Bogleheads® on Investing Podcast 032 – Phil DeMuth, host Rick Ferri (audio only)

00:00:00.000 | (upbeat music)

00:00:02.580 | - Welcome to Bogle Heads on Investing, podcast number 32.

00:00:11.080 | We're talking taxes today with Phil DeMuth.

00:00:14.440 | Phil is an investment advisor

00:00:16.280 | and the author of nine investment books,

00:00:19.240 | including "The Overtaxed Investor",

00:00:22.120 | "Slash Your Tax Bill" and "Be a Tax Alpha Dog".

00:00:25.880 | (upbeat music)

00:00:28.620 | (upbeat music)

00:00:31.200 | Hi everyone, my name is Rick Ferry

00:00:37.980 | and I'm the host of Bogle Heads on Investing.

00:00:40.540 | This episode, as with all episodes,

00:00:43.140 | is brought to you by

00:00:43.980 | the John C. Bogle Center for Financial Literacy,

00:00:47.540 | a non-profit organization

00:00:49.180 | dedicated to expanding John Bogle's legacy

00:00:51.840 | by promoting the principles of successful investing

00:00:55.020 | and financial wellbeing through education and community.

00:00:59.160 | The website is boglecenter.net

00:01:02.140 | and your tax-deductible donations are greatly appreciated.

00:01:06.460 | Today, our special guest is Phil DeMuth.

00:01:09.140 | Phil is a PhD, an investment advisor,

00:01:12.660 | a prolific writer about financial topics,

00:01:15.620 | and one of Phil's books is called "The Overtaxed Investor",

00:01:18.980 | which he updates frequently.

00:01:21.620 | John Bogle said, and all Bogle Heads know,

00:01:24.500 | that costs matter.

00:01:26.300 | And one of the biggest costs in investing is taxes.

00:01:29.740 | So today we're talking with Phil

00:01:31.380 | about strategies for reducing your cost

00:01:34.100 | by reducing your investment taxes.

00:01:37.100 | So with no further ado, I am pleased to welcome Phil DeMuth.

00:01:41.740 | Welcome to the Bogle Heads on Investing podcast, Phil.

00:01:45.260 | Rick, great to be here.

00:01:46.300 | Thanks for having me.

00:01:48.300 | Phil, you're a, well, I call you a tax expert

00:01:51.780 | because you wrote a book

00:01:53.220 | called "The Overtaxed Investor, Slash Your Tax Bill

00:01:56.500 | and Be a Tax Alpha Dog".

00:01:59.620 | And you update this quite frequently.

00:02:01.700 | I imagine you're gonna be updating it again

00:02:03.420 | with all the different changes to the tax code.

00:02:06.460 | Why did you write the book

00:02:07.620 | and tell us a little bit about it and yourself.

00:02:10.420 | Well, I wrote the book 'cause I'm an investment advisor

00:02:14.300 | and I manage money for clients.

00:02:16.280 | And what happened is we had a little family business

00:02:19.460 | that never made any money,

00:02:20.620 | but it made my tax form like a phone book.

00:02:23.780 | I had to file it in six states.

00:02:25.740 | I had no clue what my taxes were about.

00:02:28.580 | But once the family business went away,

00:02:30.980 | I suddenly could see it in its naked form.

00:02:34.300 | And I saw I was paying all these taxes on dividends

00:02:37.060 | and capital gains that I didn't want, I didn't need.

00:02:40.780 | Holy smokes, what can I do about this?

00:02:43.860 | So then I dove into the tax code

00:02:45.940 | and tried to find some way to figure it out

00:02:47.780 | so I could help myself and help my clients.

00:02:49.980 | Before we jump into the book,

00:02:52.060 | let's make some observations about what's going on

00:02:55.440 | about 2020 tax returns.

00:02:58.460 | Can you give us a quick review?

00:03:01.020 | Well, of course, the big news is that we don't have to file

00:03:04.140 | our federal tax returns until May 17th.

00:03:07.820 | So they've given us an extra month and two days.

00:03:11.140 | Although I think we still have to pay

00:03:12.660 | our quarterly estimated taxes,

00:03:15.220 | first quarter taxes on April 15th.

00:03:17.420 | So we can't postpone that.

00:03:19.540 | Well, Phil, I wanna just go over the major taxes

00:03:22.740 | that everyone is liable for first.

00:03:26.780 | And then we'll get into different phases of people's lives

00:03:31.580 | and how different taxes begin to affect us

00:03:35.140 | as we go from early in our career to midlife

00:03:39.180 | to pre-retirees, retirees,

00:03:42.180 | and then passing money on to our family members.

00:03:45.060 | Then we're just gonna talk about federal taxes.

00:03:47.960 | We start with just the basic income tax.

00:03:51.980 | Well, it started in 1913,

00:03:55.820 | and it's been a popular idea

00:03:58.060 | with the government ever since.

00:03:59.700 | And it's gone up quite a bit,

00:04:02.180 | and it may be about to go up again.

00:04:04.780 | This is probably the largest single tax

00:04:07.180 | that most of our listeners will be paying.

00:04:09.420 | It's a graduated tax,

00:04:10.980 | and it's basically thought of in terms of buckets.

00:04:13.900 | So up to a certain level of income,

00:04:15.900 | you might not pay any tax because everybody gets

00:04:18.680 | a tax deduction to start off.

00:04:21.360 | And then you fill up the 10% bracket, 12% bracket,

00:04:26.360 | 22% bracket, 24% bracket as your income rises,

00:04:31.120 | 32% bracket, 35% bracket, 37% bracket,

00:04:35.240 | and it'll probably be going back to a 39.6% bracket.

00:04:38.800 | So it's just depending on your income level

00:04:41.120 | and which thresholds you cross,

00:04:43.400 | you will be paying each additional tax tier at that level.

00:04:48.400 | You know, when you're filling out your 1040,

00:04:50.680 | there are three important lines, right?

00:04:52.600 | There's your total income line,

00:04:55.040 | and then you have deductions from that.

00:04:57.320 | And meaning if you're putting money away

00:05:00.040 | into say a retirement plan of some sort or an IRA,

00:05:04.040 | and this gives you your adjusted gross income.

00:05:06.540 | And then once you have your adjusted gross income,

00:05:08.440 | you subtract from that your either itemized deduction

00:05:11.640 | or standard deduction generally.

00:05:14.280 | And this thing gives you your taxable income,

00:05:16.720 | which would go to the tax tables

00:05:18.520 | and figure out how much you owe.

00:05:21.000 | Is that generally how it works?

00:05:22.400 | Perfectly said.

00:05:23.240 | Oh, thank you.

00:05:24.060 | Perfectly said.

00:05:24.900 | All right, so that's the income tax.

00:05:26.520 | I mean, we're all very familiar with it

00:05:27.760 | because we pay it every year.

00:05:29.560 | But in addition to that,

00:05:30.680 | it gets a little more complicated when you're working

00:05:33.440 | or if you have a business where you have to pay FICA,

00:05:38.680 | which is Federal Insurance Contributions Act,

00:05:43.440 | which is Social Security and Medicare.

00:05:45.680 | Now, this gets a little complicated

00:05:48.400 | because we all have to pay it.

00:05:49.480 | If you're working for somebody else,

00:05:51.040 | you pay half and your employer pays half.

00:05:53.360 | If you're doing it as a self-employed person,

00:05:56.080 | of course, you have to pay both sides.

00:05:58.880 | So could you talk with us a little bit about FICA?

00:06:02.440 | Again, it covers Social Security.

00:06:05.840 | That's about 6.2%.

00:06:08.480 | Medicare is about another one and a half percent.

00:06:11.600 | Then it's paid by both you and your employer.

00:06:14.600 | So basically about 15%, a little bit over that,

00:06:18.880 | is subtracted.

00:06:20.800 | It's a lot of money,

00:06:22.000 | although you never see it in the bank.

00:06:24.880 | So you don't feel it's lost quite as keenly as other things.

00:06:29.680 | And of course, it's become controversial recently

00:06:31.760 | because President Biden had proposed

00:06:35.160 | to increase the level at which this would be taxed.

00:06:38.840 | You know, it's taxed up to a certain level now at $142,800.

00:06:43.840 | And then there would be a gap,

00:06:45.520 | and then anybody earning over $400,000

00:06:48.600 | would have it reinstituted again

00:06:51.240 | on all the money above that.

00:06:53.120 | But the good news is that that's not gonna happen

00:06:56.680 | because under the Senate's rules

00:06:59.960 | to pass a tax bill under the reconciliation,

00:07:03.720 | which is what he would have to do

00:07:05.360 | 'cause the Republicans won't sign on to it,

00:07:07.720 | you cannot change Social Security in any way.

00:07:12.000 | So this is not gonna be happening to us.

00:07:14.320 | So that tax will stay the way it is,

00:07:16.200 | even though many other taxes might be going up.

00:07:18.760 | - We have to pay this tax,

00:07:20.560 | either half of it or the whole thing,

00:07:22.720 | if we're self-employed,

00:07:25.120 | of approximately 15.3% is what it comes out to,

00:07:29.120 | up to $142,800 this year.

00:07:32.960 | And it goes up every year, that number.

00:07:34.800 | If you look at all the different inflation numbers,

00:07:37.000 | like how much extra you get in Social Security,

00:07:40.160 | or me as a military retiree, how much extra I get,

00:07:43.800 | it seems to creep up by about 1%, 1.5% per year.

00:07:47.440 | Yet this number seems to creep up faster than that.

00:07:50.600 | But then it stops for Social Security,

00:07:54.920 | but it doesn't stop for the 2.9% Medicare tax.

00:07:59.720 | It just keeps on going.

00:08:00.880 | In fact, there's another Medicare surtax

00:08:03.880 | that kicks in for single people at 200,000

00:08:06.840 | and for people filing jointly at 250,000.

00:08:10.040 | Married filing separately, it actually starts at 125,

00:08:13.160 | and it's an extra 0.9%.

00:08:16.720 | This tax is on your wages going forward forever.

00:08:21.720 | - And that's not adjusted for inflation.

00:08:24.520 | - And you have the Affordable Care Act, NIIT tax,

00:08:29.520 | which is 3.8% on capital gains and dividends

00:08:34.600 | that starts at the same place,

00:08:36.240 | also not adjusted for inflation.

00:08:39.240 | And this is deliberate

00:08:41.080 | because they wanted to only catch rich people, so to speak,

00:08:46.080 | the millionaires and billionaires earning more than 200,000.

00:08:50.280 | But eventually, with inflation,

00:08:52.640 | the middle-class incomes will rise,

00:08:55.320 | and they will also be smeared by this.

00:08:57.760 | And they did that because they knew

00:08:59.720 | that these programs are incredibly underfunded.

00:09:03.660 | So it's just sort of a backdoor way

00:09:05.600 | of trying to get more revenue to keep them afloat.

00:09:08.920 | - Yeah, let's talk about that net investment income tax

00:09:10.840 | because it gets laid on top of any investment income

00:09:15.400 | from dividends or capital gains or rent,

00:09:19.780 | not municipal bond income, but anything that's taxable,

00:09:24.400 | it gets laid on top of that.

00:09:25.960 | So if you have a long-term capital gain

00:09:28.240 | and you're paying 15%,

00:09:30.520 | if your adjusted gross income is above 200,000

00:09:34.760 | if you're single or 250,000

00:09:36.620 | if you're married, filing jointly,

00:09:38.560 | this 3.8% tax gets laid upon the 15%.

00:09:43.560 | And of course, once you have higher capital gains

00:09:47.080 | or higher income and you get above 500,000

00:09:50.060 | for married, filing jointly,

00:09:51.820 | now you're at 20% capital gain

00:09:54.580 | and you get this 3.8% laid upon that as well.

00:09:59.580 | So I think that people really should be watching then

00:10:05.860 | how much dividend, interest, capital gain, and rent

00:10:10.600 | they're getting from their taxable portfolios.

00:10:13.880 | - Yeah, well, plus it's part of the Biden tax plan proposal

00:10:18.880 | to bring back the P's limitation on deductions.

00:10:23.620 | And that is an additional tax

00:10:26.380 | of about 1.2% on dividends, capital gains, rent.

00:10:31.380 | So that really takes for people,

00:10:34.340 | say earning more than 400,000 married, filing jointly,

00:10:38.260 | that's gonna take their capital gains,

00:10:39.700 | dividends tax up to 25%.

00:10:42.540 | - It adds up.

00:10:44.100 | Let's talk about another tax.

00:10:46.100 | And this doesn't hit you until you're 65.

00:10:51.100 | And that is Medicare Part B and Part D,

00:10:54.540 | how much you pay for that, which is a backdoor tax.

00:10:58.260 | - Yes, well, there's a certain base rate

00:11:01.100 | that everybody pays.

00:11:02.820 | But then what happens is at certain levels of income,

00:11:07.600 | the rate for the Medicare Part B,

00:11:11.400 | there are surcharges that are put on that tax.

00:11:15.240 | If you're married, filing jointly,

00:11:17.400 | it starts rising at 218,000.

00:11:20.880 | And then it just keeps stepping up as a number of step ups

00:11:24.200 | until finally, if your income is as high as 750,000

00:11:29.200 | married, filing jointly,

00:11:31.480 | the premium is basically two and a half times

00:11:34.640 | what it was when you started.

00:11:37.080 | And the bad part about that is that would be true

00:11:39.920 | for both you and for your spouse.

00:11:42.800 | And that would carry on as long as you have

00:11:46.120 | that higher income.

00:11:47.680 | So potentially this could go all the way through retirement.

00:11:50.800 | So it adds a lot of dollars to your healthcare expenditure

00:11:55.240 | and retirement.

00:11:56.320 | And nevermind the fact that there's a ton of stuff

00:11:59.880 | that you'll need during retirement for healthcare

00:12:02.660 | that is not even covered by Medicare.

00:12:04.760 | So it's not cheap.

00:12:06.320 | And it's also, of course, still woefully underfunded

00:12:09.040 | relative to what Medicare pays for the services

00:12:11.520 | it gives you.

00:12:12.560 | - A lot of the incomes that we're talking about

00:12:14.800 | to determine what you pay in Medicare,

00:12:17.480 | what you might have to pay for net investment income tax

00:12:20.380 | is based on modified adjusted gross income,

00:12:23.640 | which has many different meanings in the tax code.

00:12:27.720 | - We try to get a big picture

00:12:30.080 | on how to address our taxes in the tax code.

00:12:33.560 | And that's great.

00:12:34.720 | But at the same time, the devil is in the details.

00:12:38.320 | And taxes is about the 73,000 pages of rules and regulations

00:12:43.320 | getting it right, getting all the details correct.

00:12:46.920 | And these general answers will only carry us so far

00:12:51.160 | 'cause it's gonna come down to the specifics

00:12:54.760 | of everybody's tax situation.

00:12:57.180 | - Only a portion of your social security is going to be taxed

00:12:59.880 | but what portion that is depends again on your income.

00:13:04.880 | - Right.

00:13:06.760 | And of course, the great danger here,

00:13:08.960 | here as elsewhere in the tax code,

00:13:11.360 | there are discontinuities.

00:13:13.960 | You expect if you earn a little bit more money,

00:13:15.840 | you'll pay a little more tax.

00:13:17.400 | Little more money than that, you'll pay a little more tax.

00:13:20.080 | And that might generally be how it works.

00:13:23.120 | But there are also places, sort of trigger points

00:13:27.240 | where you can earn a little bit more money

00:13:29.480 | and suddenly your marginal tax rate might go up 100%.

00:13:33.280 | These places actually exist.

00:13:35.200 | So that's why you have to be very careful

00:13:38.800 | in calculating your taxes.

00:13:40.840 | And by the way, this is not for millionaires.

00:13:43.040 | This is people that earn $60,000

00:13:45.840 | or show $60,000 of income

00:13:47.920 | or people that might show $150,000 in income.

00:13:51.280 | You have to be very careful.

00:13:52.720 | At the end of the year, when you figure out your taxes,

00:13:55.120 | you have to basically just plug in another $100

00:13:59.800 | and see what that $100 does to your tax bracket.

00:14:03.680 | And if it shows it jump exactly

00:14:06.240 | what the marginal tax rate says it should jump, you're fine.

00:14:10.200 | But again, with Social Security,

00:14:12.080 | it can jump way, way above that.

00:14:14.960 | So you have to make sure you're not hitting

00:14:17.640 | one of these bump zones,

00:14:19.720 | one of these discontinuities in the tax code.

00:14:22.400 | Otherwise you're gonna have to maneuver

00:14:24.240 | to get around it.

00:14:25.800 | And this is exactly the kind of thing

00:14:27.360 | that your accountant may not even be aware of

00:14:30.680 | and may not point out to you.

00:14:32.360 | So this is something you have to ask the accountant to check

00:14:37.040 | or you have to check yourself during your own taxes.

00:14:40.280 | - Let's do one more tax.

00:14:41.400 | And this one has always confused me.

00:14:43.280 | This is the alternative minimum tax.

00:14:45.800 | This is a completely different methodology

00:14:48.240 | for figuring out taxes

00:14:49.640 | to ensure that certain people pay enough in taxes.

00:14:54.320 | - Well, fortunately, I've forgotten a lot of it

00:14:56.520 | because under the Trump Tax Cuts and Jobs Act,

00:14:59.440 | very few people were paying it.

00:15:01.400 | But prior to that, a lot of people were paying it.

00:15:04.120 | It started out as a alternative tax system

00:15:07.560 | to make sure that rich people were paying their fair share.

00:15:11.520 | But then what happened is thanks to bracket creep,

00:15:14.280 | it suddenly started to ensnare a lot of the middle class

00:15:18.640 | and the upper middle class.

00:15:20.040 | So everybody had to figure out their taxes twice

00:15:22.600 | once the IRS way, once the alternative minimum tax way,

00:15:27.040 | and then pay whichever is more.

00:15:29.280 | - Well, I'll tell you a story about myself.

00:15:31.680 | I sold a business and did an installment sale

00:15:34.560 | and I did it over three years.

00:15:37.000 | - Very smart.

00:15:37.840 | - Well, thanks, except that last year, 2019,

00:15:42.320 | the big part of the installment came to me.

00:15:45.240 | And I wasn't subject to the net investment income tax

00:15:47.600 | because I own the company and I manage the company,

00:15:50.840 | but I did get hit with the alternative minimum tax

00:15:55.560 | because the capital gain that I took

00:15:59.200 | from the sale of my equity bumped me up to a threshold

00:16:04.200 | where when we did the alternative minimum tax,

00:16:09.200 | I did get hit with that.

00:16:11.280 | So if you're selling a business,

00:16:13.040 | you might still see the alternative minimum tax

00:16:15.600 | come into play.

00:16:17.160 | You know, you think you did your taxes right,

00:16:18.840 | but you skipped over the alternative minimum tax

00:16:21.880 | and you send all your information into your CPA

00:16:24.840 | and next thing you know, it's like, oh, by the way,

00:16:26.920 | yeah, it's this extra $10,000 over here

00:16:29.360 | that you got to pay.

00:16:31.360 | Okay, we've been over all of these taxes,

00:16:33.640 | the income tax, the social security

00:16:37.680 | and Medicare tax called FICA.

00:16:40.920 | We've been over the capital gains taxes

00:16:43.920 | and the net investment income tax

00:16:46.360 | that you might get hit with.

00:16:48.680 | We've talked about taxes for Medicare,

00:16:52.560 | how they can go up based on your income

00:16:56.000 | and taxes for social security.

00:16:58.600 | Oh, and then the net investment income tax.

00:17:00.320 | We have all these different taxes

00:17:01.840 | that we have to look out for

00:17:03.000 | and they kind of come in and hit you.

00:17:04.240 | You know, it's like, zing, boom.

00:17:06.080 | Oh, I didn't see that one coming.

00:17:08.520 | Anyway.

00:17:09.680 | But Rick, you've left out a lot of taxes.

00:17:12.320 | I mean, there's the federal unemployment tax,

00:17:14.640 | which is about 6%.

00:17:16.320 | State unemployment tax.

00:17:18.360 | You've got your state taxes.

00:17:20.440 | You've got property taxes.

00:17:22.640 | You've got licensing taxes on your car.

00:17:25.200 | You've got excise taxes.

00:17:27.440 | It's an endless list.

00:17:30.560 | It's really, it's astonishing.

00:17:32.280 | You know, when you start adding

00:17:33.320 | all the state taxes in there,

00:17:34.840 | especially if you have your own business

00:17:36.120 | and you have employees, it just gets to be crazy.

00:17:38.960 | I know if you live in some states like California,

00:17:41.160 | just, you know, the income taxes

00:17:43.360 | and state income taxes alone,

00:17:45.360 | and you're over the 50% tax bracket,

00:17:47.080 | not even including your property taxes

00:17:49.720 | or any of the other taxes that you may have to pay 'em,

00:17:51.600 | it's a lot of money.

00:17:52.920 | And we could see a migration in the country

00:17:55.520 | out of these high-tax states

00:17:57.040 | towards low-tax states or no-tax states

00:17:59.360 | just to avoid all of that.

00:18:01.480 | And, you know, and there's a tax strategy

00:18:03.360 | that I talk about with clients.

00:18:04.640 | Let's say a client who lives in California.

00:18:06.600 | I might be getting ahead of myself here.

00:18:08.600 | I say, you know, if you put a lot of money

00:18:09.920 | into a retirement plan, like a 401(k) or a 403(b),

00:18:13.560 | you don't have to pay income taxes on that,

00:18:16.440 | federal income tax, or state income tax.

00:18:18.880 | And then when you retire, if you move out of state,

00:18:22.800 | you still have to pay the federal income tax

00:18:24.560 | when you withdraw that money,

00:18:25.560 | but you have avoided paying the state income tax.

00:18:28.520 | And thus far, states have not been able to come after you.

00:18:32.280 | - Yes, wonderful.

00:18:33.480 | If you can retire and move to a no-tax state,

00:18:38.880 | you've done yourself a great favor.

00:18:40.640 | - Now that we've briefly gone over

00:18:44.040 | all the different taxes that you could get hit with,

00:18:46.360 | we're gonna talk about, at different stages of your life,

00:18:50.240 | how you can plan, do tax planning,

00:18:53.960 | and adjust your investments,

00:18:56.840 | and where you invest and how you invest.

00:18:59.480 | And you call this the stages of a dog's tax life

00:19:03.600 | in your book, "The Overtaxed Investor."

00:19:06.040 | Let's go ahead and go through these stages.

00:19:07.360 | You know, they're trying to,

00:19:08.400 | but only paying what you're required to pay, you know, by law.

00:19:12.200 | And so let's start with a young person

00:19:14.920 | who graduated from college, or graduated from school,

00:19:17.760 | is now going out into the world, going to get a job.

00:19:20.840 | This is all new to them.

00:19:22.280 | So take us from there.

00:19:23.880 | - The basic idea is that young people

00:19:26.240 | should, that are in low-income brackets,

00:19:29.240 | ought to place money in a Roth IRA

00:19:32.560 | and let that compound for the rest of their lives

00:19:34.640 | till retirement.

00:19:36.840 | - Well, let's clarify a couple of things.

00:19:38.080 | First of all, a Roth IRA, the money goes in after tax.

00:19:41.200 | So there's no current tax break

00:19:43.400 | on putting money into a Roth.

00:19:45.560 | And the idea is you put money in, it grows tax-free,

00:19:49.480 | and then later on down the road,

00:19:50.760 | you could take it out tax-free.

00:19:52.280 | And in fact, if you don't ever use it,

00:19:54.080 | your children, if you have children,

00:19:56.160 | or whoever's gonna inherit your money,

00:19:57.520 | inherits that account tax-free,

00:19:59.720 | and they have 10 years to take the money out,

00:20:02.200 | but it's all tax-free.

00:20:03.800 | So coming out of school, you get your first job.

00:20:07.480 | You go to your employer.

00:20:09.120 | Your employer says, "We have a 401(k) or a 403(b),

00:20:12.840 | "and you should put money in it."

00:20:15.280 | What are the first question you should be asking?

00:20:17.720 | - Well, the first question you should be asking,

00:20:21.240 | I would say, is do you have an after-tax

00:20:25.320 | or a Roth option on this?

00:20:28.760 | 'Cause as a young person with a relatively low income,

00:20:32.480 | I would want to take advantage of that.

00:20:34.160 | And the second question, which is equally important,

00:20:37.880 | is what's the employer match

00:20:40.560 | on this contribution that I make?

00:20:43.400 | - I agree that if you're not making much money

00:20:45.400 | and you're in a low-tax bracket,

00:20:46.920 | that putting the money in the Roth side of a 401(k)

00:20:51.080 | is a smart idea.

00:20:54.000 | Your employer, by the way, can't do that.

00:20:56.400 | Your employer has to put their match

00:20:59.320 | into a pre-tax 401(k).

00:21:01.960 | - Correct.

00:21:02.800 | - So you're going to get a statement of some sort

00:21:06.200 | that shows pre-tax side and after-tax Roth side.

00:21:11.200 | All right, so now we get married.

00:21:15.640 | We're going to buy a house.

00:21:19.040 | We're pregnant.

00:21:20.120 | We're going to have children.

00:21:22.360 | And we need to save money for college.

00:21:25.000 | How do we do that?

00:21:25.920 | - The smart way to save money for college these days

00:21:30.640 | is through the 529 plan,

00:21:32.600 | which is a plan where you can put money in.

00:21:36.040 | You don't get any federal tax benefit for doing it.

00:21:39.680 | Some states will offer you a tax benefit

00:21:42.400 | for using their plan if you're a resident of their state.

00:21:46.080 | And you can put in $15,000 apiece, husband, wife.

00:21:51.080 | That could be $30,000.

00:21:53.920 | And they let you front load the contribution for five years.

00:21:58.600 | So that's $75,000 apiece or $150,000, if you've got it,

00:22:03.600 | for both of you.

00:22:06.000 | Put that in the 529 plan,

00:22:08.160 | and that covers the five years worth of contributions.

00:22:12.040 | This money inside the plan compounds as Junior grows up.

00:22:17.040 | And then when it comes time for college,

00:22:20.640 | you can take the money out

00:22:21.960 | and you can spend it on college tuition

00:22:25.840 | and on room and board, books, college expenses, computer.

00:22:30.840 | And this is a fabulous way to pay for college,

00:22:34.480 | especially as opposed to the alternative,

00:22:36.400 | which is either having to pay ordinary income

00:22:39.480 | or having to sell stocks, pay capital gains taxes,

00:22:43.920 | and then send the tuition checks to college.

00:22:46.600 | These are sensational vehicles.

00:22:48.720 | Some people have even used them

00:22:50.880 | in ways that were not intended by the original legislation

00:22:55.360 | as de facto retirement savings plan for themselves,

00:22:59.040 | naming themselves as beneficiaries,

00:23:01.080 | take the money out,

00:23:02.240 | paying the penalty for not using it for education.

00:23:06.240 | Or else they can take the money out

00:23:07.760 | and they can take golf lessons at Hilton Head.

00:23:10.680 | But those are unusual uses.

00:23:12.840 | The real idea is kids' college education,

00:23:15.440 | and it's a terrific way to go.

00:23:17.520 | - You could also use it nowadays

00:23:18.800 | to pay for private school up to a certain point.

00:23:22.200 | - It is, but it's generally less valuable

00:23:24.480 | because the point is to have, again,

00:23:26.800 | a long-term compounding.

00:23:29.360 | You can fund the plan the day the child is conceived.

00:23:33.480 | Then you've got a real running start for college.

00:23:37.400 | And if you have enough money,

00:23:38.880 | you can then start using it for high school

00:23:41.920 | or elementary school or even kindergarten.

00:23:45.040 | - So I have clients who even go further than that.

00:23:47.680 | They will fund a 529 in their own name.

00:23:51.840 | And then when they start having children,

00:23:53.960 | they will change the beneficiary to the child.

00:23:56.880 | - And you can do that too.

00:23:57.880 | And you can also rope grandma and grandpa into this,

00:24:01.840 | and they can set up plans for the kids.

00:24:04.600 | - Interesting that you have the grandparents saved

00:24:06.600 | because when you do the FAFSA form,

00:24:08.560 | the money that the parents have counts more

00:24:11.520 | towards whether the child gets financial aid

00:24:14.080 | than what the grandparents have saved.

00:24:16.000 | - But then there's also the question of graduate school.

00:24:18.520 | Because graduate school is not gonna be looking

00:24:20.840 | at parent income, 'cause they'll assume

00:24:23.880 | your child is an adult.

00:24:26.080 | - So now that we are working and we have a family,

00:24:30.000 | we have children, we're saving in a 529,

00:24:32.680 | at what point do we decide, as we make more money,

00:24:36.320 | decide that we're not going to do the Roth 401(k) anymore,

00:24:39.720 | but we're going to start doing the pre-tax 401(k)?

00:24:42.840 | And then since the 401(k) of 403(b)

00:24:46.840 | isn't being fully utilized,

00:24:48.680 | we start doing what's called a mega backdoor Roth.

00:24:51.120 | Can we get into those?

00:24:52.320 | - Sure.

00:24:53.360 | Well, the question about, should I put money in a Roth,

00:24:57.560 | or should I put it in a traditional 401(k),

00:25:02.040 | 403(b), IRA, is a one variable problem.

00:25:07.040 | All you need to know is this.

00:25:10.120 | Am I paying more taxes now,

00:25:12.800 | or will I be paying taxes at a higher rate

00:25:15.560 | when I pull the money out?

00:25:17.300 | You know what you're going to be paying this year in taxes.

00:25:20.000 | You don't know what you're going to be paying

00:25:22.080 | after year 72, or whenever you're going to have to start

00:25:24.720 | pulling the money out.

00:25:26.080 | But at that rate, you're going to have to estimate

00:25:27.760 | what your tax bracket is going to look like.

00:25:30.140 | And if it looks like your tax bracket is higher today

00:25:34.560 | than it is then, which it is for most people,

00:25:36.960 | most people are earning more in midlife,

00:25:40.160 | and they're going to be earning less in retirement.

00:25:44.200 | And so it's the smart move for most people

00:25:48.020 | is to put money in a traditional plan.

00:25:50.580 | You want to pay the taxes when your taxes are lower.

00:25:54.060 | - I want to talk about what's called a mega-backdoor Roth,

00:25:56.780 | because I find it's very useful.

00:25:59.020 | And here is where you have a 401(k) or a 403(b),

00:26:03.620 | where you're putting in the maximum.

00:26:05.460 | And if you're below the age of 50,

00:26:06.860 | the maximum this year is 19,500.

00:26:09.220 | That's what you can put in.

00:26:10.900 | Once you get over 50, it goes up to 26,000.

00:26:14.180 | But your employer on the other side puts money in also,

00:26:19.180 | and that's the match, or sometimes the profit sharing.

00:26:23.420 | And for people under the age of 50,

00:26:26.660 | the maximum this year is 58,000,

00:26:29.780 | and that includes your 19,500

00:26:31.340 | plus what the employer puts in.

00:26:33.040 | So if it's not being utilized,

00:26:36.300 | let's say the employer, you're putting in 19,500,

00:26:39.220 | and the employer is putting in 10,000,

00:26:42.380 | I'll call it 10,500 to make a nice round number.

00:26:45.100 | So they're putting in total of 30,000 is going in,

00:26:48.180 | but a total of 58,000 could be going in.

00:26:51.820 | It's $28,000 worth of that 401(k) or 403(b)

00:26:56.820 | that is not being utilized.

00:26:58.820 | It is, it's a window of opportunity that is not being used.

00:27:03.760 | And you could do, maybe, depending on the plan document,

00:27:10.300 | could do what's called a mega backdoor Roth.

00:27:13.460 | If you have the capacity to put money into a 401(k)

00:27:16.860 | or a 403(b) in excess of the 19,500,

00:27:21.860 | and the plan document allows you

00:27:24.580 | to put that money in after tax,

00:27:27.940 | and then the plan document allows you

00:27:30.700 | to do what's called an in-service distribution,

00:27:34.380 | which means nothing more than you're continuing

00:27:36.180 | to work there, but you can take this money out

00:27:39.080 | and put it into a Roth account.

00:27:40.940 | So those two things, you can put money in after tax,

00:27:44.920 | and then you could take that money out

00:27:46.220 | and roll it over to a Roth after tax.

00:27:49.060 | You could potentially, in my scenario,

00:27:51.820 | where you're putting in 19,500

00:27:53.900 | and the employer's putting in 10,500 and that leaves 28,000,

00:27:57.300 | if you have the ability to do it,

00:27:58.700 | you could potentially put $28,000 a year

00:28:01.900 | into your Roth account using this mega backdoor Roth.

00:28:04.860 | - It's a fabulous strategy.

00:28:07.680 | - If you have the funds available to do that,

00:28:11.220 | that's a great way to go.

00:28:12.580 | And even if your employer won't let you

00:28:15.160 | roll the money out immediately,

00:28:17.340 | it's not the employer, if the plan documents

00:28:19.500 | don't let you roll it out immediately,

00:28:21.620 | even if you have to wait 'til you retire to roll it out,

00:28:24.860 | that's fine, especially assuming you've got

00:28:28.020 | some decent investment options inside the 401(k),

00:28:31.060 | which increasingly you do.

00:28:32.620 | And if you have the kind of plan

00:28:34.140 | that allows this kind of sophisticated strategy,

00:28:36.540 | you probably also have pretty good

00:28:38.560 | investment options within the plan.

00:28:40.400 | So it's a great move.

00:28:41.920 | And one of the few nice moves available

00:28:44.640 | to higher income people.

00:28:47.080 | So they should definitely take advantage of it.

00:28:49.360 | - One more concept for the midlife accumulators

00:28:53.200 | is this idea of asset location.

00:28:56.120 | If you've decided that you wanna have

00:28:57.760 | some bonds in your portfolio, where do they go?

00:29:00.520 | If you wanna have stocks in your portfolio,

00:29:02.640 | where do they go?

00:29:03.680 | Can you address that?

00:29:05.460 | - Well, this has been thrashed around

00:29:08.140 | in the financial planning community forever.

00:29:11.860 | And the answer seems to be this, the short answer.

00:29:16.620 | Stocks go in taxable accounts, bonds go in qualified plans.

00:29:21.620 | Now, there could be some exceptions to this.

00:29:26.180 | For example, with municipal bonds,

00:29:28.540 | you might wanna put those, you would put those

00:29:31.020 | typically in a taxable account.

00:29:32.980 | And if you have other more tax intensive assets,

00:29:37.880 | such as real estate investment trusts, commodities,

00:29:42.120 | you would wanna put those in a qualified plan.

00:29:45.520 | That's the general picture.

00:29:47.720 | - What about the idea of putting growth stocks

00:29:49.940 | in a taxable account and putting high dividend paying stocks

00:29:53.660 | in a Roth or a tax deferred account?

00:29:56.080 | - A great idea, I think that dividend stocks

00:30:01.240 | are very tricky because people love dividend stocks,

00:30:05.200 | but they have to understand that a dividend

00:30:08.840 | is basically a capital gain with a zero cost basis,

00:30:13.840 | the worst kind you can have.

00:30:16.580 | So I've come to love dividend stocks a lot less

00:30:19.420 | unless they're in retirement accounts.

00:30:22.040 | I love dividend stocks in retirement accounts.

00:30:24.620 | And just as you say, I much prefer growth stocks

00:30:28.420 | that don't pay a dividend or pay very low dividends

00:30:31.740 | in taxable accounts, that's great advice.

00:30:34.540 | - I wanna get into another issue,

00:30:36.260 | and this doesn't have anything to do

00:30:37.940 | with saving for retirement,

00:30:40.180 | but it has to do with buying a house

00:30:41.980 | and whether you should take out a mortgage

00:30:45.420 | or whether you should make a big down payment.

00:30:48.180 | And I wanna tie that into the standard deduction

00:30:51.400 | that we have nowadays.

00:30:53.740 | What do you think about when you're talking with clients

00:30:55.720 | who may have the ability to pay cash,

00:30:58.040 | maybe they had some RSUs, restricted stock

00:31:01.520 | from a company that they sold,

00:31:02.780 | and they have a lot of after-tax cash,

00:31:04.820 | and they're thinking about using that

00:31:06.980 | to pay off their mortgage or buying a home

00:31:09.100 | without a mortgage, what's the formula

00:31:11.740 | that we're using these days?

00:31:13.820 | - Well, I may be doing something perverse, I don't know.

00:31:16.340 | I tell clients, and we're talking about people

00:31:19.460 | in their 50s, 60s, that I encourage them

00:31:23.700 | to take as big a mortgage as they can get

00:31:26.340 | as they approach retirement.

00:31:28.020 | But this is not for tax reasons

00:31:30.840 | because they're not gonna get,

00:31:32.300 | of course, this will change under President Biden.

00:31:34.460 | Currently, most of them are not able

00:31:36.740 | to use the itemized deductions.

00:31:39.920 | They won't get a big mortgage deduction for it.

00:31:42.300 | The reason I like it is because a mortgage

00:31:45.860 | is a inflation-sensitive asset.

00:31:49.260 | So if you conceive of inflation

00:31:53.420 | as being the number one enemy of a retiree,

00:31:56.740 | this is a great way to have a lot of,

00:31:59.740 | to have a sort of defensive position.

00:32:01.960 | Your mortgage will decrease with inflation

00:32:05.180 | while other assets on the other side of the ledger

00:32:07.860 | will be decreasing as well.

00:32:09.700 | So it's a way of decreasing your liabilities.

00:32:12.300 | But that's just, that's not so much a tax strategy

00:32:15.140 | as it is a retirement inflation strategy,

00:32:18.340 | especially now that the new stimulus bill has been passed,

00:32:22.100 | America's Rescue Plan, it's called.

00:32:24.700 | We suddenly find inflation poking up its head

00:32:28.180 | for the first time in 20 years.

00:32:30.620 | - Generally, the way I frame it,

00:32:32.220 | and now we're getting into the midlife accumulators,

00:32:34.820 | you know, age 50 or so, we'll continue to march here,

00:32:39.460 | is that if you're gonna hold a lot of cash

00:32:42.260 | in your taxable account, you're not gonna hold CDs

00:32:45.840 | or short-term municipal bonds in your taxable account.

00:32:50.580 | That buying back your mortgage,

00:32:53.340 | if you're not doing itemized deductions

00:32:55.060 | because you're doing standard deduction,

00:32:56.940 | buying back your mortgage is the best bond you could buy

00:33:00.180 | because it gives you an after-tax return

00:33:03.440 | based on the amount of your mortgage interest.

00:33:06.500 | Now, again, this is for people

00:33:07.860 | who are going to hold fixed income anyway.

00:33:10.260 | I try to encourage them,

00:33:11.780 | well, don't hold so much fixed income.

00:33:14.060 | If you're gonna hold fixed income,

00:33:15.260 | take some of that fixed income

00:33:16.460 | and just buy your mortgage back.

00:33:18.220 | - Yes, yes, a mortgage is just a negative bond.

00:33:21.540 | And so the two cancel each other out,

00:33:23.540 | except to the extent to which

00:33:24.780 | you have a liquidity preference.

00:33:26.740 | And it's not irrational to have a liquidity preference.

00:33:29.980 | So there's that as well.

00:33:31.180 | I should also say that I've been pushing

00:33:33.060 | the idea of mortgages when the mortgage rate

00:33:36.580 | has been two and a half, 3%,

00:33:39.140 | figuring that this is gonna likely to go up over time.

00:33:42.780 | As mortgage rates starts to amp up themselves,

00:33:46.140 | I'm gonna become less geeky

00:33:48.340 | about trying to take advantage of that.

00:33:51.420 | - Let's talk about large, unrealized gains in stock

00:33:56.420 | that someone may have, might be A shares of stock,

00:34:01.620 | which are original owner stock

00:34:04.340 | of a company that went public,

00:34:06.220 | or maybe somebody was fortunate enough

00:34:08.140 | to buy Amazon 20 years ago,

00:34:11.300 | or Apple 20 years ago in their account,

00:34:13.660 | and they have a very large capital gain in one stock.

00:34:18.060 | How do we deal with that?

00:34:20.020 | - This is a very tough problem.

00:34:23.420 | Every sensible person you talk to will say,

00:34:25.740 | sell and diversify.

00:34:27.540 | Sell the stock, pay the taxes,

00:34:30.660 | and diversify into a broad index portfolio.

00:34:34.380 | And I can't argue with that.

00:34:37.540 | And whatever you do will turn out to be wrong.

00:34:41.140 | So if you hang on to what the stock's gonna crater,

00:34:45.060 | if you sell it, it's gonna immediately double.

00:34:47.340 | It's a tough position to be in.

00:34:49.340 | And there are different strategies.

00:34:50.900 | You can try to buy a portfolio of stocks

00:34:55.100 | that are going to complement it

00:34:57.260 | and behave differently than how Amazon might behave,

00:35:01.300 | if you can figure that one out.

00:35:03.460 | Or you can use some option strategy.

00:35:06.300 | You've gotta be careful there

00:35:08.020 | because if you get it too tightly bound,

00:35:11.020 | you can end up with a constructive sale of the stock anyway.

00:35:14.460 | The people that are selling those

00:35:15.940 | tends to be quite expensive service they're providing

00:35:18.980 | when you look at all that.

00:35:21.420 | You can use these exchange funds

00:35:24.700 | where people will take it off your hands

00:35:26.740 | and they'll give you shares of a mutual fund

00:35:29.460 | made from other people's discarded, unloved big holdings.

00:35:34.460 | But that is also one

00:35:36.780 | I've never really seen work out that well.

00:35:39.220 | The fees tend to be very high

00:35:41.580 | and it's hard to know

00:35:42.420 | what you're gonna actually be getting

00:35:43.980 | when these things terminate.

00:35:46.300 | So I don't know.

00:35:47.140 | What do you think, Gregg?

00:35:47.980 | What do you do?

00:35:49.380 | - Well, you could use gifting

00:35:52.220 | to gift a portion of your shares to a charity

00:35:56.300 | through a donor advised fund

00:35:57.780 | so that you could take a big tax deduction upfront.

00:36:01.780 | And then now that you have a big tax deduction,

00:36:05.260 | you can offset that with taking a capital gain

00:36:08.980 | on the rest of the shares.

00:36:10.780 | So you're gonna be popping up

00:36:13.100 | probably to a 20% capital gain tax

00:36:15.500 | and then you have your 3.8%

00:36:20.220 | net investment income tax on top of that.

00:36:22.700 | And so whatever you gift to charity

00:36:26.260 | can help to offset that at the same time.

00:36:30.180 | So they go hand in hand, right?

00:36:31.660 | A gift to charity,

00:36:33.020 | sell some of your appreciated assets.

00:36:36.100 | And once you sell the appreciated assets, by the way,

00:36:38.060 | I tell people to do this at the beginning of the year,

00:36:40.300 | the beginning of the year.

00:36:41.540 | Why do I say do it at the beginning of the year?

00:36:44.300 | Because then you could take the money

00:36:46.620 | and you could buy a total stock market index fund,

00:36:50.100 | total international index fund, call it ETFs.

00:36:53.780 | I like ETFs and taxable accounts.

00:36:55.700 | And why would it be wise

00:36:57.980 | to do this at the beginning of the year?

00:37:00.820 | Because once you buy the total stock market ETF

00:37:04.380 | and the total international ETF,

00:37:05.980 | if during the year the market goes down,

00:37:08.980 | you could do tax loss harvest

00:37:11.820 | by selling the total stock market ETF or one of them

00:37:16.660 | and turning around and buying another one that's similar,

00:37:18.660 | but not substantially identical.

00:37:20.740 | You could sell the Vanguard total stock market ETF,

00:37:22.820 | you can buy the iShare total stock market ETF.

00:37:25.660 | There are two different companies,

00:37:26.860 | there are two different indices,

00:37:28.300 | not substantially identical,

00:37:29.780 | but you get to take a tax loss.

00:37:31.420 | And that's the key.

00:37:32.540 | So if you did these trades,

00:37:34.420 | you wanna do them at the beginning of the year

00:37:35.900 | so you could take the money and do something else with it

00:37:38.900 | so that if the market does go down,

00:37:40.900 | you could do tax loss harvesting

00:37:42.780 | and swapping into similar funds,

00:37:45.340 | take the tax loss from that and offset some of the gain.

00:37:48.540 | - Very good.

00:37:50.620 | The only caveat I would say is that

00:37:53.900 | under the new Biden plan,

00:37:56.620 | the idea is to cap the deductions at 28%.

00:38:01.620 | And of course, the devil's in the details,

00:38:05.220 | we'll see what actually emerges.

00:38:07.380 | But if your deductions are capped at 28%,

00:38:11.740 | the benefit from donating your appreciated stock

00:38:15.660 | to a donor advised fund

00:38:17.700 | might not be as much as it was before.

00:38:22.300 | So it's gonna make the strategy slightly less good.

00:38:25.940 | It's better than nothing.

00:38:27.260 | It's a great way to go.

00:38:28.540 | It's better than holding onto the stock

00:38:30.620 | and watching it go down 90%

00:38:32.820 | because of something you didn't see,

00:38:34.580 | which is what will happen if you keep it.

00:38:36.300 | - There are some people who say

00:38:37.380 | that doing what's called direct indexing is a good idea,

00:38:39.580 | which is to take from the sale

00:38:41.620 | of a highly appreciated security,

00:38:43.900 | taking that money

00:38:45.700 | and putting it into a direct indexing portfolio,

00:38:48.340 | which is nothing more than

00:38:50.380 | you give it to an investment advisor

00:38:51.980 | who buys all 500 stocks in the S&P 500 in one account.

00:38:56.700 | And then as the individual stocks one by one have losses

00:39:01.700 | to harvest the losses and therefore in the first year,

00:39:05.260 | again, if you did this at the beginning of the year,

00:39:07.620 | in the first year,

00:39:08.460 | you could harvest a lot more losses

00:39:10.820 | than doing the ETF strategy that I talked about.

00:39:13.500 | The problem with that is number one,

00:39:16.340 | you have 500 stocks.

00:39:18.380 | That's a problem right there.

00:39:19.780 | And secondly, 20 years from now,

00:39:21.940 | you still have 500 stocks,

00:39:23.420 | even though this thing has played out

00:39:26.060 | and you've gotten your losses from it.

00:39:27.900 | And you have to continue

00:39:28.740 | to pay management fees along the way.

00:39:30.540 | It makes it very cumbersome for you

00:39:32.540 | and complicated to try to do this direct indexing.

00:39:36.020 | And getting back to your concept of turning your stock in

00:39:40.020 | and getting a basket of stocks later,

00:39:41.700 | I think you have to wait seven years.

00:39:43.540 | Yes, seven years at very high fees typically too.

00:39:47.740 | Right.

00:39:48.780 | So there's really no great solution

00:39:50.700 | to what to do about the highly appreciated stock

00:39:54.780 | in the portfolio.

00:39:56.540 | Selling little by little as you move along

00:39:59.100 | might be helpful.

00:40:00.180 | It's always a question that people have.

00:40:02.300 | What do I do with this?

00:40:03.140 | And my answer was,

00:40:04.100 | well, you should have done a mega backdoor Roth

00:40:06.260 | and you should have bought it in a Roth.

00:40:07.660 | (laughing)

00:40:09.620 | Yes.

00:40:10.460 | And you wouldn't have any tax issues.

00:40:12.260 | In fact, I tell people,

00:40:13.540 | going forward now that we finally cleaned up your portfolio,

00:40:16.580 | if you're ever gonna buy stocks again,

00:40:18.940 | individual stocks, please do them in your Roth.

00:40:21.580 | So we don't have any tax issues.

00:40:22.940 | That's where you would wanna buy individual stocks.

00:40:24.860 | If you have the capacity, buy them in your Roth.

00:40:27.780 | I am a fan of the idea of direct indexing.

00:40:31.820 | I don't think the implementation

00:40:34.180 | is quite where we want it to be yet,

00:40:36.780 | but I think it will get there.

00:40:38.340 | I think there's real potential there,

00:40:40.620 | especially if it will let me tweak the portfolio

00:40:44.100 | along the dimensions that I wanna tweak it.

00:40:46.620 | And that will go into factor investing

00:40:49.140 | or zero dividend investing and stuff like that.

00:40:52.100 | So I think it has potential,

00:40:53.300 | but I haven't seen a solution to it

00:40:56.860 | that I'm been on board enough with yet to say,

00:41:00.100 | okay, let's do that.

00:41:01.980 | - Yeah, I think the solution in the end,

00:41:03.660 | I've been putting this out there for years,

00:41:05.420 | has been if somebody, some entrepreneurial person

00:41:08.220 | came up with a methodology for taking that portfolio

00:41:13.220 | and turning it into an ETF company

00:41:16.620 | and getting shares of one single ETF

00:41:19.220 | at the cost basis of the entire portfolio,

00:41:21.380 | that would be a marvelous idea.

00:41:22.780 | Of course, the direct indexing companies

00:41:24.260 | are not gonna do that

00:41:25.460 | because they don't wanna lose

00:41:26.300 | those management fees every year.

00:41:28.220 | So it would have to be an ETF company

00:41:31.260 | that actually comes up with that solution.

00:41:32.900 | Take your direct indexing portfolio,

00:41:35.260 | turn it into us,

00:41:36.420 | and we will give you shares of S&P 500 index fund

00:41:40.380 | at the cost basis of the whole portfolio

00:41:42.260 | if the IRS will buy off on that.

00:41:44.860 | - Well, I think it's up to you to do it, Rick.

00:41:47.220 | - No, no, no, no.

00:41:48.060 | - Can I just say one more thing about this?

00:41:49.980 | Under the new Biden tax plan,

00:41:52.260 | it could well be the case

00:41:53.700 | that if you earn over a million dollars,

00:41:56.420 | that you would be paying 39.6% on capital gains.

00:42:01.220 | Now you're looking at your Amazon stock that's appreciated,

00:42:05.060 | and you're thinking,

00:42:05.900 | "Well, gee, do I wanna pay 20% on capital gains this year,

00:42:10.020 | or do I wanna roll the dice

00:42:11.540 | and maybe pay 40% on capital gains next year?"

00:42:14.900 | So these are the kinds of things

00:42:16.380 | that investors are gonna be thinking about

00:42:18.180 | by the end of 2021.

00:42:20.980 | - I think we will know by the end of 2021

00:42:23.380 | which direction these tax changes are gonna go.

00:42:27.020 | Next year, remember, is another election year.

00:42:30.100 | Let's go ahead and move on to getting ready for retirement.

00:42:33.060 | Again, getting ready for retirement.

00:42:34.420 | We have money in a 401(k).

00:42:36.060 | We have money in a Roth account.

00:42:37.980 | We have something in our taxable account.

00:42:41.220 | We need to take Social Security at some point,

00:42:43.020 | but we don't know when.

00:42:44.060 | We may wanna do some Roth conversions.

00:42:47.020 | This period between age 59 1/2 and call it 69

00:42:52.420 | before, if you decide to delay Social Security,

00:42:56.060 | or even 65 when you get Medicare,

00:42:59.700 | there's a lot going on during this period of time.

00:43:02.380 | - This is the most underrated period

00:43:06.020 | for tax planning imaginable.

00:43:08.540 | There is suddenly a lot of potential.

00:43:11.580 | I think it really starts when you decide to retire.

00:43:15.300 | Between the retirement

00:43:17.140 | and between when you have to start taking

00:43:19.740 | required minimum distributions from your retirement plans,

00:43:24.740 | you have a window of opportunity to look ahead

00:43:28.380 | over the entire sweep of your retirement

00:43:31.180 | and do some canny tax planning.

00:43:35.740 | And so I strongly encourage people

00:43:39.660 | to take advantage of this time

00:43:41.860 | because suddenly your income is low.

00:43:45.100 | You're not getting a big paycheck from your job

00:43:49.420 | and that means that you have the potential

00:43:52.180 | to possibly do some Roth IRA conversions.

00:43:56.660 | If you fail to take advantage of this,

00:43:59.180 | what will happen is that you'll be forced to withdraw money

00:44:03.180 | from your traditional IRAs, 401(k)s, 403(b)s,

00:44:07.380 | all of your traditional qualified plans.

00:44:10.540 | And that check starts out being 3.6%, something like that.

00:44:17.580 | But the amount of the check is going to escalate

00:44:21.700 | as a percentage of the plan every year

00:44:24.100 | until by the time you're 90 years old,

00:44:25.740 | you're taking out 10% of your plan every year.

00:44:28.500 | And so it's gonna knock you into higher tax brackets

00:44:32.340 | over the course of your retirement,

00:44:34.220 | or at least that's what you wanna guard against.

00:44:36.980 | So you need to sort of step back

00:44:39.620 | and take a look at what's gonna be happening.

00:44:42.100 | The second big thing you need to take a look at

00:44:44.500 | is in the event that you don't live forever

00:44:47.460 | or your spouse doesn't live forever,

00:44:49.620 | what's gonna happen when you or your spouse die

00:44:53.380 | and the remaining party, the last person standing,

00:44:57.620 | is gonna suddenly be filing single

00:45:00.220 | rather than married filing joint.

00:45:02.900 | And they're gonna find, wait a minute,

00:45:05.020 | I've got a whole different set of tax brackets

00:45:07.380 | that I've gotta apply now.

00:45:09.380 | And so I'm paying taxes at a much higher rate

00:45:11.940 | than I was before.

00:45:13.340 | So you've got to step back and see,

00:45:16.500 | how can I plan for these contingencies

00:45:18.940 | and what's the best way of doing it?

00:45:21.260 | - Well, let's also throw into this that at age 65,

00:45:24.260 | you're gonna go on Medicare.

00:45:25.500 | And Medicare is gonna be based on the decisions you make

00:45:29.940 | at age 63, unless you file a form otherwise,

00:45:34.380 | where if you're doing these Roth conversions,

00:45:36.980 | 63, 64, 65, it could bump you up into higher Medicare costs.

00:45:45.260 | You have to take into account so many variables,

00:45:48.900 | it's unbelievable.

00:45:50.460 | And they're variables that are in many cases,

00:45:53.540 | we just don't know the answer.

00:45:55.020 | We don't know what the future of the tax code is.

00:45:57.540 | We don't know how long you're gonna live

00:45:59.580 | or your spouse is gonna live if you're married.

00:46:01.820 | We don't know what the future

00:46:02.860 | of your investment returns are gonna be.

00:46:05.060 | So this is not an easy Rubik's cube to get lined up.

00:46:10.060 | There are all these different thresholds

00:46:12.220 | you've gotta be watching out for.

00:46:14.780 | And this is why we have to resort to the use of tools,

00:46:19.780 | financial planning tools,

00:46:22.260 | to try to wrap our brains around the problem.

00:46:26.340 | - Well, there's a lot of good software out there now,

00:46:29.780 | new retirement and income solver.

00:46:32.780 | There's several software packages that help you do this.

00:46:35.900 | - And I encourage people to be very judicious

00:46:39.700 | in their use of it.

00:46:40.780 | I don't think people should just plug in the numbers,

00:46:43.580 | push the button and then do what it says.

00:46:45.620 | They need to really think about

00:46:47.180 | how all these things interact and ask questions.

00:46:50.620 | What happens if I live longer?

00:46:52.820 | What happens if tax rates rise more than I think?

00:46:56.700 | What if my investment returns

00:46:57.860 | aren't as good as I hope they are?

00:46:59.980 | And look at many different kinds of scenarios

00:47:02.860 | to get a sense of where's the sweet spot

00:47:05.860 | in terms of my Roth IRA conversion strategy

00:47:09.780 | and my retirement income drawdown strategy.

00:47:13.420 | - I'll give a plug to the Bogleheads on bogleheads.org.

00:47:17.220 | If you go to bogleheads.org wiki, tools and calculators,

00:47:22.220 | there's a whole range of calculators

00:47:26.020 | that Bogleheads have created for free

00:47:28.540 | and put it up on the wiki.

00:47:30.060 | And there's all types of RMD calculators,

00:47:33.340 | retirement calculators, social security calculators,

00:47:36.900 | Roth conversion calculators.

00:47:38.780 | If you're looking for a calculator

00:47:40.740 | to come up with some numbers and for free

00:47:44.140 | on bogleheads.org, the wiki under tools and calculators,

00:47:48.700 | you're gonna find it there.

00:47:51.020 | - A sensational resource.

00:47:53.460 | - So we've got this dilemma here

00:47:55.860 | where we have to look at all this

00:47:58.180 | and we have to make a determination at some point.

00:47:59.980 | When do we take social security

00:48:01.580 | and how did social security work into all of that?

00:48:05.180 | - This is something that I would turn over to a calculation,

00:48:08.540 | to a tool of some kind.

00:48:10.620 | Social Security Solutions offers one,

00:48:13.180 | Kotlikoff offers one, I think with Maxify Planner.

00:48:17.020 | There are free versions of this floating around.

00:48:19.740 | - Michael Piper has a great version.

00:48:21.140 | - Michael Piper's version, exactly.

00:48:22.820 | - Open social security.com.

00:48:25.020 | - And there's a little bit of judgment involved

00:48:26.660 | in using these, but basically you want to plug in

00:48:29.340 | your numbers, spouse numbers or earnings,

00:48:32.780 | longevity estimates and find out

00:48:34.940 | when to take social security.

00:48:36.540 | Maybe it's just me, I have an inherent bias towards,

00:48:39.980 | let's put it off to the last possible minute.

00:48:42.620 | The idea of being able to get an inflation adjusted annuity

00:48:47.140 | from the government is, I mean, this is not sold in stores.

00:48:51.220 | You can't buy this from any private company.

00:48:54.580 | So I love the idea of watching that grow 8% a year

00:48:59.220 | from full retirement age to the maximum age

00:49:03.180 | at which I can take it.

00:49:04.580 | I just don't see anybody offering anything like that.

00:49:07.580 | - And especially if you are married and you die first,

00:49:12.540 | that annuity is gonna be very valuable for your spouse.

00:49:16.700 | - Yes.

00:49:17.540 | - So my bias is to wait, but the claiming strategies

00:49:20.860 | do get complicated and you should pay close attention

00:49:23.780 | to them because there are occasions when one person

00:49:25.940 | should wait, the other person should file early.

00:49:28.820 | You need to look at the software

00:49:30.700 | and then before you start getting cute

00:49:32.220 | with your own opinions about things.

00:49:35.500 | - So at age 72, at least that's the age now,

00:49:37.900 | you have to start taking required minimum distributions

00:49:40.420 | and you take your ending balance of December 31st

00:49:44.620 | to divide it by 25.6 is the number right now.

00:49:48.140 | And it tells you how much you have to take as an RMD.

00:49:51.060 | And then it goes up, have to take out more and more

00:49:52.980 | and more and more, so your taxes go up.

00:49:55.460 | But I've got some clients who looked at that and said,

00:49:58.740 | you know, that's okay because my children

00:50:03.740 | are not making much money.

00:50:05.140 | So, and maybe my health isn't all that great.

00:50:10.020 | So I wanna die with a lot of money

00:50:13.100 | in my pre-tax retirement account

00:50:15.140 | so that my children will inherit this money.

00:50:16.940 | And even if they had to take it out

00:50:18.140 | over a 10 year period of time, which is the new law,

00:50:22.660 | they're in a low tax bracket and they can actually

00:50:25.020 | get the money out at a lower tax bracket than I can.

00:50:28.140 | And then I have the opposite, by the way,

00:50:29.620 | where there are some people who are retired who say,

00:50:31.700 | no, you know, our children are making a lot of money

00:50:34.900 | and they're all in the highest tax brackets.

00:50:36.660 | We are retired and we're in the low tax bracket.

00:50:39.700 | So we're gonna take out as much as we can

00:50:41.620 | up to say the top of the 32% bracket every year,

00:50:45.100 | more than what we need to take out.

00:50:46.700 | We're gonna put that into a Roth

00:50:48.500 | because even though we're paying the taxes currently

00:50:50.740 | on that, we're paying it at a lower tax bracket

00:50:52.620 | than what our children would pay it at

00:50:54.460 | when they get their inheritance.

00:50:55.980 | Now it just depends on each person.

00:50:58.560 | - Well, it goes back to the same question as earlier.

00:51:03.340 | These retirement plans are owned partly by you

00:51:05.660 | and partly by the government.

00:51:07.380 | And you want to pull the money out

00:51:09.860 | when your share is the greatest

00:51:11.940 | and the government share is the least.

00:51:13.860 | So if your taxes are higher than your kids,

00:51:17.100 | then that dictates a different plan

00:51:19.020 | than if your kids' taxes are higher than yours.

00:51:21.100 | If your kids' taxes are higher,

00:51:22.180 | you wanna give them a Roth.

00:51:23.620 | If your taxes are higher,

00:51:25.340 | then you want to give the kids a traditional,

00:51:28.700 | let them inherit the traditional IRA.

00:51:31.300 | - Now there is one thing we could do

00:51:32.440 | to lower our required minimum distribution,

00:51:34.420 | and that is a qualified charitable distribution.

00:51:37.700 | I wanna touch on this and then get into,

00:51:40.980 | last thing we'll talk about is estate planning.

00:51:43.380 | What is a qualified charitable distribution?

00:51:45.980 | - Well, the IRS has said that anybody over 70

00:51:51.620 | can apply up to $100,000

00:51:56.260 | of their required minimum distribution.

00:51:59.780 | And instead, they can ship it to a charity,

00:52:04.580 | not a private family foundation,

00:52:06.760 | not a donor-advised fund.

00:52:08.940 | But if it's a public charity,

00:52:10.760 | they can give the money to that,

00:52:12.320 | or they can split it to 20 public charities if they want.

00:52:16.000 | Up to $100,000 will count towards their RMD.

00:52:21.000 | So this is gonna become very useful,

00:52:23.680 | especially for higher income individuals in retirement.

00:52:28.720 | You can use it to target a particular number

00:52:31.840 | for Medicare or capital gains or whatever you want.

00:52:35.940 | You could just look at the tax code and say,

00:52:37.720 | I wanna have my income this year hit this number.

00:52:41.880 | And using strategically

00:52:44.140 | these qualified charitable distributions,

00:52:46.500 | it's a way to do it.

00:52:48.020 | Just make sure that the qualified charitable distribution

00:52:50.920 | comes out before the rest of your RMD.

00:52:53.960 | You can't pull out the RMD

00:52:55.720 | and then think at the end of the year,

00:52:56.960 | well, now I'll take out this

00:52:58.380 | qualified charitable distribution.

00:53:00.160 | It's too late.

00:53:01.000 | That'll just count as you won't get the tax benefit from it.

00:53:03.920 | - Oh, thank you.

00:53:04.920 | I didn't know that.

00:53:05.760 | I appreciate that.

00:53:07.040 | Let's talk about some more estate planning things

00:53:10.400 | as we're now at the end of life

00:53:12.640 | and what can we be doing tax-wise to help future generations?

00:53:17.160 | - One of the big things now,

00:53:19.080 | again, I'm looking at the Biden plan.

00:53:23.080 | It's gonna reshape estate planning significantly

00:53:27.040 | because the goal is to get the estate tax exemption

00:53:31.800 | from whatever it is, 11.68 million,

00:53:35.120 | cut it 70% down to three and a half million,

00:53:39.160 | which means suddenly lots of people that thought,

00:53:41.240 | oh, estate problems, we don't got them.

00:53:44.320 | Suddenly they have estate problems.

00:53:46.760 | So your estate planning attorneys,

00:53:49.420 | tax planning attorneys

00:53:50.640 | are gonna be doing a booming business this year,

00:53:53.920 | redoing everybody's estate plan.

00:53:55.520 | So the big question is gonna be like,

00:53:57.600 | a small business owner, holy smokes,

00:54:00.400 | I don't wanna pay 40% of the taxes

00:54:02.840 | on the sale of this business to IRS.

00:54:05.140 | I've gotta find some way of getting this business,

00:54:07.920 | this personal business out of my estate.

00:54:11.640 | And I'm gonna have to maybe do an installment sale

00:54:15.160 | to a trust of some kind,

00:54:18.120 | but somehow I don't want it to be part of my estate

00:54:21.000 | because it could even be taxed twice.

00:54:23.360 | It could be taxed as part of my income tax,

00:54:25.840 | and it could also be taxed as part of my estate tax

00:54:28.280 | if I were to sell it.

00:54:29.400 | 'Cause remember, they're talking about

00:54:31.200 | enforced capital gains recognition at death.

00:54:35.920 | And this is another whole new thing

00:54:38.700 | that's going to really stir the pot in estate planning.

00:54:43.320 | And it's gonna even have implications

00:54:44.880 | for people that are retired,

00:54:47.120 | who suddenly think I've got my $10 million in Amazon stock,

00:54:51.880 | so do I wanna pay the tax on it at 40%

00:54:55.120 | where I wanna ship $4 million to the government when I die,

00:54:59.360 | or do I wanna ship just 2 million to the government

00:55:02.880 | if I sell it this year?

00:55:04.800 | There are gonna be all these issues rising to the forefront

00:55:08.000 | one way or the other.

00:55:08.960 | We don't know what the final plan's gonna look like.

00:55:10.860 | We know what has been discussed,

00:55:13.360 | but it's gonna have very, very big implications

00:55:16.800 | and coordinating your tax planning and retirement

00:55:20.200 | with your estate plan is going to be absolutely crucial.

00:55:25.000 | - Phil, it's been wonderful to have you on the show today.

00:55:27.000 | Really appreciate your insights.

00:55:28.660 | And the name of the book is called

00:55:30.120 | "The Overtaxed Investor, Slash Your Tax Bill

00:55:33.480 | and Be a Tax Alpha Dog."

00:55:36.160 | And I imagine that when the new Biden tax bill comes out,

00:55:40.480 | you're gonna be doing another edition?

00:55:42.760 | - Back to the drawing board, you bet.

00:55:44.120 | - (laughs) Okay.

00:55:45.520 | Well, thank you so much for being

00:55:46.980 | on the Bogle Heads on Investing show.

00:55:48.520 | We greatly appreciate having you today.

00:55:50.760 | - Thanks so much for having me, Rick.

00:55:51.960 | Take care.

00:55:53.360 | - This concludes Bogle Heads on Investing,

00:55:55.320 | podcast number 32.

00:55:57.800 | I'm your host, Rick Ferry.

00:56:00.080 | Join us each month to hear a new special guest.

00:56:03.400 | In the meantime, visit bogleheads.org

00:56:06.800 | and the Bogleheads Wiki.

00:56:08.560 | Participate in the forum and help others find the forum.

00:56:12.800 | Thanks for listening.

00:56:13.800 | (upbeat music)

00:56:16.380 | (upbeat music)

00:56:18.960 | (upbeat music)

00:56:21.540 | (upbeat music)

00:56:24.120 | [BLANK_AUDIO]

Bogleheads® on Investing Podcast 032 – Phil DeMuth, host Rick Ferri (audio only)

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