If you missed the first part of this series, I suggest you read it before this post so you’re up to speed.
Last time we covered sections 1 and 2, so let’s get rolling today with section 3…
Section 3 — Retirement Distribution Planning
This section started with a reiteration of points already made…tax rates were going up, you may need as much income in retirement as while working, your tax bracket could be higher, and so on.
Now they presented their solution to these problems.
The recommendation was to get to the proper allocation in the three types of retirement accounts (according to the course/teacher):
- Taxable — Savings accounts, money markets, CDs, mutual funds, stocks, etc.
- Tax-Deferred — 401k, IRA, 403b, etc.
- Tax-Advantaged (which the presenter kept calling Tax Free) — Roth IRA, Roth 401k, some cash value life insurance policies.
After a lot of methodology, they summarized their recommended allocation for each of these as follows:
- Taxable — 6 months of basic income needs. This is your emergency fund. Not sure why they just can’t say “6 months of expenses”. Later they say “6 months of income”, which is worse IMO (it assumes income = expenses).
- Tax-Deferred — Keep your balances low enough that your Required Minimum Distributions (RMDs) are equal to or less than your standard deduction (to minimize taxes). His rule of thumb for a married couple at age 72 is that this should be around $500k.
- Tax-Advantaged — Everything else.
So if you had $3 million, it would look as follows (my example, he didn’t share this):
- Taxable — $30k (assuming you spend $5k per month)
- Tax-Deferred — $500k
- Tax-Advantaged — $2,470k
Now let’s consider the audience he’s talking to — people who are mostly in their 50s or early 60s.
The 401k was established in 1978 and from there took some time to be adopted by companies on a widespread basis.
The Roth 401k (and Roth IRA) was established in 2001. It took some time to spread as well. In fact, when I retired in 2016, none of the companies I worked for had offered a Roth option. All had regular 401ks though.
Even today there’s a gap between 401k and Roth 401k offerings. Here’s a quote from CNBC highlighting this fact:
Seven in 10 employers now offer a Roth option within their 401(k) that lets workers put in after-tax dollars, which can then grow and be withdrawn tax-free in retirement. But only 18 percent of workers contributed after-tax dollars to their 401(k) in 2016, per the Plan Sponsors Council of America.
So needless to say, most Americans have most of their money in tax-deferred 401ks. (I looked but couldn’t find definitive numbers for the total amounts in 401ks versus Roth 401ks.)
The audience for this workshop has and even more disproportionate amount in tax-deferred options because that’s all they’ve known for most (or all) of their working lives.
And the presenter is telling them that anything over $500k in a 401k is going to cost them money. That’s probably most of them (if they’re lucky). Intuit says, “According to the Federal Reserve, the average net worth for Americans between the ages of 55 and 64 is $1,167,400, while the median is at $187,300.”
Now they have one of two problems. Those with $187k don’t have enough money. Those with $1.2 million likely have too much in tax-deferred accounts.
I wonder who could help these people with either issue? 😉
We have the vast majority of our money in tax-deferred options (the rest is in taxable accounts). The reason: At first, using a 401k was the only option. Then once Roths showed up, we always made too much to qualify for a Roth (even this year, in retirement, we earned too much). And as for conversion from our IRAs to a Roth, do I really want to convert now and pay even higher taxes? And yet I might have massive taxes in the future. There seems to be no great answer.
I know, tough problem to have. I’m sure you feel sorry for me.
But seriously, anyone else in this position? If so, what are you doing (if anything)?
Before we leave this section, let me cover a couple random items that came up:
- He introduced the concept of RMDs and noted that they “may have unintended consequences as it relates to your overall tax burden in retirement as well as affect Social Security taxation.”
- He talked a bit about inflation (really just mentioned it) and this set off a couple people on how inflation is “way higher than 2% or 3%.” After a lot of chatter about how this costs so much more and that costs so much more than in the past, I made the point that everyone really has their own personal inflation rate based on what they buy. This either made lots of sense or confused the individuals bemoaning inflation because they shut up.
At this point, the class took a 10 minute break.
Section 4 — Estate Planning
When we came back to the classroom, the presenter was Justin Fish, an estate planning attorney from Colorado Springs.
This turned out to be the most interesting and valuable part of the workshop for a couple reasons.
First, we recently finished our estate plan and I wanted to see what he thought of it.
Second, after what he said, I’ll probably arrange a follow-up meeting with him to re-look at what we did.
Here are the highlights of Justin’s presentation:
- He shared the documents everyone should have in addition to a will: financial power of attorney, living will, health care power of attorney, and HIPAA notification document.
- He contrasted the pros and cons of a will versus a living trust (also called a revocable trust or grantor trust). The underlying themes were: a will is better than nothing, but for most people, a trust is the best option. Guess which one he makes the most from? I know, call me Mr. Cynical.
- He recommends a review of your estate planning documents at least every 3-4 years (sooner if things change) since some banks and other institutions won’t accept powers of attorney if they are too old.
- He said that in his 20 years of practice or so that “inherited money is not viewed the same as money a person has worked for.” It’s seen as free, extra, etc. As such, his experience is that “inherited money usually lasts for 18 months and then it’s gone.”
- A will has to go through probate. In Colorado probate has to be open for a minimum of six months, but the averages he sees are more like nine months.
- Probate runs about $2,500 to $7,500 in Colorado.
- Probate is public and there are people who look for probate notices to prey on beneficiaries of higher-level estates.
- A trust is “an account that owns all your assets.” You transfer everything to a trust which is overseen by a trustee (you).
- A trust operates under your Social Security number.
- You can appoint successor trustees in case you become incapacitated. With a will, generally a judge or physician has to agree to label you as incapacitated for someone else to take over, and there are sticking points with each of these (courts are full and both judges and doctors may be loathe to label someone as incompetent.) With a trust you can name a “disability panel” (spouse, kids, friends) who can make that determination (which is much easier).
- There’s no probate with a trust (if you own property in multiple states, as we do, you have to have probate open in multiple states).
- If you die with a trust then there’s a successor trustee named who takes over and allocates assets according to the trust’s specifications.
- Assets in a trust are protected from divorce and creditors.
- He recommends that you do NOT name one of your kids as the successor trustee. He rarely sees that work out well if there are other kids. It just gets wacky even if the siblings generally get along well. So he recommends an institution as your trustee because they don’t care who gets mad at them (they do what you’ve specified no matter what). These cost roughly 1% to 1.2% of assets annually.
From there we got into questions and answers and several things stood out:
- He not only sets up your trust, but as part of his fee he transfers all your assets into the trust. This is the main reason I didn’t do a trust when we recently did our estate plan — I knew I would not take the time and energy to transfer all our assets to the trust. This is because doing so would make completing income taxes look like a walk in the park. I can’t imagine anything I think would be a more complicated, time-consuming, and frustrating process than doing that. BTW, Justin has found that MAYBE one in ten people who have trusts set up and opt do the transfers themselves actually take the step to transfer assets. This is why he does it for his clients.
- A lady asked for the costs of doing a trust. He didn’t give exact numbers but said it “was around $4k”. This includes setting up the trust, all the supporting documents, changing over the assets you have into ownership by the trust, and any follow ups or updates (as long as they aren’t a complete re-do of the trust).
- Managing life with a trust is not much different than managing as you do now. I had always thought it introduced hassles into daily financial life, but according to him, it does not. Is this accurate? Anyone out there with a trust who can verify this?
He offered a free follow-up visit as well, and I think we’ll take him up on it. The one factor I haven’t been able to find in an attorney is someone who does all the transfers, but since he does, I think setting up a meeting with him would be worthwhile.
Of course I’ll keep you updated on details if and when that happens.
Section 5 — Maximizing Social Security
The next section was titled “Maximizing Social Security” but would more accurately be titled “How to Minimize Taxes on Social Security Earnings”.
The presenter didn’t talk about how to claim Social Security (SS) for maximum benefits (which I would have loved to hear) but how to set up your finances so your Social Security isn’t taxed.
Here are the highlights:
- SS may get taxed depending on the level of your “provisional income”.
- Things that count as provisional income are all earned income, distributions from retirement plans, RMDs, and on and on. The Motley Fool defines provisional income as “a recipient’s gross income, tax-free interest, and 50% of Social Security benefits.”
- If you’re a married couple, you currently pay on 0% of your SS earnings if you earn $32k in income or less. This goes all the way up to paying on 85% of SS earnings (at your current marginal income tax rate) if you earn over $44k per year. Here’s a chart with the specifics.
- Take a wild guess at what’s NOT counted in provisional income? You got it — distributions from Roth IRAs, Roth 401ks, and some forms of cash value life insurance. As such, the teacher suggested we refer back to the optimal distribution of assets into taxable, tax-deferred, and tax-advantaged accounts that he shared earlier if we wanted to minimize taxes on SS earnings.
- If you want more details on how to calculate taxes on SS income, here’s a fairly good resource.
Overall, it seems to me that there’s more money at stake by working on maximizing SS benefit claims versus focusing to reduce taxes, but perhaps I’m wrong.
At this point, if I get any SS I’ll consider it a plus as I don’t need it.
And I don’t think there’s a realistic way I can or want to set up my finances so that none of our income is taxable. I’m assuming I’ll pay tax on 85% of what I receive.
This was the end of the first class. As we drove home we chatted about what was shared and if we learned anything new (not much for me and my wife said it was a bit fast for her).
Anyway, we had a week to digest it all and were prepared to go back for class #2 on Tuesday, March 10.
Any thoughts on these sections? Agree or disagree with what’s being said?
For details of the last class as well as a wrap up of the entire workshop, read part 3 of this series.