Beyond the Accumulation Phase: Save Thousands By Distributing Your Assets in the Most Efficient Way

May 11, 2023

Wealth Advisor

Wealth Advisor

Episode Transcript

Welcome to EWA’s Finlyt podcast. EWA is a fee -only RIA based at Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you.

And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. This week’s episode of the Finlyt by EWA podcast, I’m joined by Chris Pavcic, who’s a lead advisor on the EWA team here.

And we’re gonna take a deep dive into planning for people that are in the distribution phase, so that are in retirement and we’re actually sending them a paycheck back on a monthly or annual basis. So Chris works with a lot of clients that are in this stage in the retiree market per se.

So thanks for joining Chris. I feel like you’re pretty much like an expert in this stage of planning. So give us the rundown. Let’s first start just why it’s important to work with an advisor that really understands the nuances of the distribution aspect of financial planning.

Yeah, absolutely. Thanks for… I’m excited to be on here and join you guys on the podcast. So the distribution area is an awesome space to kind of work in and help clients because this is whenever the plan’s actually live and we’re actually, like you said, replicating that paycheck.

We’ve seen through new clients in that stage of life where maybe they’re retiring in a few years where they’ve already retired. They come to us, they’ve been working with an advisor for many years and if we look at the statistics, the average age of a financial advisor in the US is 55 years old right now.

Wow, that’s fast. So a lot of times these clients come to us and they’ve been working with somebody for their entire careers and they end up retiring at the same time. So very important that you have somebody that’s gonna be with you through that whole phase.

and somebody that’s gonna be able to manage that whole process and see it through. Yeah, I guess I would agree with that. We see a lot of like, if you think about like the life stage of a financial advisor and especially like how the industry was years ago and think of like baby boomers getting ready to retire, like people started, advisors started 20, 30 years ago and it was really just like a, you’re just gathering clients.

And so all there were, you know, they’re just building up this book of business and then now they’re getting to the point where they’re gonna retire and they’ve, you know, maybe never actually, most of their clients are in that same situation.

They started working with like similar demographic people that went while they were trying to build this book. And now it’s like, okay, well, if your advisor is gonna retire right when you are, when you’re getting ready to retire, that’s the most important stage of your plan.

Like you just said, the plan’s actually live. So I think like, really important to have a young team or maybe not even a young team but a firm that has been there is going to be around for a long time that can like navigate through the complexity of this.

So couldn’t agree more. Let’s talk a little bit about just walk us through like the analogy we love to use is like the mountain climbing analogy and then so like how is it different in the accumulation versus the de -cumulation phase and then what are some of the risks coming down the mountain.

Yeah, absolutely. So it’s a completely different different approach to planning whenever we’re getting up the mountain like you said up climbing Mount Everest and accumulating assets and preparing to retire versus actually distributing.

So whenever we’re saving very equity focused, we want to shoot for the most growth with taking on appropriate risk. But whenever we’re we’re unwinding the portfolio, we got to make sure that there’s mechanisms in place so that if the market goes down, you don’t have to adjust your lifestyle based on what your portfolio is doing.

A lot of factors that we need to consider like taxes and sequence of return risks and Medicare brackets and so on. So much different approach and we need to make sure that the right again the right vehicles are in place to do that safely and replicate that paycheck for clients.

Yeah. Yeah, I totally agree. We’ll dive into like the technical side of some of these risks really like taxes or security Medicare longevity sequence of returns long term care. And like we’ve talked about.

So when you’re in the accumulation phase, you have a paycheck coming in. So like what the market is doing doesn’t really matter as long as you get long term returns. But then it kind of turns upside down.

You’re going down the mountain. So you need a set of tools in your backpack to go up, but then to go down. You hold different tool set to make sure that you navigate all of those risk as you come down the mountain.

And that’s actually where a lot of the mistakes happen. So we’ll take a deep dive into the technical side. But Chris talk about there’s a huge psychological aspect to this, which I like. Financial planning is almost, in my opinion, more psychological than the technical side.

The technical side is table stakes. You should be able to do it anyway. But talk about navigating, especially in our market that we work with, a lot of physicians, executives, business owners, how hard does that mindset shift just to go from my whole identity and life a lot of times is tied up in this profession of making such a huge impact on society and now it’s like, I have to have a complete mindset shift to stop working.

So what have you seen with clients that you’ve worked with? Yeah, I think that’s a product of getting to the kind of finish line or at the top of the mountain, if you will. So the people that accumulate assets, they’re usually top of their field.

We have the pleasure of working with a lot of physicians and business owners, executives here at our firm. And usually these people are really passionate about what they do and they love working. And a favorite quote that…

I know a lot of us use here on the team as the best savers or the worst spenders because one, you’re in this mindset of working towards something you’re passionate about and two, to again, to accumulate those assets, you have to be responsible, very disciplined to save, not only save but save in the right areas.

And then all of a sudden you stop working that like you said, the paycheck’s not coming in. And not only are you not saving anymore, but you have to take that even a step further and start to unwind your savings.

So stuff like we were just saying with the market, not living your life based on what the market’s doing, that’s much easier said than done. Whenever, you know, it’s easy for us to say that as advisors, but whenever you’re a client and you’re watching your portfolio go down and again, you’re not adding to that, you’re relying on it.

It’s a complete mindset shift. So I totally agree. It’s definitely, it’s more psychological I think than technical because a lot of the stuff like you said is table stakes and we need to get that right.

So understanding the psychological aspect, that’s going to go the furthest I think in guiding somebody through a successful retirement plan. So would you say that, well I think a lot of like really successful competitors, just naturally these people are like generally competitive from what I’ve found.

Like you, people track, like they track their net worth and so it’s like they see this number grow, you know, with all their accounts on their balance sheet and then it gets to a point where like you have to, okay now I have to spend this, I have to see this go down, which is like hard, hard to do.

So I think one of the biggest value ads that we’ve seen is really helping people. Well, the first thing is we don’t like to use the word retirement because we, there’s studies that show that a lot of people that like we just said, if they’re, if they’re, they love what they do, it gives them joy, they end up being more unhappy by not working at all versus like some sort of phased retirement to work.

So we don’t want to use retirement, we use financial independence. So that’s a total mindset shift. It’s like, Hey, let’s get to a point where you’re financially independent, you are working because you want to, not because you have to have a paycheck coming in.

And so that mindset. shift then, if you start kind of, when a client gets to that point, they can start designing their life the way they want, and they can look at their job and be like, well, I like doing these things, and I don’t like doing these things.

And I can, let’s try to design this or I’m not doing the things I don’t like because I don’t need to make this paycheck. I don’t need this paycheck. So that’s been, from what I’ve found helpful with just navigating through, like, nobody, a lot of people don’t want to get to a point where they just stop working completely.

So what you’ve found with a lot of people we work with, do they generally go from full on working to not working? Is it a phased retirement? What have you seen most people do? Yeah, I think in theory, a full stop sounds great, but like you said, the reality of this, what we see play out is definitely a tiered approach for the most part.

I’d say three out of four times at some sort of, you know, going to 80%, 70% halftime, part time, et cetera. And that just helps because all of a sudden, if every day. You know, you don’t have, you have 24 hours in a day, you’re sleeping for eight, and all of a sudden the rest of your time is, it’s on you on what you’re doing.

Then, you know, you gotta find ways to fill up that time. And if you’re used to doing your job and used to doing what you’re passionate about, that can be a big kind of, big just psychological shift, like we’ve been saying, like an identity.

So, yeah, most oftentimes it is a tiered approach, and we encourage that too, just because that helps you really give thought and make sure that you’re doing what you wanna do and spending the time the way that you wanna do it.

So, talk about the, I love what you said about the time. So, there’s a time exercise that we will take clients through and then talk us through that and then how that impacts a lot of decision making.

Yeah, so that’s it, I kind of led into it, but we’ll, oftentimes we’ll draw two pie charts. The first one is while you’re working and both of them represent your time. So, each pie chart’s 24 hours, sleep for eight or so, if you’re at work for 10 while you’re working, how are you spending that remaining, those remaining hours of your day?

And then whenever we shift to the second pie chart, that’s when you’re no longer working, so still sleeping, right? But now, how are you feeling the rest of that day? And it’s just to exercise the goals just to provoke some thoughts and try to be intentional and think ahead before, because it sounds great again in theory with, I don’t have to work anymore, but…

So, what are you gonna do with your time? A lot of times we get blank stares, when it’s like, okay, well, if you have 12 hours of your day, now dedicated to this profession, and we’ll generally ask the question, if you could not do that anymore, what would you do?

Like, you just can’t do that, and at other times, we’ll just stare at us, they have no idea. So yeah, it’s understanding what could you, what do you want to do, and then building life by design rather than just default.

I think a lot of people default to, they stress about finances, what the balance sheet is or isn’t doing, and they have no idea what they could do. And that’s a huge value add that I’ve seen is just letting people know what are the barriers of what could you spend, they have no idea.

And so there’s a study done. So how this relates to retirement planning is there’s a playground with children on it. And so the first thing they looked at, there’s no fence around the playground. It was just a playground and open field.

And all the children, I’m gonna totally misquote this, but they stayed within 10 feet of the playground. Like they didn’t go explore the field. And then they did another aspect of this where they put the fence, like, I don’t know, 50 feet outside of the playground.

And all the kids went out to the fence to explore the field. And so it’s the same thing with retirement planning. If people don’t know, people end up becoming more stressed out. It’s like, like you said, the best savers are the worst spenders.

So they save, save, save, they accumulate. And then it’s like, they think they have to live on this very low lifestyle. And they don’t know there’s better… boundaries, there’s the fence outside of the playground that they can go explore and just showing people, hey, this is like how much you could spend while still leaving this legacy or leaving no legacy, whatever the goals are, has been super impactful.

So that leads into talk about like competing goals, which we’ve found, we’ll dive into the values exercise a little bit, but what have you seen, like, how do goals generally compete with each other? Yeah, I think this is extremely relevant, especially for retirees in the distribution phase.

I love that playground analogy. I remember part of it said, like, the kids actually went up and they were touching the fence, they were literally going out and exploring that full boundary. So I think that’s a that’s a huge part of our job, because we view, we view under accumulating and over accumulating both equally as failures, because we’re not maximizing the potential of what what somebody’s worked their entire career to save.

And if we’re, you know, if we’re not maximizing that, then we’re not, you know, we’re not doing our jobs right. But I think for retirees, the conflicting goals really can come out because what we most commonly hear, we ask our clients to rank how important is their own financial independence rank that on a scale of one to 10.

A 10 would mean that you’re spending the most that your portfolio can sustain without risking running out of money. So if if something’s a 10, if that if that financial independence is a 10 out of 10, we would we’d want to find ways to make sure that that they can maximize their time.

If it’s travel to go see family or travel for fun, we want to find ways to do that and do it safely without risking the portfolio. So the first one’s financial independence rank it out of one to 10. And then the second one is legacy.

How important is it that there’s something left over for your kids, other beneficiaries, charities, whatever, whatever it is, because those directly are going to influence. one another. So we find that maybe a client will say that their own financial independence is like an eight out of 10 and their legacy is a two out of 10 and their annual withdrawal rates like 1%.

They’re not spending it. Yeah. So it’s they have the capacity to spend all this money, but they can’t get over that psychological hurdle and actually pull the money out. So what ends up happening is their own financial independence is like a two out of 10 in practice.

Legacy is a 10. Yeah. And the legacy is a 10 and they’re on track to leave, you know, millions of dollars to yeah. And that may not even be important. Right. Maybe there’s lifetime gifting. Maybe they’ve paid for education.

So it’s like we helped and like, yeah, no, that’s that’s that’s great insight. I think that yeah, it’s really just letting people know here’s what you could do here. You’re offering people with options and and then here’s how if you’re on track or off track for that.

Right. And that’s a great segue into let’s talk about like a lot of clients, their children are very important. And so it is this dynamic of like, I want to help them. I want to leave a legacy. I want to pay for college.

I want to do things that my parents never did for me. But on the flip side, it’s also like, I want to maximize my spending now and live a lifestyle that I want to. And that’s where the computing goals come into play.

So what have we seen? Talk about just like, I guess the first thing, like helping versus enabling your children how that impacts your financial plan. Yeah, absolutely. We think that just through being in so many of these meetings with retirees, it’s such a fine line between like you said, enabling versus helping.

So we really try to encourage to have these conversations proactively and upfront because our time is finite. We’re not going to be here forever. So while you’re here with your kids, want to make sure that you’re teaching them how you got here and teaching them those values and what led you to accumulate what you have and teach them really what this wealth represents.

Because it’s so easy to help by you could either do annual gifting and right now the limit’s 17 ,000 or 34 for a married couple that you can gift tax -free without any extra tax forms or anything. So we could look at, should we put that in a 529 plan where it’s guaranteed to go towards college and that would be helping?

Or you could just give it to them outright and say, here it’s up to you on what to do. So we try to encourage clients to guide their children and teach them how they accumulated that money so that the wealth stays for the next generation and hopefully the generation to come.

There’s a lot of crazy studies that show what small percentage of legacy actually lasts. I think it’s 70% of wealth is gone by the second generation and then 90% of the wealth is gone by the third generation.

And so then this is, I’m going to go back to the slide. I’m probably gonna misquote this, but it’s like, hard times create hard people, hard people create good things, good things create easy times. Easy times create weak.

Easy times create soft people or something like that. There’s like this cycle. And so that’s true on like a macro level and like a micro level. So if you look like a macro level of like bigger picture things like society and stuff, but on a micro level, like if you’ve helped your children, if you’ve accumulated this big nest egg of wealth and you’ve like gone through the hard times and you’ve done the hard stuff and to do this and then you wanna help your kids, like naturally everybody wants to help their kids and that creates that cycle that’s a very delicate balancing act of like, we wanna help them, we wanna do this as efficiently as possible at the same time, make sure that, the wealth’s not gone in the next generation.

They don’t just, I don’t know what the statistic is, like 80% or 90% of like lottery ticket winners like are bankrupt. shortly after. So it’s like, if you don’t understand how that wealth was accumulated, just like you said, understanding the core values, then that can be a disaster we’ve seen.

Yeah, I think a big part of it is we’ve seen, oftentimes, motivation for the next generation can diminish after they kind of see behind the curtain, for lack of a better way to put it, and truly understand what maybe their parents have been able to accumulate and what that’s gonna mean for them.

Sometimes motivation can really go down from there. So most often, our clients aren’t okay with that, and they want their kids to be successful in their own right, but still help them. So very delicate balancing act between enabling versus helping, and we try to navigate that.

That’s a big part of these discussions, at least our clients with kids and grandkids. Big part of the discussion is how to navigate that and do it the right way. So basically the first half of the understanding when we’re existing clients or new clients, it’s like we want a clear understanding of all the stuff we just talked about.

So how’d you get to where you are? What’s like, there’s a psychological understanding behind it of how they accumulated this, what their goals are now going forward. So everything that you just said, do you wanna spend, do you wanna leave a legacy?

Are there charitable aspirations? Is that a goal? What are these goals? How do we navigate all of the, I like to call it like the artwork, the soft skills of financial planning. And so that allows us then to catalyst into, now let’s get a little bit nerdy and technical of like, now that we have a clear understanding of all that stuff, now we really get to work and can build that financial plan.

And I love what you said, when people get into the distribution phase, like the plan’s live, needs to be done properly, there can be a lot of mistakes made, this is a high risk situation. So that’s one of the biggest, probably the biggest area of distribution planning, is just taxing.

tax bracket management. So talk to us about, I guess maybe just give us an example of a client that, obviously, without giving any names for confidentiality, like somebody that’s in the distribution phase and what are we doing to navigate tax bracket management?

Yeah, great, great topic. So we can go so many different directions with this. So the way, just a quick high level, the way the tax system works in the US, it’s a progressive system. So for 2023, the first, if you’re married, the first 22 ,000 that you earn is taxed to 10%.

And come between 22 to about 90 ,000 is 12%, then 89 to 190 is 22. So you progress through these tiers as you go. And if you’re retired, oftentimes, you either claim Social Security or you’re gonna claim it soon.

Sometimes we see that there’s pension income if you work to job that. offers a traditional benefit that pays you a paycheck every month. Then on top of that, you may have annuities too that are qualified, and these withdrawals will show up on that income tax schedule.

So it’s very important that with these guaranteed income sources that are going to come in before we even think about touching the portfolio, those are going to fill up those oftentimes as 10, 12, maybe even touch the 22% bracket if you have pensions.

So that leads into whenever we’re actually using the portfolio, where are we going to pull from? Because if you’re already in that 12% bracket that ends at 89 ,000, social security is filling that up, your pensions are filling that up.

Every dollar that you pull next is going to be in the 22% bracket. We have a decision to make, are we going to pull that from the traditional IRA where distributions are taxable? Does the client have a taxable account where we can pull from and it doesn’t show up as income at all or a Roth IRA?

So it’s important that we’re structuring all of these sources correctly to be tax efficient, but even more important than that is doing the right planning in the years leading up because a lot of times whenever we’re sitting down with new clients, the majority of their assets reside in a pre -tax environment, which makes sense naturally as you’re saving into those accounts or getting tax deductions, you’re saving along the way, but whenever you get to retirement, it’s a big tax liability that we have to unwind.

So Roth conversion planning, I know we’ll probably talk on that a little bit, but just structuring the balance sheet to make sure that we have the right assets in place that we can pull and kind of be artful around the tax brackets to avoid just paying unnecessary.

Yeah, let’s go through like a real, so I’m thinking of a client I talked to you yesterday, getting ready, they’re getting ready to retire probably within the next like three, well, one to five years.

It’s kind of that whole psychological aspect of like you could retire now and so it’s like, we’re designing this, like what are you doing? that you want to do versus like you have to do. So that conversation, but then like if we think about a misconception people have is like, I’m a high income earner, I’ve been in the highest tax bracket forever, and I’m gonna be in a lower tax bracket when I retire, which is like generally most likely not true because of what you just said.

So like this example, there’s social security, say that’s paying 100 ,000 a year, if you have two spouses of maxed out social security, 100 ,000 a year, maybe there’s a pension, a lot of times then their money has, they’ve accumulated a lot of money in a non -qualified taxable account.

So any dividends that get paid out or show up as income. So like in this situation, that was another like 50 ,000. And then there was just some other income streams, there’s like some consulting income, that was another like 50 ,000 and private equity payout.

So like at this point, like you’re already up with just stuff that’s coming in. before you take any distributions, and then let it learn if you wanna work on top of that, like probably already up over like 200, 250 ,000 of income that’s coming in for you not doing anything, just based on your situation.

So then the biggest risk is, okay, we ideally wanna fill up 10, 12, 22, 24, just like you said. But if there’s no planning done, talk about how RMDs impact then, well I guess first what are RMDs, and then how does that come into play?

Even if those income streams I just talked about, if you have 250 ,000 a year coming in, and maybe that covers lifestyle, you can’t just choose to not take money out. So talk a little about that and how that impacts your plan.

RMDs required minimum distributions. These are mandatory withdrawals that the government makes you take whenever you reach age 73. That was just updated this current year. So this applies for any pre -tax accounts.

So most commonly that’s gonna be a traditional IRA, SEP IRA, things that your 401K plan or 403B plan, where those accounts are rolled into most often whenever you’re retired. So it’s not necessarily a percentage, but it’s based on your life expectancy per these IRS tables for mortality.

But it generally starts out at about 4%. So if you’re a retiree that has… Just say you have like $2 million in the IRA, which is very realistic. Right, yeah you’re looking at 80 ,000 right off the bat.

Yeah, just by taking out in the first year and that increases as you get older. And the reason for that is they’re pre -tax accounts so over the years those contributions were not included in your taxable income.

So the government simply wants their share now as you’re getting older, they’re gonna make you take that money out and realize that income. So to the example you just were talking through if pensions really…

real estate, private equity, all of these things are filling up these 10 to 24% brackets if you all of a sudden have an RMD and maybe this is even from an inherited account too. Inherited IRAs also have RMDs, works a little bit differently but you stop to take the money out over a 10 year window generally.

These withdrawals could easily push you into those higher brackets. The jump from 24 is the next one’s 32 so it’s an 8% hike for these withdrawals. If we’re not doing the right planning ahead of time, a lot of money is going to get wasted that could either go towards your own financial independence and you’re be able to spend more today or leaving more for beneficiaries later on.

Taxes, Medicare brackets, all of these things that are income tested, it’s very important. Yeah, so RMDs, people think that I won’t use this money but you’re going to be forced to take it out. And taxes, we did a whole other episode on this.

Taxes are historically low right now. So our professional opinion is like, those are going up in the future. So it’s like, who knows what tax rates will be? And you may be in, you may be, you aren’t a little tax bracket.

Maybe you’re in the 22% now. Well, maybe 10 years from now, that 22% brackets now 32, just based on tax law change. So that’s a risk. So one way around all of this, and we’ll get into Medicare here in a second and how that impacts it.

But one way around this is Roth conversions. So we can take the idea of, we can take pre -tax money, volunteer to pay the tax now, and then there are no RMDs with a Roth IRA, freely take the money out.

Talk about like, we generally will reverse engineer that based on the RMDs. So how do we decide how much goes to Roth and how’s that calculated? Yeah, that goes back to, it goes back to the overall balance sheet and how, where have you accumulated these assets?

Meaning in what types of accounts and pre -tax, did you naturally accumulate the majority in these pre -tax accounts? Or do you have a lot in non -qualified or a lot in Roth already? But when it gets down to it, we wanna try to have a minimum of one third of your retirement dollars in a Roth environment.

But we need to look ahead and project, what are those RMDs gonna be whenever you meet that age? And we wanna make sure that between your income sources, like if you have social security and those pensions, if we change nothing, what are we estimating those RMDs?

What are they gonna be? And where’s that gonna land you in terms of the tax brackets? So we have to look ahead, we have to plan proactively. We’re kinda trying to shoot a moving target, but our goal is we wanna convert enough and do those conversions year to year to minimize that future RMD and save on future taxes.

If rates, like you said, go up and the 22% brackets now, the 32% bracket, who knows all speculation on who’s in office at that time. But we wanna make sure that we’re not make our best educated guess and minimize those RMDs before we get to there.

So it’s basically like two things we want to look at. First is the tax bracket. So can we avoid this high tax? And the second is the Medicare bracket. So a lot of people don’t know that you’re Medicare.

So Medicare Part B, there’s a surcharge on it. That’s based on your income. So do you have the brackets up actually? I do, yeah. So let’s just continue with that example of like, let’s just say you have, first off, Medicare is based on modified adjusted gross income.

So it’s your gross on the year basically. And so let’s just hypothetical, you have 220 ,000 coming in from all the sources that we said, no matter what. How, what are we then looking at? What Medicare brackets do we need to be aware of?

Yeah, so this is where, if you’ve heard of Irma, that’s where this comes into play. So the way it works is if you’re single versus married, the brackets are different. So your runway is double if you’re married for these brackets.

But. In your example if we’re already showing 220 of income and you’re married that’ll put you in the second tier of Of these Medicare premiums so that the lowest is 194 and under So your Medicare Part B premium if you’re in the lowest here would be $164 and 90 cents and that goes up to what like yeah, then the next year is 230 the third tears 330 next one’s 430 and then the top one goes all the way up to 560 and this is per person so What’s the jump from like What’s that Medicare premium at the highest of 560 so that’s anything over 750 I’ve been coming for married and how many the premium is 560 okay, so that’s it like a that could be like a three to four thousand dollar a year difference in Medicare Just based on Showing income with RMDs that you’re not even spending you don’t even need to spend yeah And the thing is oftentimes like we just did this yesterday for somebody a Lot of our clients they don’t even they take these RMDs and they reinvested in their taxable count So they’re not even seeing the benefit of being able to spend that So it’s purely balance sheet and efficiency Whenever we get to this point we’re paying these unnecessary surcharges Yes, again that money’s just getting reinvested So had we done the right planning ahead of time and had the right mix we would avoid paying these unnecessary charges So tax bracket management Medicare management are like Probably the easiest way just like that’s a low hanging fruit with this right like this can save hundreds of thousands of millions of dollars over Over the course of of a portfolio.

So let’s now dive into sequence of returns risk and how that I mean it translates into everything we just talked about but explain what is sequence of returns risk and then why You know how we navigate around it.

Yeah real quick if you don’t mind I wanted to hit on A really relevant piece in terms of these RMDs and Medicare tax bracket management something called the widow penalty. Yeah, yeah, yeah, that’s great.

So this is something not a lot of people think about because you don’t want to think about, you know, your spouse passing away, being alone, or by yourself and for the rest of the retirement. But the reality of it is, if something does happen to your spouse, significant other, whatever, your brackets get shrunk in half.

And oftentimes, the way we see beneficiaries are set up, goes to each other if something happens to the husband. So you go from married filing joint to now single taxpayer. Right, yeah. Which means like the runways, okay, so taxes are high.

Yeah, so instead of that 10% bracket ending at 22, it now ends at 11, for example, is single. Instead of your Medicare, first bracket of Medicare being 194, it’s now 97. So these runways get shrunk in half, but oftentimes your balance sheet is the same because like I said, the primary beneficiaries are usually each other, contingents maybe, maybe children or a trust, but 90% of the time.

its spouses are each other. And back to that example, like that 200 ,000 of income is still, maybe Social Security shrinks a little bit, but it’s still there. Yeah, because the highest benefit always stays.

So the higher spouses Social Security stays in place, maybe those annuities are probably still paying the pensions, maybe there’s survivorship. And then the RMD, now that, you still have to take those distributions.

So even though it’s just one person in the picture, now your distributions may go down slightly, but not enough to offset that, the 50% reduction. So your income’s still gonna be the same, probably, or close to it.

You’re paying now higher taxes and a higher Medicare rate, just because only one spouse is living. Yeah, so. So Roth conversions, Roth planning is a way to get around it. One mechanism around this. Yeah.

Okay, yeah, that’s insightful, and I don’t think a lot of people consider that. But yeah, let’s dive into the sequence of returns risk. So what is that and how do we navigate it? Yeah, sequence of returns risk.

So it’s exactly what it sounds like. So it’s the order that we see the returns in your portfolio. So while we’re accumulating wealth, that sequence doesn’t matter. We have a really awesome example that shows three hypothetical clients climbing Mount Everest, and it shows one set of returns that kind of jumps all over the place, but at the end of the road, it’s a 7% average.

And then the next example is the same set of returns, but flipped. So the first one starts with plus 22%. The other one starts with negative 22%. And if that makes sense, the first one’s the last one, second one’s the second.

So basically on the accumulation phase, the order in which you get the returns makes no difference, because you pay tax. But then when we go down the mountain, that makes a huge difference. Yeah, so if we flip it then, and we look at one sequence of returns versus the opposite.

So now instead of starting with that, that really good year of returns. if we flip it and now that first year is a bad year. You’re still taking withdrawals. You’re still taking withdrawals. It’s a huge difference because now we’re retiring off of whatever it is and we see a down year, we’re not only having that market loss, but we’re also pulling out.

So if you have a million dollars, let’s say it goes down 20% to 800 and you take 50 out, now that portfolio is 750 versus taking it at a year where it’s up 20%, you’re taking withdraw from 1 .2 million.

That’s a huge difference long term on the portfolio. So basically it’s what the market is doing and RMDs force you to take this out no matter what the market is, like if the market’s up or down, the government’s gonna see if to take this distribution.

So how do we solve this problem? What are some ways that we fix it? Yeah, so it goes back to making sure the balance sheet’s structured properly. So in terms of both the pre -tax and Roth accounts, because again, You said the pre -tax, those are gonna have those RMDs.

So if we run into those down years, it’s not up to us if we’re taking that money out. Maybe we’re able to delay it and reinvest it so it’s not that big of an impact because we’re just moving it from one account to the other and it’s staying invested and we’re not really feeling, we’re not taking that money out and realizing the loss.

But more importantly, we need to have the right asset mix in terms of what’s inequities, what’s in bonds, what’s in cash, what’s in cash value life insurance to make sure that we have a buffer. On our team, we use a minimum of a seven year backup, we call it.

And that’s based on many studies that have concluded that if you’re in a diversified portfolio that’s well -rounded, has exposure to all of the major asset classes and in the US, large, mid, small cap, international developed, emerging markets, real estate bonds and so on.

If you have a portfolio that has exposure to each of these, that’s crucial because all of these markets are not correlated to one another. So if one area of the portfolio is up at one time, it’s not all gonna go down at the same time at the same.

So having that seven year backup, we call it, and cash we wanna use, we wanna use fixed income that’s not gonna fluctuate as much as equities do. If we can have enough in that backup where we can avoid pulling from equities and realizing losses, that can really help mitigate that sequence of returns.

So let’s just look at how we come up with that seven year backup is back to the example with someone that’s 200 ,000 a year coming in no matter what and they’re gonna spend 300 after a lot of calculated planning, lifestyle and everything they wanna do, let’s say it’s $300 ,000.

We have to bridge the gap of 100 in portfolio withdrawals. That’s where we come up with 100 times seven, 700 ,000 should be in something safe. And so we think of just like a $5 million balance sheet, like that is $500 ,000.

is less than 20% in something safe. And so we have a lot of clients that have cash value instead of a life insurance contract can be really beneficial here if the policy is matured and they funded it over many years.

That’s gonna grow like 2022 stocks were down, SPO 100 was down like 19% and bond aggregates are down like over 10%. It was like weird year where it’s like, okay bonds are safer per se, but like there are times where they’re negative too and you have to put in a loss.

So if you have like one example, if you have money inside of a cash value inside of a life insurance contract, you really, you may not even need to hold any equities or any bonds inside of your portfolio because you have this thing on the sideline that’s growing no matter what.

So basically positioning that no matter what the market is doing, we have seven years of spending, safe, guaranteed to be there. And we don’t have to worry about what equities are doing. And that is just, that’s like the minimum.

Like some clients, it’s all about peace of mind. Some clients want 10 years. This is where there’s some artwork we don’t want, especially with like people are starting to live longer, longevity risk, like these are now like 30 plus year retirements.

And so it’s like, if you’re in too many bonds, you don’t have those equities for the latter half of retirement that’s gonna generate that long -term growth. So this is a really interesting thing that we talked about yesterday.

Talk about the 100 minus age rule and why we, you don’t agree with that and how that correlates to the seven year backup. Yeah, so the 100, that rule that you’re talking about is, it’s geared to try to tell you how your portfolio should be allocated based on how old you are, which we think is completely backwards because if you’re doing financial planning the right way, it should, everything should be based on your lifestyle, not just blindly saying how old are you and we’re gonna, this is what your portfolio is gonna look like.

So example would be if you’re 70 years old, you should have 100 minus 70, 30% of your portfolio should be inequities and 70% should be in fixed. Which is crazy, because think of the example I just said, if you have $5 million and you have 200 in coming in and you need that gap of 100, you could be like 15% bonds and you’re not gonna run the risk of running out of money.

Yeah, exactly, so it’s completely backwards. So like you said, $5 million if you’re pulling 100 out times seven, 700, you could be 14% technically should be in fixed income, but if you have cash value life on the side.

But at the same time, we need to acknowledge the peace of mind aspect. If you’re not able to go on that vacation or go golfing, whatever it is, without looking at your phone to see the portfolio, what it’s doing.

If you’re in all equities and that really. you know, stresses you out, then we should reevaluate it. But we think that being too conservative is just as big of a risk as being too aggressive. And it’s our job to point that out both ways.

Yeah, and I think that’s a lot of people don’t. So if you just like Google, we did this yesterday, if you Google search like what should my portfolio be as I enter retirement, it’ll be that 100 minus eight rule, which is like blanket advice.

Like people just genuinely don’t know that like, that’s not good advice. And so it’s just like helping people understand like, here’s where you could be and like really just like rewiring like the thought process behind it.

And it’s that psychological side of this of like, you can be way more aggressive than you need to be. You’re going to be okay. And how do we position this that no matter what taxes are doing, no matter what the stock market’s doing, you’re fine.

And it’s not gonna interrupt your lifestyle at all. Let’s do quickly hit on target date funds based on everything we just said. Go ahead. Very much in the same vein, because what target date funds are, what they do is that, again, it strictly looks at your age.

If anybody listening to this goes into their 401k plan, log into whatever your account is and go to manage my investments, you’re going to see XYZ 2060 fund or 2040 fund, 2030 fund. All of these are, those years are intended to line up with your retirement date.

So if you’re young, you’re 30 years older, whatever your accumulating assets, the majority of your money, but still not all of it, is going to be in equities. But even if you’re 35, some of that’s still going to be in bonds, but you’re not touching that money.

So basically, what’s just a layer deeper? So if you’re 35, our philosophy is most, like anything you’re investing, you’re probably not touching long term. Anything short term the next five years should be in something safe for financial planning reasons.

Meaning if you wanted to buy a house in two years and you need $200 ,000, keep that out of market. Other than that, everything really should be in equities. Yeah, well, we’re talking about retirement dollars.

So anything in your 401k, that should be all, if you’re 35, you’re not pulling from your 401k. Exactly, yeah. So if that’s, and then get into a target date fund, so if a 35 year old is a target date fund, it’s telling them to be in 20% bonds, just incorrect in our opinion.

And then we fast forward to retirement. What’s a 20, like 25 or 20, 30 allocation? Yeah, it’s probably 20% equities or 30% equities. So your default then, if you just do this, and it’s just looking at, the other thing that’s just like blanket advice is just looking at that one account.

And so it’s like, it’s telling you, OK, put 70% of your money in this fund that is all bonds. Right. Yeah, and mostly it’s robbing you. It’s not, you’re not going to lose money by doing this, but you’re going to lose in the sense of you’re not getting what you could have otherwise got.

in terms of rate of return. And then beyond that, it’s very risky whenever it comes to actually unwinding that. Yeah, so it’s a distribution phase is like the biggest problem actually. Right. Yeah. So one, you’re being too conservative and you’re missing out on returns that you could get or beneficiaries could get.

Maybe that’s not incredibly important to you. But whenever it comes to unwinding the portfolio, I kind of talked very briefly on the importance of a well -rounded portfolio. So like we said, we want to have funds for US large cap to, you know, that are going to be big blue chip companies in the US and the S &P, mid cap, small cap, and then international developed emerging markets, fixed income, real estate.

So all of these major asset classes, if you have a couple funds that are making up each of these, we can pick and choose where we’re actually selling out of and getting that money back to you. So these recent year or two years where we’ve seen this volatility in certain asset classes, like Emerging markets, for example, has gotten crushed over the last 24 months or so.

With the exception of 2023, it’s starting to rebound. That’s the last place that we would have sold money from and pulled out of. But if you’re in a target date fund or a single fund solution, they’re often called, you don’t have that flexibility and you just have to sell out of this one.

So if you need $100 ,000, you have to sell everything. It’s selling across the board. A portion of every asset class. If you’re in a target date fund. And that’s just a lot of advisory portfolios are versus if you’re properly diversified, we could take a sniper shot and say, OK, most things are 2022.

Most things are down. But let’s just hypothetically say you’re holding a real estate fund. This isn’t factual, but hypothetically, a real estate fund is the only fund in the portfolio that’s operating to gain.

We take that sniper shot and sell the real estate fund to avoid any losses versus the target date fund you just sell across the board. And so you’re forced to lock in losses, which is back to the sequence of return risk.

We’re selling things at a loss that’s going to really just derail your long term portfolio. Yeah. All of these things, really, they tie together. But yeah, that’s the biggest thing is we don’t want to be too conservative.

And then beyond that, we want to make sure that we have the flexibility to pull from the right asset class and not just blindly sell across the board and take the easy way out. For lack of a better way to put it, we need to do the right thing.

Manage the portfolio responsibly and pull from the right places. Yeah. So we didn’t take a too deep of a dive into social security and Medicare. We’ll probably do a whole other podcast on that. One other quick hit, so long term care planning is another risk in retirement.

And I would say there’s a lot of misinformation. Basically long term care planning used to be like standalone long term care policies. You buy it, use it or lose it. Insurance companies totally mispriced those 20 years ago -ish.

And so these policies now are becoming obsolete. realizing that more people are needing long -term care. And so there’s some different hybrid options to cover this. There’s a lot of, I would say, more bad than good around some of these insurance products.

But the main benefit, a lot of these, especially the clients we’re working with that are higher net worth, they are self -insured. So they’ve had enough assets where it’s like, if you had to spend 100 ,000 a year on long -term care needs, like you’re fine.

But there’s a tax bracket management aspect to that, like we talked about. So if you, we have those income streams, and now you’re forced to take 100 ,000 out a year from your portfolio to pay for long -term care, net gross with taxes, that’s gonna be like 140 ,000 that you have to take.

But there’s mechanisms for long -term care planning that you could pull money out, like a hybrid life insurance, long -term care policy, for example, you could pull money out tax -free that just works off the death benefit that would avoid those high tax brackets.

So it’s not really a standpoint of like, could you afford it, you could. It’s like, how do we… navigate this as efficiently as possible. Flipside, if the net worth’s not quite as high, that could be crucial.

If you have to spit another 100 ,000 a year off, that could just derail the whole financial plan in retirement. Well, that’s a high -level overview of kind of some of the stuff that we talk about in the distribution phase when the plan goes live.

But Chris, anything else to add that we missed that you wanted to make sure you hit on? No, I’m sure we could have gone another hour longer on this topic. Like you said, the social security Medicare, that stuff can be its own episode and its own right.

So yeah, I think that was pretty much the cliff notes of it and excited to hopefully dive into some of these topics a little bit deeper in another time. Yeah, well thanks for joining us. I feel like you’re an expert in the distribution phase of planning and this is where a lot of value is added to a lot of clients we work with.

Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button. Make sure to rate the podcast and please share with any friends or family members that would also find this beneficial.

Thank you very much.

Show Full Transcript

Recommended Videos

Unlock 10 Key Stress Tests for Your Financial Plan
10 Tips for Maximizing Your Financial Plan in 2023: Tip 9- 529 Plans
Lifetime Gifting
5 Tips to Run Your Business Stress Free- Tip 1- Have Great Systems In Place
Should You Have All of Your Money with One Team or Spread Among Several Advisors?
The Truth About Target Date Funds