Category: Independent Advisor

What is a fiduciary financial advisor?

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

What is a fiduciary financial advisor in the first place?  

Are fiduciaries always fiduciaries?  

What are the limitations of a fiduciary financial advisor?  

How do fiduciary financial advisors charge?

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

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

How about a definition from good ole’ ChatGPT?!  

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

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

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

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

Are fiduciary financial advisors always fiduciaries?

fiduciary financial advisor always a fiduciary

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

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

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

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

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

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

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

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


What are the limitations of a fiduciary financial advisor?

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

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

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

The other advisor was like a deer in headlights.  

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

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

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

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

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

How do fiduciary financial advisors charge?

flat fee fiduciary financial advisor fee structures

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:

  1.  % of assets under management (typically 1% – 1.5%/year of your investment portfolio)
  2. Flat fee 
  3. Hourly or project-based

The % of assets model is by far the most popular, as many of the larger RIA’s have been operating in this arrangement for decades.  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:

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

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

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

Follow me on Facebook @kevinlaocfp if you are nearing retirement or recently retired and want education on traditional retirement planning.

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!

Benefits of Working with an Independent Financial Advisor

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

Quick Disclosure

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

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

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

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

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

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

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

My initial take on this...

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

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

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

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

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

Fiduciary Standards

fiduciary independent financial advisor

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

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

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

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

The Ability to Customize

customize retirement plan

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

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

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

I’ll give you an example.

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

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

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

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

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!


niche, specialist

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

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

It's all about the relationship

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

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

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

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

In Summary

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

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

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

Until next time. 

Are Financial Advisors Worth It?

"How do fiduciary financial advisors add value?"

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

What is comprehensive advice?

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

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

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

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

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

  1. Tax planning
  2. Income Distribution Planning
  3. Risk Management
  4. Expense Management
  5. Second set of eyes

Tax planning

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

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

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

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

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

Income Distribution Strategy

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

Risk Management

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

  1. Bear market
  2. Behavioral
  3. Longevity
  4. Inflation
  5. Long-term care
  6. Premature death
  7. Incapacity or aging process

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

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

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

Expense Management

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

Second set of eyes

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

If we tally up our TIRES acronym:

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

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

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Should I use an HSA for Retirement Planning?

"Should I use an HSA?"

In simple terms, a Health Savings Account, or “HSA,” is an account owned by an individual that can be used to pay for health care expenses, either now, or in the future.  The accounts are eligible for those who have a High Deductible Health Plan and are funded with pre-tax dollars.  If the funds are used to pay for qualified expenses, the funds can also be withdrawn tax free for those purposes.  If leveraged appropriately, it will be the most tax efficient vehicle you will utilize for retirement planning.

Why participate in a Health Savings Account?


Fidelity conducted a study that estimates a 65 year old couple will need $300,000 earmarked to pay for healthcare expenses.  This does not include costs for long-term care services.  $300,000 of course represents true expenses, meaning the funds used to pay for those expenses will be net of taxes.  If the bulk of your retirement savings are held in a traditional 401k or IRA, you will need close to $450,000-$500,000 in your account balance earmarked for healthcare costs alone.  Therefore, many of my clients are leveraging the HSA as part of their overall retirement planning strategy, and I’ll summarize some of the benefits in more detail below. 

1.  You recognize a tax deduction today. 

If you are single, the maximum contribution is $3,600 for 2021 ($3,650 for 2022).
If you are married and participating in a family plan for insurance, the maximum contribution is $7,200 for 2021 ($7,300 for 2022).  If you are over 55, there is a $1,000 catch up contribution available as well.  Unlike other tax efficient saving strategies, your adjusted gross income level does not phase you out of a contribution.   Also, you don’t need to worry if you itemize your deductions or take the standard deduction come tax time, all contributions will reduce your taxable income.  You will typically have the ability to make your HSA contribution before tax time.  This is helpful as you could wait until March or April before making your contribution from the previous year after you estimate what your tax liability might be.   Of course, consult with your tax advisor on federal and state tax impacts of making an HSA contribution. 

2.  Tax efficient growth

Once the contributions are made, the growth from year to year is not taxable.  Unlike a taxable brokerage account (investing in stocks/bonds/mutual funds), you will not receive a 1099 for interest or capital gains purposes.  Furthermore, the distributions are also tax free as long as they are used for qualified healthcare expenses.  Unlike a normal retirement account, you don’t have to wait until 59 1/2 to take those qualified distributions. We will cover what a qualified healthcare expense is later, but think about the tax power of this vehicle.  All other retirement vehicles that you take a tax deduction up front grows tax deferred, not tax free.  Furthermore, tax free retirement vehicles like Roth IRAs, Roth 401ks, etc., don’t allow for a tax deduction up front!  Therefore, the HSA has the best of both worlds from a tax standpoint in that it’s tax deductible, and grows tax free (as long as it’s used for qualified healthcare expenses). 

3.  Flexibility

A health savings account can be used for current medical expenses, or future medical expenses.  This means you are not required to “empty out” your HSA at the end of the year, unlike it’s cousin, the Flexible Spending Account.  This means that the HSA can be used in a year where you have abnormally high medical bills (major surgery, having a child, unexpected ER visit etc.), or can be used in future years, or better yet in your retirement years.  Furthermore, there is no limit on the timing of reimbursement.  Let’s say you had major surgery in 2021, but had some cash on hand to pay for the expenses.  Therefore, instead of taking an HSA distribution, you decided to let it compound and invest it for the long term.  Let’s say 15 years later, you needed to raise some cash.  Well, let’s say that surgery set you back $5,000 out of pocket, you could reimburse yourself for that surgery that occurred more than a decade ago.  This feature also allows you to grow the funds over time with compounding interest before reimbursing yourself.  Make sure you have a process to archive receipts, which often times can be done with your HSA provider.  The final component of flexibility is portability.  If you leave an employer, the HSA always remains with you.  You can even roll it over to a different HSA provider if your new company offers a plan that you want to participate in. 

4.  Growth opportunities

Given the ability to make contributions over your working years without the requirement of withdrawing funds, the HSA also offers an opportunity to accumulate a sizeable balance that can be used in your retirement years.  Additionally, you can even invest those unused funds in a basket of securities such as mutual funds or ETFs for even more growth opportunities.  Typically, the HSA provider will require some reserve amount that cannot be invested, let’s say $1,000.  Once you exceed the $1,000 mark, you can choose from a menu of investment options that suit your time horizon and risk tolerance. 

The tax deduction up front, the tax free growth, flexibility, and growth opportunity are all reasons why this vehicle is the most powerful vehicle you can utilize for retirement savings.  We already know healthcare is going to be a major expense during retirement, so why not get the most bang for your buck when paying for those healthcare expenses and leverage the HSA?!


Who is eligible?

Anyone who is not enrolled in Medicare and is enrolled in a high deductible health plan is eligible to participate in an HSA.  Most of you probably won’t worry about this, but you cannot be listed as a dependent on someone else’s tax return.  Some may view the high deductible health plan requirement as a downside, but most high deductible plans still provide your preventative care like annual physicals, child/adult immunizations, screening services and other routine check ups with little to no out of pocket charge.  The minimum annual deductible required to qualify as a high deductible is $1,400 for individual coverage and $2,800 for family coverage.  Additionally, the maximum out of pocket expense plus deductible needs to be $7,000 for individual plans or $14,000 for family coverage.  These are the basic requirements for the health insurance plan in order to be eligible for an HSA.  As you can see, the deductible may be slightly higher, but the tax benefits of the HSA contribution alone can help offset that slightly higher out of pocket cost.  Furthermore, that tax free compounded growth on your investments makes the high deductible plan worth it in many instances allowing you to build up that retirement health care nest egg. 

What are qualifying medical expenses?

The list of qualifying medical expenses is very extensive.  Chances are, anything that is non cosmetic is likely a qualified medical expense, including costs associated with dental and vision.  If the HSA distribution is deemed non-qualified, the funds are taxable and subject to a 20% penalty if you are under the age of 65.  Here is a link to a resource that provides a list of all qualified medical expenses:  CLICK HERE

Outside of the traditional list, I wanted to point out a few that might not come to mind initially.

1.  Long-term care services, and qualified Long-term Care Insurance premiums

This is monumental, given the likelihood of retirees needing long-term care.  The most recent statistic is 70% of those 65 and older will need some type of long-term care services during their lifetime.  On average, women receive care slightly longer at 3.7 years vs. men at 2.2 years.  Given the costs associated with long-term care, it is prudent to incorporate a plan well before you retire, whether it’s buying insurance, “self insuring,” or a combination of the two.  For those who decide to buy insurance, you can withdrawal funds from your HSA tax free to pay the premiums, as long as it’s a qualified long-term care policy.  Traditional, stand alone, long-term care policies without any cash value features are generally qualified policies, and HSA funds can be tapped to pay these premiums.  Hybrid policies, however, are a bit more complex.  These hybrid policies combine life insurance with a long-term care benefit, so if you never need long-term care services, typically your beneficiary will receive some sort of death benefit when you pass away.  These policies have historically been considered NOT qualified, and HSA funds could not be used to pay these premiums tax free.  However, companies are now identifying what is called a “separately identifiable long-term care premium,” which would be allowable as a qualified premium, and therefore HSA funds could be used in this situation.  Consult with your insurance agent and tax advisors to ensure you don’t make any mistakes here. 

If you decide not to buy insurance, or you plan on buying a small policy and “self insuring” for any additional long-term care costs, an HSA is a home run tool for this pool of dollars.  Long-term care services are in fact qualified expenses, and HSA funds can be tapped to pay these costs.  It’s estimated that a private room nursing home is upwards of $105k/year in the US (depending on where you live).  If you needed to tap $105k/year to pay into a nursing home and only had tax deferred accounts on your balance sheet, such as a 401k, you would need to make distributions in the amount of $125k-$150k/year depending on your tax bracket.  On the contrary, a $105k expense is a $105k distribution from an HSA given the tax free nature of these withdrawals.

I wrote an entire article on long-term care planning.  If you are interested in reading more, you can use the link HERE.

2.  Medicare premiums

This would apply to Medicare part B, C and D.  However, Medigap policies are not considered qualified expenses.  This is important because if you build up a substantial HSA balance, you could guarantee that you will have qualified medical expenses simply by way of being enrolled in Medicare.  Additionally, there might be years where your Medicare premiums go up based on your income (think selling a business or real estate property, Required Minimum Distributions etc.), and you can use the HSA to offset that increase in premium.

What happens to your HSA when you die?

If your spouse is named as beneficiary when you pass away, your spouse will take over and continue the tax benefits as an HSA.  Basically, there are no changes.  However, when the HSA is passed to a non spouse (adult child or other beneficiary), the account is no longer an HSA and the full balance is taxable income for that beneficiary.  Nobody has a crystal ball, but if you are building significant savings in an HSA, you might want to have a process to make regular reimbursements during retirement so you don’t create a tax windfall for your heirs.  Given the flexibility in the timing of reimbursements, you can very easily go back over the years and pay yourself for medical bills incurred in the past.  One other final disclaimer on that note.  You cannot reimburse yourself from an HSA for expenses that were incurred before that HSA was established!  If you set up an HSA in 2015, you can only reimburse yourself for expenses as long as that HSA was established (2015 and beyond). 

Final Word

Medical costs are pretty much a given, so why not take advantage of the IRS tax code and maximize your ability to pay for them now and in the future.  If you are young and healthy, I would strongly encourage the use of a high deductible health plan combined with an HSA.  If you have concerns about the higher deductible given your medical history or unique situation, simply do the math on the tax savings of making an HSA contribution vs having a slightly higher out of pocket expense for the deductible.  Most HSA providers even give you calculators to help you with that math.  However, the real power is in the ability to build up a substantial nest egg with tax free compounding and investment opportunity within the HSA.  This will allow for you to recognize some tax relief while you are working and contributing, but have another layer of tax free distributions to supplement your retirement income.  This is especially true if you no longer qualify for Roth IRA contributions or don’t have a Roth 401k/403b option available at your employer.  Even if are are closer to retirement, don’t let that discourage you.  You can still max out the HSA contribution every year, invest the funds in a well diversified portfolio, and have a decent account balance to pay healthcare costs in your retirement years. 

Be sure to consult with your tax advisors and financial planner before making any changes to your situation.  If you would like to schedule a call with me to review your situation and figure out what strategy fits in your overall plan, you can book a “Mutual Fit” meeting by clicking the button below. 

What is a safe withdrawal rate for retirement?

What factors go into retirement withdrawal strategies?

The primary concern for just about everyone I meet with is how to retire with the same lifestyle they currently enjoy.  “Retiring” has a different meaning now than it did 20-30 years ago.  Nowadays, people retire TO something.  Whether it be to travel the world, spend time with family, volunteer, start a hobby, or work a dream job without compensation concerns.  Naturally, income replacement is the primary topic for those that are approaching retirement.  With pensions becoming less common, Social Security and income from investments have become the primary drivers to support the retirement lifestyle.  My most recent article (link here) was about Social Security and how to maximize the benefits for retirement.  Studies have shown Social Security represents approximately 40% of retiree’s income.  Therefore, I get a lot of questions on how much clients should withdraw from their portfolios to subsidize the income gap.

It depends.  There are two primary questions that we begin with to come up with the right answer.  First, what are the main spending objectives in retirement?  And second, what level of risk is acceptable?  These factors work in tandem and create many hypothetical “right answers” depending on each unique client.  This is why starting with a strategical financial plan with meaningful spending goals and meaningful stress tests is critical.  All future financial planning decisions will be influenced by these goals, which I find evolve over time.   As I continue to work with my clients, naturally new goals are added, and former goals are either accomplished or removed.  What I find is that as folks are approaching retirement, we typically focus on the “needs.”  Once they start to experience retirement and feel the plan is working, they can begin to relax and think more about their wish-list goals.

I want to clarify two housekeeping items first that are very important.  First, there are a number of “what-if” scenarios that can impact anyone’s retirement. We could have a beautifully designed income plan that is completely wiped away from a significant healthcare or long-term care expense.  I wrote about four of the stress-tests I run for my clients as they plan for retirement here.  This article, however, will be focused solely on navigating a safe withdrawal rate, all else being equal.  Second, I want to change the method of thinking from a safe withdrawal percentage to a safe withdrawal dollar figure.  Using a safe withdrawal dollar figure ensures that the client’s spending goals can be achieved throughout their life (adjusted for inflation), regardless of short term swings in the market.  I have found this method of withdrawals, known as a flexible withdrawal strategy, resonates with clients as they sleep better at night knowing they have a set income each month.  In order to accomplish this, or any prudent income plan for that matter, we must have a defined distribution process to avoid a big mistake.  I once met a client that had a dozen or so securities in his portfolio, and was selling his investments pro rata to meet his income needs.  This is often a default method for big brokerage firms, but not a prudent distribution process.  The reason being it will just about guarantee you are selling certain securities at the wrong time each distribution you make.  Having a prudent distribution process is a critical assumption when we begin the stress tests, as a big mistake can completely negate years or even decades of growth.  With that being said, I will reference withdrawal rates as an average percentage over the life expectancy of a plan, but understand they will fluctuate each year in practice.

Most people I meet with have one of the following primary income goals for retirement:

  1. Replace income to maintain their current lifestyle, but without depleting the principal of their investments.
  2. Replace income, but with the goal to maximize the legacy transfer to the next generations, or to charity.
  3. Maximize spending and die penniless.

Replace income without depleting principal

I find most people strive for this in retirement, mainly because of the psychological benefits it provides.  If you are burning through your principal in your early years, you might naturally have concerns about running out of money.  I had a client I worked with years ago that was consistently needing about 8%-10% of the portfolio each year to supplement his Social Security.  Each time we had market volatility, it was pretty much guaranteed I would get a call from him in a panic.  Over the years, his portfolio was consistently declining in value.  I kept reminding him that his burn rate was too high, but instead of looking at his own expenses, he blamed performance despite wanting to have a relatively safe portfolio.  Conversely, my clients that are in a sweet spot for distributions don’t panic when we go through bouts of volatility.  They are out enjoying retirement knowing we have a solid process and plan in place, which is my goal when I take on a new client. 

In order to accomplish principal preservation while drawing income, we must first understand the objectives for income and the risk capacity for each individual.  I started working with a client a few years ago that had a solid nest egg built up for retirement and wanted to see how to maintain her principal while replacing her pre-retirement income.  However, she was in the mindset (like many folks approaching retirement) of making the portfolio ultra conservative before this transition period.  After running some hypothetical scenarios, I showed her the results of our models.  Looking at the illustration below, the results on the left show a moderate risk portfolio, which as you can see falls in the green zone, or the Confidence Zone.  On the right, we modeled the impact of moving to a conservative risk.  As you can see, becoming more conservative causes this plan to fall below the green zone, or Confidence Zone, which is not ideal.   In some situations, clients that have saved more than enough for retirement can afford to reduce risk without jeopardizing the longevity of their plan.  However, in other situations like the one below, one might need to maintain some risk in the portfolio in order to achieve their income goals and maintain principal over time.  It’s critical to find that sweet spot of portfolio risk when implementing your distribution plan.

Why does reducing risk impact the probability of success negatively for this client?  The reason is somewhat simple.  Given the prolonged low interest rate environment we are still in, the more conservative investments are not yielding much in the way of annual returns.  Therefore, the expected returns annually from a more conservative portfolio are going to be lower than a portfolio taking on a reasonable amount of risk.  This resulted in a conversation of her wanting to maintain some risk in the portfolio so she didn’t have to worry about going through her nest egg too quickly.  After all, she does have longevity in her family and we could be planning for a 30+ year retirement!

I have found that in general, if someone is more conservative, the average withdrawal rate needed to preserve principal will be in the range of 3%-4%/year.  If a client is comfortable with some risk, 4%-5.5%/year can achieve the goal of income and principal preservation.  Finally, someone who is comfortable with a significant amount of risk may even be able to get away with 6%/year or perhaps higher in average withdrawals.  Inherently, the more risk one takes, the less probable the outcome is.  I typically find folks that want to take on more risk will fall into the next category of replacing income but also maximizing legacy. 

Replace Income but maximize legacy

For those who are looking to maximize legacy, of course we need to first make sure their income goals are taken care of.  Once we have tested all possible outcomes and have a solid baseline average of withdrawals, we can then determine how this will impact their legacy objectives.   Naturally, the lower the withdrawal rate the better.  Sometimes, clients may only need 2%-3%/year from the portfolio.  If they are generating an average of 5%/year in returns, this will allow them to grow their net worth over time and potentially keep pace with inflation.  However, in other situations folks still need a reasonable amount of withdrawals to meet their spending goals.  In any event, I will outline three strategies below to help with maximizing returns while drawing down retirement income. 

  1. Asset location strategy
  2. Spending strategy
  3. Tax efficiency

Asset Location is a buzz term used in our industry, but many clients I speak with don’t fully grasp what this means as they are more familiar with the term asset allocation.  Asset allocation is the method in which you determine what percentage of your net worth is dedicated to a variety of asset classes to create the properly diversified investment strategy.  Asset location is more specific on what asset classes you would own based on the different types of accounts you have.  I’ll give you an example.  I am working with a client who has one  Traditional IRA  (which is tax deferred) and another account that is a  non-qualified brokerage account (which is taxable each year).  We strategically own the tax efficient investments in the taxable account, and the tax inefficient investments in the IRA.  This makes sense because the more tax efficient an investment is, the less in taxes you would pay on that particular investment.  It’s like the old saying, “it’s not what you earn, it’s what you keep.”  In this case, it’s not what her before tax rate of return is, it’s her after tax rate of return.  Having an efficient asset location strategy can help with maximizing retirement income simply by taking a holistic view on what investments you should own in each type of account you have.

Having a spending strategy may feel like a given, but rarely do I hear people talk about this the right way.  Many folks focus solely on what percentage of the account they can reasonably draw down.  However, in order to maximize long term performance while drawing retirement income, you have to be strategic based on the timing of withdrawals.  Let me explain.  I have another couple I work with that has three buckets of accounts.   One is a non-qualified brokerage account, the next are Traditional IRA’s, and finally they each have a ROTH IRA.  Sequentially, most experts would agree that you should tap your brokerage account first, your IRA second and your ROTH IRA last.  The reason is to maximize your after tax income as you’ve already paid taxes on the cost basis for that non-qualified brokerage account.  Once you turn age 72, you will then be forced to make withdrawals on your Traditional IRA or 401ks.  For your ROTH IRA, you won’t ever have mandatory withdrawals and they will be tax free if/when you do take money out (as long as they are considered qualified withdrawals).  Therefore, we are taking the most risk in their ROTH IRAs, and the least amount of risk in their non-qualified brokerage account.  By using this approach, we will experience less volatility on the account they are likely to withdrawal in the short term (brokerage account), and will be able to maximize the growth potential on the accounts they won’t be tapping into until longer term, if ever (ROTH IRA’s).  I have found this approach works more effectively than incorporating a singular investment strategy across all accounts.

I talked a lot about tax efficiency in a previous article called the Tax Trap of Traditional 401ks and IRAs here.  This goes hand and hand with a smart spending strategy.  If you want to live a nice lifestyle but also maximize your legacy goals, consider what accounts are more or less tax efficient for that wealth transfer goal.  With the new rules around the elimination of the stretch IRA, leaving your Traditional IRA or 401k to your children is not as tax friendly as it was before The SECURE Act was passed.  Therefore, spend those during retirement and consider leaving the ROTH IRAs (if you have one) or even non-qualified brokerage accounts as your legacy assets.  Currently, non-qualified accounts have the benefit of a step up in cost basis upon the owner’s passing, although this is currently in the cross hairs in Washington to potentially eliminate.  However, under the current rules, a non-qualified account is a great tool to use for those wealth transfer goals.  Therefore, you may want to try to preserve these assets more during retirement and increase spending on those traditional 401ks or IRAs.  Another tool you could add to your arsenal, if you don’t have it already, is a permanent life insurance policy.  This works beautifully with several clients I work with where legacy is an important objective.  It allows for them to leverage the death benefit, which is passed on tax free, while only paying a relatively nominal premium while they are living.  One theme I hear from these folks is there is a psychological benefit in knowing you have something that is guaranteed to pass along to the next generation regardless of what the stock market brings.  It also gives them freedom to spend their retirement accounts without guilt knowing this legacy goal is taken care of by the insurance. 

With all of this in mind, these strategies should apply to all three types of clients who are preparing for retirement.  Those who want to spend income and preserve principal, those who want to generate retirement income and maximize inheritance, and those who want to spend it all while they are living.  All prudent retirement plans should employ these three tactics.  By not following a disciplined plan, the margin for error increases dramatically and the more prone the plan is to risk of failure.

Max spending with no inheritance

For the client who wants to maximize spending without leaving any inheritance, it can sometimes be unnerving as a financial advisor.  However, we start with the same process of unpacking the goals and stress testing those goals based on the income sources and risk tolerance.  The challenge is to figure out a scenario where the withdrawal rate in their last year of life is nearly 100%.  Obviously, I say this tongue-in-cheek as that would involve knowing exactly how long the client will live.  However, we will use our best guess based on longevity in their family history and our life expectancy calculators.  Once we see how much cash can be raised from the portfolio, I will show the client the withdrawal rates over time, assuming an average expected return.  Let’s take a look at this client below.  She doesn’t have children and wants to spend it all while she’s alive.  There are some charities she could leave it to, but she will probably give them money during her retirement years, especially when Required Minimum Distributions kick in.  So, we went towards the path of max spending and dying without any assets left. 

For this client, you can see the withdrawal rates start around 6%-10%/year the first 4 years.  At age 70 she will begin taking Social Security and the withdrawal rate goes down a bit.  However, looking into her late 80s and 90s, you can see how the withdrawal rates ramp up and at the last year of life expectancy, she is taking out nearly 100% of the portfolio balance.  Obviously, you can see the reason this is unnerving.  What if she lives longer than 94? What if there is a long-term care need or major healthcare expense?  What if we have lower than expected average returns?  What about inflation?  All of these stress tests failed miserably in this type of scenario.  Therefore, after sharing these results and discussing the potential risks, we backed down the rate of withdrawal slightly to create a buffer for those unexpected events.  The good news is, I will continue to revisit this with her and track our progress as time goes on.  If we run into some challenging conditions, we can have that discussion about trimming the withdrawal rate.  Conversely, if we are going through periods of significant growth, we can potentially spend more or gift more in those years.  I find this is a nice balance between maximizing spending, but also not doing something that will impact her ability to be financially independent.  Nobody wants to be a burden on others!

In summary, withdrawal rates are not static in our world.  We need to be dynamic to adjust to the cash needs of our clients.  Additionally, the withdrawal rates will be driven by the primary goals of the client, the income sources available to achieve those goals, and the capacity for risk.  This formula will bring to light what a reasonable amount of income that can be taken from the portfolio would be, adjusted for inflation over time.  There is not one right answer, and it’s important to take all of your financial planning considerations, tax considerations and investment considerations before making any decisions.

My firm specializes in this type of planning and we are happy to help you prepare for retirement. You can schedule a no obligation initial consultation here, or by giving us a call at 904-323-2069.

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