flat fee financial planner Archives

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?

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.”

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?

I dedicated an entire blog post to fees, and if you’re interested in diving deep, check out my article here.

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

% of assets under management (typically 1% – 1.5%/year of your investment portfolio)
Flat fee
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. But, there are inherent challenges to this model for my practice. First and foremost, many of my clients are in spending mode during retirement! They want honest opinions when it comes to paying off a mortgage, gifting to charity or maximizing their spending in retirement! I’ve heard some horror stories about AUM %-based advisors fighting clients to withdraw funds from other accounts instead of the ones they are managing. This is a big reason retirees are seeking flat-fee financial planners/advisors.

Additionally, as someone’s net worth grows, the complexity of their financial situation doesn’t necessarily grow in lockstep like the % of assets model would suggest. With the % of assets model, the larger the portfolio, the larger the fee.

For flat-fee financial advisors, oftentimes the fee is based on complexity, which isn’t solely predicated on how much of your investment portfolio is managed with that firm.

Furthermore, what if you want to purchase a rental property with some of your funds, or pay off your mortgage? Do you think you will get an unbiased viewpoint if your advisor’s fee goes down because of a large withdrawal from the portfolio?

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.

Perhaps you are a business owner with all of your net worth tied up in your business.

Or, perhaps most of your funds are in a 401k plan at work.

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

Our firm also has a one-time engagement model where we can add a ton of value to someone who otherwise wouldn’t be able to receive customized advice. Oftentimes these clients turn out to be long-term ongoing relationships, but at least we can establish a solid foundation when they need it the most.

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:

Of course, make sure you hire a fiduciary who is always a fiduciary!
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.
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!
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.”
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.
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).
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).

Follow me on Instagram @imaginefinancialsecurity if you are a high-income Millennial or Gen X looking to achieve financial independence early!

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If you are interested in learning more about how we can serve you, make sure to take our complimentary “Retirement Readiness Analysis” and we’ll reach out with our initial thoughts on how well you’re tracking towards your goal of financial independence. The cool thing is, you don’t need to share ANY financial statements or personally identifiable information to participate!

Thanks for reading!

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Kevin Lao

October 18, 2023

How to Reduce Taxes on Your Social Security Retirement Benefits

If you have already begun drawing Social Security, you might be surprised to learn taxes are owed on some of your benefits! After all, you’ve been paying into the system via payroll taxes, so why is your benefit also taxable? If you have yet to begin drawing Social Security yet, you can never say you weren’t told! As a result, I’m often asked if there is a way to reduce taxes on your Social Security benefits. This blog post will unpack how Social Security taxes work and how to reduce taxes on your benefits. Make sure to join our newsletter so you don’t miss out on any of our retirement planning content (click here to subscribe!). I hope you find this article helpful!

A brief history of Social Security

The Social Security Act was signed into law by President Roosevelt in 1935! It was designed to pay retired workers over the age of 65. However, life expectancy at birth was 58 for men and 62 for women! Needless to say, there weren’t a huge number of retirees collecting benefits for very long. As people began to live longer, several key provisions were added later. One was increasing the benefits paid by inflation, also known as Cost of Living Adjustments (COLA). Another was changing the benefits from a lump sum to monthly payments. Ida Fuller was the first to receive a monthly benefit, and her first check was $22.54! If you adjust this for inflation, that payment would be worth $420.15 today! If you compare this to the average Social Security benefit paid to retirees of $1,782/month, those early payments were chump change!

The Aging Population has Led to Challenges

According to data from 2021, life expectancy at birth is 73.5 years for men and 79.3 years for women! In 2008, there were 39 million Americans over age 65. By 2031, that number is projected to reach 75 million people! We’ve all heard of the notion that older (more expensive) workers are being replaced by younger (less expensive) workers. While taxable wages are going down and retirees collecting benefits are increasing, the result is a strain on the system.

Social Security benefits are actually funded by taxpayer dollars (of course). If you look at a paystub, you will see FICA taxes withheld automatically. FICA stands for Federal Insurance Contributions Act and is the tax revenue to pay for Social Security and Medicare Part A. The Social Security portion is 6.2% for the employee and 6.2% for the employer, up to a maximum wage base of $160,200. So, once you earn above $160,200 you likely will notice a “pay raise” by way of not paying into Social Security any longer. Medicare is 1.45% up to $200,000, and then an additional 0.9% for wages above $200k (single filer) or $250k (married filing jointly).

Up until 2021, FICA taxes have fully covered Social Security and Medicare benefits. However, because of the challenges mentioned earlier, FICA taxes no longer cover the benefits paid out. The good news is there is a Trust Fund for both Social Security and Medicare for this exact reason. If there is a shortfall, the trust fund covers the gap. The big challenge is if nothing changes, Social Security’s trust fund will be exhausted in 2034 and Medicare’s in 2031.

How are the taxes on Social Security calculated?

The first concept to understand is that the % of your Social Security that will be taxable is based on your “combined income,” also known as provisional income. If your combined income is below a certain threshold, your entire Social Security check will be tax-free! If your combined income is between a certain threshold, up to 50% of your Social Security benefit will be taxable. And finally, if your income is above the final threshold, up to 85% of your Social Security benefit will be taxable. Here are the thresholds below.

How is “Combined Income” calculated?

The basic formula is to take your Adjusted Gross Income (NOT including Social Security), add any tax-exempt interest income, and then add in 50% of your Social Security benefits.

If you are retired, you likely will have little to no earned income, unless you are working part-time. Your adjusted gross income will be any interest income, capital gains (or losses), retirement account distributions, pensions, etc. This is important to note because not all retirement account distributions are treated the same! Additionally, capital gains can be offset by capital losses. So even though your cash flow might exceed these numbers significantly, you still might be able to reduce or even eliminate how much tax you pay on your Social Security Income.

Let’s look at two examples (both are Married Filing Jointly)

Client A has the following cash flows:

$40,000 of Social Security benefits
$50,000 Traditional IRA distribution (all taxable)
$10,000 of tax-free municipal interest income

The combined income in this scenario is $80,000.

Half of Social Security ($20,000) + $50,000 IRA distribution + $10,000 municipal bond income = $80k.

Notice how the municipal bond income is added back into the calculation! Many clients try to reduce taxes on their bond interest payments by investing in municipal bonds. However, it’s important to note how this interest income might impact other areas of tax planning.

In this scenario, 85% of their Social Security benefit will be taxable.

The first $32,000 of income doesn’t trigger any Social Security taxes.

The next $12,000 will include 50% ($6,000)

And finally, the amount over $44,000 ($36,000) includes 85% (85% * $36,000 = $30,600).

$6,000 + $30,600 = $36,600

If you divide $36,600 by the $40,000 Social Security benefit, it gives you 91.5%. However, a maximum of up to 85% of the Social Security benefit is taxable, so in this case, they are capped at 85% and $34,000 will be their “taxable Social Security” amount.

Client B has the following cash flows:

$40,000 Social Security Income
$50,000 Roth IRA distribution
$4,000 Interest Income

Client B’s provisional income is only $24,000!

Half of Social Security ($20k) + $0 retirement account distributions + $4,000 interest income = $24,000

As you can see, the Social Security benefits are identical to client A. However, the $50,000 retirement account distribution is from a Roth account, and in this case, it was a tax-free distribution. And finally, the interest income was way down because the client elected to reduce their bond allocations in their taxable account and instead owned them inside of their IRAs (which is not taxable).

So despite having essentially identical cash flows, Client B enjoys 100% of their Social Security check being tax-free! In other words, they have reduced their taxable income by $34,000 compared to client A!

A huge challenge arises for clients who are under the max 85% threshold. Each dollar that is added to their retirement income will increase how much Social Security is taxed! If someone is in the 50% range and they take an additional $1,000 from a Traditional IRA, they will technically increase their adjusted gross income by $1,500! $1,000 for the IRA distribution and $500 for taxable Social Security income!

What can you do about reducing taxes on Social Security?

So while you shouldn’t let the tail wag the dog, you should absolutely begin mapping out how you can make your retirement income plan as tax efficient as possible! Here are a few ways to reduce your “combined income” and thus reduce your taxes on Social Security payments.

Roth Conversions

Simply put, a Roth conversion allows you to “convert” all or a portion of your traditional IRA/401k/403b to a Roth account. Of course, you will have to pay taxes on the amount converted, but all of the growth and earnings can now be tax-free!

This is perhaps one of the most impactful strategies you can incorporate! However, you must start this strategy at the right time! If you are still employed and perhaps at the peak of your earnings, you may not benefit from Roth conversions…yet. However, if you recently retired and have yet to begin the Required Minimum Distributions (RMDs), you might find it to be a valuable strategy if you execute it properly.

One of our most recent podcast episodes is about this topic; you can listen to it here.

Avoid the RMD Trap!

The RMD trap is simply the tax trap that most people with Traditional IRAs or 401ks run into. In the early years of retirement, your RMD starts out quite low because it’s based on your life expectancy according to the IRS. However, each year the amount you are required to withdraw increases. By the time you are in your 80s and even 90s, the amount you are taking out could exceed what you need for cash flows! But despite needing it for income or not, you have to withdraw it to avoid the dreaded penalties, and this could push you into higher tax brackets later in retirement. And of course, this could also increase the taxation of your Social Security check!

Roth conversions help with this, but it could also help to try to even out the distributions! Instead of just waiting for the RMDs to balloon, perhaps you devise a better withdrawal strategy to target a certain tax bracket threshold throughout your retirement.

Asset Location strategies

You may have heard of the term “Asset Allocation,” which involves careful selection of asset classes that align with a portfolio’s objectives. In essence, what % of stocks, bonds, real estate, and cash does the portfolio hold? Asset Location involves selecting which accounts will own those asset classes in order to maximize tax efficiency and time horizon.

When we looked at the Social Security examples earlier, you probably noticed Client B had less taxable interest income. This is because they elected to reduce the amount of fixed income in their “taxable” account, and moved those assets into their IRAs.

Alternatively, you might have a longer time horizon with some of your accounts, like a Roth IRA. Given Roth’s tax-free nature and the NO RMDs, this account is a great “long-term” bucket for retirement income planning. As a result, you might elect to have this account ultra-aggressive and not worry much about capital gains exposure, etc.

You should take advantage of the tax characteristics of different “buckets” for retirement income planning. Not all of your investment accounts should look identical in that sense.

Tax Loss Harvesting

Perhaps one of the most UNDERRATED strategies is tax loss harvesting. Oftentimes when the market is down, people bury their heads in the sand hoping that things will improve one day. And this is certainly better than selling out and moving to cash! However, there is one step many people miss: realizing losses when the markets are down. These losses can then be used to offset capital gains, and even reduce your ordinary income!

I oftentimes hear pushback that people don’t want to offload investments at a loss because they were trained to “buy low and sell high.” This is a great point, but with tax loss harvesting, after the loss is realized, you then turn around and replace the investment you sold with something similar, but not “substantially identical.” That way, you avoid the Wash-Sale rule so you can recognize the tax loss, but you stay invested by reallocating funds into the market.

Episode 19 of The Planning for Retirement Podcast is all about this topic and you can listen to it here!

Qualified Charitable Distributions

Okay, so you missed the boat on Roth conversions, and you are already taking RMDs from your accounts. Qualified Charitable Distributions, or QCDs, allow for up to $100,000/year to be donated to charity (qualified 501c3) without recognizing any taxable income to the owner! Of course, the charity also receives the donation tax-free, so it’s a win-win! I oftentimes hear of clients donating to charity, but they are itemizing their deductions. Almost 90% of taxpayers are itemizing because of the Tax Cuts and Jobs Act of 2017. QCDs can be utilized regardless if you are taking the standard deduction or not! And the most powerful aspect of the QCD is that it will reduce your RMD dollar for dollar up to $100k.

Let’s say your RMD for 2023 is $50k. You typically donate $10k/year to your church but you write a check or donate cash. At the end of most tax years, you end up taking the standard deduction anyways, so donating to charity doesn’t hurt or help you.

Now that you’ve learned what a QCD is, you go to the custodian of your IRA and tell them you want to set up a QCD for your church. You fill out a QCD form, and $10k will come out of your IRA directly to your Church (or whatever charities you donate to). Now, your RMD is only $40k for 2023 instead of $50k! In essence, it’s better than a tax deduction because it was never recognized as income in the first place!

Two important footnotes are the QCD has to come from an IRA and the owner must be at least 70.5 years old! It cannot come out of a 401k or any other qualified plan!

We wrote an entire article on QCDs (and DAFs) that you can read here.

Final Thoughts

Retirement Planning is so much more than simply what is your investment asset allocation. Each account you own has different tax characteristics, and the movement of money within or between those accounts also has tax consequences. Instead of winging it, you could save tens or even hundreds of thousands of dollars in taxes in retirement if you are proactive. However, the tax code is constantly changing! In fact, the Tax Cuts and Jobs Act of 2017 is expiring after 2025, so unless something changes, tax rates are going up for most taxpayers. Additionally, the markets are beginning to recover, so strategies like tax loss harvesting or Roth conversions become less impactful. But, there is still plenty of time and opportunity!

Thanks for reading and I hope you learned something valuable. Make sure to SUBSCRIBE to our newsletter to receive updates on me personally, professionally, and of course, content to help you achieve financial independence! CLICK on the “keep me up to speed” button below.

-Kevin

Kevin Lao

June 16, 2023

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

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

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.

Independent Financial Advisors Have Modern Fee Schedules!

Have you heard of the financial advisor who babysits client assets for a management fee and does NO financial planning? (I’VE HEARD A FEW STORIES!)

Consumers are getting smart and are tired of overpaying for financial advice that doesn’t deliver. Many people are learning about different models like “advice only,” “flat fee financial advisor,” or “one-time engagements.” Most of the big firms charge the traditional methods of either commission-based compensation or a percentage of assets under management. But more importantly, they don’t require any financial planning for that fee!

Jeff McDermott is the owner of Create Wealth Financial Planning, an independent firm based in St Johns, FL serving young families and professionals. He had this to say about the fee models of independent advisors;

“A client who doesn’t fit the traditional advisor mold because they don’t yet have substantial investment assets, are looking for planning to address specific needs, or possibly hourly or one-time project planning might be more likely to find a good fit in the independent financial advisor world.”

My firm, Imagine Financial Security, serves retirees and pre-retirees for a flat fee. Our firm also provides one-time financial plans to ensure clients are on track.

It’s fun to be able to serve people in different ways that are innovative and ultimately better for the client.

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

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

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.

Kevin Lao

April 5, 2023

What are the rules for Required Minimum Distributions?

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

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

What are RMDs and when do they start?

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

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

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

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

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

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

How are RMDs calculated?

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

Example:

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

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

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

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

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

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

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

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

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

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

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

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

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

Are there RMDs on my current employer plan?

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

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

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

Can I aggregate my RMDs into one plan?

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

My favorite answer is, “it depends.”

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

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

IRA RMD #1: $10,000

IRA RMD #2: $25,000

Total IRA RMD = $35,000

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

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

IRA RMD #1: $10,000

401k RMD #2: $20,000

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

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

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

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

Let’s look at an example:

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

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

What is the 10-year rule?

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

Everyone else will follow the 10-year rule.

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

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

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

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

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

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

Why would I want to pay more taxes now?

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

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

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

Consider taking advantage of "Qualified Charitable Distributions" or QCDs

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

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

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

Bill’s RMD for 2023 is $50,000.

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

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

Action Items

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

Here are some action items and questions to consider:

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

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

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

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

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

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

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

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

Until next time, thanks for reading!

Kevin Lao

February 27, 2023

4 Bear Market Retirement Income Strategies

The 2022 bear market hits retirees the hardest

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

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

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

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

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

Let’s dive in.

#1: Asset Dedication

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

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

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

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

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

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

BONUS Strategy

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

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

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

#2: “Income Flooring”

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

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

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

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

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

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

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

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

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

Caution

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

#3: Cash Value Life Insurance

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

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

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

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

Here are the basics:

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

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

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

You have two options.

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

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

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

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

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

Here’s the challenge.

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

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

Caution

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

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

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

#4: Tap into Home Equity

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

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

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

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

In Summary

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

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

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

Retirement planning = reduce stress and worry less!

Kevin Lao

December 2, 2022

The 7 Most Tax Efficient Retirement Income Strategies

Tax efficiency maximizes retirement income!

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

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

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

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

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

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

1. Roth IRAs + other Roth Accounts

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

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

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

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

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

There are some limitations on these accounts.

Contributions:

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

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

Income phaseouts:

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

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

Enter the backdoor and mega backdoor Roth contributions

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

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

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

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

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

2. Health Savings Accounts (HSA)

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

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

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

HSA’s have a triple tax benefit:

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

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

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

Try not to tap into this account early

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

Save your medical bill receipts

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

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

Don’t leave this as a legacy

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

3. Life Insurance

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

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

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

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

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

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

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

Which type of insurance should I own?

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

Pro tips:

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

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

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

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

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

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

4. Taxable Brokerage Accounts

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

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

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

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

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

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

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

Intergenerational Wealth Planning

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

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

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

5. Non Qualified Annuities

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

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

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

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

The tax efficiency components are twofold:

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

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

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

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

Intergenerational Wealth Planning

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

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

6. Reverse Mortgage

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

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

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

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

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

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

7. Real Estate Income

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

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

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

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

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

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

Final word

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

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

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

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

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

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

Until next time, thanks for reading.

-Kevin

Kevin Lao

September 9, 2022

How to divide assets in a blended family

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

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

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

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

How to divide your estate with stepchildren?

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

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

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

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

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

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

How to protect assets from stepchildren

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

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

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

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

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

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

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

What about adult children in a blended family?

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

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

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

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

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

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

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

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

Elective Share

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

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

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

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

Consider Life Insurance

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

Here’s an example:

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

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

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

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

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

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

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

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

Effects of an unequal inheritance

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

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

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

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

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

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

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

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

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

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

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

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

Tax Considerations

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

Qualified Retirement Accounts

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

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

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

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

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

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

Taxable Investments

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

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

How does the step up in cost basis rule work?

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

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

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

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

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

Life Insurance

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

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

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

Action Items

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

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

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

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

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

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

I hope you found this information valuable!

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

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And finally, join our “BLENDED FAMILY RETIREMENT AND ESTATE PLANNING” Facebook group for ongoing dialogue and insights from our team of experts!

Kevin Lao

August 19, 2022

Retirement Readiness Checklist

You are in the final stretch of your career!

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

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

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

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

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

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

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

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

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

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

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

Step 2: Create an ideal day/week

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

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

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

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

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

How do you solve this issue?

Create an ideal day or week and decide:

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

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

Step 3: Make a Budget

Stay with me on this one!

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

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

- Needs

- Wants

- Wishes

Examples of NEEDS are:

Housing
Utilities
Food
Clothing
Transportation
Insurance
Healthcare needs

A Quick "Aside" on The Housing Decision

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

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

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

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

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

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

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

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

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

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

Examples of WANTS are:

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

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

Examples of WISHES are:

Leaving a financial legacy
Major gifting/donations
Dream vacation home

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

Enjoy this exercise and make it fun and interactive!

Estimate each cost

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

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

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

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

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

Social Security
Pension
Annuities
Employment Income

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

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

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

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

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

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

Step 5: Determine your income gap

What is a safe withdrawal rate for retirement?

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

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

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

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

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

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

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

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

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

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

Death
Disability
Incapacity

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

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

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

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

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

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

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

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

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

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

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

The argument against doing a 401k rollover might include:

– Plans to work past 72 and defer required minimum distributions

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

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

Other Benefits to Consider

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

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

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

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

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

Here are the limits for 2022 on certain qualified plans:

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

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

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

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

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

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

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

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

The basic estate planning package that everyone needs includes:

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

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

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

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

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

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

Step 9: Medicare or Healthcare Decisions

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

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

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

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

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

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

Episode 13: Planning for Healthcare Costs in Retirement

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

Healthcare.gov

Step 10: Make a Long-term Care Plan

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

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

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

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

Some considerations if you decide to self-insure:

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

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

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

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

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

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

Step 11: Communication and Ongoing Review

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

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

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

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

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

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

Final word

I hope you found this information helpful.

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

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

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

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

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

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

Thanks for reading and I look forward to hearing your feedback along with suggestions for future topics! You can drop me a line at [email protected]

Kevin Lao

August 12, 2022

What is a flat fee financial planner?

Primary service models for financial advisors

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

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

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

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

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

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

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

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

Just to name a few:

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

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

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

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

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

Broker, or Commission Based Advisor

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

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

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

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

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

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

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

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

Fee-Based Financial Advisors

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

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

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

Here is the confusing part.

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

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

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

Fee-Only Financial Advisor

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

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

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

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

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

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

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

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

Flat Fee Financial Advisor, Flat Fee Financial Planner

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

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

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

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

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

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

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

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

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

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

We have two separate offerings:

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

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

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

Resources to find a flat fee financial advisor or financial planner

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

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

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

Wealthtender has an article about flat fee financial advisors.

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

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

In summary

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

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

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

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

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

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

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

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

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

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

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

Kevin Lao

August 2, 2022

4 Retirement and Estate Planning Strategies for Blended Families in Florida

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

First, what is a blended family?

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

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

How does having a blended family impact my retirement plan?

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

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

1. When should you claim Social Security?

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

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

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

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

Other blended family Social Security nuances....

Dependent benefits are also important.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Should I follow the 4% rule?

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

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

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

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

Using the "Guardrail" approach to withdrawals...

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

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

Should I Buy An Annuity?

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

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

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

3. Long-term care planning

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

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

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

Should I buy Long-term Care Insurance?

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

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

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

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

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

What about “self-insuring?”

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

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

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

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

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

4. Estate Planning Basics for Blended Families

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

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

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

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

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

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

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

Should you consider a trust for your blended family?

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

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

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

A few reasons why a trust could make sense are:

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

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

Life Insurance

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

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

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

Elective Share Rules

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

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

Final word

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

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

Book a call with us!

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Kevin Lao

July 6, 2022