(upbeat music) Welcome to the Bogleheads Chapter Series. This episode was hosted by the Retired Life States Chapter and recorded September 21st, 2021. It features Wade Pfau, PhD, CFA, discussing RISA, his retirement income style awareness tool, as well as tax planning considerations in retirement. Bogleheads are investors who follow John Bogle's investing philosophy for attaining financial independence.

This recording is for informational purposes only and should not be construed as personalized investment advice. Welcome everybody to the Retired Life Stage meeting. I'm Alan, one of the chapter coordinators along with my colleagues, Robert, Henry, and Raj. We're very pleased to have Wade Pfau joining us this evening. We'll start with our usual disclaimer that this presentation is for informational purposes only and should not be construed as personalized investment advice.

And I'll turn the mic over to my colleague, Robert, who will formally introduce Wade and the presentation topics. Thank you, Robert. - Thank you, Alan. Yes, well, it's my pleasure this evening to introduce our guests, Dr. Wade Pfau. I think many in the Boglehead community are quite aware of his accomplishments.

Wade is a retirement researcher and professor of retirement income in the PhD program for financial and retirement planning at the American College of Financial Services. He's also principal director of retirement research at McLean Asset Management, and he's the founder of Retirement Researcher. Wade holds a master's and doctorate in economics from Princeton University and a bachelor of arts and a bachelor of science degrees from the University of Iowa.

He's also a chartered financial analyst. Wade is a prolific writer and researcher. He's authored many papers and books on a wide spectrum of retirement-related topics, including in-retirement withdrawal rates, optimum asset allocations for retirement, and the role of annuities retirement portfolio. His latest book, of which we will speak from tonight, is called "The Retirement Planning Guidebook," which I have, let me show you, nice and big.

"Navigating Important Decisions for Retirement Success." As a retirement community here, most of us know that the deaccumulation phase of our assets can be a lot more complex than the accumulation phase, and I think this work helps us in that regard. Wade's gonna speak twice tonight, two different presentations. The first presentation's gonna work the left side of our brain, and it's directed more towards the behavioral side of finance.

We'll be looking at the retirement income styles and decisions. It's kind of a Morningstar-style box for self-awareness of income strategies. I believe they use the acronym RESA, which is Retirement Income Style Awareness. These questionnaires in RESA, in theory, can reveal an individual's tolerance for risk in retirement, what income style best fits that individual, and the value of financial advice if they choose to move in that direction.

The second presentation will work the other side of our brain, and it really deals with Chapter 10 from his textbook, and it's "Tax Planning for Efficient Retirement Distributions." Here, Wade will present some tax-efficient distributions that can prolong the sustainability of retirement assets and take an advantage of really of tax diversification and tax bracket management.

So with that, I hand it over to Dr. Wade Fowler. - Okay, thank you, Robert, and thanks, Alan and Raj and Lady Geek and everyone who's been helpful in setting up the meeting today. Can you see my screen okay? I don't have the usual Zoom. Can everyone hear me and see?

- Yes. - Okay, great. So thanks, everyone. I joined the Bogleheads, I think it was 2010. My profile will verify that. I was pretty active for a few years. I haven't been as active in recent years, but it is great to reconnect again with the Bogleheads community. And as Robert mentioned, the presentations today are from, based on the "Retirement Planning Guidebook," which I've really been writing for nine years now, and it's finally finished.

The presentations aren't equal in length, just in terms of this topic was about 15 pages of the book, and then the tax planning chapter was more than 70 pages. So we won't have that big of a difference in presentation lengths, but hopefully we'll have some more time for the tax planning compared to, we'll start with the retirement income styles.

So with that being said, I've now generally tried to approach retirement with these 12 general topic areas. And I think what we're talking about first is retirement income styles is the best starting point to start thinking about building a retirement strategy. And also in that regard too, we ran a poll about which chapters my retirement researcher community was most interested to hear about.

In tax planning, our second presentation today won that poll by a wide margin. And the retirement income styles was in third place. The second place one was the, how much can you spend from an investment portfolio? That whole 4% rule world type topic that I know is also quite popular at Bogleheads.

But we'll talk about the retirement income styles, and then you can just see the other aspects of like understanding different retirement risks, quantifying your goals, determining if you're prepared for retirement, looking at different investment and annuity strategies, which will stem from understanding your retirement income style. And then the social security claiming decision, healthcare and Medicare decisions, long-term care, retirement housing, the tax planning, legacy and incapacity planning.

And then just as important as any of the finances is just the non-financial aspect of having purpose and passion for retirement and then implementing and monitoring the plan. So would that be instead for the retirement income style discussion, the agenda will be to just discuss that there are a lot of different retirement income strategies out there.

And we haven't really in the past had a way to choose among them. And I think that's just created conflict because there's just, you can ask basic questions about retirement and get completely different answers based on who you're talking to. And so we need a way to better filter these styles.

And that's, this led to a research project that I did with Alex Mardia, where we tried to identify just by reading and reading everything out there about retirement planning. How did people talk about retirement planning? Were there particular factors that seem to be prevalent in terms of there's some sort of trade-off out there?

And then we did try to test those with, we started with about 900 questions. Alex likes to talk about that. We whittled it down quite a bit since then. But can we figure out if there are distinct preferences that might help to define a style? And what was really interesting was about that.

And as I'll be talking about is just how well these different preferences work together to actually explain the main retirement strategies that we know about. And so then linking these styles to the different strategies and different retirement tools. So we know that retirement is different from pre-retirement, that this is the whole issue of what makes retirement income planning distinct.

Pre-retirement, you're still working and can rely on work to fund your lifestyle, you're saving for the future. But you're generally, you have more of an accumulation mindset where you can focus more on risk-adjusted returns, modern portfolio theory, like building that efficient frontier, seeking a well-diversified investment portfolio. But a few things change in retirement.

You now change from adding new savings to now taking distributions. And that you don't know how long you're gonna be doing that for. So there's this element of longevity risk. There's an element of when you're taking distributions from your portfolio, there are sequence of returns risk that a market downturn can harm you in a way that it doesn't pre-retirement.

Because if you have to sell from a declining portfolio, there's less available to recover from any sort of subsequent market recovery. And then the different spending shocks with the healthcare, long-term care and so forth. And so this analogy about mountain climbing is, with mountain climbing, we might think the goal is to make it to the top of the mountain.

Just like with retirement planning, we think the goal is to reach the retirement date with a certain wealth accumulation target, whatever that number may be. But the reality is, you need to make it back down the mountain as well. And with mountain climbing, most of the accidents do happen on the way down the mountain.

With a retirement income, it's more difficult. There's more challenges post-retirement than pre-retirement. And so that speaks to the need to think about retirement a bit differently. But it is still the Wild West in terms of retirement income strategies. And you'll see so much debate and discussion. And that's where we wanna try to just provide some more general guidance or some framework for thinking about these different retirement strategies.

Now, this is from a book I wrote a few years back that was focused more on investment-based strategies. But I think there's 37 different strategies here. And that's just a sampling of... And one of these, like the Bogleheads, I would classify as having a variable spending strategy. There's that variable withdrawal percentage, I think that's the name of it.

Lady Geek, I'm sure, is already putting in the chat. There's a number of different strategies out there. And well, more generally beyond that as well, for about 10 years, the Financial Planning Association has clarified that there's three main types of retirement strategies. And there can be a lot of subcategories.

And that's where the previous slide was more about the subcategories. But you have generally systematic withdrawal strategies that in this retirement income style awareness, we're gonna rename as just total returns, because it's more about taking systematic withdrawals from a total return investing portfolio. It's probably where a lot of Bogleheads are kind of thinking as a starting point for retirement income.

There's essential versus discretionary, which is about building a floor of more lifetime-based reliable income, protected lifetime income, like emphasizing more social security. And then beyond that, beyond any pensions, there may be a role for an annuity to help build a protected lifetime income floor. And then with the remaining assets, investing for upside and investing more for discretionary types of expenses.

And then time segmentation was always some sort of hybrid between the two. And that's also known as a bucketing strategy that's where you invest differently for the short-term and the long-term. With time segmentation, you might say, well, if I have bonds maturing for the next five years, I can have at least five years worth of expenses covered.

And then all my other assets in my growth diversified investment portfolio are meant to cover the expenses in year six and beyond. And I have an opportunity to endure a market downturn and to have time for the portfolio to recover because I'm just spending my fixed income until I get through that period.

And hopefully then the market will recover and then I can resume drawing from the growth portfolio to replenish the time segmentation portfolio, the front end fixed income ladder. And so again, the systematic withdrawals is the total return investing approach. It's starting point is like the 4% rule of thumb that's discussed quite a bit.

I know I saw even on the main page of Bogleheads right now, there was a thread mentioning the 4% rule. That was what Bill Bingen developed in the 1990s. The idea of if you have a portfolio with 50 to 75% stocks and you're planning for a 30 year retirement horizon, you should be able to take 4% out of the portfolio in year one.

And then that gives you a level of spending that you can adjust for inflation. And based on US historical data, anticipate your money will last for at least 30 years. Now this can also include like variable spending strategies where you're spending changes in response to portfolio performance and so forth.

But this is very much an investment focused, diversified portfolio spending from the portfolio as a core retirement strategy. And then sort of opposite from it is more like that essential versus discretionary, but we'll call that income protection with retirement income style awareness. And that's more the sense of thinking about simple income annuities, building a lifetime protected income floor to cover your essential expenses.

So you're protected from longevity risk. Even if you live to 100, you still have the money coming in through the contract. You're protected from the market risk for that, but then you can use the investment portfolio on top to then cover more diversified or more discretionary types of spending.

And these are gonna be, as we get into the retirement income style awareness, these will be the two core strategies. And the other two strategies I'll talk about really have more of a behavioral element to them. So time segmentation, again, it's that I invest with bonds for the short-term expenses and then with stocks or other more growth-focused assets for longer-term expenses.

And that's some sort of hybrid, trying to rely on the market, but also getting some sort of short-term contractual protection, just not over the lifetime, but over a shorter time period. And then a fourth strategy we'll consider is the risk-wrap strategy, which is a cousin of that income protection strategy.

The simple income annuities are not very popular in practice. And in practice, deferred annuities with living benefits are used much more frequently, whether it's the variable annuities or the fixed index annuities, or now we even have the registered index-linked annuities. These are annuities that still provide some sort of underlying liquidity, still provide some upside potential, but can also support a lifetime income.

And so it really is gonna work out to be a distinct strategy from income protection. So these are the four basic retirement strategies that most anything can then kind of be somewhat close to one of these four. And like the Boglehead's variable percentage withdrawal strategy, I would put in the family of total return strategies.

Now, the next question is, how do retirees choose from these possibilities? And so they might be listening to a radio show or hearing commercials on the radio about different financial advisors pitching different strategies. They may just be personal finance blogs. Of course, discussions at the Boglehead's is gonna be a great resource for everyone on the call today.

They may just be reading the consumer finance, personal finance type consumer media, attending different seminars or other events, webinars, a local class, a lot of local organizations, adult education programs will provide retirement planning classes or working with a financial advisor. But still, we don't really have the tools to identify who should use what type of strategy.

Like, that's the question. If I'm starting to think about retirement, should I use an income protection strategy? Should I use a total return strategy? We haven't really had the tools for that. And a lot of financial service professionals tend to like put their stake into one camp. And so if I'm an investment manager, I would tend to recommend a total return strategy to everyone.

Or if I'm an insurance agent, I would tend to recommend some sort of annuity-based strategy to everyone. And it's like, if the only tool you have is a hammer, then everything looks like a nail, even when it's not. And so we haven't had a way to really better filter these strategies.

Now, this starts to get into like, with the retirement's different as we started the presentation. So people might have different concerns about different types of retirement risks. And you can think about like, what are you the most worried about? Is it the idea that you might outlive your assets?

Are you really worried about that sequence of returns risk, which is like, you know, Robert's, or not Robert's law, but Murphy's law, the one where like, if I retire today, tomorrow's gonna be the day that the stock market drops. Is that something that you're really worried about? The different spending shocks, like, are you very worried about what if I have a significant long-term care event?

The impacts of declining cognitive abilities, the impacts of compounding inflation and so forth. And that speaks to, these are the four L's. These are the financial goals of retirement and they're impacted by different risks. And so you may then have different concerns about these goals. So longevity is about your essential spending.

And it's the idea that no matter how long you live, you wanna at least ensure you have your basics covered. Is that something that resonates with you? Is something you're worried about? Or are you maybe just focused more on the lifestyle, which is your overall lifestyle goal, including discretionary spending?

Are you someone who might view your retirement as a failure if you're not able to meet all your lifestyle expenses? And I'm guessing with bogleheads, there's probably more of an emphasis on kind of the longevity because bogleheads tend to not just spend excessively and so forth. But lifestyle does imply some sort of, like if you're a member of a country club, a lot of people would classify that as a discretionary expense.

But some people might be really worried if they can't meet that expense, they may feel like their retirement is a failure. So do you have a greater concern for lifestyle expenses? Legacy goals. Now, what we find in practice is legacy goals are often not a primary concern for most people.

A lot of people do take the view that, well, the errors can have whatever's left over at the end. Of course, some people do like to earmarks a specific legacy goal. I would like to leave X number of dollars to so-and-so. And so if that's a bigger concern, it's usually not gonna rank as a top concern for most retirees, but it might for you.

It's just, how do you think about legacy as a particular concern in terms of a goal you want to be able to ensure you can meet? And then liquidity is about having additional liquid assets available to cover unexpected spending shocks. And there's different ways to think about liquidity. We'll get to that in a moment.

But is liquidity something that worries you? And if you're very worried, like you're concerned about spending today because you're concerned about a long-term care event that could happen, that would imply more of a liquidity concern as being something that you're... Liquidity is more about than just an emergency fund.

It's significant spending shocks and needing to make sure that you can handle unexpected expenses outside of what you budgeted for. So then how do we match up your style based on your concerns, the risks that you're concerned about and just going through that thought process? Well, that's where this research that Alex and I did.

And just it's a project that was going on last year and finished it this year. And this is the actual research article for it. If anyone's interested to read the full length version, it is pretty long, but I'll give a more basic explanation of it today. And then what we found is, like I said, we were just looking at all kinds of different writings about retirement planning, trying to identify factors.

And then what we did was an exploratory factor analysis to just let the data tell us from the questionnaires, which factors or which questions seem to correspond into some sort of particular factor that can explain a set of preferences. And then what we found, and I'll talk about what these are, but the two primary factors that came out of this exploratory factor analysis is a statistical method.

It's this, what we call probability-based versus safety first, and then optionality versus commitment. And then we found four factors that were significant. They weren't shown to be as distinct or as important, but ultimately they can help tell the story. And that's these, well, I'll go through each of these in detail, so no need to list them by name right now, but we'll talk about these.

And then what comes out of that, and I'll explain that as well, is when we understand how somebody scores on these different factors, that really can help to describe what type of retirement strategy will resonate with them, whether it's a total return or a risk graph or income protection or a time segmentation.

And so this is based on the retirement income optimization framework, which is those four L's as the financial goals on the left, mapping into liabilities or expenses on the right, and then thinking about how we position assets to meet our goals. And the different styles are gonna put different emphasis there, where if you're total return, you don't care as much about reliable income as a specific asset.

You're fine using the diversified portfolio to cover essential expenses. And also if you're total return, you're gonna put less emphasis on having reserves as a distinct category. You're more comfortable with just general liquidity, not necessarily thinking about how assets are earmarked for different purposes and so forth. So this slide is just in an article that came out today in Advisor Perspectives.

So risk tolerance questionnaires, that's the fundamental tool a lot of people use to decide on an asset allocation. It's like how much short-term market volatility can you stomach to explain, should I have a 40% stock allocation or a 90% stock allocation? There's a lot of concerns about risk tolerance questionnaires in general about how well they work.

And really the point here is not to get into any of that discussion, but to just point out, risk tolerance questionnaires don't really line up with retirement concerns very well. And as can be expected, they actually, they do line up with the lifestyle concern, which is kind of how you might think about it.

Like if I'm more risk tolerant, if I can stomach more market volatility, it might, especially when we get through this whole discussion, it might imply I'm comfortable, or I have more concern about my overall lifestyle, and I'm not necessarily thinking as much about the other concerns. But with the two main factors that we'll look at with retirement income style awareness, we can find a match to all of the different retirement concerns where reserves would be liquidity in this context.

Okay, so these two main factors now, this is where we're starting to get into the meat of the matter. So how would you like to draw your retirement income? If you're someone who's probability-based, you're more comfortable relying on market growth. We have the idea of the risk premium that stocks will outperform bonds over reasonable holding periods.

And if you're comfortable relying on the risk premium, and historically the S&P 500s outperformed long-term government bonds by 6% on average since the 1920s, if you're comfortable using that to fund your retirement, you're more probability-based. Safety first is you really would prefer to have some sort of contractual protection supporting your income.

That could be holding individual bonds to maturity, or it could also be using risk pooling through an annuity, but you're less comfortable relying on the market in this regard. You'd rather have some sort of contractual protection backing up your retirement plan. And you can think about how you might answer or how you might identify yourself on that spectrum.

And then optionality, this kind of surprised me because if I had to guess in advance which would be the two most important factors, I don't think I would have picked this one. I probably would have picked something more like accumulation versus distribution, but this is just how much optionality do you want in your plan?

And if you're someone who has more of an optionality preference, you really emphasize having flexibility, wanting to keep your options open. And that's because of a sense of you wanna be able to take advantage of new opportunities. You don't wanna really be locked into any particular strategy. You really value the optionality for a plan.

And commitment orientation is you feel more comfortable just locking into a solution. If you know that something will solve for a lifetime income need, you don't necessarily need the optionality as much. Of course, you're gonna want to have some liquid assets, but you have the sense partly as well that you've got a plan that will work.

So you can take it off your to-do list. You don't have to worry about ongoing decision-making and everything. You're more comfortable committing to a strategy. And this, as I said, is gonna be one of the two important factors based on that exploratory factor analysis. And then, well, we can see how these fit together.

So we create this matrix. And that's how Robert said, like a Morningstar style box type situation. On the left is safety first. On the right is probability-based. On the top is optionality, and on the bottom is commitment. And so you can see these four quadrants developing where if you're in the upper right, you're probability-based, comfortable with market growth, and wanna keep your options open.

If you're in the lower left, you're safety first. You want contractual protections, and you're comfortable committing to a strategy. And then it's a mixture in the other two. So then the secondary factors that can help tell the story, but are not primary. They're less important in terms of, they're not as distinct as important factors to help describe a strategy.

But one is like, how do you view flooring? Time-based or perpetual? And this time-based is like time-segmented flooring. I'm thinking about, I wanna build a protected floor to cover my basic expenses. If a time-based preference would mean, it's like time segmentation. If I can have my basic expenses covered over the next three to five to eight years, there's some flexibility there.

But if I can have the front-end expenses covered, I could have a time-based preference versus perpetual flooring. Well, that's more like the world of like an annuity with risk pooling and supporting a lifetime income need. So do you have a time-based or a perpetual flooring desire? How do you view your reserve assets?

And this is where I mentioned there's these two attitudes about liquidity. If you have a true liquidity mindset, you really wanna have assets that are not earmarked for other goals, that are truly liquid in the sense that they're your reserves. You've already got other assets that are covering your future budgeted expenses, covering your legacy goals.

These are assets specifically set aside as reserves to provide the liquidity to cover unexpected contingencies or spending shocks. And you make that distinction as important. I wanna be able to have these assets earmarked separately as reserves. Whereas those who have more of a technical liquidity mindset aren't making that type of distinction.

They're thinking about their assets more generally as they have a total pot of assets and they don't necessarily have to have distinct reserves. They'll just figure things out whether if they have an unexpected expense, they'll figure out later how that's gonna impact other spending and so forth. Technical liquidity is like a brokerage account.

It's liquid, but it may be earmarked for other purposes, but you're really not thinking about things that way. You're just generally thinking about a big pot of assets. Now, what's your mindset about retirement investing? If you have an accumulation mindset, you're really just maintaining the pre-retirement accumulation style of investing post-retirement, which is to focus on risk-adjusted returns for your portfolio.

And that's where your emphasis is over trying to maintain a predictable income from the portfolio. And I mean, any of these preferences are completely valid. There's no problem with that, but you're not worried as much about predictable income. You'd rather focus more on just maximizing portfolios returns subject to your risk tolerance.

Whereas if you had a distribution mindset, you do focus more on predictable income. And in that regard, you don't necessarily need to maximize your portfolio returns anymore. You'd rather have stable, predictable income being generated by your portfolio. And so you'd prefer strategies that do that, even if they sacrifice having the highest possible total return from the portfolio.

And then the final one of these is front-loading versus back-loading. If you have a front-loaded preference, you wanna spend more today while you're healthy and alive and assured that you can actually enjoy it. And you worry less about like, if you have to cut your spending in the future, that's okay.

And with a front-loaded preference. And if you have a back-loaded preference, this is the idea of longevity risk aversion, that you're worried about outliving your money. So you're willing to sacrifice some spending today to better protect your future lifestyle. You're wanting to more back-load your spending. You don't wanna be 95 years old and not have anything left except a social security benefit.

So you're willing to spend less today to stretch that money out into the future. And now we can add those characteristics to this recent matrix as well. And it's all based on correlations. So probability-based does tend to be correlated with optionality. That if you're comfortable with market growth, you also tend to want more optionality.

That's what that diagonal arrow's about, going from the upper right to lower left. And then at the same time, safety first tends to be correlated with commitment. Like if you want contractual protections, you also tend to be more comfortable committing to a strategy. And then if you're safety first and optionality, those tend to not be as correlated with each other.

And that's where the sense of a behavioral strategy develops. You want contractual protections, but you want optionality. It's kind of a bit of a contradiction there, but there's a strategy that has been created over the, since around the 1980s that can accommodate that. Likewise, in the bottom right-hand corner, probability-based and commitment, you're comfortable relying on market growth, but you'd also want to commit to a strategy.

And there's also a bit of a, those two don't necessarily go together. And then we can start adding in where these other characteristics apply. So in the upper right-hand corner, that's more of an accumulation mindset, tends to be up there as well. The top half of the chart is more front-loading as a preference.

The, well, on the left-hand side, you have the true liquidity. In the bottom left corner, you've got more of a distribution, predictable income, perpetual income floor. On the whole bottom half, you can have more of a back-loading preference. And then on the right, you also do have a technical liquidity at work there.

So this really gives us our retirement strategies. Think about a total return investing strategy. You're comfortable relying on market growth. You want to keep your options open. You're more comfortable with like the tools of modern portfolio theory, more of an accumulation, risk-adjusted return. You do think more in terms of technical liquidity.

You have more of a front-loaded preference and the time-base. You don't really have a need for perpetual income floor. So that's the 4% rule. I mean, that's systematic withdrawals from an investment strategy. And those characteristics can explain that quite well. Then in the bottom left, where the other kind of consistent preferences are, your safety first.

So you want contractual protections. You're willing to commit to a lifetime strategy, well, commit to a strategy. You have a distribution mindset. So you want predictable income. You're comfortable with a perpetual income floor. You want more true liquidity, which is earmarking assets for specific goals and then seeing what's left as reserves.

And you have more of a back-loaded preference. So that's kind of describing simple income annuities for building a lifetime income floor. And then a diversified investment portfolio can go on top of that. Then in the upper left, that's time segmentation. You want contractual protections, but you also want optionality.

And so the framework developed to provide both of those concerns is, you have contractual protections with holding fixed income assets for short-term expenses, but then most of your assets are left in a growth-based investment portfolio, providing the optionality. And then the risk wrap in the lower right-hand corner, that's also a behavioral type strategy that's just been developed since the 1990s.

And again, that's that whole world of deferred annuities, like variable annuities with lifetime income benefits attached to them. You're comfortable relying on market growth, but you're not completely comfortable in some way. You want to commit to a strategy. You have more of a back-loaded preference. You have that technical liquidity mindset, which is the whole, the deferred annuities talk about how they're liquid, but that's been earmarked for your future spending, so you can't really take advantage of that liquidity.

But that all explains building a lifetime income floor with deferred annuities with living benefits, and then applying the investment strategy on top of that. And then based on the retirement researcher on my website, the kind of people who are part of that community, the study we did with them, we did find about a third of them were in that total return quadrant, somewhere around a third are in the income protection, and then somewhere around 15% were either time segmentation or risk-wrap.

And then these are styles, so that once you understand your retirement income style, it doesn't mean that you have to stick to that strategy, but I think it can be a useful starting point to think about how you want to go to approach building a retirement income strategy. And I've really explained at this point, but again, it's just going through the four strategies, the total return and the characteristics it has, the income protection and the characteristics it has, the time segmentation and the characteristics it has, and then the risk-wrap strategy and the characteristics it has.

And so to conclude about this, there are a number of different viable retirement income strategies, and this is a really important starting point that I do try to be agnostic and to say that any of these strategies are valid and viable. It's just a matter of understanding who they're right for.

And the right approach for someone depends on their personal style. And just because one strategy is right for you, a different strategy might be right for someone else. And there's more like flexibility out there for people to find the kind of strategy that will best resonate with their personal preferences and personal style.

I mean, it's just like when you pick a career, there's not one kind of job that's superior for everyone. Some people might like more of a salesman type role where they have to like maybe more volatility to their income and that sort of thing, more like a total return approach.

A college professor tends to be more of like an income protection style with the bond of a tenured position providing income on an ongoing basis. So there's no right or wrong answer to what job someone chooses. And really there's no right or wrong answer to which style someone chooses for their retirement.

And so this RISA, retirement income style awareness can provide a starting point for that discussion. So then that was chapter one of the book and we don't really need this slide. We had it at the beginning too, but chapter one covered that. And then let me get through that.

And the book is at any retailers can be guessed. And let me go ahead and stop there. And at one... Get the slides pulled up here. - Yeah, so if you can share screen. - Zoom's going slow. Here we go. Okay, can you see the slides okay? - Not yet.

- No. Is it now? - Yes. - Okay, I think there's just a lag. Okay, thanks everyone. So now we'll get into the discussion around tax planning for efficient retirement distributions. And as some of you noted, at least a few of you, it sounds like I did this presentation today at Retirement Researcher.

And it's a really hot topic right now. And I don't have too much in the way of tax reform in this, but with... And we don't know what the ultimate new tax legislation will look like. But with what we've heard in the last couple of weeks, it's not necessarily changing too much of this discussion.

Some of the tax brackets are moving around. The big thing might be, we're not gonna have the backdoor Roth anymore and we'll have to see how that plays out. But otherwise, the ongoing tax reform debate's not really impacting too much of what's in this presentation. Okay, so in that 12-step process for thinking about retirement, we're talking about tax planning now.

And so we'll talk about the logic of tax efficiency, tax diversification, asset location, tax efficient retirement distributions, pitfalls to monitor when generating taxable income, and then an example for tax bracket management. And that was one, I did put an excerpt of that book into a column at Advisor Perspectives that was picked up at the Bogleheads.

So if you saw that thread, that's one of the places where this session was announced. I'll talk more about that example, like some more commentary on it. So the logic of tax efficiency, and this is the punchline coming out of that example at the end, where with retirement planning, there's so many different aspects of it where making short-term sacrifice can help support a long-term benefit.

And that's what we'll see in that example at the end, where the gray-colored strategy is watching the wealth spend down. For someone who claims social, they're a 60-year-old, they have $2 million at age 60, they're retired. If they take Social Security at 62, and then do a conventional spend-down strategy, taxable, tax-deferred, tax-free, you can see they've got more money there for a while, until about age 77, and then it keeps plummeting.

And then they run out of money around age 88. And the strategy that I'll identify as a more tax-efficient strategy is gonna do really get into the whole strategic Roth conversion. They're gonna manage a very high level of taxable income until they turn 70, and then they're gonna start their Social Security benefit, and then subsequently be able to manage a much lower taxable income level, much lower adjusted gross income.

And so in the short run, they're gonna fall behind, especially because they're delaying Social Security, and they're paying more taxes early on. But that's gonna set them up for long-term benefit. And ultimately with that strategy, their money is gonna last 5.6 years longer. Okay, and they're at age 88, they still have about 200, I'm sorry, $320,000 left compared to that other strategy that's run out at that point.

So in the short run, there's gonna be a smaller legacy value for their assets, but in the long run, the strategy is gonna pay off and help them. And this is the example I'll be showing at the end of the presentation. So short run costs for long-term efficiency, and this is an important topic because it really can extend the portfolio longevity for a retiree.

And why is that? Like, why is what we're talking about important? Because we have a progressive tax system in the United States where as your income goes up, you're paying taxes at higher tax rates. And so this is all about trying to, like we have to pay taxes, but trying to pay taxes when we can pay them at lower tax rates, and then try as much as we can within the law, this is all within the law, avoid paying taxes when we're in higher tax rates by strategically preparing for that.

And also the tax code is filled with all kinds of nonlinearities and traps in terms of, I'll get into how, you may think you're in the 22% tax bracket in retirement when you might actually be paying more than a 50% marginal tax rate in some circumstances. A marginal tax rates, that's like I just said, can be higher than income tax rates.

And we have a number of different types of tax treatment in the tax code to coordinate. So nonlinearities in the tax code, many tax rules are connected to adjusted gross income, not taxable income. And the difference there is the below the line tax deductions. So having a big tax deduction can't save you from some of these nonlinearities because it's the adjusted gross income before the deduction that counts.

Itemized deductions then only count when they're higher than the standard deduction. Preferential income sources, long-term capital gains and qualified dividends stack on top of other income and have different tax rates. And there can be implications of that. A dollar of income can trigger tax on up to 85 cents of a social security dollar, as well as triggering tax on that dollar of income.

It can also, a dollar of income can trigger higher Medicare premiums. And I won't get into detail about that, but we also have that 3.8% net investment income tax is very nonlinear and how you have to calculate it as the minimum of two different numbers. And required minimum distributions will start to play a role after age 72.

And that can surprise someone by pushing them into a higher tax bracket. So what we're talking about here with income taxes, the basic kind of, when you're going through the 1040, total income is all your taxable income sources. You take off the above the line deductions, retirement account contributions, HSA contributions, that sort of thing.

Gives you the adjusted gross income. And then you can either take the standard deduction or itemize, and that will give you then taxable income. Okay, so this is where I probably with this group tonight, we can accelerate this conversation. Everyone most likely is aware of the taxable brokerage accounts, tax deferred accounts, such as IRAs and 401ks and other employer-based retirement plans.

And then after tax accounts, which are sometimes called tax exempt, sometimes called tax-free and sometimes called Roth. And these are the three main types of tax structures we have in terms of the tax code providing different tax treatment. So the taxable accounts, you pay ongoing taxes on income shot off from the account, as well as any realized capital gains.

Long-term capital gains, qualified dividends qualify for lower tax rates. The cost basis or principle into the account can be taken out without tax. You do get a step up in cost basis at death, avoiding capital gains tax. And that was something people were worried was gonna disappear with the tax reform.

But as of now, it looks like it will remain. And then also distributions from taxable accounts can be structured to get capital gains or capital losses. You can trigger capital gains or you can trigger capital losses. And if you trigger a capital loss, there's the wash sale rule. You have to wait 30 days to buy back the same asset, but you can trigger capital gains by selling the asset and immediately buying it back and triggering that taxable income if you're doing that for a strategic reason.

Tax-deferred accounts. We think of them as generally being deductible, contributions, and then tax-deferred until distributions are taken. And those are taxes, ordinary income, required minimum distribution start at age 72. You may have an employer match and also early withdrawal penalties can be an issue before age 59 and a half.

Tax-exempt or Roth accounts, Roth IRAs, employee contributions to Roth 401ks. You had to pay taxes on that money. It's not tax deductible. But once it goes into the account, assuming you have a qualified distribution, which you can set up to have fairly easily, assuming you're at least 59 and a half and had the Roth IRA open for at least, had a Roth IRA open for at least five years, then you do not have to pay taxes on the distribution.

Roth IRAs do not have required minimum distributions. Roth 401ks do, but you can just roll over to a Roth IRA to avoid that problem. There are income restrictions on making contributions to Roth IRAs. And like I said, right now we have the backdoor Roth idea where you make a non-deductible contribution to an IRA and then convert that to a Roth.

That currently with the proposed legislation will not be allowed starting in 2022. But that, of course, any of that can change. So we're nowhere near the final tax law. And this can be a good choice in low income years to contribute to the Roth account when you're in a lower tax rate relative to the future.

So when you're choosing between the two, this is all kind of basic financial literacy type stuff as well, that you're trying to pay taxes at lower rates. So when you have a high income or you're paying, you're in high marginal tax brackets, that's a good idea to make the contribution to a tax deferred account and get the tax deduction.

If you're in between jobs or something where you're currently have a lower income facing lower tax rates, that can be a good opportunity to put into a Roth account. And the same logic applies to Roth conversions. You wanna do it when the current tax rates are lower relative to what you believe they'll be in the future for your situation.

And it's also nice to have some tax diversification between each of the different types of tax structures. Now, if you'd like, because there's limits on how much can go into the Roth and employer plans and IRAs, if you'd like additional tax benefits beyond that, there are different options, 529 plans, health savings accounts with the high deductible health insurance where you get that triple benefit of tax deductions, tax deferral, and tax redistributions for qualified medical expenses.

I-bonds or E-bonds give you that they're taxable, but you get tax deferral. You're not paying taxes until the distribution or until you have redeemed them. Tax-exempt bonds can give you tax deferral and tax redistributions, though they have a warning when it comes to retirement. Interest from those can be counted towards determining Social Security and Medicare taxes.

Non-qualified annuities and then life insurance can all provide tax benefits as well. Asset location. So we have these different tax structures. Where do we put our assets? First, asset allocation is always most important. Like if I view my strategic stock allocation is 60% stocks, I should go with that first, even if I only have 40% of my investable space in a taxable account.

It's always asset allocation first, but then you can follow the guidelines on asset location about where to keep that money. And so when we talk about taxable versus tax-advantaged accounts, whether that's tax-deferred or tax-free, we start with, well, any tax-exempt bonds, there's no point in owning them anywhere but a taxable account.

Then like US stock index funds tend to be very tax-efficient asset classes, so they can easily go into a taxable brokerage account. International stock index funds may have a higher dividend, so a little bit more taxable income coming out of it, but if it's low turnover, generating less taxable income.

Like I was saying today, interest rates are very low right now. And so because cash or bonds are not really generating much income, that unfortunately makes them very tax-efficient because there's no taxable income being generated. So in a very low interest rate environment, bonds can actually get pushed higher up on the list, but in a more normal situation, bond interest is taxed as ordinary income on an ongoing basis.

So bond funds are generally less tax-efficient, actively managed stock funds are less tax-efficient because of the more turnover and realized capital gain within the fund itself and so forth. Then commodities and real estate investment trusts is being the least tax-efficient, most benefit from having some sort of tax-advantaged account.

Then within the tax-advantaged world, should it go in tax-deferred or tax-exempt? Well, the general thought there is assets with higher expected returns can go in that Roth tax-exempt environment. So if you have any emerging market stock funds, any small cap value type funds, a Roth is a good candidate for where you might wanna put that sort of thing.

And then assets with lower expected returns like bonds or other kind of lower yielding but tax-inefficient asset classes would belong more in the tax-deferred account. Now, there's two reasons for that is one of the side effects of a tax-deferred account is if you had any long-term capital gains, their tax is ordinary income.

You lose that long-term capital gains treatment in the tax-deferred account, but you can get around that issue by having... In a Roth account, you don't have to worry about paying taxes on any of those gains. That's all coming out tax-free. And also to the extent that we tend to spend Roths later in retirement, having more longer-term higher yielding but meant to be held for the long-term type assets there can make sense.

So taxable accounts for tax-efficient asset classes, tax-deferred for tax-inefficient lower returns, tax-free for tax-inefficient but higher return asset classes. Now, the tax-efficient retirement distributions which is more our focus for this. The conventional wisdom on a withdrawal order sequencing strategy is to spend taxable assets first, then tax-deferred and then tax-exempt.

But we can do better than that by using a tax bracket management framework. And so tax bracket management is, we're gonna aim to pay taxes at the lowest possible rates. And that means if we currently have an opportunity to generate more taxable income and pay a lower tax rate on it, we'll wanna do that.

So we might be paying a higher tax bill because we're on purpose generating more taxable income, but we're doing that to pay at a lower tax rate and to help better set up the situation that in the longer term, we can better avoid the higher tax rates. So we wanna fill up lower tax brackets with taxable income and potentially draw from other resources that are not taxed if we still wanted to spend more but wanted to avoid a higher tax bracket.

That will also help with the process of required minimum distributions after age 72, where if we can get some of that money out before, we're less likely to face a big RMD that could push us into a higher tax bracket. It's part of that story of short-term sacrifice. You have to pay more taxes in the short run, but by doing that at lower tax rates, that can create longer-term benefits.

And the biggest impacts we can see for that, they both happen at around the same income levels, which is the point where you jump from the 12% to the 22% federal tax bracket, which is 40,525 for singles, $81,050 for married filing jointly. And then the preferential income, it jumps from zero to 15% at not quite the same numbers, but very close, 40,400 for singles, 80,800 for joint filers.

So if you're able to manage a lifestyle and spending, especially from taxable resources and keep your taxable incomes under these thresholds, that can give you strong opportunities to go ahead and fill up these thresholds. And it's the same story for other tax brackets too. It's just, this is where you'll see the biggest impact of tax planning.

And so this is more of a middle-class type retirement strategy, as opposed to like a very high net worth strategy, 'cause these are not super high income levels from the perspective of like a high net worth type individual and there's a lot of tax advantage that can be available, especially when we start adding in some of the other nonlinearities in a moment.

So we're talking about generating more taxable income than necessary to pay taxes at a lower tax rate. So there's three ways we can do that. The first is, we said the conventional wisdom is you spend all your taxable money first, then tax deferred and then tax free. Well, what you can do to generate more taxable income is you cut back on the distribution from the taxable account and replace that with the distribution from the tax deferred account.

And so that can give you the spending you want while raising taxable income to the desired bracket that you're trying to manage. Second, you can cover the spending goal from taxable accounts, but then increase your taxable income by doing Roth conversions from the IRA to the Roth IRA. And then that would also, you can pay the taxes on those conversions, ideally from the taxable account as well, not from the IRA.

So that's an even a reason why you could accelerate payments out of the taxable account even faster, 'cause you're using that to pay the taxes on the Roth conversions. And you're using the Roth conversions to generate more taxable income in the short run. And then the third approach is to, on purpose, sell assets with long-term capital gains, not for any sort of market timing or anything, but you can immediately repurchase them.

And you're doing that to generate taxable long-term capital gains and to reset your cost basis to a higher level. And especially if you can take advantage of doing that when you're still in the 0% tax bracket for the long-term capital gains, and that we saw those around 40,000 for singles, 80,000 for married filing jointly, you can really take advantage of that.

And just you're paying taxes, but at a 0% tax rate. And so that's a very attractive feature. Then it jumps to 15 and 20%. And one of the aspects of the tax reform being discussed now is to have it 0%, 15%, and then 25%. And then that net investment income tax on top of that too, potentially.

So you can work around with this. You have resources that will create taxable income on the left. You have the income with preferential tax rates in the middle, the qualified dividends, long-term capital gains. And then you can have spending resources. Once you've filled up the tax bracket, if you still want more spending, you have ways to draw additional spending power without generating more taxable income.

And that can be cost basis of your taxable account, Roth IRA distributions, a portion of a non-qualified annuity distribution, a portion of social security benefits, self-savings accounts distributions for qualified medical expenses, reverse mortgages, and also cash value from life insurance as different options for covering spending, but not having more taxable income.

So Roth conversions, it's the, it could be within employer plans too, but it's easiest to just say like an IRA to a Roth IRA. You cannot Roth convert required minimum distributions. So it's gotta be an amount in excess of that. They only begin at age 72. So you can, it's not an issue before 72, but it is after 72.

You can't convert amounts that are required to come out as required minimum distributions. Like I said, ideally you wouldn't pay taxes from the IRA on those conversions. Hopefully you have some other resources to pay those taxes. Now, if you're retired by your 60s and you're delaying social security, that can be a great opportunity where you don't have a whole lot of taxable income to really get a strategic kind of Roth conversion strategy running.

Also other times you might do this. If you have a year with a large tax deduction, maybe a big medical expense or something that's just a big tax deduction in a particular year, you might offset that by generating more taxable income. And then also moving more shares during a market downturn can be an opportunity.

If you have other resources to pay the taxes, if the market goes down, you just have more opportunity to get money sent over to the Roth generating less taxable income. You're moving shares over at a lower value so that you're generating less taxable income when you do that. Now, I'm talking about front-loading taxes and here's some additional reasons why you might like to front-load taxes beyond what I'm describing.

And the first is just the public policy risk. A lot of people are concerned that taxes will be higher in the future. And if that is something that concerns you, you might like to therefore accelerate some of those tax payments today when you feel like you may be in a lower tax system today than in the future.

The death of a spouse is important as well for tax planning because after the year of the spouse's death, that household shifts from married filing jointly to a single filer. And those tax brackets are a lot lower. And so some expenses might go away, but income doesn't necessarily drop in half by any means.

And you're gonna have a higher tax bill as a single filer than as married filing jointly. So you could have more exposure to paying tax on social security, more exposure to Medicare premium hikes and so forth. And also the SECURE Act in 2019 created a lot of conversation around Roth conversions because now receiving an IRA as a beneficiary is a lot less attractive.

Like if you're an adult child receiving an IRA as a beneficiary, you may be in your peak earnings years. And before the SECURE Act, you could use a lifetime stretch to distribute. You had inherited IRAs have required minimum distributions, but the rules work differently. You used to be able to extend those out over your life expectancy.

After the SECURE Act, adult children are all gonna face the 10-year window where you have to distribute the entire account balance within 10 years. And so if that's overlapping with your highest tax years, highest earnings years, at the peak of your career at that point, that would speak to this strategic Roth conversion.

If I already know that some of my IRAs may be inherited, 'cause I'm not necessarily gonna run out of money at this point, I'm gonna be comparing my tax bracket today as a retiree to my beneficiary's tax bracket. And that might accelerate my Roth conversions. At the same time, anything going to a charity, the IRA can be a great resource for that because it's the same concept of paid taxes when you're in the lowest tax bracket.

Anything going from an IRA to a charity can be taxed at 0%. And so you wouldn't necessarily want to convert assets that would go to charity, but you might like to convert assets that will go to a non-eligible designated beneficiary. So a human who doesn't get special treatment to have a lifetime distribution.

There's still some people that can get the lifetime stretch. Spouses, well, spouses can just rename the account in their own name, but also people who are less than 10 years younger than the deceased individual. So perhaps siblings in that situation, permanently disabled individuals, but otherwise most human beneficiaries are going to face that 10 year window.

Okay, so those are reasons why you might want to accelerate taxes. Now here's some pitfalls to monitor when you are generating more taxable income. So there's a number of issues and I'll emphasize three of them here. The first is the social security tax torpedo. And if you haven't heard of that before, it's gonna be a lot of fun.

The potential for increased Medicare Part B and Part D premiums, pushing preferential income into higher tax brackets. So pushing more into a higher tax bracket, I'll explain that. And then some others that I'm not getting into now, but also if you're pre-Medicare age and you have a Affordable Care Act, health insurance policy, subsidies could be jeopardized, although there was in 2021 and 2022, this is not an issue.

The subsidy cliff there was taken away, but it returns in 2023, where if your income goes $1 above 400% of the poverty line, you suddenly lose all subsidies for the health insurance. The net investment income surtax, that 3.8%. The additional Medicare taxes on higher earnings and the alternative minimum tax are all kind of pitfalls of generating more taxable income.

But again, we'll focus on those first three with the boxes next to them. So the social security tax torpedo. Up to 85% of your social security benefits are taxable. The tax schedule to determine how much of your social security is taxable was designed in 1994. And it's one of those rare parts of the tax code that's not inflation adjusted.

So those numbers have been the same since 1994. And that just means over time with inflation, more people are gonna be hit by taxes on their social security benefits. Determining the benefit taxation and then the marginal tax rate is quite complex. And this is where the people who designed how social security will be taxed, I don't know how they could have created a more difficult situation than they did.

I had to spend days just with the programming on this to make sure I wasn't making mistakes and everything because you calculate three different numbers, see which is smallest. And there's so many nonlinearities here, but we'll walk through what's going on in just a moment. And then proactive planning can help to potentially avoid the full tax torpedo that you may be able to set up so you're not paying taxes on 85% of your social security benefits.

It might be hard to get that down to 0%, but if you can pay taxes on 20% of your benefits instead of 85% of your benefits, that could be a big win. And that's gonna be a key part of what's helping when I talk about the tax efficient strategy adding so many years of portfolio longevity.

And a key point, if I was giving a presentation about social security, a key message would be to think about delaying towards age 70 to take advantage of the insurance value, the inflation protection, the survival benefits. And this whole tax planning discussion is just another reason to consider delaying social security towards, at least for the higher earner in a couple, towards age 70 and for a single individual.

The lower earner might claim earlier in a couple, but not the higher earner. Okay, so this is where things start to get tricky with the social security tax torpedo. So there's gonna be a bunch of different modified adjusted gross income numbers. And if you look into the tax rules, the definitions will be quite long, but there's a bunch of small things that probably don't affect most people.

When we talk about social security, the basic idea of the social security modified adjusted gross income is, it's your adjusted gross income less your taxable social security benefits. And you don't know what percent of, that's what makes it so hard here, is you're not gonna know what percent of your benefits are taxable until you've figured all this stuff out.

So you kind of have to work through a loop. But your provisional income, and it's sometimes called combined income based on the source, it's that social security modified adjusted gross income. So it's your adjusted gross income less your taxable social security benefits, but then plus half of your benefits.

So you're putting half of the benefits back into this. And then also any tax exempt interest is gonna be added as well into this number. And then this is what we're working with in terms of those 1994 thresholds to determine how much of your social security benefits will be taxable.

And these are not like taxable incomes. These are that provisional income, which is that unusual measure that includes half of your social security benefit. So this is what the tax torpedo would look like. Every social security benefit has a different tax torpedo, every level of benefit. So if you had 30, so a single filer 2021 with a $30,000 annual social security benefit, what we're graphing on the bottom is your, it's like all your income except social security.

So it's that your adjusted gross income minus your taxable social security plus your tax exempt interest. And then we're looking at your marginal tax rates. And those jump up to be 12%, 22% and so on with the yellow. And then the purple is looking at social security, what's your marginal tax rate?

And you can see, you may have thought, well, by the time you added social security, you may have thought you were gonna be in the 22% tax bracket, but there's a little period there where you're actually paying a marginal tax rate of 40.7%. And that's the social security tax torpedo.

That's where at these kinds of income levels, you may be paying a much higher tax rate than you expected. And so what's happening in that is you're a dollar of income when you're in that range identified there up to that 43,000 plus, you're a dollar of income, you're gonna pay tax at 22%, 22% on that dollar, plus that's gonna uniquely trigger a dollar of your social security to be taxed at 85%.

So 22% of 85% of a dollar of social security. And so those add up to 40.7%. And that's now your marginal tax rate. A dollar of income, you're paying taxes not just on that, but it's also pushing another dollar of your social security to be taxed at 85%. And that torpedo jumps around because there's just where you are with the tax brackets, it's jumping around at different places.

But that 40.7% is the highest it gets. And that's in that range where it's pushing you into paying tax on 85 cents of a dollar of social security. And with this benefit level that adds up or that happens up into an adjusted gross income of $69,206, which if you took a standard deduction off of that, we're talking about a taxable income of $56,806 if you're under age 65.

So that income's just below that range. You're at a 40.7% marginal tax rate, even though you were expecting to be in the 22% marginal tax rate. The next thing is Medicare, the income-related Medicare adjustment amount, adjustments, adjustment amounts, the premium increases that work differently. And this is where you have to pay higher premiums for Part B Medicare, as well as if you have a prescription Part D drug plan, Part D as well.

And those premiums just jump at different income thresholds. Now your Medicare modified adjusted gross income is your adjusted gross income, plus a bunch of minor things, but the main one is just that tax exempt interest. But the tricky thing there is it's from two years prior, not from the current year.

Now, two years ago up to today, things can change. So if you do have a life-changing event, such as you retired and don't have earned income anymore, you can file Form SSA-44 and request not to have that IRMA premium hike and see that there's a whole list of valid excuses.

Just doing a strategic Roth conversion is not a valid excuse, so you will be stuck with any higher Medicare premiums that generates. But in some cases, you might have a valid reason to request not having those premium hikes. But how this plays out is, so if you're a single and your modified adjusted gross income is $88,000, your total premiums for the year, and I'll show that better on the next slide, about $2,179, one more dollar of income causes you to face annual premium increases of $860 in 2021.

So that is an 86,000% marginal tax rate on that dollar of income. And then it goes back down again beyond that. But this is working differently than the tax torpedo. This is, if you have $1 too much, you're gonna trigger a big additional premium hike for that year. Well, not, I mean, for two years later.

In two years, you're gonna trigger a big additional premium hike. And so this becomes relevant. Even if you start Medicare at 65, this starts to become an issue with your income at 63. And so here's the table for 2021. So this is based on incomes in 2019. And here you can see the thresholds for single filers marry filing jointly.

You have standardized Part B Medicare premiums for the medical insurance. Part D can vary, but this is gonna be based on the average Part D premium in 2021, which was $33.06 per month. And so those are monthly numbers, but then the number on the right is annual. So it's the Part B plus the Part D times 12, and that's per individual.

So married couples would have to double those numbers. And you can see that once you get $1 higher into that second one, it's $860 more, 21.78 or 21.79 per year up to 3,039 per year. And that is, again, the next premium jump, it's at $111,001 for singles, $222,000 for couples married filing jointly.

And then you're jumping up by another $1,300 of annual premiums. And so it's just that $1 of income is triggering the big increase in Medicare premiums. And so that's something to be aware of. Now, if you have to occasionally generate, trigger one Medicare hike, it might be worthwhile in the long run, but you wanna be careful about making ongoing mistakes where you accidentally just trigger slightly too much income and therefore have to deal with a much bigger Medicare premium two years later.

And then we have this preferential income issue. So your long-term capital gains and your qualified dividends stack on top of your other taxable income. And so here's an example to illustrate the basic idea. We have a single individual, their taxable income is $42,400, but that's divided, they have 38,400 as ordinary income, 4,000 as long-term capital gains.

So taxes on that, the 38,400, they're still in the 12% federal income tax bracket on their ordinary income. And then they stack the 4,000 on top of that, 2,000 of that will be taxed at 0% and 2,000 of that will be taxed at 15%. Now, suppose they add $1 more of ordinary income.

So they have $38,401 of ordinary income. That they have to pay 12% tax on that dollar, but look at what else it does. They now have one less dollar being taxed at 0% for their long-term capital gains and one more dollar being taxed at 15%. So they're paying 15% on that long-term capital gain dollar also.

So they thought they were in the 12% federal income tax bracket, but they're actually paying a 27% marginal tax rate on that dollar of income. And where that can get really fun is that when it also overlaps with the Social Security tax torpedo. So that 47%, you can add another 15% on that if you're also having the same issue happen where you're triggering another dollar to be taxed at 15% on the long-term capital gains.

Now you're at like a 55.7% federal marginal tax bracket. So even though we may think taxes will be less in retirement, if we're not planning for this, taxes can be quite a bit higher than we expect when these circumstances are triggered. Okay, so let's now see how this plays out with an example.

And this example, it's a 60-year-old single individual. I'll refer to her as she, although gender doesn't matter for the example, that just makes it easier to stick with one. So she's 60 years old. We're simplifying investment returns. She's basically investing in bonds. I just assume inflation is zero to not, 'cause I wanna show all their future tax numbers and to not have to worry about inflation and how that impacts what those numbers mean.

I think it helps to make it more easy to interpret the results if we just assume there's no inflation, but she is getting a 2% real return. So all of her assets are growing at 2% a year. Now she's got 400,000 in her taxable account, 1.3 million in tax-deferred and 300,000 in tax-exempt.

She wants to spend $95,000 a year pre-tax. So that is, this came up at the bow of the heads. That is more than 4%. But also she's gonna have, something like the 4%, really, that rule never can be used in practice just because no one actually spends a constant amount from their portfolio every year.

You always have to deal with, we're not doing anything complicated here. She always wants to spend $95,000, but at some point, social security is gonna kick in for her. And also taxes are gonna go on top of that. And if she doesn't have constant taxes every year, there's no constant distribution amount from her investments.

She does have a nice, smooth spending goal, but taxes go on top of that. And then at some point, social security will come into play. If she claims that that's her primary insurance amount, her full retirement age is 67. So if she claims at 62, she'll get $21,000 a year from social security.

If she claims at age 70, she'll get $37,200 a year from social security. Now there's five strategies I do look at in the book chapter. And for this, we'll focus on one in five, the first and the last. But let me just walk through these. The first strategy, she's gonna claim social security at 62, and she'll follow that taxable, tax-deferred, tax-free distribution strategy.

Her money, she'll be able to meet that spending goal for 28.99 years. Then her money runs out, no more investment assets. And then she'll continue to have social security at $21,000. Now, strategy number two, she doesn't change her tax strategy, but if she just delays social security at 70, until 70, that will increase 1.86 years onto her portfolio longevity.

Her money will last 1.86 years longer. Okay, and that's the benefit of delaying social security. Now, the rest of these strategies all have social security at 70, but they're adding more sophistication with the taxes. So strategy three is, they're going to do tax bracket management, she will do, but without Roth conversions.

She's just going to spend less from taxable, more from tax-deferred, to manage an adjusted gross income of $60,000. And a little bit later, I'll show you the charts of how I come up with that number. I think that is something I haven't seen elsewhere in doing this. I checked every adjusted gross income level and see which one gave her the most portfolio longevity.

And so managing $60,000 was the amount that worked best to give her the most portfolio longevity. And that gave her 3.83 more years than the baseline strategy, or almost two more years than just delaying social security. So an additional two years of portfolio longevity by being more tax-efficient. Strategy four, she's now going to do Roth conversions.

And coincidentally, the same adjusted gross income level would maximize her portfolio longevity. And that's getting her about four and a half years longer than the baseline strategy one. And then strategy five, she's gonna do a two-part strategy. She's 60 years old right now. So until she's 69, for the first 10 years of her retirement, she's gonna manage an adjusted gross income that goes right up to the second Medicare threshold.

So she will have a higher Medicare premiums starting at age 65 for one threshold, but she's gonna go up to just before the second threshold. Then she'll stop doing that when she turns 70. So the year she starts collecting social security, she's already done such a big Roth conversion strategy by that point.

But now for the rest of her retirement, she can manage $25,000 of adjusted gross income, have much less of her social security be taxed, and her money lasts 5.6 years longer than in the baseline. Okay, so that's what we're walking through here. So this is the claim at 62, claim social security at 62, conventional wisdom taxable, tax deferred, tax free.

And I'm sorry if your monitor is not so big, you might not see these numbers very well, but let me just kind of tell the story of what's happening. This is her whole like retirement situation as she's spending down from her taxable account, the tax deferred account, tax exempt account.

So you're seeing the account balances on the left, the amount distributed from each of the accounts each year under the spending, her social security benefits, her required minimum distribution amounts. They're never binding in this example. She always wants to take out more from her tax deferred than the required minimum distribution.

Roth conversions, her adjusted gross income, and then her taxable income, which would just take the standard deduction off of that, the amount of her social security that's taxable, and then her federal income tax bill. So this strategy, the first years of retirement through age 64, she's just spending her taxable account.

And I was assuming her cost basis matched her account value. So she's not really generating much taxable income. She does have the 2% interest every year in her adjusted gross income, but it's nowhere near the amount of her standard deduction. So she's paying 0% federal income taxes, but she's wasting tax capacity.

She could have at least generated taxable income up to the standard deduction and still had 0% tax rates, whether she went beyond that is up to her, but she could have generated more taxable income without actually generating any taxes. But then she gets into trouble around age 65, 'cause this is where she switches to just spending from tax deferred.

And to meet her spending goal and pay her tax bill, that's pushing her up to an adjusted gross income of $115,000 for most of those years. That's into that second Medicare threshold for her. So she's looking at more than 2,000 additional dollars of Medicare premiums. And I'm just adding that to the federal income tax numbers.

So when she's spending from her tax deferred account, she's being taxed on 85% of her social security. That's the 17,850 out of 21,000. And she has more than $20,000 of taxes for a long time, all the way through age 82. That's when she runs out of tax deferred account and start spending from her tax exempt account.

Then she's back to the issue where she just, she doesn't have any taxable income at this point. She still has to pay those higher Medicare premiums. That's that age 83 tax bill of the $2,164. That's just that additional Medicare premium based on her income at age 81. But after that, she doesn't have any more taxes.

Her adjusted gross income is zero. She's just spending from her Roth. She doesn't have taxes, but she's wasting tax bracket space again. And she ends up running out of money before she turns 89 years old. And then at ages 89 and higher, she's able to spend her $21,000 of social security benefits.

That's not enough to trigger taxes. So it's not even above the, sorry, it might be above the standard deduction. I was kind of thinking of the joint one when I was talking, but anyway, she's not triggering any taxable income. It is well below those thresholds for provisional income. So she had a lot of taxes between ages 65 up to about age 82, and that really disrupted her retirement.

She can do better than this to have that money last longer. And these were, what I was saying, I test every level of adjusted gross income, see how long the portfolio lasts. And that's where I find like a tax bracket management strategy. $60,000 of adjusted gross income claim at 70 is giving her the most portfolio longevity there.

And that's why I picked that as the standard. If you look at $60,000, that's where that curve gets the highest on the top purple curve for the Roth conversions, social security at 70. And then this is just a matter of like trial and error of saying, well, what if she did two different things?

What if she managed an even higher level before social security begins and then reduce after that? And this is where she's going right up to the threshold of where her social security or her Medicare would be taxed two times, into two of those thresholds. In reality, you probably wouldn't wanna go this close because one more dollar of income would accidentally trigger the higher Medicare premium.

So you might kind of build in a buffer of $1,000. But the basic idea, you're gonna pay more taxes early on, but then after age 70, you're gonna manage a $25,000 tax bracket. And that gives you the most portfolio longevity in that bifurcated strategy. And here's how the tax situation plays out with this most tax efficient version.

With this, she's gonna do Roth conversions early on. So she's spending from her taxable account. She's paying taxes from her taxable account. She's then doing Roth conversions up to manage that $111,000 of adjusted gross income. And then she's gonna have a higher federal income tax bill in those early years.

Her taxable account depletes by age 64. Then she doesn't do Roth conversions anymore 'cause she doesn't have a way to really pay the taxes on that. So she's taking $111,000 out to spend from her tax deferred account. That doesn't meet the full amount she needs to cover her taxes.

So she's taking a bit more out of her tax exempt account at that point. And she continues to pay those high taxes up until age 70. Then her social security begins. And then she's able to, at that point forward, manage $25,000 of adjusted gross income. That's going to dramatically reduce her tax bill.

She does have the one year there where she's paying the higher Medicare premium again, or one or two years. I've got that part of my screen covered with everybody's pictures here. But at some point then, her taxes dropped down to 1,460. And that's just based on, you can see her social security, $6,843 is taxable out of the benefit of $37,200.

So she's paying taxes on a much smaller percent of her social security benefit. That's helping a lot. She front loaded her taxes. But after age 70, it's smooth sailing. She's able to take much less out of her tax deferred account at that point, blend it more with her Roth account distributions and her higher social security benefit.

And her money lasts until she's 94. And then after it does run out at that point, she still has that higher social security benefit. So it's, I mean, her money lasts 5.6 years longer. And even if she does run out, she still has 77% more coming out of social security.

So that's kind of how this fits together to work better for her to help manage in particular. Well, in that first example, she was paying two bumps up the Medicare brackets as well as 85% on her social security. She was wasting tax capacity. Here, she's front loading her taxes and setting herself up very well.

So once her social security begins, not much of it is taxable and she gets to pay lower taxes for the rest of her life. And that's what's generating more portfolio longevity for her in this example. So key ideas coming out of all this, the progressive tax code in the US and all those various pitfalls I talked about really can have an impact on your marginal tax rates.

And so it can make this kind of planning important. So setting up pre-retirement with tax diversification and asset location. And then as you enter into retirement, thinking about social security claiming and how that impacts as well with managing tax brackets and potentially conducting a strategic Roth conversion strategy. Again, for money that you don't anticipate going to charity can lay the foundation for a much stronger retirement income plan in that regard.

So again, the book, chapter 10 of the book, that's more than 70 pages about what I was talking about right now. And let me go ahead and wrap up. Let me show you that disclosure, but otherwise we can go ahead and wrap up there and get into the questions again.

So thank you. - Thank you, Wei. That was wonderful. I'm gonna go ahead and pause the recording here so we can take our questions. - Okay, Wei, we just wanna thank you once again for your time and expertise. These are pretty thought-provoking discussions that we as retirees certainly are trying to maneuver at a time where things should become simpler and they become more complex.

And so we appreciate your insight into these issues that we're all gonna have to face to some degree. And again, we thank you for the work you put into the book where we can kind of ponder it a little bit more, but thanks again. We really appreciate it. - Okay, my pleasure.

- By the way, Wei, will you make your slides available for the Bogleheads possibly? - Yeah, I can do that. - Okay. - Let me make a little note to remind myself. - Lady Geek will post that on the forum. I also wanna thank, in addition to Robert, for doing a superb job in getting this organized.

Also, Henry and Raj helped out behind the scenes with their input and perspectives. We appreciate that. As a reminder for everybody, we now have a Bogleheads YouTube channel. Once we have this recording edited, we'll have it posted up there. Also, I advise everybody to please bookmark the Bogleheads calendar of events, which is in the blog section of the forum to see all the upcoming local and chapter national meetings as well.

But with YouTube channel now also has the Bogleheads on investing podcasts. They're being uploaded as well with Rick Ferry. Again, thank you so much, Wei. This was a phenomenal presentation. We appreciate your efforts, especially after having done a webinar already this afternoon. And it definitely gave us a tremendous food for thought and piqued our curiosity to investigate this further with the book and other resources you have to offer.

So, thank you very much. - Thank you. - Thank you, everybody. - Thank you. (upbeat music) (upbeat music continues) (upbeat music continues) (upbeat music continues) (upbeat music continues) (upbeat music)