Bogleheads® Chapter Series – Wade Pfau on Retirement Income Style Analysis, Tax Efficiency

00:00:00.000 | (upbeat music)

00:00:01.980 | Welcome to the Bogleheads Chapter Series.

00:00:04.640 | This episode was hosted by the Retired Life States Chapter

00:00:08.100 | and recorded September 21st, 2021.

00:00:11.420 | It features Wade Pfau, PhD, CFA, discussing RISA,

00:00:15.900 | his retirement income style awareness tool,

00:00:18.580 | as well as tax planning considerations in retirement.

00:00:22.220 | Bogleheads are investors who follow

00:00:23.700 | John Bogle's investing philosophy

00:00:25.420 | for attaining financial independence.

00:00:27.860 | This recording is for informational purposes only

00:00:30.140 | and should not be construed

00:00:31.280 | as personalized investment advice.

00:00:33.980 | Welcome everybody to the Retired Life Stage meeting.

00:00:36.860 | I'm Alan, one of the chapter coordinators

00:00:38.820 | along with my colleagues, Robert, Henry, and Raj.

00:00:42.300 | We're very pleased to have Wade Pfau joining us this evening.

00:00:45.580 | We'll start with our usual disclaimer

00:00:47.260 | that this presentation is for informational purposes only

00:00:50.340 | and should not be construed

00:00:51.460 | as personalized investment advice.

00:00:54.380 | And I'll turn the mic over to my colleague, Robert,

00:00:56.340 | who will formally introduce Wade

00:00:57.980 | and the presentation topics.

00:01:00.300 | Thank you, Robert. - Thank you, Alan.

00:01:01.580 | Yes, well, it's my pleasure this evening

00:01:04.060 | to introduce our guests, Dr. Wade Pfau.

00:01:07.340 | I think many in the Boglehead community

00:01:11.020 | are quite aware of his accomplishments.

00:01:14.020 | Wade is a retirement researcher

00:01:16.440 | and professor of retirement income in the PhD program

00:01:20.480 | for financial and retirement planning

00:01:23.100 | at the American College of Financial Services.

00:01:26.500 | He's also principal director of retirement research

00:01:29.660 | at McLean Asset Management,

00:01:32.060 | and he's the founder of Retirement Researcher.

00:01:34.460 | Wade holds a master's and doctorate in economics

00:01:38.780 | from Princeton University

00:01:40.620 | and a bachelor of arts and a bachelor of science degrees

00:01:43.180 | from the University of Iowa.

00:01:44.900 | He's also a chartered financial analyst.

00:01:47.700 | Wade is a prolific writer and researcher.

00:01:52.020 | He's authored many papers and books

00:01:54.180 | on a wide spectrum of retirement-related topics,

00:01:57.700 | including in-retirement withdrawal rates,

00:02:00.300 | optimum asset allocations for retirement,

00:02:03.160 | and the role of annuities retirement portfolio.

00:02:07.220 | His latest book, of which we will speak from tonight,

00:02:10.420 | is called "The Retirement Planning Guidebook,"

00:02:13.420 | which I have, let me show you, nice and big.

00:02:20.140 | "Navigating Important Decisions for Retirement Success."

00:02:24.380 | As a retirement community here,

00:02:27.160 | most of us know that the deaccumulation phase of our assets

00:02:31.780 | can be a lot more complex than the accumulation phase,

00:02:35.140 | and I think this work helps us in that regard.

00:02:38.900 | Wade's gonna speak twice tonight,

00:02:41.400 | two different presentations.

00:02:43.140 | The first presentation's gonna work

00:02:45.280 | the left side of our brain,

00:02:47.100 | and it's directed more towards

00:02:48.420 | the behavioral side of finance.

00:02:50.820 | We'll be looking at the retirement

00:02:52.260 | income styles and decisions.

00:02:54.700 | It's kind of a Morningstar-style box

00:02:58.220 | for self-awareness of income strategies.

00:03:01.980 | I believe they use the acronym RESA,

00:03:05.100 | which is Retirement Income Style Awareness.

00:03:07.860 | These questionnaires in RESA, in theory,

00:03:12.820 | can reveal an individual's tolerance

00:03:14.780 | for risk in retirement,

00:03:16.480 | what income style best fits that individual,

00:03:19.420 | and the value of financial advice

00:03:21.060 | if they choose to move in that direction.

00:03:23.100 | The second presentation

00:03:25.980 | will work the other side of our brain,

00:03:27.500 | and it really deals with Chapter 10 from his textbook,

00:03:31.100 | and it's "Tax Planning

00:03:32.700 | for Efficient Retirement Distributions."

00:03:36.500 | Here, Wade will present some tax-efficient distributions

00:03:40.380 | that can prolong the sustainability of retirement assets

00:03:45.000 | and take an advantage of really of tax diversification

00:03:48.420 | and tax bracket management.

00:03:51.100 | So with that, I hand it over to Dr. Wade Fowler.

00:03:54.340 | - Okay, thank you, Robert,

00:03:55.420 | and thanks, Alan and Raj and Lady Geek

00:03:57.740 | and everyone who's been helpful

00:03:59.740 | in setting up the meeting today.

00:04:00.940 | Can you see my screen okay?

00:04:03.180 | I don't have the usual Zoom.

00:04:04.580 | Can everyone hear me and see?

00:04:07.820 | - Yes. - Okay, great.

00:04:09.780 | So thanks, everyone.

00:04:11.060 | I joined the Bogleheads, I think it was 2010.

00:04:14.020 | My profile will verify that.

00:04:16.580 | I was pretty active for a few years.

00:04:18.000 | I haven't been as active in recent years,

00:04:19.980 | but it is great to reconnect again

00:04:21.980 | with the Bogleheads community.

00:04:23.780 | And as Robert mentioned,

00:04:25.020 | the presentations today are from,

00:04:27.020 | based on the "Retirement Planning Guidebook,"

00:04:28.760 | which I've really been writing for nine years now,

00:04:31.100 | and it's finally finished.

00:04:32.820 | The presentations aren't equal in length,

00:04:34.820 | just in terms of this topic was about 15 pages of the book,

00:04:38.980 | and then the tax planning chapter was more than 70 pages.

00:04:42.100 | So we won't have that big of a difference

00:04:44.460 | in presentation lengths,

00:04:45.540 | but hopefully we'll have some more time

00:04:47.540 | for the tax planning compared to,

00:04:49.660 | we'll start with the retirement income styles.

00:04:51.900 | So with that being said,

00:04:54.700 | I've now generally tried to approach retirement

00:04:57.020 | with these 12 general topic areas.

00:04:59.940 | And I think what we're talking about first

00:05:01.500 | is retirement income styles is the best starting point

00:05:04.820 | to start thinking about building a retirement strategy.

00:05:08.020 | And also in that regard too,

00:05:09.300 | we ran a poll about which chapters

00:05:11.580 | my retirement researcher community

00:05:13.260 | was most interested to hear about.

00:05:15.460 | In tax planning, our second presentation today

00:05:17.580 | won that poll by a wide margin.

00:05:20.060 | And the retirement income styles was in third place.

00:05:22.900 | The second place one was the,

00:05:24.820 | how much can you spend from an investment portfolio?

00:05:27.100 | That whole 4% rule world type topic

00:05:30.580 | that I know is also quite popular at Bogleheads.

00:05:32.900 | But we'll talk about the retirement income styles,

00:05:35.420 | and then you can just see the other aspects

00:05:37.420 | of like understanding different retirement risks,

00:05:40.460 | quantifying your goals,

00:05:41.740 | determining if you're prepared for retirement,

00:05:44.420 | looking at different investment and annuity strategies,

00:05:46.660 | which will stem from understanding

00:05:48.420 | your retirement income style.

00:05:50.260 | And then the social security claiming decision,

00:05:52.260 | healthcare and Medicare decisions,

00:05:54.140 | long-term care, retirement housing, the tax planning,

00:05:58.140 | legacy and incapacity planning.

00:06:00.420 | And then just as important as any of the finances

00:06:02.620 | is just the non-financial aspect

00:06:04.380 | of having purpose and passion for retirement

00:06:07.900 | and then implementing and monitoring the plan.

00:06:10.300 | So would that be instead

00:06:12.460 | for the retirement income style discussion,

00:06:15.500 | the agenda will be to just discuss

00:06:17.300 | that there are a lot of different

00:06:18.460 | retirement income strategies out there.

00:06:21.020 | And we haven't really in the past

00:06:22.660 | had a way to choose among them.

00:06:24.780 | And I think that's just created conflict

00:06:27.060 | because there's just,

00:06:27.940 | you can ask basic questions about retirement

00:06:29.940 | and get completely different answers

00:06:31.420 | based on who you're talking to.

00:06:33.460 | And so we need a way to better filter these styles.

00:06:36.620 | And that's, this led to a research project

00:06:39.100 | that I did with Alex Mardia,

00:06:41.180 | where we tried to identify just by reading

00:06:43.700 | and reading everything out there about retirement planning.

00:06:46.540 | How did people talk about retirement planning?

00:06:48.700 | Were there particular factors that seem to be prevalent

00:06:52.420 | in terms of there's some sort of trade-off out there?

00:06:56.140 | And then we did try to test those with,

00:06:58.740 | we started with about 900 questions.

00:07:00.740 | Alex likes to talk about that.

00:07:01.900 | We whittled it down quite a bit since then.

00:07:04.060 | But can we figure out if there are distinct preferences

00:07:08.020 | that might help to define a style?

00:07:09.780 | And what was really interesting was about that.

00:07:11.740 | And as I'll be talking about is just

00:07:13.860 | how well these different preferences work together

00:07:17.300 | to actually explain the main retirement strategies

00:07:20.220 | that we know about.

00:07:22.020 | And so then linking these styles

00:07:24.460 | to the different strategies and different retirement tools.

00:07:27.740 | So we know that retirement is different from pre-retirement,

00:07:33.020 | that this is the whole issue

00:07:34.900 | of what makes retirement income planning distinct.

00:07:38.260 | Pre-retirement, you're still working

00:07:40.100 | and can rely on work to fund your lifestyle,

00:07:43.060 | you're saving for the future.

00:07:45.220 | But you're generally,

00:07:46.060 | you have more of an accumulation mindset

00:07:47.860 | where you can focus more on risk-adjusted returns,

00:07:50.500 | modern portfolio theory,

00:07:52.020 | like building that efficient frontier,

00:07:54.180 | seeking a well-diversified investment portfolio.

00:07:57.300 | But a few things change in retirement.

00:07:59.420 | You now change from adding new savings

00:08:01.900 | to now taking distributions.

00:08:04.100 | And that you don't know how long

00:08:06.100 | you're gonna be doing that for.

00:08:06.940 | So there's this element of longevity risk.

00:08:08.940 | There's an element of when you're taking distributions

00:08:11.220 | from your portfolio,

00:08:13.060 | there are sequence of returns risk

00:08:14.740 | that a market downturn can harm you

00:08:17.580 | in a way that it doesn't pre-retirement.

00:08:19.460 | Because if you have to sell from a declining portfolio,

00:08:22.500 | there's less available to recover

00:08:24.300 | from any sort of subsequent market recovery.

00:08:27.060 | And then the different spending shocks

00:08:28.500 | with the healthcare, long-term care and so forth.

00:08:31.580 | And so this analogy about mountain climbing is,

00:08:34.660 | with mountain climbing,

00:08:35.540 | we might think the goal is to make it

00:08:36.780 | to the top of the mountain.

00:08:37.900 | Just like with retirement planning,

00:08:39.540 | we think the goal is to reach the retirement date

00:08:41.900 | with a certain wealth accumulation target,

00:08:44.180 | whatever that number may be.

00:08:46.180 | But the reality is,

00:08:47.260 | you need to make it back down the mountain as well.

00:08:49.620 | And with mountain climbing,

00:08:50.620 | most of the accidents do happen on the way down the mountain.

00:08:53.620 | With a retirement income, it's more difficult.

00:08:56.900 | There's more challenges post-retirement than pre-retirement.

00:09:00.380 | And so that speaks to the need

00:09:01.940 | to think about retirement a bit differently.

00:09:04.220 | But it is still the Wild West

00:09:07.580 | in terms of retirement income strategies.

00:09:09.380 | And you'll see so much debate and discussion.

00:09:12.180 | And that's where we wanna try

00:09:13.740 | to just provide some more general guidance

00:09:16.740 | or some framework for thinking

00:09:19.540 | about these different retirement strategies.

00:09:22.020 | Now, this is from a book I wrote a few years back

00:09:25.300 | that was focused more on investment-based strategies.

00:09:27.660 | But I think there's 37 different strategies here.

00:09:31.460 | And that's just a sampling of...

00:09:33.740 | And one of these, like the Bogleheads,

00:09:36.460 | I would classify as having a variable spending strategy.

00:09:39.380 | There's that variable withdrawal percentage,

00:09:42.140 | I think that's the name of it.

00:09:43.140 | Lady Geek, I'm sure, is already putting in the chat.

00:09:45.860 | There's a number of different strategies out there.

00:09:50.100 | And well, more generally beyond that as well,

00:09:54.340 | for about 10 years,

00:09:55.180 | the Financial Planning Association has clarified

00:09:57.580 | that there's three main types of retirement strategies.

00:10:00.420 | And there can be a lot of subcategories.

00:10:01.860 | And that's where the previous slide

00:10:03.580 | was more about the subcategories.

00:10:05.740 | But you have generally systematic withdrawal strategies

00:10:09.220 | that in this retirement income style awareness,

00:10:11.140 | we're gonna rename as just total returns,

00:10:13.220 | because it's more about taking systematic withdrawals

00:10:15.620 | from a total return investing portfolio.

00:10:18.300 | It's probably where a lot of Bogleheads

00:10:20.540 | are kind of thinking as a starting point

00:10:22.420 | for retirement income.

00:10:24.060 | There's essential versus discretionary,

00:10:26.740 | which is about building a floor

00:10:28.380 | of more lifetime-based reliable income,

00:10:31.380 | protected lifetime income,

00:10:33.500 | like emphasizing more social security.

00:10:35.460 | And then beyond that, beyond any pensions,

00:10:38.580 | there may be a role for an annuity

00:10:40.140 | to help build a protected lifetime income floor.

00:10:43.020 | And then with the remaining assets,

00:10:44.740 | investing for upside and investing more

00:10:47.380 | for discretionary types of expenses.

00:10:49.700 | And then time segmentation

00:10:50.940 | was always some sort of hybrid between the two.

00:10:53.340 | And that's also known as a bucketing strategy

00:10:56.540 | that's where you invest differently

00:10:58.420 | for the short-term and the long-term.

00:11:00.580 | With time segmentation, you might say,

00:11:02.780 | well, if I have bonds maturing for the next five years,

00:11:06.100 | I can have at least five years worth of expenses covered.

00:11:09.140 | And then all my other assets

00:11:10.540 | in my growth diversified investment portfolio

00:11:13.540 | are meant to cover the expenses in year six and beyond.

00:11:16.660 | And I have an opportunity to endure a market downturn

00:11:19.540 | and to have time for the portfolio to recover

00:11:21.740 | because I'm just spending my fixed income

00:11:24.340 | until I get through that period.

00:11:25.980 | And hopefully then the market will recover

00:11:28.260 | and then I can resume drawing from the growth portfolio

00:11:31.220 | to replenish the time segmentation portfolio,

00:11:34.020 | the front end fixed income ladder.

00:11:37.100 | And so again, the systematic withdrawals

00:11:41.540 | is the total return investing approach.

00:11:43.700 | It's starting point is like the 4% rule of thumb

00:11:46.580 | that's discussed quite a bit.

00:11:47.900 | I know I saw even on the main page of Bogleheads right now,

00:11:50.740 | there was a thread mentioning the 4% rule.

00:11:53.980 | That was what Bill Bingen developed in the 1990s.

00:11:56.620 | The idea of if you have a portfolio with 50 to 75% stocks

00:12:01.420 | and you're planning for a 30 year retirement horizon,

00:12:04.660 | you should be able to take 4% out of the portfolio

00:12:07.260 | in year one.

00:12:08.660 | And then that gives you a level of spending

00:12:10.700 | that you can adjust for inflation.

00:12:13.100 | And based on US historical data,

00:12:15.060 | anticipate your money will last for at least 30 years.

00:12:18.620 | Now this can also include like variable spending strategies

00:12:21.780 | where you're spending changes

00:12:23.220 | in response to portfolio performance and so forth.

00:12:25.940 | But this is very much an investment focused,

00:12:29.300 | diversified portfolio spending from the portfolio

00:12:33.340 | as a core retirement strategy.

00:12:35.660 | And then sort of opposite from it

00:12:39.140 | is more like that essential versus discretionary,

00:12:41.900 | but we'll call that income protection

00:12:43.540 | with retirement income style awareness.

00:12:45.620 | And that's more the sense of thinking

00:12:47.420 | about simple income annuities,

00:12:49.020 | building a lifetime protected income floor

00:12:50.980 | to cover your essential expenses.

00:12:53.460 | So you're protected from longevity risk.

00:12:55.780 | Even if you live to 100,

00:12:57.220 | you still have the money coming in through the contract.

00:12:59.980 | You're protected from the market risk for that,

00:13:02.420 | but then you can use the investment portfolio on top

00:13:05.820 | to then cover more diversified

00:13:07.940 | or more discretionary types of spending.

00:13:10.700 | And these are gonna be,

00:13:11.660 | as we get into the retirement income style awareness,

00:13:14.260 | these will be the two core strategies.

00:13:16.620 | And the other two strategies I'll talk about

00:13:19.100 | really have more of a behavioral element to them.

00:13:21.540 | So time segmentation, again,

00:13:23.980 | it's that I invest with bonds for the short-term expenses

00:13:27.980 | and then with stocks or other more growth-focused assets

00:13:31.260 | for longer-term expenses.

00:13:33.340 | And that's some sort of hybrid,

00:13:35.740 | trying to rely on the market,

00:13:37.540 | but also getting some sort

00:13:38.780 | of short-term contractual protection,

00:13:41.060 | just not over the lifetime,

00:13:42.540 | but over a shorter time period.

00:13:44.780 | And then a fourth strategy we'll consider

00:13:48.660 | is the risk-wrap strategy,

00:13:50.260 | which is a cousin of that income protection strategy.

00:13:53.820 | The simple income annuities

00:13:55.820 | are not very popular in practice.

00:13:57.940 | And in practice,

00:13:59.260 | deferred annuities with living benefits

00:14:01.580 | are used much more frequently,

00:14:02.900 | whether it's the variable annuities

00:14:04.540 | or the fixed index annuities,

00:14:06.700 | or now we even have the registered index-linked annuities.

00:14:10.460 | These are annuities that still provide

00:14:12.820 | some sort of underlying liquidity,

00:14:15.060 | still provide some upside potential,

00:14:17.220 | but can also support a lifetime income.

00:14:19.740 | And so it really is gonna work out

00:14:21.500 | to be a distinct strategy from income protection.

00:14:24.860 | So these are the four basic retirement strategies

00:14:27.540 | that most anything can then kind of

00:14:30.500 | be somewhat close to one of these four.

00:14:32.460 | And like the Boglehead's

00:14:36.220 | variable percentage withdrawal strategy,

00:14:37.900 | I would put in the family of total return strategies.

00:14:41.380 | Now, the next question is,

00:14:42.620 | how do retirees choose from these possibilities?

00:14:46.860 | And so they might be listening to a radio show

00:14:49.300 | or hearing commercials on the radio

00:14:50.980 | about different financial advisors

00:14:52.940 | pitching different strategies.

00:14:55.220 | They may just be personal finance blogs.

00:14:56.780 | Of course, discussions at the Boglehead's

00:14:58.860 | is gonna be a great resource for everyone on the call today.

00:15:03.060 | They may just be reading the consumer finance,

00:15:05.620 | personal finance type consumer media,

00:15:08.460 | attending different seminars or other events, webinars,

00:15:11.780 | a local class, a lot of local organizations,

00:15:15.100 | adult education programs will provide

00:15:16.900 | retirement planning classes

00:15:18.540 | or working with a financial advisor.

00:15:21.460 | But still, we don't really have the tools

00:15:25.620 | to identify who should use what type of strategy.

00:15:27.860 | Like, that's the question.

00:15:28.740 | If I'm starting to think about retirement,

00:15:31.100 | should I use an income protection strategy?

00:15:32.860 | Should I use a total return strategy?

00:15:35.100 | We haven't really had the tools for that.

00:15:37.420 | And a lot of financial service professionals

00:15:39.540 | tend to like put their stake into one camp.

00:15:42.580 | And so if I'm an investment manager,

00:15:45.700 | I would tend to recommend a total return strategy

00:15:48.020 | to everyone.

00:15:49.020 | Or if I'm an insurance agent,

00:15:50.980 | I would tend to recommend

00:15:52.260 | some sort of annuity-based strategy to everyone.

00:15:54.980 | And it's like, if the only tool you have is a hammer,

00:15:57.620 | then everything looks like a nail, even when it's not.

00:16:00.300 | And so we haven't had a way

00:16:01.780 | to really better filter these strategies.

00:16:04.100 | Now, this starts to get into like,

00:16:08.260 | with the retirement's different

00:16:10.060 | as we started the presentation.

00:16:12.100 | So people might have different concerns

00:16:14.220 | about different types of retirement risks.

00:16:16.140 | And you can think about like,

00:16:17.180 | what are you the most worried about?

00:16:18.700 | Is it the idea that you might outlive your assets?

00:16:22.020 | Are you really worried about that sequence of returns risk,

00:16:24.340 | which is like, you know, Robert's,

00:16:25.980 | or not Robert's law, but Murphy's law,

00:16:28.540 | the one where like, if I retire today,

00:16:30.740 | tomorrow's gonna be the day that the stock market drops.

00:16:33.140 | Is that something that you're really worried about?

00:16:36.420 | The different spending shocks,

00:16:37.740 | like, are you very worried about

00:16:39.220 | what if I have a significant long-term care event?

00:16:42.780 | The impacts of declining cognitive abilities,

00:16:45.220 | the impacts of compounding inflation and so forth.

00:16:47.900 | And that speaks to, these are the four L's.

00:16:52.940 | These are the financial goals of retirement

00:16:55.180 | and they're impacted by different risks.

00:16:57.060 | And so you may then have different concerns

00:16:59.100 | about these goals.

00:17:00.860 | So longevity is about your essential spending.

00:17:03.820 | And it's the idea that no matter how long you live,

00:17:05.580 | you wanna at least ensure you have your basics covered.

00:17:08.460 | Is that something that resonates with you?

00:17:10.660 | Is something you're worried about?

00:17:12.580 | Or are you maybe just focused more on the lifestyle,

00:17:15.740 | which is your overall lifestyle goal,

00:17:17.660 | including discretionary spending?

00:17:19.940 | Are you someone who might view your retirement as a failure

00:17:23.260 | if you're not able to meet all your lifestyle expenses?

00:17:26.700 | And I'm guessing with bogleheads,

00:17:28.140 | there's probably more of an emphasis

00:17:29.980 | on kind of the longevity

00:17:32.540 | because bogleheads tend to not just spend excessively

00:17:34.940 | and so forth.

00:17:35.860 | But lifestyle does imply some sort of,

00:17:38.460 | like if you're a member of a country club,

00:17:40.660 | a lot of people would classify that

00:17:43.060 | as a discretionary expense.

00:17:45.260 | But some people might be really worried

00:17:46.620 | if they can't meet that expense,

00:17:48.100 | they may feel like their retirement is a failure.

00:17:50.180 | So do you have a greater concern for lifestyle expenses?

00:17:54.940 | Legacy goals.

00:17:56.460 | Now, what we find in practice is legacy goals

00:17:59.220 | are often not a primary concern for most people.

00:18:02.580 | A lot of people do take the view that,

00:18:04.460 | well, the errors can have whatever's left over at the end.

00:18:08.020 | Of course, some people do like to earmarks

00:18:10.060 | a specific legacy goal.

00:18:11.460 | I would like to leave X number of dollars to so-and-so.

00:18:14.660 | And so if that's a bigger concern,

00:18:16.940 | it's usually not gonna rank as a top concern

00:18:19.260 | for most retirees, but it might for you.

00:18:20.820 | It's just, how do you think about legacy

00:18:23.260 | as a particular concern in terms of a goal

00:18:25.940 | you want to be able to ensure you can meet?

00:18:28.620 | And then liquidity is about having additional liquid assets

00:18:33.860 | available to cover unexpected spending shocks.

00:18:37.180 | And there's different ways to think about liquidity.

00:18:39.180 | We'll get to that in a moment.

00:18:41.140 | But is liquidity something that worries you?

00:18:43.420 | And if you're very worried,

00:18:44.820 | like you're concerned about spending today

00:18:46.780 | because you're concerned about a long-term care event

00:18:49.020 | that could happen, that would imply

00:18:51.180 | more of a liquidity concern as being something that you're...

00:18:54.740 | Liquidity is more about than just an emergency fund.

00:18:57.420 | It's significant spending shocks

00:19:00.100 | and needing to make sure

00:19:01.300 | that you can handle unexpected expenses

00:19:03.900 | outside of what you budgeted for.

00:19:05.780 | So then how do we match up your style

00:19:10.460 | based on your concerns,

00:19:11.780 | the risks that you're concerned about

00:19:14.420 | and just going through that thought process?

00:19:17.060 | Well, that's where this research that Alex and I did.

00:19:20.500 | And just it's a project that was going on last year

00:19:23.900 | and finished it this year.

00:19:25.020 | And this is the actual research article for it.

00:19:27.220 | If anyone's interested to read the full length version,

00:19:30.260 | it is pretty long,

00:19:31.460 | but I'll give a more basic explanation of it today.

00:19:34.260 | And then what we found is, like I said,

00:19:38.540 | we were just looking at all kinds of different writings

00:19:41.420 | about retirement planning, trying to identify factors.

00:19:45.780 | And then what we did was an exploratory factor analysis

00:19:48.780 | to just let the data tell us from the questionnaires,

00:19:52.540 | which factors or which questions seem to correspond

00:19:56.740 | into some sort of particular factor

00:19:59.060 | that can explain a set of preferences.

00:20:01.940 | And then what we found, and I'll talk about what these are,

00:20:04.860 | but the two primary factors

00:20:06.460 | that came out of this exploratory factor analysis

00:20:09.020 | is a statistical method.

00:20:11.060 | It's this, what we call probability-based

00:20:13.100 | versus safety first,

00:20:14.340 | and then optionality versus commitment.

00:20:16.980 | And then we found four factors that were significant.

00:20:20.060 | They weren't shown to be as distinct or as important,

00:20:23.340 | but ultimately they can help tell the story.

00:20:25.180 | And that's these,

00:20:26.020 | well, I'll go through each of these in detail,

00:20:27.620 | so no need to list them by name right now,

00:20:30.340 | but we'll talk about these.

00:20:32.180 | And then what comes out of that,

00:20:36.460 | and I'll explain that as well,

00:20:37.700 | is when we understand how somebody scores

00:20:41.940 | on these different factors,

00:20:43.660 | that really can help to describe

00:20:45.180 | what type of retirement strategy will resonate with them,

00:20:48.220 | whether it's a total return or a risk graph

00:20:50.260 | or income protection or a time segmentation.

00:20:52.820 | And so this is based on the retirement income optimization

00:20:57.580 | framework, which is those four L's

00:20:59.340 | as the financial goals on the left,

00:21:01.580 | mapping into liabilities or expenses on the right,

00:21:05.420 | and then thinking about how we position assets

00:21:07.420 | to meet our goals.

00:21:08.940 | And the different styles

00:21:09.940 | are gonna put different emphasis there,

00:21:11.580 | where if you're total return,

00:21:13.940 | you don't care as much about reliable income

00:21:16.300 | as a specific asset.

00:21:17.580 | You're fine using the diversified portfolio

00:21:19.700 | to cover essential expenses.

00:21:22.020 | And also if you're total return,

00:21:23.660 | you're gonna put less emphasis on having reserves

00:21:26.140 | as a distinct category.

00:21:27.300 | You're more comfortable with just general liquidity,

00:21:30.580 | not necessarily thinking about how assets are earmarked

00:21:33.340 | for different purposes and so forth.

00:21:35.180 | So this slide is just in an article

00:21:41.380 | that came out today in Advisor Perspectives.

00:21:44.140 | So risk tolerance questionnaires,

00:21:46.780 | that's the fundamental tool a lot of people use

00:21:48.740 | to decide on an asset allocation.

00:21:50.540 | It's like how much short-term market volatility

00:21:52.460 | can you stomach to explain,

00:21:55.060 | should I have a 40% stock allocation

00:21:57.940 | or a 90% stock allocation?

00:22:00.900 | There's a lot of concerns

00:22:01.940 | about risk tolerance questionnaires in general

00:22:03.420 | about how well they work.

00:22:04.460 | And really the point here

00:22:06.020 | is not to get into any of that discussion,

00:22:09.140 | but to just point out,

00:22:10.620 | risk tolerance questionnaires don't really line up

00:22:12.500 | with retirement concerns very well.

00:22:14.940 | And as can be expected,

00:22:15.980 | they actually, they do line up with the lifestyle concern,

00:22:18.900 | which is kind of how you might think about it.

00:22:21.260 | Like if I'm more risk tolerant,

00:22:22.460 | if I can stomach more market volatility,

00:22:25.740 | it might, especially when we get through

00:22:27.140 | this whole discussion,

00:22:27.980 | it might imply I'm comfortable,

00:22:30.180 | or I have more concern about my overall lifestyle,

00:22:33.260 | and I'm not necessarily thinking as much

00:22:35.180 | about the other concerns.

00:22:36.820 | But with the two main factors

00:22:38.220 | that we'll look at with retirement income style awareness,

00:22:40.980 | we can find a match

00:22:42.620 | to all of the different retirement concerns

00:22:44.700 | where reserves would be liquidity in this context.

00:22:47.660 | Okay, so these two main factors now,

00:22:51.980 | this is where we're starting

00:22:52.900 | to get into the meat of the matter.

00:22:55.660 | So how would you like to draw your retirement income?

00:22:59.660 | If you're someone who's probability-based,

00:23:02.820 | you're more comfortable relying on market growth.

00:23:05.940 | We have the idea of the risk premium

00:23:07.700 | that stocks will outperform bonds

00:23:09.180 | over reasonable holding periods.

00:23:11.500 | And if you're comfortable relying on the risk premium,

00:23:14.060 | and historically the S&P 500s

00:23:16.260 | outperformed long-term government bonds

00:23:18.500 | by 6% on average since the 1920s,

00:23:21.540 | if you're comfortable using that to fund your retirement,

00:23:24.820 | you're more probability-based.

00:23:27.060 | Safety first is you really would prefer

00:23:30.100 | to have some sort of contractual protection

00:23:32.220 | supporting your income.

00:23:34.180 | That could be holding individual bonds to maturity,

00:23:37.580 | or it could also be using risk pooling through an annuity,

00:23:41.100 | but you're less comfortable

00:23:43.140 | relying on the market in this regard.

00:23:45.140 | You'd rather have some sort of contractual protection

00:23:47.380 | backing up your retirement plan.

00:23:50.340 | And you can think about how you might answer

00:23:53.740 | or how you might identify yourself on that spectrum.

00:23:56.340 | And then optionality, this kind of surprised me

00:24:01.300 | because if I had to guess in advance

00:24:03.140 | which would be the two most important factors,

00:24:05.980 | I don't think I would have picked this one.

00:24:07.620 | I probably would have picked something more

00:24:09.340 | like accumulation versus distribution,

00:24:11.380 | but this is just how much optionality

00:24:14.180 | do you want in your plan?

00:24:15.580 | And if you're someone

00:24:16.420 | who has more of an optionality preference,

00:24:19.420 | you really emphasize having flexibility,

00:24:21.820 | wanting to keep your options open.

00:24:24.060 | And that's because of a sense

00:24:25.500 | of you wanna be able to take advantage of new opportunities.

00:24:28.740 | You don't wanna really be locked

00:24:30.180 | into any particular strategy.

00:24:31.980 | You really value the optionality for a plan.

00:24:36.020 | And commitment orientation is you feel more comfortable

00:24:39.820 | just locking into a solution.

00:24:41.460 | If you know that something will solve

00:24:43.420 | for a lifetime income need,

00:24:45.660 | you don't necessarily need the optionality as much.

00:24:49.420 | Of course, you're gonna want to have some liquid assets,

00:24:52.420 | but you have the sense partly as well

00:24:55.140 | that you've got a plan that will work.

00:24:58.100 | So you can take it off your to-do list.

00:24:59.860 | You don't have to worry

00:25:00.700 | about ongoing decision-making and everything.

00:25:03.820 | You're more comfortable committing to a strategy.

00:25:06.940 | And this, as I said,

00:25:08.260 | is gonna be one of the two important factors

00:25:11.940 | based on that exploratory factor analysis.

00:25:15.660 | And then, well, we can see how these fit together.

00:25:18.860 | So we create this matrix.

00:25:20.460 | And that's how Robert said,

00:25:21.700 | like a Morningstar style box type situation.

00:25:25.300 | On the left is safety first.

00:25:27.100 | On the right is probability-based.

00:25:28.940 | On the top is optionality,

00:25:30.900 | and on the bottom is commitment.

00:25:33.020 | And so you can see these four quadrants developing

00:25:35.820 | where if you're in the upper right,

00:25:37.060 | you're probability-based, comfortable with market growth,

00:25:39.580 | and wanna keep your options open.

00:25:41.500 | If you're in the lower left, you're safety first.

00:25:44.140 | You want contractual protections,

00:25:45.700 | and you're comfortable committing to a strategy.

00:25:48.380 | And then it's a mixture in the other two.

00:25:50.540 | So then the secondary factors that can help tell the story,

00:25:55.900 | but are not primary.

00:25:57.180 | They're less important in terms of,

00:25:59.100 | they're not as distinct as important factors

00:26:01.460 | to help describe a strategy.

00:26:03.980 | But one is like, how do you view flooring?

00:26:07.380 | Time-based or perpetual?

00:26:09.380 | And this time-based is like time-segmented flooring.

00:26:12.300 | I'm thinking about, I wanna build a protected floor

00:26:14.180 | to cover my basic expenses.

00:26:15.980 | If a time-based preference would mean,

00:26:18.700 | it's like time segmentation.

00:26:19.820 | If I can have my basic expenses covered

00:26:22.740 | over the next three to five to eight years,

00:26:24.980 | there's some flexibility there.

00:26:26.140 | But if I can have the front-end expenses covered,

00:26:29.180 | I could have a time-based preference

00:26:31.020 | versus perpetual flooring.

00:26:33.580 | Well, that's more like the world of like an annuity

00:26:35.900 | with risk pooling and supporting a lifetime income need.

00:26:39.460 | So do you have a time-based or a perpetual flooring desire?

00:26:43.460 | How do you view your reserve assets?

00:26:47.300 | And this is where I mentioned

00:26:48.460 | there's these two attitudes about liquidity.

00:26:51.700 | If you have a true liquidity mindset,

00:26:54.700 | you really wanna have assets

00:26:56.380 | that are not earmarked for other goals,

00:26:58.660 | that are truly liquid in the sense

00:27:00.620 | that they're your reserves.

00:27:02.740 | You've already got other assets

00:27:04.220 | that are covering your future budgeted expenses,

00:27:06.820 | covering your legacy goals.

00:27:08.740 | These are assets specifically set aside as reserves

00:27:12.220 | to provide the liquidity

00:27:13.500 | to cover unexpected contingencies or spending shocks.

00:27:16.860 | And you make that distinction as important.

00:27:18.660 | I wanna be able to have these assets earmarked

00:27:20.980 | separately as reserves.

00:27:23.580 | Whereas those who have more of a technical liquidity mindset

00:27:27.460 | aren't making that type of distinction.

00:27:29.300 | They're thinking about their assets more generally

00:27:31.380 | as they have a total pot of assets

00:27:33.780 | and they don't necessarily have to have distinct reserves.

00:27:36.380 | They'll just figure things out

00:27:37.780 | whether if they have an unexpected expense,

00:27:40.540 | they'll figure out later how that's gonna impact

00:27:42.580 | other spending and so forth.

00:27:44.060 | Technical liquidity is like a brokerage account.

00:27:48.660 | It's liquid, but it may be earmarked for other purposes,

00:27:52.500 | but you're really not thinking about things that way.

00:27:54.460 | You're just generally thinking about a big pot of assets.

00:27:58.300 | Now, what's your mindset about retirement investing?

00:28:03.580 | If you have an accumulation mindset,

00:28:06.460 | you're really just maintaining

00:28:07.980 | the pre-retirement accumulation style of investing

00:28:11.420 | post-retirement, which is to focus

00:28:13.660 | on risk-adjusted returns for your portfolio.

00:28:16.900 | And that's where your emphasis is

00:28:18.340 | over trying to maintain a predictable income

00:28:20.620 | from the portfolio.

00:28:22.180 | And I mean, any of these preferences are completely valid.

00:28:24.860 | There's no problem with that,

00:28:26.300 | but you're not worried as much about predictable income.

00:28:29.740 | You'd rather focus more on just maximizing portfolios

00:28:32.540 | returns subject to your risk tolerance.

00:28:35.020 | Whereas if you had a distribution mindset,

00:28:38.100 | you do focus more on predictable income.

00:28:40.900 | And in that regard, you don't necessarily need

00:28:43.180 | to maximize your portfolio returns anymore.

00:28:45.940 | You'd rather have stable, predictable income

00:28:48.020 | being generated by your portfolio.

00:28:50.380 | And so you'd prefer strategies that do that,

00:28:52.460 | even if they sacrifice having the highest possible

00:28:55.380 | total return from the portfolio.

00:28:57.540 | And then the final one of these

00:29:00.820 | is front-loading versus back-loading.

00:29:03.420 | If you have a front-loaded preference,

00:29:06.060 | you wanna spend more today while you're healthy and alive

00:29:09.940 | and assured that you can actually enjoy it.

00:29:12.380 | And you worry less about like,

00:29:14.220 | if you have to cut your spending in the future, that's okay.

00:29:16.660 | And with a front-loaded preference.

00:29:18.860 | And if you have a back-loaded preference,

00:29:21.220 | this is the idea of longevity risk aversion,

00:29:23.580 | that you're worried about outliving your money.

00:29:25.220 | So you're willing to sacrifice some spending today

00:29:28.980 | to better protect your future lifestyle.

00:29:31.100 | You're wanting to more back-load your spending.

00:29:33.300 | You don't wanna be 95 years old

00:29:35.420 | and not have anything left except a social security benefit.

00:29:38.900 | So you're willing to spend less today

00:29:40.900 | to stretch that money out into the future.

00:29:43.020 | And now we can add those characteristics

00:29:47.660 | to this recent matrix as well.

00:29:48.980 | And it's all based on correlations.

00:29:51.780 | So probability-based does tend to be correlated

00:29:54.900 | with optionality.

00:29:55.780 | That if you're comfortable with market growth,

00:29:57.580 | you also tend to want more optionality.

00:29:59.260 | That's what that diagonal arrow's about,

00:30:02.380 | going from the upper right to lower left.

00:30:06.100 | And then at the same time,

00:30:07.140 | safety first tends to be correlated with commitment.

00:30:09.900 | Like if you want contractual protections,

00:30:12.180 | you also tend to be more comfortable

00:30:13.460 | committing to a strategy.

00:30:15.260 | And then if you're safety first and optionality,

00:30:19.100 | those tend to not be as correlated with each other.

00:30:21.260 | And that's where the sense

00:30:22.140 | of a behavioral strategy develops.

00:30:24.780 | You want contractual protections, but you want optionality.

00:30:27.980 | It's kind of a bit of a contradiction there,

00:30:30.940 | but there's a strategy that has been created

00:30:33.460 | over the, since around the 1980s that can accommodate that.

00:30:38.460 | Likewise, in the bottom right-hand corner,

00:30:40.580 | probability-based and commitment,

00:30:42.660 | you're comfortable relying on market growth,

00:30:44.380 | but you'd also want to commit to a strategy.

00:30:46.460 | And there's also a bit of a,

00:30:48.380 | those two don't necessarily go together.

00:30:50.620 | And then we can start adding

00:30:51.940 | in where these other characteristics apply.

00:30:54.020 | So in the upper right-hand corner,

00:30:55.540 | that's more of an accumulation mindset,

00:30:57.740 | tends to be up there as well.

00:30:59.620 | The top half of the chart is more front-loading

00:31:02.340 | as a preference.

00:31:03.940 | The, well, on the left-hand side,

00:31:06.860 | you have the true liquidity.

00:31:09.220 | In the bottom left corner,

00:31:10.540 | you've got more of a distribution,

00:31:11.780 | predictable income, perpetual income floor.

00:31:14.860 | On the whole bottom half,

00:31:15.860 | you can have more of a back-loading preference.

00:31:18.100 | And then on the right,

00:31:18.940 | you also do have a technical liquidity at work there.

00:31:22.620 | So this really gives us our retirement strategies.

00:31:25.820 | Think about a total return investing strategy.

00:31:28.860 | You're comfortable relying on market growth.

00:31:31.300 | You want to keep your options open.

00:31:33.580 | You're more comfortable with like the tools

00:31:34.940 | of modern portfolio theory,

00:31:36.260 | more of an accumulation, risk-adjusted return.

00:31:39.220 | You do think more in terms of technical liquidity.

00:31:41.940 | You have more of a front-loaded preference

00:31:44.740 | and the time-base.

00:31:46.220 | You don't really have a need for perpetual income floor.

00:31:48.940 | So that's the 4% rule.

00:31:50.700 | I mean, that's systematic withdrawals

00:31:52.660 | from an investment strategy.

00:31:53.820 | And those characteristics can explain that quite well.

00:31:57.060 | Then in the bottom left,

00:31:58.220 | where the other kind of consistent preferences are,

00:32:01.180 | your safety first.

00:32:02.020 | So you want contractual protections.

00:32:04.140 | You're willing to commit to a lifetime strategy,

00:32:06.380 | well, commit to a strategy.

00:32:08.420 | You have a distribution mindset.

00:32:10.140 | So you want predictable income.

00:32:11.900 | You're comfortable with a perpetual income floor.

00:32:14.740 | You want more true liquidity,

00:32:16.500 | which is earmarking assets for specific goals

00:32:19.180 | and then seeing what's left as reserves.

00:32:21.700 | And you have more of a back-loaded preference.

00:32:24.140 | So that's kind of describing simple income annuities

00:32:27.140 | for building a lifetime income floor.

00:32:29.220 | And then a diversified investment portfolio

00:32:31.260 | can go on top of that.

00:32:33.100 | Then in the upper left, that's time segmentation.

00:32:35.780 | You want contractual protections,

00:32:37.380 | but you also want optionality.

00:32:39.380 | And so the framework developed

00:32:41.340 | to provide both of those concerns is,

00:32:43.900 | you have contractual protections

00:32:45.220 | with holding fixed income assets for short-term expenses,

00:32:48.500 | but then most of your assets are left

00:32:50.220 | in a growth-based investment portfolio,

00:32:52.140 | providing the optionality.

00:32:54.260 | And then the risk wrap in the lower right-hand corner,

00:32:57.380 | that's also a behavioral type strategy

00:32:59.380 | that's just been developed since the 1990s.

00:33:02.140 | And again, that's that whole world of deferred annuities,

00:33:05.140 | like variable annuities

00:33:06.340 | with lifetime income benefits attached to them.

00:33:09.140 | You're comfortable relying on market growth,

00:33:11.580 | but you're not completely comfortable in some way.

00:33:14.100 | You want to commit to a strategy.

00:33:17.180 | You have more of a back-loaded preference.

00:33:20.300 | You have that technical liquidity mindset,

00:33:22.220 | which is the whole, the deferred annuities

00:33:24.300 | talk about how they're liquid,

00:33:25.460 | but that's been earmarked for your future spending,

00:33:28.060 | so you can't really take advantage of that liquidity.

00:33:30.540 | But that all explains building a lifetime income floor

00:33:32.980 | with deferred annuities with living benefits,

00:33:35.340 | and then applying the investment strategy on top of that.

00:33:38.300 | And then based on the retirement researcher on my website,

00:33:43.620 | the kind of people who are part of that community,

00:33:46.820 | the study we did with them,

00:33:48.940 | we did find about a third of them

00:33:51.500 | were in that total return quadrant,

00:33:53.380 | somewhere around a third are in the income protection,

00:33:56.180 | and then somewhere around 15%

00:33:57.860 | were either time segmentation or risk-wrap.

00:34:00.580 | And then these are styles,

00:34:01.740 | so that once you understand your retirement income style,

00:34:03.780 | it doesn't mean that you have to stick to that strategy,

00:34:06.820 | but I think it can be a useful starting point

00:34:09.420 | to think about how you want to go to approach

00:34:12.380 | building a retirement income strategy.

00:34:14.460 | And I've really explained at this point,

00:34:17.700 | but again, it's just going through the four strategies,

00:34:20.100 | the total return and the characteristics it has,

00:34:23.020 | the income protection and the characteristics it has,

00:34:26.540 | the time segmentation and the characteristics it has,

00:34:30.380 | and then the risk-wrap strategy

00:34:32.020 | and the characteristics it has.

00:34:33.700 | And so to conclude about this,

00:34:36.660 | there are a number of different viable

00:34:38.500 | retirement income strategies,

00:34:39.580 | and this is a really important starting point

00:34:41.900 | that I do try to be agnostic

00:34:43.540 | and to say that any of these strategies

00:34:47.460 | are valid and viable.

00:34:49.820 | It's just a matter of understanding who they're right for.

00:34:52.580 | And the right approach for someone

00:34:54.140 | depends on their personal style.

00:34:56.660 | And just because one strategy is right for you,

00:34:58.580 | a different strategy might be right for someone else.

00:35:01.420 | And there's more like flexibility out there

00:35:03.580 | for people to find the kind of strategy

00:35:05.460 | that will best resonate with their personal preferences

00:35:08.260 | and personal style.

00:35:09.180 | I mean, it's just like when you pick a career,

00:35:12.020 | there's not one kind of job that's superior for everyone.

00:35:14.540 | Some people might like more of a salesman type role

00:35:17.340 | where they have to like maybe more volatility

00:35:20.260 | to their income and that sort of thing,

00:35:22.540 | more like a total return approach.

00:35:24.460 | A college professor tends to be more

00:35:26.260 | of like an income protection style

00:35:27.860 | with the bond of a tenured position

00:35:31.220 | providing income on an ongoing basis.

00:35:33.100 | So there's no right or wrong answer

00:35:35.420 | to what job someone chooses.

00:35:37.300 | And really there's no right or wrong answer

00:35:38.740 | to which style someone chooses for their retirement.

00:35:42.140 | And so this RISA, retirement income style awareness

00:35:44.900 | can provide a starting point for that discussion.

00:35:47.460 | So then that was chapter one of the book

00:35:50.900 | and we don't really need this slide.

00:35:52.820 | We had it at the beginning too,

00:35:53.820 | but chapter one covered that.

00:35:55.180 | And then let me get through that.

00:35:57.860 | And the book is at any retailers can be guessed.

00:36:01.540 | And let me go ahead and stop there.

00:36:04.500 | And at one...

00:36:05.340 | Get the slides pulled up here.

00:36:08.980 | - Yeah, so if you can share screen.

00:36:10.780 | - Zoom's going slow.

00:36:15.780 | Here we go.

00:36:19.180 | Okay, can you see the slides okay?

00:36:23.980 | - Not yet.

00:36:26.460 | - No.

00:36:27.300 | Is it now?

00:36:30.500 | - Yes.

00:36:31.340 | - Okay, I think there's just a lag.

00:36:33.300 | Okay, thanks everyone.

00:36:34.940 | So now we'll get into the discussion around tax planning

00:36:38.460 | for efficient retirement distributions.

00:36:40.820 | And as some of you noted, at least a few of you,

00:36:43.500 | it sounds like I did this presentation today

00:36:45.940 | at Retirement Researcher.

00:36:48.020 | And it's a really hot topic right now.

00:36:50.420 | And I don't have too much in the way of tax reform in this,

00:36:53.140 | but with...

00:36:53.980 | And we don't know what the ultimate new tax legislation

00:36:56.380 | will look like.

00:36:57.220 | But with what we've heard in the last couple of weeks,

00:36:59.660 | it's not necessarily changing too much of this discussion.

00:37:02.820 | Some of the tax brackets are moving around.

00:37:04.820 | The big thing might be,

00:37:05.820 | we're not gonna have the backdoor Roth anymore

00:37:07.700 | and we'll have to see how that plays out.

00:37:09.420 | But otherwise, the ongoing tax reform debate's

00:37:12.700 | not really impacting too much

00:37:14.460 | of what's in this presentation.

00:37:16.060 | Okay, so in that 12-step process

00:37:22.900 | for thinking about retirement,

00:37:23.740 | we're talking about tax planning now.

00:37:25.900 | And so we'll talk about the logic of tax efficiency,

00:37:29.420 | tax diversification, asset location,

00:37:33.100 | tax efficient retirement distributions,

00:37:35.860 | pitfalls to monitor when generating taxable income,

00:37:39.380 | and then an example for tax bracket management.

00:37:41.820 | And that was one,

00:37:42.660 | I did put an excerpt of that book

00:37:44.260 | into a column at Advisor Perspectives

00:37:46.340 | that was picked up at the Bogleheads.

00:37:48.140 | So if you saw that thread,

00:37:51.420 | that's one of the places where this session was announced.

00:37:54.540 | I'll talk more about that example,

00:37:56.740 | like some more commentary on it.

00:37:58.900 | So the logic of tax efficiency,

00:38:03.220 | and this is the punchline coming out of that example

00:38:05.780 | at the end, where with retirement planning,

00:38:08.860 | there's so many different aspects of it

00:38:10.300 | where making short-term sacrifice

00:38:12.180 | can help support a long-term benefit.

00:38:14.620 | And that's what we'll see in that example at the end,

00:38:17.020 | where the gray-colored strategy

00:38:19.100 | is watching the wealth spend down.

00:38:21.540 | For someone who claims social,

00:38:22.860 | they're a 60-year-old,

00:38:24.020 | they have $2 million at age 60, they're retired.

00:38:26.980 | If they take Social Security at 62,

00:38:31.380 | and then do a conventional spend-down strategy,

00:38:33.620 | taxable, tax-deferred, tax-free,

00:38:35.500 | you can see they've got more money there for a while,

00:38:39.340 | until about age 77, and then it keeps plummeting.

00:38:43.300 | And then they run out of money around age 88.

00:38:46.420 | And the strategy that I'll identify

00:38:48.460 | as a more tax-efficient strategy

00:38:50.900 | is gonna do really get into

00:38:54.100 | the whole strategic Roth conversion.

00:38:55.980 | They're gonna manage a very high level of taxable income

00:38:59.580 | until they turn 70,

00:39:01.700 | and then they're gonna start their Social Security benefit,

00:39:04.260 | and then subsequently be able to manage

00:39:06.060 | a much lower taxable income level,

00:39:08.380 | much lower adjusted gross income.

00:39:10.420 | And so in the short run, they're gonna fall behind,

00:39:12.580 | especially because they're delaying Social Security,

00:39:14.660 | and they're paying more taxes early on.

00:39:16.660 | But that's gonna set them up for long-term benefit.

00:39:19.820 | And ultimately with that strategy,

00:39:21.820 | their money is gonna last 5.6 years longer.

00:39:25.380 | Okay, and they're at age 88,

00:39:27.700 | they still have about 200, I'm sorry, $320,000 left

00:39:31.660 | compared to that other strategy

00:39:33.380 | that's run out at that point.

00:39:35.020 | So in the short run,

00:39:36.020 | there's gonna be a smaller legacy value for their assets,

00:39:39.180 | but in the long run,

00:39:40.660 | the strategy is gonna pay off and help them.

00:39:42.620 | And this is the example I'll be showing

00:39:44.460 | at the end of the presentation.

00:39:46.020 | So short run costs for long-term efficiency,

00:39:50.380 | and this is an important topic

00:39:53.260 | because it really can extend the portfolio longevity

00:39:56.020 | for a retiree.

00:39:58.140 | And why is that?

00:39:59.540 | Like, why is what we're talking about important?

00:40:02.340 | Because we have a progressive tax system

00:40:04.100 | in the United States where as your income goes up,

00:40:06.540 | you're paying taxes at higher tax rates.

00:40:09.340 | And so this is all about trying to,

00:40:11.180 | like we have to pay taxes,

00:40:13.340 | but trying to pay taxes

00:40:14.660 | when we can pay them at lower tax rates,

00:40:17.140 | and then try as much as we can within the law,

00:40:19.180 | this is all within the law,

00:40:21.060 | avoid paying taxes when we're in higher tax rates

00:40:24.100 | by strategically preparing for that.

00:40:26.940 | And also the tax code is filled

00:40:28.780 | with all kinds of nonlinearities and traps

00:40:30.980 | in terms of, I'll get into how,

00:40:32.780 | you may think you're in the 22% tax bracket in retirement

00:40:36.300 | when you might actually be paying

00:40:37.460 | more than a 50% marginal tax rate in some circumstances.

00:40:40.980 | A marginal tax rates, that's like I just said,

00:40:44.460 | can be higher than income tax rates.

00:40:46.500 | And we have a number of different types of tax treatment

00:40:49.980 | in the tax code to coordinate.

00:40:51.500 | So nonlinearities in the tax code,

00:40:56.100 | many tax rules are connected to adjusted gross income,

00:40:59.300 | not taxable income.

00:41:00.540 | And the difference there

00:41:01.380 | is the below the line tax deductions.

00:41:04.620 | So having a big tax deduction can't save you

00:41:06.820 | from some of these nonlinearities

00:41:08.260 | because it's the adjusted gross income

00:41:09.740 | before the deduction that counts.

00:41:12.460 | Itemized deductions then only count

00:41:14.500 | when they're higher than the standard deduction.

00:41:16.900 | Preferential income sources,

00:41:19.380 | long-term capital gains and qualified dividends

00:41:21.620 | stack on top of other income

00:41:24.060 | and have different tax rates.

00:41:25.740 | And there can be implications of that.

00:41:28.260 | A dollar of income can trigger tax

00:41:31.260 | on up to 85 cents of a social security dollar,

00:41:35.180 | as well as triggering tax on that dollar of income.

00:41:37.980 | It can also, a dollar of income

00:41:40.340 | can trigger higher Medicare premiums.

00:41:42.260 | And I won't get into detail about that,

00:41:45.500 | but we also have that 3.8% net investment income tax

00:41:48.940 | is very nonlinear and how you have to calculate it

00:41:51.940 | as the minimum of two different numbers.

00:41:54.540 | And required minimum distributions

00:41:56.260 | will start to play a role after age 72.

00:41:58.380 | And that can surprise someone

00:41:59.700 | by pushing them into a higher tax bracket.

00:42:01.820 | So what we're talking about here with income taxes,

00:42:05.740 | the basic kind of, when you're going through the 1040,

00:42:08.700 | total income is all your taxable income sources.

00:42:11.460 | You take off the above the line deductions,

00:42:13.700 | retirement account contributions,

00:42:15.460 | HSA contributions, that sort of thing.

00:42:17.820 | Gives you the adjusted gross income.

00:42:19.900 | And then you can either take the standard deduction

00:42:21.860 | or itemize, and that will give you then taxable income.

00:42:25.380 | Okay, so this is where I probably with this group tonight,

00:42:29.980 | we can accelerate this conversation.

00:42:32.340 | Everyone most likely is aware

00:42:34.740 | of the taxable brokerage accounts,

00:42:37.180 | tax deferred accounts, such as IRAs and 401ks

00:42:40.540 | and other employer-based retirement plans.

00:42:42.980 | And then after tax accounts,

00:42:44.380 | which are sometimes called tax exempt,

00:42:46.140 | sometimes called tax-free and sometimes called Roth.

00:42:49.700 | And these are the three main types of tax structures

00:42:52.580 | we have in terms of the tax code

00:42:54.740 | providing different tax treatment.

00:42:57.020 | So the taxable accounts,

00:42:58.860 | you pay ongoing taxes on income shot off from the account,

00:43:02.500 | as well as any realized capital gains.

00:43:05.300 | Long-term capital gains,

00:43:06.780 | qualified dividends qualify for lower tax rates.

00:43:09.980 | The cost basis or principle into the account

00:43:12.660 | can be taken out without tax.

00:43:14.860 | You do get a step up in cost basis at death,

00:43:17.500 | avoiding capital gains tax.

00:43:19.020 | And that was something people were worried

00:43:20.380 | was gonna disappear with the tax reform.

00:43:22.260 | But as of now, it looks like it will remain.

00:43:25.020 | And then also distributions from taxable accounts

00:43:27.260 | can be structured to get capital gains or capital losses.

00:43:30.860 | You can trigger capital gains

00:43:32.820 | or you can trigger capital losses.

00:43:34.580 | And if you trigger a capital loss,

00:43:35.780 | there's the wash sale rule.

00:43:36.700 | You have to wait 30 days to buy back the same asset,

00:43:40.100 | but you can trigger capital gains by selling the asset

00:43:42.820 | and immediately buying it back

00:43:44.740 | and triggering that taxable income

00:43:46.460 | if you're doing that for a strategic reason.

00:43:49.660 | Tax-deferred accounts.

00:43:51.580 | We think of them as generally being deductible,

00:43:53.500 | contributions, and then tax-deferred

00:43:56.780 | until distributions are taken.

00:43:58.340 | And those are taxes, ordinary income,

00:44:00.740 | required minimum distribution start at age 72.

00:44:03.820 | You may have an employer match

00:44:05.180 | and also early withdrawal penalties

00:44:06.820 | can be an issue before age 59 and a half.

00:44:09.220 | Tax-exempt or Roth accounts,

00:44:13.460 | Roth IRAs, employee contributions to Roth 401ks.

00:44:17.900 | You had to pay taxes on that money.

00:44:19.380 | It's not tax deductible.

00:44:20.980 | But once it goes into the account,

00:44:22.940 | assuming you have a qualified distribution,

00:44:25.540 | which you can set up to have fairly easily,

00:44:28.980 | assuming you're at least 59 and a half

00:44:31.300 | and had the Roth IRA open for at least,

00:44:33.900 | had a Roth IRA open for at least five years,

00:44:36.900 | then you do not have to pay taxes on the distribution.

00:44:40.380 | Roth IRAs do not have required minimum distributions.

00:44:43.820 | Roth 401ks do, but you can just roll over to a Roth IRA

00:44:47.060 | to avoid that problem.

00:44:48.980 | There are income restrictions

00:44:50.420 | on making contributions to Roth IRAs.

00:44:53.180 | And like I said, right now we have the backdoor Roth idea

00:44:56.260 | where you make a non-deductible contribution to an IRA

00:44:59.500 | and then convert that to a Roth.

00:45:01.580 | That currently with the proposed legislation

00:45:05.660 | will not be allowed starting in 2022.

00:45:08.460 | But that, of course, any of that can change.

00:45:10.260 | So we're nowhere near the final tax law.

00:45:13.260 | And this can be a good choice in low income years

00:45:15.620 | to contribute to the Roth account

00:45:17.420 | when you're in a lower tax rate relative to the future.

00:45:20.340 | So when you're choosing between the two,

00:45:23.860 | this is all kind of basic financial literacy type stuff

00:45:27.180 | as well, that you're trying to pay taxes at lower rates.

00:45:30.300 | So when you have a high income or you're paying,

00:45:32.700 | you're in high marginal tax brackets,

00:45:35.220 | that's a good idea to make the contribution

00:45:37.860 | to a tax deferred account and get the tax deduction.

00:45:40.900 | If you're in between jobs or something

00:45:43.020 | where you're currently have a lower income

00:45:45.260 | facing lower tax rates,

00:45:46.940 | that can be a good opportunity to put into a Roth account.

00:45:50.420 | And the same logic applies to Roth conversions.

00:45:53.380 | You wanna do it when the current tax rates are lower

00:45:56.020 | relative to what you believe they'll be in the future

00:45:58.340 | for your situation.

00:45:59.860 | And it's also nice to have some tax diversification

00:46:02.260 | between each of the different types of tax structures.

00:46:05.780 | Now, if you'd like, because there's limits

00:46:09.020 | on how much can go into the Roth and employer plans

00:46:13.220 | and IRAs, if you'd like additional tax benefits beyond that,

00:46:16.940 | there are different options, 529 plans,

00:46:20.420 | health savings accounts

00:46:21.460 | with the high deductible health insurance

00:46:23.060 | where you get that triple benefit of tax deductions,

00:46:25.660 | tax deferral, and tax redistributions

00:46:28.300 | for qualified medical expenses.

00:46:30.700 | I-bonds or E-bonds give you that they're taxable,

00:46:33.460 | but you get tax deferral.

00:46:34.860 | You're not paying taxes until the distribution

00:46:37.260 | or until you have redeemed them.

00:46:39.980 | Tax-exempt bonds can give you tax deferral

00:46:44.020 | and tax redistributions,

00:46:45.220 | though they have a warning when it comes to retirement.

00:46:48.580 | Interest from those can be counted

00:46:50.180 | towards determining Social Security and Medicare taxes.

00:46:53.620 | Non-qualified annuities and then life insurance

00:46:57.420 | can all provide tax benefits as well.

00:46:59.580 | Asset location.

00:47:02.860 | So we have these different tax structures.

00:47:04.860 | Where do we put our assets?

00:47:07.260 | First, asset allocation is always most important.

00:47:09.740 | Like if I view my strategic stock allocation is 60% stocks,

00:47:14.740 | I should go with that first,

00:47:16.060 | even if I only have 40% of my investable space

00:47:19.700 | in a taxable account.

00:47:20.780 | It's always asset allocation first,

00:47:24.700 | but then you can follow the guidelines on asset location

00:47:27.580 | about where to keep that money.

00:47:29.900 | And so when we talk about taxable

00:47:31.460 | versus tax-advantaged accounts,

00:47:33.340 | whether that's tax-deferred or tax-free,

00:47:36.180 | we start with, well, any tax-exempt bonds,

00:47:38.700 | there's no point in owning them anywhere

00:47:40.500 | but a taxable account.

00:47:42.180 | Then like US stock index funds

00:47:43.740 | tend to be very tax-efficient asset classes,

00:47:47.340 | so they can easily go into a taxable brokerage account.

00:47:50.940 | International stock index funds may have a higher dividend,

00:47:53.780 | so a little bit more taxable income coming out of it,

00:47:56.140 | but if it's low turnover, generating less taxable income.

00:48:01.140 | Like I was saying today, interest rates

00:48:02.500 | are very low right now.

00:48:03.980 | And so because cash or bonds

00:48:06.700 | are not really generating much income,

00:48:09.100 | that unfortunately makes them very tax-efficient

00:48:12.300 | because there's no taxable income being generated.

00:48:14.980 | So in a very low interest rate environment,

00:48:17.500 | bonds can actually get pushed higher up on the list,

00:48:19.900 | but in a more normal situation,

00:48:22.460 | bond interest is taxed as ordinary income

00:48:24.820 | on an ongoing basis.

00:48:26.700 | So bond funds are generally less tax-efficient,

00:48:30.820 | actively managed stock funds are less tax-efficient

00:48:33.380 | because of the more turnover and realized capital gain

00:48:36.740 | within the fund itself and so forth.

00:48:39.900 | Then commodities and real estate investment trusts

00:48:42.180 | is being the least tax-efficient,

00:48:44.260 | most benefit from having

00:48:46.500 | some sort of tax-advantaged account.

00:48:48.300 | Then within the tax-advantaged world,

00:48:51.980 | should it go in tax-deferred or tax-exempt?

00:48:54.660 | Well, the general thought there is

00:48:56.620 | assets with higher expected returns

00:49:00.380 | can go in that Roth tax-exempt environment.

00:49:03.340 | So if you have any emerging market stock funds,

00:49:06.460 | any small cap value type funds,

00:49:08.940 | a Roth is a good candidate

00:49:10.660 | for where you might wanna put that sort of thing.

00:49:13.100 | And then assets with lower expected returns like bonds

00:49:16.380 | or other kind of lower yielding

00:49:18.060 | but tax-inefficient asset classes

00:49:20.380 | would belong more in the tax-deferred account.

00:49:23.020 | Now, there's two reasons for that

00:49:26.420 | is one of the side effects of a tax-deferred account

00:49:29.900 | is if you had any long-term capital gains,

00:49:32.860 | their tax is ordinary income.

00:49:34.340 | You lose that long-term capital gains treatment

00:49:36.780 | in the tax-deferred account,

00:49:38.260 | but you can get around that issue by having...

00:49:40.740 | In a Roth account,

00:49:42.740 | you don't have to worry about paying taxes

00:49:44.660 | on any of those gains.

00:49:45.580 | That's all coming out tax-free.

00:49:47.420 | And also to the extent that we tend to spend Roths

00:49:50.020 | later in retirement,

00:49:51.540 | having more longer-term higher yielding

00:49:53.700 | but meant to be held for the long-term type assets there

00:49:56.740 | can make sense.

00:49:59.180 | So taxable accounts for tax-efficient asset classes,

00:50:03.140 | tax-deferred for tax-inefficient lower returns,

00:50:05.980 | tax-free for tax-inefficient

00:50:07.620 | but higher return asset classes.

00:50:09.500 | Now, the tax-efficient retirement distributions

00:50:13.940 | which is more our focus for this.

00:50:16.060 | The conventional wisdom

00:50:19.100 | on a withdrawal order sequencing strategy

00:50:21.340 | is to spend taxable assets first,

00:50:24.660 | then tax-deferred and then tax-exempt.

00:50:27.860 | But we can do better than that

00:50:29.500 | by using a tax bracket management framework.

00:50:32.500 | And so tax bracket management is,

00:50:36.220 | we're gonna aim to pay taxes at the lowest possible rates.

00:50:40.340 | And that means if we currently have an opportunity

00:50:43.300 | to generate more taxable income

00:50:44.740 | and pay a lower tax rate on it,

00:50:46.700 | we'll wanna do that.

00:50:48.220 | So we might be paying a higher tax bill

00:50:50.580 | because we're on purpose generating more taxable income,

00:50:54.220 | but we're doing that to pay at a lower tax rate

00:50:56.740 | and to help better set up the situation

00:50:58.940 | that in the longer term,

00:50:59.860 | we can better avoid the higher tax rates.

00:51:03.460 | So we wanna fill up lower tax brackets with taxable income

00:51:07.460 | and potentially draw from other resources

00:51:09.060 | that are not taxed if we still wanted to spend more

00:51:11.700 | but wanted to avoid a higher tax bracket.

00:51:14.580 | That will also help with the process

00:51:16.180 | of required minimum distributions after age 72,

00:51:19.740 | where if we can get some of that money out before,

00:51:23.660 | we're less likely to face a big RMD

00:51:25.460 | that could push us into a higher tax bracket.

00:51:28.460 | It's part of that story of short-term sacrifice.

00:51:31.140 | You have to pay more taxes in the short run,

00:51:33.180 | but by doing that at lower tax rates,

00:51:35.460 | that can create longer-term benefits.

00:51:37.900 | And the biggest impacts we can see for that,

00:51:39.820 | they both happen at around the same income levels,

00:51:41.900 | which is the point where you jump from the 12%

00:51:44.620 | to the 22% federal tax bracket,

00:51:47.340 | which is 40,525 for singles,

00:51:50.060 | $81,050 for married filing jointly.

00:51:54.180 | And then the preferential income,

00:51:55.660 | it jumps from zero to 15%

00:51:58.420 | at not quite the same numbers, but very close,

00:52:01.220 | 40,400 for singles, 80,800 for joint filers.

00:52:05.780 | So if you're able to manage a lifestyle and spending,

00:52:09.380 | especially from taxable resources

00:52:12.180 | and keep your taxable incomes under these thresholds,

00:52:15.460 | that can give you strong opportunities

00:52:17.300 | to go ahead and fill up these thresholds.

00:52:19.300 | And it's the same story for other tax brackets too.

00:52:21.340 | It's just, this is where you'll see

00:52:22.980 | the biggest impact of tax planning.

00:52:25.260 | And so this is more of a middle-class type

00:52:27.180 | retirement strategy,

00:52:28.860 | as opposed to like a very high net worth strategy,

00:52:31.500 | 'cause these are not super high income levels

00:52:33.780 | from the perspective of like a high net worth type individual

00:52:37.220 | and there's a lot of tax advantage that can be available,

00:52:40.540 | especially when we start adding in

00:52:41.940 | some of the other nonlinearities in a moment.

00:52:44.500 | So we're talking about generating more taxable income

00:52:49.460 | than necessary to pay taxes at a lower tax rate.

00:52:53.060 | So there's three ways we can do that.

00:52:56.220 | The first is, we said the conventional wisdom

00:52:58.980 | is you spend all your taxable money first,

00:53:00.820 | then tax deferred and then tax free.

00:53:03.260 | Well, what you can do to generate more taxable income

00:53:06.540 | is you cut back on the distribution from the taxable account

00:53:10.060 | and replace that with the distribution

00:53:11.660 | from the tax deferred account.

00:53:13.740 | And so that can give you the spending you want

00:53:16.020 | while raising taxable income to the desired bracket

00:53:18.900 | that you're trying to manage.

00:53:21.060 | Second, you can cover the spending goal

00:53:22.740 | from taxable accounts,

00:53:24.340 | but then increase your taxable income

00:53:26.980 | by doing Roth conversions from the IRA to the Roth IRA.

00:53:31.980 | And then that would also,

00:53:34.100 | you can pay the taxes on those conversions,

00:53:36.580 | ideally from the taxable account as well, not from the IRA.

00:53:39.660 | So that's an even a reason why you could accelerate payments

00:53:43.700 | out of the taxable account even faster,

00:53:45.380 | 'cause you're using that to pay the taxes

00:53:47.660 | on the Roth conversions.

00:53:49.300 | And you're using the Roth conversions

00:53:50.780 | to generate more taxable income in the short run.

00:53:54.980 | And then the third approach is to, on purpose,

00:53:57.700 | sell assets with long-term capital gains,

00:54:01.180 | not for any sort of market timing or anything,

00:54:03.020 | but you can immediately repurchase them.

00:54:05.700 | And you're doing that to generate

00:54:07.460 | taxable long-term capital gains

00:54:09.820 | and to reset your cost basis to a higher level.

00:54:13.060 | And especially if you can take advantage of doing that

00:54:15.460 | when you're still in the 0% tax bracket

00:54:17.660 | for the long-term capital gains,

00:54:19.980 | and that we saw those around 40,000 for singles,

00:54:22.780 | 80,000 for married filing jointly,

00:54:25.780 | you can really take advantage of that.

00:54:27.100 | And just you're paying taxes, but at a 0% tax rate.

00:54:30.460 | And so that's a very attractive feature.

00:54:33.460 | Then it jumps to 15 and 20%.

00:54:35.740 | And one of the aspects of the tax reform being discussed now

00:54:38.420 | is to have it 0%, 15%, and then 25%.

00:54:44.500 | And then that net investment income tax

00:54:46.540 | on top of that too, potentially.

00:54:48.140 | So you can work around with this.

00:54:51.700 | You have resources that will create

00:54:53.620 | taxable income on the left.

00:54:55.340 | You have the income with preferential tax rates

00:54:58.780 | in the middle, the qualified dividends,

00:55:00.300 | long-term capital gains.

00:55:02.100 | And then you can have spending resources.

00:55:04.660 | Once you've filled up the tax bracket,

00:55:06.380 | if you still want more spending,

00:55:08.260 | you have ways to draw additional spending power

00:55:10.060 | without generating more taxable income.

00:55:12.060 | And that can be cost basis of your taxable account,

00:55:15.780 | Roth IRA distributions,

00:55:17.940 | a portion of a non-qualified annuity distribution,

00:55:21.260 | a portion of social security benefits,

00:55:23.580 | self-savings accounts distributions

00:55:26.180 | for qualified medical expenses, reverse mortgages,

00:55:29.620 | and also cash value from life insurance

00:55:32.220 | as different options for covering spending,

00:55:35.740 | but not having more taxable income.

00:55:40.780 | So Roth conversions,

00:55:42.260 | it's the, it could be within employer plans too,

00:55:45.100 | but it's easiest to just say like an IRA to a Roth IRA.

00:55:48.460 | You cannot Roth convert required minimum distributions.

00:55:51.940 | So it's gotta be an amount in excess of that.

00:55:54.420 | They only begin at age 72.

00:55:56.140 | So you can, it's not an issue before 72,

00:55:59.860 | but it is after 72.

00:56:01.020 | You can't convert amounts that are required

00:56:03.420 | to come out as required minimum distributions.

00:56:06.060 | Like I said, ideally you wouldn't pay taxes

00:56:07.940 | from the IRA on those conversions.

00:56:10.060 | Hopefully you have some other resources to pay those taxes.

00:56:13.820 | Now, if you're retired by your 60s

00:56:15.820 | and you're delaying social security,

00:56:17.940 | that can be a great opportunity

00:56:19.260 | where you don't have a whole lot of taxable income

00:56:21.820 | to really get a strategic

00:56:23.900 | kind of Roth conversion strategy running.

00:56:26.100 | Also other times you might do this.

00:56:29.740 | If you have a year with a large tax deduction,

00:56:31.820 | maybe a big medical expense or something

00:56:34.540 | that's just a big tax deduction in a particular year,

00:56:37.700 | you might offset that by generating more taxable income.

00:56:41.340 | And then also moving more shares during a market downturn

00:56:44.780 | can be an opportunity.

00:56:45.700 | If you have other resources to pay the taxes,

00:56:49.100 | if the market goes down,

00:56:50.260 | you just have more opportunity to get money sent over

00:56:52.540 | to the Roth generating less taxable income.

00:56:54.860 | You're moving shares over at a lower value

00:56:58.940 | so that you're generating less taxable income

00:57:00.740 | when you do that.

00:57:01.580 | Now, I'm talking about front-loading taxes

00:57:06.140 | and here's some additional reasons

00:57:07.500 | why you might like to front-load taxes

00:57:09.500 | beyond what I'm describing.

00:57:11.100 | And the first is just the public policy risk.

00:57:14.260 | A lot of people are concerned

00:57:15.460 | that taxes will be higher in the future.

00:57:17.780 | And if that is something that concerns you,

00:57:19.780 | you might like to therefore accelerate

00:57:21.860 | some of those tax payments today

00:57:23.180 | when you feel like you may be in a lower tax system today

00:57:26.180 | than in the future.

00:57:28.020 | The death of a spouse is important as well for tax planning

00:57:31.580 | because after the year of the spouse's death,

00:57:34.900 | that household shifts from married filing jointly

00:57:36.820 | to a single filer.

00:57:38.420 | And those tax brackets are a lot lower.

00:57:40.140 | And so some expenses might go away,

00:57:43.140 | but income doesn't necessarily drop in half by any means.

00:57:46.660 | And you're gonna have a higher tax bill

00:57:48.660 | as a single filer than as married filing jointly.

00:57:51.020 | So you could have more exposure

00:57:52.420 | to paying tax on social security,

00:57:54.620 | more exposure to Medicare premium hikes and so forth.

00:57:58.260 | And also the SECURE Act in 2019

00:58:00.900 | created a lot of conversation around Roth conversions

00:58:05.420 | because now receiving an IRA as a beneficiary

00:58:09.660 | is a lot less attractive.

00:58:11.020 | Like if you're an adult child

00:58:12.380 | receiving an IRA as a beneficiary,

00:58:16.780 | you may be in your peak earnings years.

00:58:19.140 | And before the SECURE Act,

00:58:20.980 | you could use a lifetime stretch to distribute.

00:58:23.620 | You had inherited IRAs have required minimum distributions,

00:58:27.220 | but the rules work differently.

00:58:29.140 | You used to be able to extend those out

00:58:30.980 | over your life expectancy.

00:58:33.820 | After the SECURE Act,

00:58:35.260 | adult children are all gonna face the 10-year window

00:58:38.700 | where you have to distribute the entire account balance

00:58:41.180 | within 10 years.

00:58:42.700 | And so if that's overlapping with your highest tax years,

00:58:46.100 | highest earnings years,

00:58:48.140 | at the peak of your career at that point,

00:58:50.620 | that would speak to this strategic Roth conversion.

00:58:54.580 | If I already know that some of my IRAs may be inherited,

00:58:57.500 | 'cause I'm not necessarily gonna run out of money

00:58:59.340 | at this point,

00:59:00.780 | I'm gonna be comparing my tax bracket today as a retiree

00:59:03.420 | to my beneficiary's tax bracket.

00:59:06.180 | And that might accelerate my Roth conversions.

00:59:08.580 | At the same time, anything going to a charity,

00:59:11.860 | the IRA can be a great resource for that

00:59:14.100 | because it's the same concept of paid taxes

00:59:16.060 | when you're in the lowest tax bracket.

00:59:18.340 | Anything going from an IRA to a charity

00:59:20.180 | can be taxed at 0%.

00:59:22.420 | And so you wouldn't necessarily want to convert assets

00:59:25.260 | that would go to charity,

00:59:27.060 | but you might like to convert assets

00:59:28.660 | that will go to a non-eligible designated beneficiary.

00:59:33.340 | So a human who doesn't get special treatment

00:59:36.220 | to have a lifetime distribution.

00:59:37.660 | There's still some people

00:59:38.500 | that can get the lifetime stretch.

00:59:39.940 | Spouses, well, spouses can just rename the account

00:59:43.900 | in their own name,

00:59:45.100 | but also people who are less than 10 years younger

00:59:48.780 | than the deceased individual.

00:59:50.860 | So perhaps siblings in that situation,

00:59:53.580 | permanently disabled individuals,

00:59:56.220 | but otherwise most human beneficiaries

00:59:59.740 | are going to face that 10 year window.

01:00:01.700 | Okay, so those are reasons

01:00:08.820 | why you might want to accelerate taxes.

01:00:11.820 | Now here's some pitfalls to monitor

01:00:13.300 | when you are generating more taxable income.

01:00:16.060 | So there's a number of issues

01:00:19.580 | and I'll emphasize three of them here.

01:00:22.420 | The first is the social security tax torpedo.

01:00:24.900 | And if you haven't heard of that before,

01:00:26.660 | it's gonna be a lot of fun.

01:00:28.060 | The potential for increased Medicare Part B

01:00:32.060 | and Part D premiums,

01:00:34.020 | pushing preferential income into higher tax brackets.

01:00:39.020 | So pushing more into a higher tax bracket,

01:00:41.220 | I'll explain that.

01:00:42.500 | And then some others that I'm not getting into now,

01:00:44.580 | but also if you're pre-Medicare age

01:00:48.660 | and you have a Affordable Care Act,

01:00:50.620 | health insurance policy,

01:00:52.180 | subsidies could be jeopardized,

01:00:53.740 | although there was in 2021 and 2022,

01:00:56.980 | this is not an issue.

01:00:58.300 | The subsidy cliff there was taken away,

01:01:00.620 | but it returns in 2023,

01:01:03.180 | where if your income goes $1 above 400% of the poverty line,

01:01:08.180 | you suddenly lose all subsidies for the health insurance.

01:01:11.660 | The net investment income surtax, that 3.8%.

01:01:16.100 | The additional Medicare taxes on higher earnings

01:01:19.180 | and the alternative minimum tax

01:01:20.780 | are all kind of pitfalls of generating more taxable income.

01:01:23.620 | But again, we'll focus on those first three

01:01:25.140 | with the boxes next to them.

01:01:26.540 | So the social security tax torpedo.

01:01:30.260 | Up to 85% of your social security benefits are taxable.

01:01:35.060 | The tax schedule to determine

01:01:38.780 | how much of your social security is taxable

01:01:40.940 | was designed in 1994.

01:01:43.620 | And it's one of those rare parts of the tax code

01:01:45.940 | that's not inflation adjusted.

01:01:47.340 | So those numbers have been the same since 1994.

01:01:50.500 | And that just means over time with inflation,

01:01:52.460 | more people are gonna be hit by taxes

01:01:55.340 | on their social security benefits.

01:01:57.180 | Determining the benefit taxation

01:02:01.140 | and then the marginal tax rate is quite complex.

01:02:04.300 | And this is where the people who designed

01:02:07.340 | how social security will be taxed,

01:02:09.660 | I don't know how they could have created

01:02:10.740 | a more difficult situation than they did.

01:02:13.260 | I had to spend days just with the programming on this

01:02:15.860 | to make sure I wasn't making mistakes and everything

01:02:17.940 | because you calculate three different numbers,

01:02:20.500 | see which is smallest.

01:02:21.540 | And there's so many nonlinearities here,

01:02:23.980 | but we'll walk through what's going on in just a moment.

01:02:28.580 | And then proactive planning can help

01:02:30.140 | to potentially avoid the full tax torpedo

01:02:32.580 | that you may be able to set up so you're not paying taxes

01:02:35.100 | on 85% of your social security benefits.

01:02:37.980 | It might be hard to get that down to 0%,

01:02:40.820 | but if you can pay taxes on 20% of your benefits

01:02:43.580 | instead of 85% of your benefits, that could be a big win.

01:02:47.020 | And that's gonna be a key part of what's helping

01:02:49.860 | when I talk about the tax efficient strategy

01:02:52.620 | adding so many years of portfolio longevity.

01:02:55.220 | And a key point, if I was giving a presentation

01:02:59.580 | about social security, a key message would be

01:03:02.180 | to think about delaying towards age 70

01:03:04.100 | to take advantage of the insurance value,

01:03:06.660 | the inflation protection, the survival benefits.

01:03:09.900 | And this whole tax planning discussion

01:03:11.700 | is just another reason to consider

01:03:13.820 | delaying social security towards,

01:03:15.740 | at least for the higher earner in a couple,

01:03:17.740 | towards age 70 and for a single individual.

01:03:20.660 | The lower earner might claim earlier in a couple,

01:03:22.780 | but not the higher earner.

01:03:24.620 | Okay, so this is where things start to get tricky

01:03:29.780 | with the social security tax torpedo.

01:03:31.300 | So there's gonna be a bunch of different

01:03:32.740 | modified adjusted gross income numbers.

01:03:34.660 | And if you look into the tax rules,

01:03:37.060 | the definitions will be quite long,

01:03:38.820 | but there's a bunch of small things

01:03:40.460 | that probably don't affect most people.

01:03:42.660 | When we talk about social security,

01:03:44.820 | the basic idea of the social security

01:03:46.820 | modified adjusted gross income is,

01:03:49.100 | it's your adjusted gross income

01:03:50.460 | less your taxable social security benefits.

01:03:53.260 | And you don't know what percent of,

01:03:56.580 | that's what makes it so hard here,

01:03:57.700 | is you're not gonna know what percent

01:03:58.700 | of your benefits are taxable

01:04:00.420 | until you've figured all this stuff out.

01:04:01.820 | So you kind of have to work through a loop.

01:04:04.700 | But your provisional income,

01:04:07.060 | and it's sometimes called combined income

01:04:08.900 | based on the source,

01:04:10.660 | it's that social security modified adjusted gross income.

01:04:14.220 | So it's your adjusted gross income

01:04:15.900 | less your taxable social security benefits,

01:04:18.660 | but then plus half of your benefits.

01:04:20.740 | So you're putting half of the benefits back into this.

01:04:23.220 | And then also any tax exempt interest

01:04:25.180 | is gonna be added as well into this number.

01:04:27.780 | And then this is what we're working with

01:04:30.820 | in terms of those 1994 thresholds

01:04:34.620 | to determine how much of your social security benefits

01:04:37.460 | will be taxable.

01:04:38.540 | And these are not like taxable incomes.

01:04:40.820 | These are that provisional income,

01:04:42.060 | which is that unusual measure

01:04:45.140 | that includes half of your social security benefit.

01:04:47.700 | So this is what the tax torpedo would look like.

01:04:53.500 | Every social security benefit has a different tax torpedo,

01:04:56.100 | every level of benefit.

01:04:57.900 | So if you had 30, so a single filer 2021

01:05:01.780 | with a $30,000 annual social security benefit,

01:05:05.940 | what we're graphing on the bottom is your,

01:05:08.500 | it's like all your income except social security.

01:05:10.700 | So it's that your adjusted gross income

01:05:12.780 | minus your taxable social security

01:05:14.300 | plus your tax exempt interest.

01:05:16.420 | And then we're looking at your marginal tax rates.

01:05:19.100 | And those jump up to be 12%, 22% and so on with the yellow.

01:05:24.100 | And then the purple is looking at social security,

01:05:27.260 | what's your marginal tax rate?

01:05:29.620 | And you can see, you may have thought,

01:05:31.740 | well, by the time you added social security,

01:05:33.260 | you may have thought you were gonna be

01:05:34.300 | in the 22% tax bracket,

01:05:36.780 | but there's a little period there

01:05:38.420 | where you're actually paying a marginal tax rate of 40.7%.

01:05:43.180 | And that's the social security tax torpedo.

01:05:45.660 | That's where at these kinds of income levels,

01:05:49.300 | you may be paying a much higher tax rate than you expected.

01:05:52.300 | And so what's happening in that is you're a dollar of income

01:05:58.260 | when you're in that range identified there

01:06:00.980 | up to that 43,000 plus, you're a dollar of income,

01:06:04.980 | you're gonna pay tax at 22%, 22% on that dollar,

01:06:09.580 | plus that's gonna uniquely trigger a dollar

01:06:12.780 | of your social security to be taxed at 85%.

01:06:15.980 | So 22% of 85% of a dollar of social security.

01:06:20.780 | And so those add up to 40.7%.

01:06:24.060 | And that's now your marginal tax rate.

01:06:26.100 | A dollar of income, you're paying taxes not just on that,

01:06:29.020 | but it's also pushing another dollar

01:06:30.620 | of your social security to be taxed at 85%.

01:06:34.020 | And that torpedo jumps around

01:06:36.140 | because there's just where you are with the tax brackets,

01:06:39.020 | it's jumping around at different places.

01:06:40.900 | But that 40.7% is the highest it gets.

01:06:43.900 | And that's in that range where it's pushing you

01:06:47.460 | into paying tax on 85 cents of a dollar of social security.

01:06:52.460 | And with this benefit level that adds up

01:06:54.860 | or that happens up into an adjusted gross income

01:06:57.660 | of $69,206, which if you took a standard deduction

01:07:02.300 | off of that, we're talking about a taxable income

01:07:04.740 | of $56,806 if you're under age 65.

01:07:09.420 | So that income's just below that range.

01:07:12.660 | You're at a 40.7% marginal tax rate,

01:07:16.180 | even though you were expecting to be

01:07:17.980 | in the 22% marginal tax rate.

01:07:20.140 | The next thing is Medicare,

01:07:24.180 | the income-related Medicare adjustment amount,

01:07:27.580 | adjustments, adjustment amounts,

01:07:29.900 | the premium increases that work differently.

01:07:33.660 | And this is where you have to pay higher premiums

01:07:37.220 | for Part B Medicare,

01:07:39.460 | as well as if you have a prescription Part D drug plan,

01:07:43.380 | Part D as well.

01:07:45.020 | And those premiums just jump at different income thresholds.

01:07:48.860 | Now your Medicare modified adjusted gross income

01:07:51.220 | is your adjusted gross income,

01:07:53.900 | plus a bunch of minor things,

01:07:55.340 | but the main one is just that tax exempt interest.

01:07:58.260 | But the tricky thing there is it's from two years prior,

01:08:00.900 | not from the current year.

01:08:03.020 | Now, two years ago up to today, things can change.

01:08:06.420 | So if you do have a life-changing event,

01:08:08.220 | such as you retired and don't have earned income anymore,

01:08:12.100 | you can file Form SSA-44

01:08:14.460 | and request not to have that IRMA premium hike

01:08:18.180 | and see that there's a whole list of valid excuses.

01:08:21.780 | Just doing a strategic Roth conversion

01:08:23.460 | is not a valid excuse,

01:08:25.100 | so you will be stuck with any higher Medicare premiums

01:08:27.660 | that generates.

01:08:28.980 | But in some cases, you might have a valid reason

01:08:31.020 | to request not having those premium hikes.

01:08:34.420 | But how this plays out is,

01:08:35.900 | so if you're a single

01:08:37.860 | and your modified adjusted gross income is $88,000,

01:08:41.180 | your total premiums for the year,

01:08:42.380 | and I'll show that better on the next slide,

01:08:44.100 | about $2,179,

01:08:47.660 | one more dollar of income

01:08:49.380 | causes you to face annual premium increases of $860 in 2021.

01:08:55.380 | So that is an 86,000% marginal tax rate

01:09:01.340 | on that dollar of income.

01:09:02.740 | And then it goes back down again beyond that.

01:09:04.980 | But this is working differently than the tax torpedo.

01:09:08.940 | This is, if you have $1 too much,

01:09:11.780 | you're gonna trigger a big additional premium hike

01:09:14.580 | for that year.

01:09:15.460 | Well, not, I mean, for two years later.

01:09:17.460 | In two years, you're gonna trigger

01:09:19.220 | a big additional premium hike.

01:09:21.460 | And so this becomes relevant.

01:09:22.580 | Even if you start Medicare at 65,

01:09:25.660 | this starts to become an issue with your income at 63.

01:09:28.500 | And so here's the table for 2021.

01:09:33.220 | So this is based on incomes in 2019.

01:09:36.780 | And here you can see the thresholds for single filers

01:09:39.380 | marry filing jointly.

01:09:41.300 | You have standardized Part B Medicare premiums

01:09:44.940 | for the medical insurance.

01:09:46.660 | Part D can vary, but this is gonna be based

01:09:49.060 | on the average Part D premium in 2021,

01:09:52.020 | which was $33.06 per month.

01:09:55.100 | And so those are monthly numbers,

01:09:57.500 | but then the number on the right is annual.

01:09:59.620 | So it's the Part B plus the Part D times 12,

01:10:04.620 | and that's per individual.

01:10:05.900 | So married couples would have to double those numbers.

01:10:08.900 | And you can see that once you get $1 higher

01:10:13.500 | into that second one, it's $860 more,

01:10:17.140 | 21.78 or 21.79 per year up to 3,039 per year.

01:10:23.220 | And that is, again, the next premium jump,

01:10:26.700 | it's at $111,001 for singles,

01:10:29.740 | $222,000 for couples married filing jointly.

01:10:33.580 | And then you're jumping up by another $1,300

01:10:36.380 | of annual premiums.

01:10:38.020 | And so it's just that $1 of income is triggering

01:10:41.140 | the big increase in Medicare premiums.

01:10:43.260 | And so that's something to be aware of.

01:10:44.860 | Now, if you have to occasionally generate,

01:10:48.660 | trigger one Medicare hike,

01:10:50.540 | it might be worthwhile in the long run,

01:10:52.940 | but you wanna be careful about making ongoing mistakes

01:10:55.540 | where you accidentally just trigger slightly

01:10:57.420 | too much income and therefore have to deal

01:11:00.100 | with a much bigger Medicare premium two years later.

01:11:03.180 | And then we have this preferential income issue.

01:11:08.900 | So your long-term capital gains

01:11:10.460 | and your qualified dividends stack

01:11:12.140 | on top of your other taxable income.

01:11:14.860 | And so here's an example to illustrate the basic idea.

01:11:19.260 | We have a single individual,

01:11:20.860 | their taxable income is $42,400,

01:11:24.100 | but that's divided, they have 38,400 as ordinary income,

01:11:28.380 | 4,000 as long-term capital gains.

01:11:31.180 | So taxes on that, the 38,400,

01:11:35.340 | they're still in the 12% federal income tax bracket

01:11:37.780 | on their ordinary income.

01:11:39.780 | And then they stack the 4,000 on top of that,

01:11:42.740 | 2,000 of that will be taxed at 0%

01:11:45.500 | and 2,000 of that will be taxed at 15%.

01:11:48.940 | Now, suppose they add $1 more of ordinary income.

01:11:52.900 | So they have $38,401 of ordinary income.

01:11:56.700 | That they have to pay 12% tax on that dollar,

01:12:00.620 | but look at what else it does.

01:12:02.860 | They now have one less dollar being taxed at 0%

01:12:05.500 | for their long-term capital gains

01:12:07.740 | and one more dollar being taxed at 15%.

01:12:10.900 | So they're paying 15%

01:12:12.620 | on that long-term capital gain dollar also.

01:12:16.060 | So they thought they were

01:12:17.180 | in the 12% federal income tax bracket,

01:12:20.300 | but they're actually paying a 27% marginal tax rate

01:12:24.060 | on that dollar of income.

01:12:26.020 | And where that can get really fun

01:12:27.500 | is that when it also overlaps

01:12:28.940 | with the Social Security tax torpedo.

01:12:31.460 | So that 47%, you can add another 15% on that

01:12:35.300 | if you're also having the same issue happen

01:12:37.860 | where you're triggering another dollar

01:12:39.700 | to be taxed at 15% on the long-term capital gains.

01:12:42.940 | Now you're at like a 55.7% federal marginal tax bracket.

01:12:48.380 | So even though we may think taxes

01:12:49.940 | will be less in retirement,

01:12:51.380 | if we're not planning for this,

01:12:53.780 | taxes can be quite a bit higher than we expect

01:12:56.700 | when these circumstances are triggered.

01:12:59.020 | Okay, so let's now see how this plays out with an example.

01:13:04.340 | And this example, it's a 60-year-old single individual.

01:13:10.780 | I'll refer to her as she,

01:13:12.500 | although gender doesn't matter for the example,

01:13:14.580 | that just makes it easier to stick with one.

01:13:16.500 | So she's 60 years old.

01:13:18.100 | We're simplifying investment returns.

01:13:20.980 | She's basically investing in bonds.

01:13:23.460 | I just assume inflation is zero to not,

01:13:26.980 | 'cause I wanna show all their future tax numbers

01:13:28.780 | and to not have to worry about inflation

01:13:31.780 | and how that impacts what those numbers mean.

01:13:34.140 | I think it helps to make it more easy

01:13:36.300 | to interpret the results

01:13:37.340 | if we just assume there's no inflation,

01:13:39.540 | but she is getting a 2% real return.

01:13:42.460 | So all of her assets are growing at 2% a year.

01:13:45.860 | Now she's got 400,000 in her taxable account,

01:13:49.260 | 1.3 million in tax-deferred and 300,000 in tax-exempt.

01:13:54.180 | She wants to spend $95,000 a year pre-tax.

01:13:58.380 | So that is, this came up at the bow of the heads.

01:14:00.380 | That is more than 4%.

01:14:01.820 | But also she's gonna have,

01:14:03.740 | something like the 4%, really,

01:14:05.340 | that rule never can be used in practice

01:14:08.100 | just because no one actually spends a constant amount

01:14:10.380 | from their portfolio every year.

01:14:11.700 | You always have to deal with,

01:14:13.500 | we're not doing anything complicated here.

01:14:14.980 | She always wants to spend $95,000,

01:14:17.780 | but at some point,

01:14:18.620 | social security is gonna kick in for her.

01:14:20.860 | And also taxes are gonna go on top of that.

01:14:23.460 | And if she doesn't have constant taxes every year,

01:14:26.100 | there's no constant distribution amount

01:14:28.260 | from her investments.

01:14:30.100 | She does have a nice, smooth spending goal,

01:14:32.220 | but taxes go on top of that.

01:14:34.180 | And then at some point,

01:14:35.060 | social security will come into play.

01:14:36.420 | If she claims that that's her primary insurance amount,

01:14:39.180 | her full retirement age is 67.

01:14:41.580 | So if she claims at 62,

01:14:43.380 | she'll get $21,000 a year from social security.

01:14:46.900 | If she claims at age 70,

01:14:48.260 | she'll get $37,200 a year from social security.

01:14:52.780 | Now there's five strategies I do look at

01:14:56.900 | in the book chapter.

01:14:57.820 | And for this, we'll focus on one in five,

01:15:00.500 | the first and the last.

01:15:02.140 | But let me just walk through these.

01:15:04.220 | The first strategy,

01:15:06.100 | she's gonna claim social security at 62,

01:15:08.900 | and she'll follow that taxable, tax-deferred,

01:15:10.860 | tax-free distribution strategy.

01:15:14.020 | Her money, she'll be able to meet that spending goal

01:15:16.940 | for 28.99 years.

01:15:19.180 | Then her money runs out, no more investment assets.

01:15:21.940 | And then she'll continue to have social security at $21,000.

01:15:25.220 | Now, strategy number two,

01:15:27.260 | she doesn't change her tax strategy,

01:15:28.980 | but if she just delays social security at 70, until 70,

01:15:33.340 | that will increase 1.86 years onto her portfolio longevity.

01:15:37.940 | Her money will last 1.86 years longer.

01:15:42.340 | Okay, and that's the benefit of delaying social security.

01:15:45.860 | Now, the rest of these strategies

01:15:47.500 | all have social security at 70,

01:15:50.060 | but they're adding more sophistication with the taxes.

01:15:52.940 | So strategy three is,

01:15:56.180 | they're going to do tax bracket management, she will do,

01:15:59.140 | but without Roth conversions.

01:16:00.580 | She's just going to spend less from taxable,

01:16:03.540 | more from tax-deferred,

01:16:05.380 | to manage an adjusted gross income of $60,000.

01:16:09.220 | And a little bit later,

01:16:10.220 | I'll show you the charts of how I come up with that number.

01:16:12.340 | I think that is something I haven't seen elsewhere

01:16:15.140 | in doing this.

01:16:16.540 | I checked every adjusted gross income level

01:16:18.740 | and see which one gave her the most portfolio longevity.

01:16:22.500 | And so managing $60,000 was the amount that worked best

01:16:26.220 | to give her the most portfolio longevity.

01:16:28.660 | And that gave her 3.83 more years

01:16:31.980 | than the baseline strategy,

01:16:34.100 | or almost two more years than just delaying social security.

01:16:37.620 | So an additional two years of portfolio longevity

01:16:41.100 | by being more tax-efficient.

01:16:43.460 | Strategy four, she's now going to do Roth conversions.

01:16:47.300 | And coincidentally,

01:16:49.380 | the same adjusted gross income level

01:16:51.300 | would maximize her portfolio longevity.

01:16:54.820 | And that's getting her about four and a half years longer

01:16:56.860 | than the baseline strategy one.

01:16:59.340 | And then strategy five,

01:17:01.540 | she's gonna do a two-part strategy.

01:17:04.820 | She's 60 years old right now.

01:17:06.180 | So until she's 69,

01:17:07.580 | for the first 10 years of her retirement,

01:17:10.140 | she's gonna manage an adjusted gross income

01:17:12.260 | that goes right up to the second Medicare threshold.

01:17:16.260 | So she will have a higher Medicare premiums

01:17:18.580 | starting at age 65 for one threshold,

01:17:22.980 | but she's gonna go up to just before the second threshold.

01:17:26.180 | Then she'll stop doing that when she turns 70.

01:17:28.940 | So the year she starts collecting social security,

01:17:32.860 | she's already done such a big Roth conversion strategy

01:17:35.860 | by that point.

01:17:37.020 | But now for the rest of her retirement,

01:17:38.660 | she can manage $25,000 of adjusted gross income,

01:17:42.300 | have much less of her social security be taxed,

01:17:44.860 | and her money lasts 5.6 years longer than in the baseline.

01:17:47.980 | Okay, so that's what we're walking through here.

01:17:51.460 | So this is the claim at 62,

01:17:56.100 | claim social security at 62,

01:17:58.500 | conventional wisdom taxable, tax deferred, tax free.

01:18:01.620 | And I'm sorry if your monitor is not so big,

01:18:03.860 | you might not see these numbers very well,

01:18:05.740 | but let me just kind of tell the story of what's happening.

01:18:09.060 | This is her whole like retirement situation

01:18:11.500 | as she's spending down from her taxable account,

01:18:15.020 | the tax deferred account, tax exempt account.

01:18:17.140 | So you're seeing the account balances on the left,

01:18:19.660 | the amount distributed from each of the accounts each year

01:18:22.700 | under the spending, her social security benefits,

01:18:26.380 | her required minimum distribution amounts.

01:18:28.780 | They're never binding in this example.

01:18:30.420 | She always wants to take out more from her tax deferred

01:18:32.820 | than the required minimum distribution.

01:18:35.660 | Roth conversions, her adjusted gross income,

01:18:39.380 | and then her taxable income,

01:18:40.460 | which would just take the standard deduction off of that,

01:18:43.860 | the amount of her social security that's taxable,

01:18:46.500 | and then her federal income tax bill.

01:18:48.380 | So this strategy, the first years of retirement

01:18:52.500 | through age 64, she's just spending her taxable account.

01:18:56.180 | And I was assuming her cost basis matched her account value.

01:18:59.940 | So she's not really generating much taxable income.

01:19:02.300 | She does have the 2% interest every year

01:19:04.460 | in her adjusted gross income,

01:19:06.260 | but it's nowhere near the amount of her standard deduction.

01:19:09.380 | So she's paying 0% federal income taxes,

01:19:12.700 | but she's wasting tax capacity.

01:19:14.900 | She could have at least generated taxable income

01:19:17.260 | up to the standard deduction and still had 0% tax rates,

01:19:22.220 | whether she went beyond that is up to her,

01:19:23.740 | but she could have generated more taxable income

01:19:25.460 | without actually generating any taxes.

01:19:28.820 | But then she gets into trouble around age 65,

01:19:32.460 | 'cause this is where she switches

01:19:34.820 | to just spending from tax deferred.

01:19:36.660 | And to meet her spending goal and pay her tax bill,

01:19:41.620 | that's pushing her up to an adjusted gross income

01:19:43.780 | of $115,000 for most of those years.

01:19:46.940 | That's into that second Medicare threshold for her.

01:19:50.180 | So she's looking at more than 2,000 additional dollars

01:19:53.460 | of Medicare premiums.

01:19:54.820 | And I'm just adding that to the federal income tax numbers.

01:19:58.140 | So when she's spending from her tax deferred account,

01:20:01.220 | she's being taxed on 85% of her social security.

01:20:03.860 | That's the 17,850 out of 21,000.

01:20:07.540 | And she has more than $20,000 of taxes for a long time,

01:20:11.220 | all the way through age 82.

01:20:13.460 | That's when she runs out of tax deferred account

01:20:15.460 | and start spending from her tax exempt account.

01:20:18.700 | Then she's back to the issue where she just,

01:20:20.860 | she doesn't have any taxable income at this point.

01:20:22.580 | She still has to pay those higher Medicare premiums.

01:20:24.620 | That's that age 83 tax bill of the $2,164.

01:20:29.620 | That's just that additional Medicare premium

01:20:32.020 | based on her income at age 81.

01:20:34.620 | But after that, she doesn't have any more taxes.

01:20:37.700 | Her adjusted gross income is zero.

01:20:39.060 | She's just spending from her Roth.

01:20:40.780 | She doesn't have taxes,

01:20:43.340 | but she's wasting tax bracket space again.

01:20:46.380 | And she ends up running out of money

01:20:48.140 | before she turns 89 years old.

01:20:50.740 | And then at ages 89 and higher,

01:20:53.460 | she's able to spend her $21,000 of social security benefits.

01:20:57.540 | That's not enough to trigger taxes.

01:20:59.780 | So it's not even above the,

01:21:01.620 | sorry, it might be above the standard deduction.

01:21:05.820 | I was kind of thinking of the joint one when I was talking,

01:21:07.580 | but anyway, she's not triggering any taxable income.

01:21:11.380 | It is well below those thresholds for provisional income.

01:21:14.820 | So she had a lot of taxes between ages 65

01:21:18.500 | up to about age 82,

01:21:20.700 | and that really disrupted her retirement.

01:21:22.700 | She can do better than this to have that money last longer.

01:21:26.300 | And these were, what I was saying,

01:21:29.900 | I test every level of adjusted gross income,

01:21:32.940 | see how long the portfolio lasts.

01:21:35.540 | And that's where I find

01:21:36.420 | like a tax bracket management strategy.

01:21:39.300 | $60,000 of adjusted gross income claim at 70

01:21:43.220 | is giving her the most portfolio longevity there.

01:21:46.420 | And that's why I picked that as the standard.

01:21:48.780 | If you look at $60,000,

01:21:50.180 | that's where that curve gets the highest

01:21:53.420 | on the top purple curve

01:21:54.940 | for the Roth conversions, social security at 70.

01:21:57.820 | And then this is just a matter of like trial and error

01:22:03.180 | of saying, well, what if she did two different things?

01:22:05.100 | What if she managed an even higher level

01:22:08.060 | before social security begins and then reduce after that?

01:22:12.780 | And this is where she's going right up to the threshold

01:22:14.820 | of where her social security

01:22:16.420 | or her Medicare would be taxed two times,

01:22:19.020 | into two of those thresholds.

01:22:21.180 | In reality, you probably wouldn't wanna go this close

01:22:23.300 | because one more dollar of income

01:22:24.740 | would accidentally trigger the higher Medicare premium.

01:22:28.140 | So you might kind of build in a buffer of $1,000.

01:22:30.780 | But the basic idea,

01:22:31.740 | you're gonna pay more taxes early on,

01:22:34.940 | but then after age 70,

01:22:37.540 | you're gonna manage a $25,000 tax bracket.

01:22:40.220 | And that gives you the most portfolio longevity

01:22:42.300 | in that bifurcated strategy.

01:22:44.420 | And here's how the tax situation plays out

01:22:48.740 | with this most tax efficient version.

01:22:51.900 | With this, she's gonna do Roth conversions early on.

01:22:55.420 | So she's spending from her taxable account.

01:23:00.340 | She's paying taxes from her taxable account.

01:23:02.740 | She's then doing Roth conversions

01:23:05.140 | up to manage that $111,000 of adjusted gross income.

01:23:10.140 | And then she's gonna have

01:23:11.100 | a higher federal income tax bill in those early years.

01:23:13.700 | Her taxable account depletes by age 64.

01:23:17.860 | Then she doesn't do Roth conversions anymore

01:23:20.900 | 'cause she doesn't have a way to really pay the taxes

01:23:23.380 | on that.

01:23:24.220 | So she's taking $111,000 out to spend

01:23:26.460 | from her tax deferred account.

01:23:28.420 | That doesn't meet the full amount she needs

01:23:30.220 | to cover her taxes.

01:23:31.300 | So she's taking a bit more out of her tax exempt account

01:23:34.700 | at that point.

01:23:36.020 | And she continues to pay those high taxes up until age 70.

01:23:40.980 | Then her social security begins.

01:23:43.820 | And then she's able to, at that point forward,

01:23:48.220 | manage $25,000 of adjusted gross income.

01:23:51.340 | That's going to dramatically reduce her tax bill.

01:23:55.140 | She does have the one year there

01:23:56.700 | where she's paying the higher Medicare premium again,

01:23:59.740 | or one or two years.

01:24:00.580 | I've got that part of my screen covered

01:24:02.580 | with everybody's pictures here.

01:24:05.420 | But at some point then, her taxes dropped down to 1,460.

01:24:10.420 | And that's just based on,

01:24:12.100 | you can see her social security, $6,843 is taxable

01:24:17.100 | out of the benefit of $37,200.

01:24:21.100 | So she's paying taxes on a much smaller percent

01:24:23.700 | of her social security benefit.

01:24:25.820 | That's helping a lot.

01:24:26.980 | She front loaded her taxes.

01:24:29.380 | But after age 70, it's smooth sailing.

01:24:33.460 | She's able to take much less

01:24:34.900 | out of her tax deferred account at that point,

01:24:36.940 | blend it more with her Roth account distributions

01:24:39.700 | and her higher social security benefit.

01:24:42.300 | And her money lasts until she's 94.

01:24:45.100 | And then after it does run out at that point,

01:24:47.660 | she still has that higher social security benefit.

01:24:50.060 | So it's, I mean, her money lasts 5.6 years longer.

01:24:54.220 | And even if she does run out,

01:24:56.500 | she still has 77% more coming out of social security.

01:25:00.820 | So that's kind of how this fits together to work better

01:25:04.140 | for her to help manage in particular.

01:25:07.140 | Well, in that first example,

01:25:08.780 | she was paying two bumps up the Medicare brackets

01:25:12.420 | as well as 85% on her social security.

01:25:14.740 | She was wasting tax capacity.

01:25:17.660 | Here, she's front loading her taxes

01:25:21.020 | and setting herself up very well.

01:25:22.900 | So once her social security begins,

01:25:25.460 | not much of it is taxable

01:25:27.620 | and she gets to pay lower taxes for the rest of her life.

01:25:30.660 | And that's what's generating more portfolio longevity

01:25:34.220 | for her in this example.

01:25:35.620 | So key ideas coming out of all this,

01:25:39.820 | the progressive tax code in the US

01:25:41.980 | and all those various pitfalls I talked about

01:25:44.700 | really can have an impact on your marginal tax rates.

01:25:48.180 | And so it can make this kind of planning important.

01:25:50.820 | So setting up pre-retirement

01:25:52.300 | with tax diversification and asset location.

01:25:55.460 | And then as you enter into retirement,

01:25:57.300 | thinking about social security claiming

01:25:59.660 | and how that impacts as well with managing tax brackets

01:26:03.140 | and potentially conducting

01:26:04.140 | a strategic Roth conversion strategy.

01:26:06.020 | Again, for money that you don't anticipate going to charity

01:26:10.660 | can lay the foundation

01:26:11.860 | for a much stronger retirement income plan in that regard.

01:26:15.260 | So again, the book, chapter 10 of the book,

01:26:18.900 | that's more than 70 pages

01:26:20.340 | about what I was talking about right now.

01:26:22.820 | And let me go ahead and wrap up.

01:26:25.180 | Let me show you that disclosure,

01:26:26.620 | but otherwise we can go ahead and wrap up there

01:26:30.020 | and get into the questions again.

01:26:32.100 | So thank you.

01:26:32.940 | - Thank you, Wei.

01:26:35.020 | That was wonderful.

01:26:35.860 | I'm gonna go ahead and pause the recording here

01:26:37.940 | so we can take our questions.

01:26:39.820 | - Okay, Wei, we just wanna thank you once again

01:26:45.900 | for your time and expertise.

01:26:48.020 | These are pretty thought-provoking discussions

01:26:51.900 | that we as retirees certainly are trying to maneuver

01:26:56.340 | at a time where things should become simpler

01:27:00.700 | and they become more complex.

01:27:02.780 | And so we appreciate your insight

01:27:05.540 | into these issues that we're all gonna have to face

01:27:09.260 | to some degree.

01:27:10.780 | And again, we thank you for the work you put into the book

01:27:15.620 | where we can kind of ponder it a little bit more,

01:27:18.260 | but thanks again.

01:27:20.380 | We really appreciate it. - Okay, my pleasure.

01:27:22.260 | - By the way, Wei, will you make your slides available

01:27:25.100 | for the Bogleheads possibly?

01:27:27.500 | - Yeah, I can do that.

01:27:28.940 | - Okay.

01:27:29.780 | - Let me make a little note to remind myself.

01:27:31.100 | - Lady Geek will post that on the forum.

01:27:33.860 | I also wanna thank, in addition to Robert,

01:27:37.060 | for doing a superb job in getting this organized.

01:27:39.340 | Also, Henry and Raj helped out behind the scenes

01:27:42.500 | with their input and perspectives.

01:27:46.140 | We appreciate that.

01:27:47.420 | As a reminder for everybody,

01:27:48.660 | we now have a Bogleheads YouTube channel.

01:27:51.380 | Once we have this recording edited,

01:27:53.580 | we'll have it posted up there.

01:27:55.180 | Also, I advise everybody to please bookmark

01:27:58.380 | the Bogleheads calendar of events,

01:28:00.700 | which is in the blog section of the forum

01:28:03.700 | to see all the upcoming local

01:28:05.660 | and chapter national meetings as well.

01:28:08.340 | But with YouTube channel now also has

01:28:10.060 | the Bogleheads on investing podcasts.

01:28:12.620 | They're being uploaded as well with Rick Ferry.

01:28:15.300 | Again, thank you so much, Wei.

01:28:16.940 | This was a phenomenal presentation.

01:28:18.500 | We appreciate your efforts,

01:28:19.780 | especially after having done a webinar

01:28:21.140 | already this afternoon.

01:28:22.740 | And it definitely gave us a tremendous food for thought

01:28:26.020 | and piqued our curiosity to investigate this further

01:28:28.380 | with the book and other resources you have to offer.

01:28:31.100 | So, thank you very much.

01:28:34.020 | - Thank you.

01:28:34.860 | - Thank you, everybody.

01:28:35.700 | - Thank you.

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