great bucket to use in your retirement years, particularly long-term care costs.  

The 2023 contribution limits are $7,750 if you are on a family plan and $3,850 if you are on a single plan.  There is also a $1k/year catch-up for those over 55.  

So, if you’re 55, you could add up to $43,750 in contributions for the next 5 years.  If you add growth/compounding interest on top of this, you are looking at 6 figures + by the time you need the funds for care in your 80s.  Not bad, right?  

Taxable brokerage accounts or "cash"

This bucket is another great option.  Mostly because of the flexibility and the tax advantages of taking distributions.  Unlike a 401k or IRA, these accounts have capital gains tax treatment.  For most taxpayers that would be 15%, which could be lower than your ordinary income tax rate (it could also be as low as 0% and as high as 20%+).

If you are earmarking some of these dollars for care, I would highly recommend two things:

  1.  Separate the dollars you intend to spend for care and give this new account a name (“long-term care account”)
  2. Invest the account assuming a time horizon for your 80s instead of your 60s.  In essence, you can make this account more aggressive in order to keep pace with the inflation rate for long term care expenses.

What’s nice about this bucket is that it’s not a “use it or lose it.”  Just because you segregated some assets to pay for care, doesn’t mean those dollars have to be used for care.  When these dollars pass on to the next generation, they should receive a step up in cost basis for your beneficiaries.  If the dollars are in fact needed for care, you will only pay taxes on the realized gains in the portfolio.   

🤔 Remember when we talked about tax loss harvesting in episode 19?  Well, this strategy could also apply to help reduce the tax impact if this account is used to self-insure long-term care.  

Of course, cash is cash.  No taxes are due when you withdraw money from a savings account or a CD.  Now, I wouldn’t suggest using a CD or cash to self-insure care, simply because it’s very likely that account won’t keep pace with inflation.  However, if there is some excess cash in the bank when you need care, this could be a good first line of defense before the more tax-advantaged accounts are tapped into.  

Traditional 401ks and IRAs

This bucket is often the largest account on the balance sheet when you are 55+.  However, many advisors and financial talking heads recommend against tapping these accounts to self insure long term care because of the tax burden.  

Well of course, it may not be ideal as a first line of defense to pay for care, but if it’s your only option, “it is what it is.”  

But here’s the thing.  If you are needing long term care, you’re most likely over the age of 80.  This means you are already taking Required Minimum Distributions or RMDs.  If you have a $1mm IRA, your RMD would be $62,500 at age 85.  Let’s say you also have Social Security paying you $24,000/year.  That’s a total income of $86,500 that is coming into the household to pay the bills.  This was my point earlier in that you likely have income coming in that can be repurposed from discretionary expenses to hiring some professional help for care.

This means that you may not need to increase portfolio withdrawals by a huge number if RMDs are already coming out automatically.  

But yes, you’ll have taxes due on these accounts based on your ordinary income rates.  And yes, if you increase withdrawals from this bucket, this could put you in a position where your tax brackets go up, or your Social Security income is taxed at a higher rate, or perhaps will have Medicare surcharges.  

On the flip side, this could also trigger the ability to itemize your deductions due to increased healthcare costs.  In fact, any healthcare costs (including long term care) that exceed 7.5% of your adjusted gross income could be counted as a tax deduction (as of 2023).  

The net effect essentially could be quite negligible as those additional portfolio withdrawals could be offset with tax deductions, where applicable.  

Life Insurance and Annuities

Maybe you bought a life insurance policy back in the day that you held onto.  Or you purchased an annuity to provide a guaranteed return or guaranteed income.  However, you may find that your goals and circumstances change throughout retirement.  Perhaps your kids are making a heck of a lot more money than you ever did, so they don’t have a big need for an inheritance.  Or, that annuity you purchased wasn’t really what you thought it was.  You could look at these accounts as potential vehicles to self-insure for long term care.

Life Insurance could have two components – a living benefit (cash value) and a death benefit.  In this case, you could use either or as the funding mechanism for long term care. 

Let’s say you have $150k in cash value and a $500k death benefit.  Instead of tapping into your retirement accounts or brokerage accounts, you could look at borrowing or surrendering your life insurance cash value to pay for care.  Or, you could look at the death benefit as a way to “replenish” assets that were used to pay for care. 

Annuities could be tapped into by turning the account into a life income, an income for a set period of time, or as a lump sum.  All of those options could be considered when it comes to raising cash for this type of emergency.

Roth Accounts

This is the second most tax-efficient retirement vehicle behind the HSA.  It’s not only a great retirement income tool, but it’s also a great tool to use for financial legacy given the tax-free nature from an estate planning perspective.  However, this account could be used to self insure long term care without triggering tax consequences.

Let’s say you need another $30k for the year to pay for care.  But an additional $30k withdrawal from your traditional 401k would bump you into the next tax bracket.  Instead, you could look to tap into the Roth accounts in order to keep your tax bracket level.  

Home equity

home equity line of credit and reverse mortgage strategy

The largest asset for most people in the US is their home equity.  However, people rarely think of this as a way to self insure long term care.  In fact, this is why many caregivers are family members!  They want their loved ones to stay at home instead of moving into a nursing home.  But perhaps there isn’t a huge nest egg to pay for care.  If you have home equity, you could tap into that asset via a reverse mortgage, a cash-out refinance, or a HELOC.  There are pros and cons of each of these, but the reverse mortgage (or HECM) is a great tool if you are over the age of 62 and need access to your equity.  

The payments come out tax-free, the loan doesn’t need to be repaid (unless the occupant moves, sells, or dies), and there are protections if the value of the home is underwater.

Inform your key decision makers

Now that you have a decent understanding of how much to set aside and which accounts might be viable for you, it’s time to have a family meeting.  

If you’re married, have a conversation with your spouse.

If you have children, bring them into the discussion, especially those that will have a key decision-making role (powers of attorney, trustee etc).

You know your family dynamic best.   The point you need to get across is that you do have a plan to self insure long term care despite not owning long term care insurance.  Your loved ones need to know how much they could tap into (especially the spouse) in the event you need care.  This is very important, give your spouse permission to spend!  Being a caregiver, especially a senior woman, will very likely result in burnout, stress, physical deterioration, mental exhaustion, and resentment.  If you simply leave it to your spouse to “figure out,” they will always resort to doing it themselves in fear of overspending on care. 

❌ Don’t do this to them!  

I hope you found this helpful!  Make sure to subscribe to our newsletter below so you don’t miss any of our retirement planning content!  Until next time, thanks for reading!

keep me up to speed

Q1 2023 Market Update

Despite two major US banks failing, coupled with central banks’ attempt to fight persistent inflation, the US and International markets experienced some positive momentum!

The Banking System

One of our recent articles was about the collapse of Silicon Valley Bank (SVB), the 2nd largest US bank failure in history.  This sent a ripple effect into the banking system, particularly a flight of deposits from smaller regional banks to big banks.  

JP Morgan posted a 52% jump in its first-quarter profits.

Wells Fargo topped analysts’ projections by 10 cents a share in Q1.

Citigroup also beat analysts’ estimates on revenue.  

In short, customers were worried that their bank might also fail following SVB and Signature’s collapse.  As I discussed in our previous post, which you can read here, SVB and Signature were heavily concentrated on client bases that had unique challenges in this economy (tech industry and crypto).

However, bank capitalization looks very healthy and has been on the uptrend since 2008 following the Global Financial Crisis.  This is one positive impact of tighter regulation on big banks following The Great Recession.

U.S. bank tier 1 capital ratio 1990–2022
Source: JP Morgan Asset Management

The real fallout

Despite big banks experiencing an inflow of deposits from smaller banks, they are still facing tighter lending standards and rapidly increasing interest rates.  They now have to pay us all higher yields in return for their money market or CD accounts.  Smaller and more regional banks, however, will face a reduction in deposits AND increased lending standards.  Regulators and board members are going to be watching like a hawk to ensure more banks don’t have the same risks that SVB and Signature Banks did.  

As banks tighten their lending standards, individuals and businesses are going to struggle to get loans.  Individuals who could previously afford that new or used vehicle might not qualify any longer.  Or, people shopping for their first home can’t afford the mortgages given the rapid uptick in rates.  

Businesses that rely on these smaller and regional banks for loans to keep their lights on or survive this challenging market will find it harder to get capital.

All of these ripple effects will contribute to a slowing economy.

But after all, this was the Fed’s goal ever since they announced their rate hike and quantitative tightening strategy back in 2021.  Their main objective was to fight inflation, and they needed to slow the economy in the short run to win the battle in the long run.

Speaking of inflation...

After setting 40-year highs in 2022, inflation is finally cooling a bit.   The peak was 8.9% in June, but we’ve seen a gradual decline ever since.  The March numbers were just released and showed a 5% year-over-year CPI figure.  The Fed’s target overall is 2%, so we are still a ways from that number.  Despite the trend going in the “right” direction, I don’t believe the Fed will get all the way to their 2% goal unless unemployment falls exponentially over the coming months.  The cooling inflation story is the primary reason the market has rallied since the start of 2023.  Inflation under check means the Feds might actually STOP raising interest rates very soon.  The market is pricing in one more 0.25% rate hike and then the expectation is rates will level off and eventually fall in 2024.  

The real question is, has the Fed done so much damage with its policy that they send the economy into a recession?  If this happens, they could even pivot to rate cuts as early as the end of 2023 or the beginning of 2024.  My hope is that they take a pause and let the economy settle itself out.  

Monthly CPI inflation heatmap table 2021–2023
Source: JP Morgan Asset Management

Unemployment and Wages

The unemployment story has been a big part of why inflation has been so sticky. 

We entered 2020 with a 3.5% unemployment rate, which was a 50-year low.  After topping over 10% unemployment (briefly) in 2020, the US now has a 3.6% rate.  Additionally, wage growth is at 5.3%, which is above the historical average of 4%.  So, if people are “working” and wages are still growing, it’s no wonder inflation has been so tough to fight.  People did not stop spending money in 2022 because of prices going up.  Sure, consumer discretionary categories took a hit, but the core goods and services were still being purchased at elevated prices.  This is a big reason I don’t believe prices are going to come down as much as the Feds want them to.  Why would corporations cut prices when their consumers have the wages to buy them?  

One of the chips likely to fall is the unemployment story in big tech firms.  Since 2018, Amazon and Meta (Facebook’s parent) have almost doubled their workforce.  During that same period, Microsoft increased its workforce by 53%, and Alphabet by 60%!  Meanwhile, Apple only grew its workforce at a moderate 20% rate.  

Remember the Paycheck Protection Program in 2020?  This was a federal loan to corporations to keep their employees on payroll during COVID.  All they had to do was use at least 60% of those loans to cover payroll and the “loan” was forgiven.  The word on the street is that big tech used their loans to go on massive hiring sprees.  Not because they NEEDED that many more workers, but to reduce the talent pool for their competitors and have their PPP loans forgiven!  Now that the economy is slowing, we’re seeing big tech begin layoffs.  Coincidently, Apple hasn’t laid anyone off just yet.  

Look at this headline from a Fortune article:

‘Penned’ tech specialists are earning six-figure salaries to ‘do nothing’ and string out 10-minute tasks. Some are even using the time to scuba dive

Some of the highest unemployment numbers by industry are:

  1. Farming – 7.4%
  2. Mining, quarrying, oil and gas extraction – 6.5%
  3. Construction – 5.6%
  4. Leisure and Hospitality – 5%
  5. Transportation and utilities – 4.6%

Meanwhile, big tech unemployment is only at 2.6%, up from 1.5% to start the year.  All of the remote workers that migrated out of the big cities during the pandemic are now experiencing some layoff concerns, and it will be very interesting to follow that narrative as big tech continues to cut their unnecessarily large workforces.  

Returns by asset class, YTD

As you can see year to date, all of the major asset classes are positive.  International, developed economies are in the top spot, with US Large Cap a close second.  What’s very encouraging is that the fixed-income markets are now showing positive returns after a rough 2022.  

During the re-balancing process for our clients at the beginning of 2023, the only asset classes we added exposure to were Large Cap Growth companies (big tech) and international equities.  This isn’t to pump our chest to say “I told you so.”  However, part of our process is to sell the winners and buy the losers.  Big tech was the worst-performing asset class in 2022, and stock performance is a leading indicator.  What I mean is, the layoffs and bad news for big tech this year were already priced into the market in 2022 (at least we hope so).  We talked a lot about interest rate increases during 2021 and 2022 and how it would impact tech companies.  After the brutal selloff in 2022, valuations looked much more attractive going into 2023…hence, buying the loser.  So far year to date it’s paid off well, but that’s not to say there isn’t more volatility ahead for big tech with the challenging interest rate environment they face.  

The same can be said about international equities as they had a rough go in 2022 but are very well positioned from a valuation perspective for the decade ahead.  International stocks tend to do well during periods of high inflation, like in the 70s and 80s.  However, geopolitical concerns with Russia/Ukraine and China still make international stocks much more volatile.  

Callan periodic table of investment returns

Final thoughts

Attempting to time the market is very dangerous.  If you look back at the past year, consumer sentiment has been at record lows.  People have not been feeling good about the economy.  This feeling oftentimes leads to investors flighting to safety.  How many articles have you seen about I-Bonds or CD Rates over the last 12-18 months?  Well, stock market returns typically accelerate very quickly after a recovery.  In fact, more than 50% of the best daily S&P 500 returns occur during a bear market.  So if you bailed out during 2022, you did not get the benefit of a strong Q1 in 2023!  

While we are going to be experiencing a tighter economy for the foreseeable future with higher rates, there is now hope with the inflation story beginning to unfold.  Let’s hope the market is correct in that the Fed will only increase rates one last time at 0.25% and be finished.  The unemployment and wage growth figures will be key to watch over the coming months as that will dictate how quickly inflation comes down in late 2023.  

If you are curious about how the market has impacted your financial goals, we’d love to hear from you!  You can either send me an email at kevin@imaginefinancialsecurity.com or book a Zoom call with us.  

Until next time, thanks for reading!

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Benefits of Working with an Independent Financial Advisor

Thinking about your financial future can be mind-numbing, let alone searching for a financial advisor who can help you.  Why are there so many different titles?  Do they all do the same thing?  Is a financial advisor a fiduciary?  Are they ALWAYS a fiduciary?  Finally, what differentiates advisors who work for large companies vs independent firms?  In this blog post, we will  unpack and answer those questions for you, and help you understand the benefits of working with an independent financial advisor.

Quick Disclosure

I spent the first 12 years of my career as a financial advisor for a large broker-dealer and a large bank.  In 2020, I made the decision to go independent for all of the reasons I will talk about below and I haven’t looked back.  So YES, I am extremely biased in my belief that the independent financial advisor avenue is where clients are provided the best service!

Let’s start with a general lay of the land. 

The Wall Street Crash in the autumn of 1929 led to an increase in regulation of the financial industry.  As a result, Theodore Roosevelt officially signed the The Glass-Steagall Act of 1933, creating a clear division between different types of financial services companies.  Simply put, insurance companies were then designed to sell insurance and banks were either investment banks or commercial banks.  Wall Street Firms/Broker-Dealers sold securities. 

Decades later, The Financial Services Modernization Act of 1999 was passed, and this law deregulated the financial services industry and essentially allowed everyone to play in each other’s sandbox.  Insurance companies could now sell securities, banks could sell both insurance and investments, and brokers could now sell insurance products and act as a bank. 

This led to a drastic shift in the financial advisor’s role.  In the 1980’s, an insurance agent would just sell insurance.  Over time the role of an insurance agent evolved, and now new hires at insurance companies are being licensed not just to sell insurance, but to sell variable products like annuities and mutual funds and even manage client assets as an investment advisor. 

In the banking world, you have representatives who help customers with deposits, but they also have licensed insurance agents and investment advisors on staff.  Have you ever gotten a call from your existing bank about a “wealth management” offering?  If you keep a meaningful amount of cash in the bank, the goal for the wealth management team is to convince those banking clients to also purchase both insurance and investment products. 

And finally, the wall street folks.  These large brokers and investment banks can now sell annuities, life insurance, long-term care insurance etc.  

My initial take on this...

I’m very keen on the idea of looking at everyone’s situation comprehensively.  As a Certified Financial Planner, I believe we need to ensure all assets on the balance sheet are coordinated and risk is managed properly.

The biggest challenge I see, however, is that the big firms aren’t truly looking at it that way.  Their main goal is to increase and diversify revenue for their stakeholders.  I’ll say it again, their main goal is to increase and diversify revenue for their stakeholders.  Not for you.  Not for your family.  But for THEIR balance sheets.  

When it comes down to working with a financial advisor, there are some phenomenal advisors that work for large firms.  The challenge is they all have their own metrics and minimums they must achieve in order to be successful and reap the rewards.  So whether consciously or subconsciously, the consumer is always left thinking, “Is this recommendation 100% in my best interest?”

This is at the core of WHY I decided to leave a big firm and launch an independent firm.  Rather than having people wonder if the recommendations are aligned with their best interests, why not simply cut out the conflicts of interest???

Let’s get into some of the reasons why working with an independent financial advisor could benefit you.

Fiduciary Standards

fiduciary independent financial advisor

It is much more difficult to abide by a true fiduciary standard when you are acting as a fiduciary some of the time.  Oftentimes advisors who are working for insurance companies or big banks might have incentives to recommend certain products.  These products often follow the less arduous standard of “suitability,” and not a fiduciary standard.  This means the product just has to be suitable at the time the recommendation is made.  This can often lead to conflicts of interest in working with clients. 

Kyle Newell, Owner and Financial Planner of Newell Wealth Management based in Orlando, Florida said this reason was a big motivator to go independent. 

“My main driver in going completely independent, is the freedom to make decisions solely for the benefit of my client.  No production/sales goals to hit, no shareholders to make happy, or managers to make look good to the higher-ups,” said Kyle. 

When you hire an independent financial advisor, they are working for YOU, not their employer!  Isn’t it nice to be sitting at the SAME side of the table as your advisor when discussing your financial future?

The Ability to Customize

customize retirement plan

At most big firms, the investment models are pre-packaged for clients.  The advisor might do some sort of risk questionnaire, and anyone who has the same risk score will have identical portfolios. 

But what about personalization?  What about taxes?  What about the time horizon of different accounts?  What about different financial objectives? 

As an independent firm, we utilize cutting-edge research and analysis but we’re able to implement it in a way that is customized to each individual family. 

I’ll give you an example.

By late 2021, we knew interest rates were going to begin to spike in 2022 (because the Fed told us so).  We had used primarily bond mutual funds and ETFs up to that point as interest rates were historically low over a decade.

At the beginning of 2022, we began to transition out of the traditional mutual funds and ETFs for some of our clients and implement their own customized individual bond portfolios.  Additionally, we used hedging strategies within the fixed-income space to protect against the rise of rate hikes.  This helped save tens and even hundreds of thousands of dollars for clients over the past year.  

This would have been virtually impossible working at a big, institutionalized firm. 

The ability to be nimble and pivot during uncertain times is invaluable over the life of a client relationship.

Innovative Technology

One of the biggest challenges as an advisor working for a large firm is adopting and adapting to new technology.  Oftentimes these big enterprises have technology embedded in their systems that are years or even decades old.  If they had to change their technology, it could take years to integrate properly.  Imagine the impact of making a change that affects one million or two million customers! 

Many independent firms serve fewer than 250 households making new integrations much more palatable. 

“The independent advisor space has advanced significantly in technology and breadth of services available,” says Newell.

Our firm utilizes two financial planning tools to help address the needs of our pre-retirees and retirees.  RightCapital allows us to model cash flows and changes in a retirement scenario using Monte Carlo analysis.    

We also use Income Lab to help manage withdrawal rates for clients throughout retirement.  Additionally, if there is a need to make an adjustment, Income Lab is there to ensure those are made in a timely fashion. 

Furthermore, these tools allow us to model Roth conversions to identify tax planning opportunities. 

This has been a game changer to add further value to the families we serve.  

Tax Planning

Tax planning versus tax preparation graphic

Speaking of Roth conversions, now we are getting to the heart of retirement planning challenges…TAX PLANNING!  Once you crossover a certain asset threshold, let’s say $1mm of investment assets, taxes in retirement become a big deal.  Social Security taxes, Medicare surcharges, tax bracket management, Required Minimum Distributions, and finally, death taxes.  The value of maneuvering through all of these hurdles successfully in retirement is worth far more than how the investments are performing relative to their benchmarks.

Every movement of money has a tax consequence.  So, wouldn’t it be nice to know what those tax consequences are before the money is moved??? 

Does your advisor have a copy of your most recently filed tax return?  If the answer is “no,” then how in the world are they able to know what the impact of money movement is on your tax situation?  

The more money you can save on taxes in retirement, the more you will have to travel or gift to your grandkids!  Win-win!

Specialization

niche, specialist

If you look at the client roster of a traditional financial advisor working at a bank or broker, you will find the demographics vary widely.  There might be a 25-year-old just getting started with their investing career all the way to a 65-year-old preparing to retire.  This might seem great on the surface as that advisor can serve multiple demographics.  However, how specialized is that advisor in working with people just like YOU?  Many independent firms specialize in working with a specific age demographic, occupation, or even serving those with certain political beliefs!  This specialized expertise allows for a deeper understanding of the client’s needs and ultimately adds more value to the relationship.

Think of a general practitioner vs. a specialist.  If you need heart surgery, you’re probably not going to see your family doctor.

It's all about the relationship

I know we’ve talked about some of the value adds and financial benefits of hiring an independent financial advisor.  But at the end of the day, the relationships and families we serve are at the forefront of why we do what we do.  

I was talking to a friend who works at a larger firm and he complains annually about how much his annual goal has increased.

And don’t get me wrong, I have business and personal goals myself.  Any motivated individual has goals.  However, when the goals get in the way of serving your clients, that’s a problem.  And that is at the core of why independence is so important to me and many others who continue to break away from big firms.  

When I review the list of families I serve, I get excited.  Helping people plan for retirement is extremely rewarding.  But furthermore, I love to help people reduce fear and start living their BEST years with the gift of time!  Who wants to sit around and play with their investment portfolio (and likely screw it up), or try to find tax planning opportunities rather than pursue their passions!?  Or spend more time with their families?  Retirement is not the end, it’s the beginning of financial freedom!  So enjoy it!

In Summary

Simply put, the independent advisor movement is growing in popularity. According to Fidelity’s 2020 Advisor Movement Study, 2/3 of all advisors who left employee financial advisor arrangements in the last 5 years left for independence.  And the trend is only accelerating.

Third-party organizations like XY Planning Network, NAPFA, Fee-Only Network, and Wealthtender all offer “find an advisor” search tools to help you narrow down what you’re looking for. 

Our firm focuses on working with individuals and couples who are over 55 and have accumulated at least $1mm for retirement (or will have accumulated at least $1mm when they do retire).   If you are curious about how we can help you, feel free to book an initial 30-minute “Mutual Fit” meeting so we can get to know one another.  Also, make sure to subscribe to our blog so you never miss out on our latest posts!

Until next time. 

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

Easy money policy beginning in 2009 led to a historical run in tech companies.  Companies that rely on leverage to aggressively grow were borrowing money for next to nothing!  Investors weren’t even concerned with cash flows, or healthy balance sheets.  If the idea seemed like it could stick, they would take their bets.  Some paid off, and some flopped.  But the overall sentiment was “risk-on.”

These policies led to the success of Silicon Valley Bank, or SVB.  Out of all of the start-ups in the US, SVB provides banking services to nearly half of them.  Whether it was providing them loans or deposits, they were the go-to Bank for start-ups. 

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

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

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

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

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

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

So how did they raise cash to give to their depositors?  

They had to sell their bonds…

What happens to bond prices when interest rates rise?

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

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

Why didn’t SVB hedge interest rate risk?

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

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

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

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

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

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

lessons to learn from svb failure

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

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

Lesson #1: Diversification

diversification

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

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

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

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

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

match your retirement cash flows with time horizon

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

  1. Known expenses
  2. Unknown expenses

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

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

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

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

Lesson #3: Have a contingency plan

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

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

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

  1. Home Equity Line of Credit
  2. Life Insurance Cash Values

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

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

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

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

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

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

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

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

What does this mean for the markets?

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

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

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

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

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

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

1. Are you overweight in speculative investments?

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

2.  What does your bond portfolio consist of?

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

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

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

4.  Where do you bank?

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

5.  Don’t be reactive, be proactive.

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

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

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

Until next time, thanks for reading.

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Sources

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

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

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

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

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

What are the rules for Required Minimum Distributions?

Congratulations!  Lots of blood, sweat, and tears went into a successful career, and you have saved enough to start thinking about when to retire.  If you’ve been saving into a 401k, 403b, or another retirement plan through work, you’ve probably heard of  Required Minimum Distributions or “RMDs.”  You might be wondering;

“What are the rules for required minimum distributions?” 

“How do RMDs impact my taxes? 

Or, “What can I do now to prepare for RMDs?”  

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

What are RMDs and when do they start?

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

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

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

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

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

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

Changes to required minimum distributions from secure act 2.0

How are RMDs calculated?

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

Example:

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

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

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

Uniform lifetime table showing ages and factors

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

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

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

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

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

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

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

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

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

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

Are there RMDs on my current employer plan?

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

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

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

Can I aggregate my RMDs into one plan?

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

My favorite answer is, “it depends.”

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

 

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

IRA RMD #1:  $10,000

IRA RMD #2:  $25,000

Total IRA RMD = $35,000

 

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

 

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

IRA RMD #1:  $10,000

401k RMD #2:  $20,000

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

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

stretch IRA elimination

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

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

Let’s look at an example: 

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

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

What is the 10-year rule?

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

Everyone else will follow the 10-year rule.

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

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

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

Spreadsheet comparing stretch-IRA vs 10-year distributions

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

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

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

Why would I want to pay more taxes now?

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

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

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

Consider taking advantage of "Qualified Charitable Distributions" or QCDs

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

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

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

Bill’s RMD for 2023 is $50,000. 

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

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

Action Items

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

Here are some action items and questions to consider:

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

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

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

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

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

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

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

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

Until next time, thanks for reading!

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Using the Guardrail Withdrawal Strategy to Increase Retirement Income

What is a safe withdrawal rate for retirement?

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

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

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

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

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

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

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

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

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

Let’s dive in!

The 4% rule

what is the 4% rule

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

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

The Findings

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

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

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

The downsides of using the 4% rule in practice

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

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

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

What about the mix of stocks and bonds?

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

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

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

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

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

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

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

What about the impact of tax planning?

tax planning season

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

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

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

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

Do retirees' expenses increase with inflation?

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

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

  1. Go-go years
  2. Slow-go years
  3. No-go years

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

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

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

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

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

Social Security and other income sources aren't counted

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

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

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

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

What is the Guardrail Withdrawal Strategy?

Curved train tracks with 20% adjustment overlays

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

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

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

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

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

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

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

Key factors to consider when implementing the guardrail withdrawal strategy

Risk tolerance

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

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

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

risk tolerance

What is the desire to leave a financial legacy?

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

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

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

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

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

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

Key takeaways and final word

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

Here are some key takeaways:

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

We hope you enjoyed this article!

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

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

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

Thanks for reading!

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