MIKE: Good morning, and thank you for listening to Decker Talk Radio’s Protect Your Retirement. A radio program brought to you by Decker Retirement Planning. This week we’re talking about potential problems in your retirement and the remedies that may fix them before they become an actual problem. The comments on Decker Talk Radio are of the opinion of Brian Decker and Mike Decker.
MIKE: Good morning everyone. This is Mike Decker and Brian Decker on another edition of Decker Talk Radio’s Protect Your Retirement. Brian Decker, a licensed fiduciary from Decker Retirement Planning. Offices in Kirkland, Seattle and Washington. We’re broadcasting today on KVI 570 out of the greater Seattle area and KNRS 105.9 in the greater Salt Lake area. Hello to everyone in Salt Lake. Brian, we had a great discussion last week on the big potential problems in retirement, and we’d like to continue that conversation today. I believe we left off on how much income is lost at the death of either spouse. Is that correct Brian?
BRIAN: That’s correct, so Mike, we have a list of 22 of the biggest problems that we face; that we see in retirement, and we covered in an hour of commercial-free broadcasting last week three of ‘em, so these are big deals. We talked last week about inflation. We talked about stock market crashes, and we talked about, “How much income do you want at retirement?” So Mike, let’s just sum these up real quick and then move on to new ground. Regarding “how much income do you want at retirement,” a lot of people think… you would think, Mike, that if you retire you don’t need as much income, right?
BRIAN: That makes sense.
MIKE: Yeah you… I mean you’re retired. That’s the idea, but I doubt that’s true, because you’d have more time on your hands, right?
BRIAN: Right and when you are working you’re engaged. You’re busy. You’re not spending money. You’re making money. When you’re retired you have time, and you do things, and doing things costs money, so normally there’s… we try to look for about a 20 percent increase in your net income, net of tax income, so that you can go hit your bucket list and do the things that you want.
BRIAN: So ideally, number one, your whole income plan revolves around making sure you know how much money you need and want to pay the bills each month, have emergency cash set aside, and also add to that entertainment and travel expenses, so that’s number one. Number two is inflation protection, and I’m going to go through this very quickly. We have, for our clients, inflation protection four different ways. Number one, we add a COLA, cost of living adjustment. Cost of living adjustment we set at three percent, so that every year you have more money to pay the higher food and energy costs.
BRIAN: That doesn’t take care of inflation, number one, but it’s part of the whole recipe. Number two, if there isn’t any… if there is inheritance, then we add that to the plan. And it’s a very awkward topic to talk about, but it’s something that is going to happen, so we’re very conservative based on time and also on dollar amounts. But we do add that to the plan. Number three, if you own real estate whether it’s residential or residential and rental income it acts as a beautiful hedge for inflation.
BRIAN: The home you have, if we do have inflation, will go up in price, because hard assets go up in price when there is an inflation period, so it acts as a nice hedge, and then the next one is you’ve got a downsize situation that typically happens in your late 70s, early 80s. You’re no longer interested in gardening and stairs, and so you sell the house for X, buy a condo for Y. X is larger than Y. There’s usually an infusion of cash back to your plan that adds to your plan and provides a layer of income protection and inflation protection.
BRIAN: And then finally we have what’s called a risk bucket which we have growing at six percent a year. The returns that we have from our managers are much higher than that, because we have two-sided models. The models that we use, because we are fiduciaries, these are mathematical algorithms that, as the markets go up and down, two-sided model, unlike the banker and broker model that have a one-sided strategy in a two-sided market, and they tell you that they want you to just ride the market out, and take the market hits and take four or five years to get back to even which by the way makes no sense to us.
BRIAN: At Decker Retirement Planning, we use two-sided models that are designed to make money in up or down markets. The models that we’re using right now made money collectively in 2008 when the markets were down big, and also they have done very well as the market’s gone up, since 2009 when the markets bottomed. So stock market crashes… these models have averaged 16.5 percent since January 1 of 2000. They have not lost money since January 1 of 2000 collectively.
BRIAN: And so when we plan for six percent growth, and they’ve averaged 16, that provides a nice buffer for people for inflation protection. Inflation protection is essential to have in your planning. The third and final one… and by the way, these are the big three of all the 22. We’re going to go through the 22, but the third biggest one that in my opinion is the number one… don’t you think, Mike, that stock market crashes is the biggest life-changer on the list?
MIKE: Yeah I would say so, because… well and this is just my opinion, but people are typically optimistic and don’t think it can happen. It’s almost like you know in your teenage years you can’t get hurt, until you do get hurt.
BRIAN: Right and Mike, how would you respond, if I’m your stockbroker, or your banker or your advisor, and I tell you, “Mike hold on. You’re 65 years old. You’ve got a million dollars. It’s all at risk. Markets just took a 30 percent hit,” and then I call you and say this. This galls me.
BRIAN: “Markets are down 30 percent. Good thing you’re with us Mike, ‘cause you only lost 22 percent of your money.” That’s $220,000 of your million dollars Mike, and it’s going to take you four years to make it back. And on top of that I tell you, “Hey you know that four percent rule where you’re drawing four percent from your income? Yeah, no. Now you need to just draw one-and-a-half or two.” You can’t do that Mike. You can’t just snap your fingers and all of a sudden make your expenses go down, in half right? So how are you supposed to respond to that?
MIKE: It’s near impossible to respond. I think one of the biggest issues too is that it feels like everyone’s doing this, and so you ask your friends. Well they took a hit, and your friends’ friends took a hit. It’s the big model that’s being used, and Brian, I’ll just put it out there. Chances are our listeners are doing this too. Chances are listeners you’re taking too much risk with your retirement, but Brian, what is the solution? What should people be doing here?
BRIAN: Well what happens, Mike, when people get that call… this just really bothers me, and they’re told that they can’t draw four percent from their portfolio anymore.
BRIAN: They need to cut it in half. A lot of people will have to do what happened in 2009. They put a for sale sign on their home. They sell their home and move in with their kids. They go back to work. They have to have a plan B because the plan with their banker and broker didn’t work, so we, because we’re fiduciaries, and we’re required by law to put our clients’ best interests before our company’s best interests, we do several things quite differently from the banker/broker model. We don’t have all your money at risk.
BRIAN: Typically we cut your risk down by 75 percent. There’s no mathematical reason for you to have all your money at risk, and by the way it makes no sense to have… gosh Mike this… now I’m going to get off track again but…
MIKE: It’s important. Let’s just wrap up that thought and take it where it’s going.
BRIAN: Okay. Just to finish the thought, it makes no sense to us. I’m just going to go down the list. To tell you that your safe money is in bond funds where bond funds are only paying less than two percent, and when interest rates go up you lose money on your bond funds.
BRIAN: In 1994 and 1999, those two years when rates went up, you lost almost 20 percent both years on your safe money. It’s not mathematically… it’s demonstrably ridiculous. Then to use the rule of 100 to tell you how much money to put in your safe money. Mike if you’re 65 years old, your banker or broker is going to tell you to put 65 percent of your money in bonds or bond funds earning almost nothing. Interest rates right now are artificially low.
BRIAN: The central banks are keeping them low right now, and it makes it very difficult, so how do you make your money on your safe money? Now we’re all over keeping your money safe, reducing your risk, but there are good investments that are out there that when the 10-year rate of return on CDs, treasuries, corporates, agencies, municipals or even fixed annuities are down to 2, 2.5, 3 percent at best… there are many good investments that in the last six years have averaged 6.5 percent, and they’re principal-guaranteed.
BRIAN: And Mike, we are fiduciaries, and we’re very math-focused in our practice. Why would we pick something at 2.5, 3 percent when there’s something out there that’s 6, 6.5? Of course we’re going to use that, so the banker/broker model, in sense, they’re brokers. They’re advisors… to keep your money at risk which makes no sense to us, to ride out the markets, to take those financial hits every seven or eight years; that makes no sense to us. Why aren’t they using the two-sided models that are designed to make money in up or down markets?
BRIAN: Why aren’t they using the spreadsheet, the distribution plan that allows people to see how much money mathematically you can draw for the rest of your life? At Decker Retirement Planning we are fiduciaries, and we do use all of the above. We make sure that you have principal-guaranteed accounts that you’re drawing from, so that when the markets get creamed every seven or eight years it does not affect you. We use two-sided models on your risk money so that when markets go up you participate, and when markets go down these are designed to make, not lose, money.
BRIAN: And then people that haven’t done the mathematical calculations, Mike, that we do for our clients at Decker Retirement Planning… we use a distribution plan so it looks at your assets that you’ve got in your 401K, your IRA, your Roth, your joint account, your trust accounts, all your investable funds. It adds them up and looks over a period of about… to age 100, and it looks at all the money that you can draw for the rest of your life, and it includes your savings, your pension, your Social Security, any rental/real estate money.
BRIAN: Totals it up minus taxes and that gives you annual and monthly income with a three percent COLA to age 100. Now if people don’t come in and talk to us and mathematically make these calculations, they’re just guessing. Mike how would you like to just guess on how much money you can draw for the rest of your life? Wouldn’t there be some anxiety attached to that?
MIKE: That would frighten me. I mean I would have so much anxiety about not knowing the future that I probably wouldn’t even enjoy my retirement.
MIKE: I would stay in. I mean I wouldn’t think the world’s going to end, but you don’t know what you can do. You don’t know if you can do things on your bucket list, so you might as well just stay in, steady the course and do the minimal things in retirement which doesn’t sound like retirement. People don’t retire to sit at home and do absolutely nothing. They want to enjoy those years.
BRIAN: I’ll never forget a meeting, Mike, that we had Boeing retired… a Boeing engineer. He was close to 70 years old. He had $6.5 million. He was working because he was so stressed about over-spending his money.
BRIAN: He told his sweet wife that she could only spend $1,500 a month, and that was it. He had $6.5 million. He had a pension. He had Social Security, and he was still working because of the anxiety of running out of money before you die, so Mike, you know the answer to this. What was the number one fear in the United States before 2008?
MIKE: I believe… and there’s a funny Seinfeld joke about this. It was… the number one fear was public speaking, and number two was… and correct me if I’m wrong.
MIKE: It was going to war. Number three was… what was number three Brian? Do you remember?
BRIAN: The fear of death.
MIKE: So people would rather die or go to war than speak publicly, right?
BRIAN: Right so after 2008 what was and still is the number one fear in the United States for people above 50 years old?
MIKE: It’s running out of money. Yeah absolutely, and something that’s so unique is, Brian, your practice is helping people see past that fear.
BRIAN: Okay so on these potential problems in retirement, make sure that you know your budget.
BRIAN: Make sure you have inflation protection, and make sure… I’m pounding my fist here on my desk. Make sure that you have a downside protection when the markets roll over, so that you can protect the money that you’ve taken 40 years to accumulate. Okay ready for… here we are 15 minutes into the program. That’s the review. Now let’s go on to new information.
MIKE: All right.
BRIAN: How much money… go ahead.
MIKE: No I said all right. Let’s do this.
BRIAN: Okay how much money is lost at the death of a spouse? This is important. Typically the woman has no idea what her financial exposure is, if the guy… and I hate to be stereotypical, but if there’s two incomes, how much… we go through the mathematical loss to the surviving spouse if… in the scenarios we kill off one spouse at a time. Normally we kill off the man first, so in our office I look at him, and I say, “Okay Susie, you just lost your husband.”
BRIAN: “The worst time in your financial life to lose your husband is right now, so he just keeled over. Had a heart attack. What are you going to do?” She looks at our plan. She says, “Well I still own the house. I still own all the assets. The pension,” so we look at the pension, if there is one, to make sure that survivability is 100 percent. 100 percent survivability means that all the pension transfers to her when he dies. If he predeceases her, there is no loss of income with 100 percent survivability.
BRIAN: When you retire, if you are offered a pension, you have a choice to make of taking higher amounts with no survivability, or less amounts with 50 percent survivability or even lesser amounts with 100 percent survivability. We put a calculator to this, and we want to tell you that it’s our opinion and our experience that two lives will draw more than one, and so we highly recommend to our clients that when you retire your option is best to choose the max income which is 100 percent survivability.
BRIAN: Okay then we go on to any rental real estate. If there’s rental real estate, the death of a spouse doesn’t change that. That income continues to come in, and then when it comes to Social Security here is where there is a loss. You have a choice of taking the higher of the two, but you can’t have both, so typically if there’s a two-income household that’s a loss of about $2,000 or $3,000 a month. When it comes to changing your income from $8,000 or $9,000 a month, net of tax, and dropping it by $2,000 and losing a spouse emotionally you’re devastated, but financially you see that you can make it.
BRIAN: One of the options that a lot of clients have regarding death of a spouse is they can always sell the home, and they can go, and move into a condo and generate a lot more income from the delta, or the gap or the difference between the home sale and the purchase of the condo. What we are watching for is let’s say that this couple is, I don’t know, 56, 57 years old. They want to work ‘til 65. Now if you lose that spouse it’s not just… it’s a valuable income stream between 55, 56, and 65 that is gone.
BRIAN: So typically we want to see if there’s insurance and how much insurance, because now we’re talking income replacement. If there’s a pension that dies with the spouse, then we need to make sure that there is income replacement, and we try to keep it inexpensive, and we try to bridge that gap and mathematically calculate how much that surviving spouse needs to get across the finish line. So there might be, in that case, 10 or 15 years of term insurance, and we would calculate how much is needed, and if their health is good, it’s an easy, quick, inexpensive way to patch that hole.
BRIAN: But that’s something that’s very important that we talk about with our client, so that there’s a smooth transition, if worst-case scenario happened, and one spouse predeceases the other. Now the next thing we do is look at the wife and say to the husband, “The worst time for you to lose your wife financially is today,” so we kill her off and do the same steps. We go through to see what loss of income there is. Was there any income that died with her, in addition to her Social Security?
BRIAN: We total it up, and we make sure that financially… I know emotionally you’re devastated, but financially that the surviving spouse can survive. It’s a very important part of income planning that we do here at Decker Retirement Planning is just go through that situation and make sure that they’re okay. All right Mike. The next question is very interesting to me. Anything else you would add on the death of a spouse? It’s just a check that we do, Mike, to make sure that worst-case scenario one spouse can survive financially, if the other one does pass.
MIKE: Well yeah. No I think you explained it perfectly, and for those that are just tuning in right now this is Decker Talk Radio’s Protect Your Retirement. You’re listening to Brian Decker, our special guest. This is being broadcast on KNRS at 105.9 the greater Salt Lake Area and KVI 570 in the greater Seattle area. Brian I think we should just keep going. We’ve got a lot of content still to cover.
BRIAN: Okay the next one is asking the couple if it’s necessary to take risk. That might seem amazing. I would say that 85 percent of our clients the answer is yes it is necessary to take risk, but I love what we do, Mike, because you know this.
BRIAN: Most everyone comes in and guess what? They’re taking way too much risk. They have all their money at risk. The banker/broker model… those bankers or brokers are paid to keep you at risk. It’s not in your best interest. It’s in their best interest. We’re fiduciaries. First thing we do is we flip that. Typically 75 percent of your money will be principal-guaranteed and will generate income for the first 20 years. How much peace of mind does that create by having your income come from a non-fluctuating account for the first 20 years of your retirement? So stock markets can crash.
BRIAN: Interest rates can go up. Economies can go down, and it does not affect you. It does not affect you. Tremendous peace of mind, because you’re not drawing income out of a portfolio that is fluctuating. Mathematically… and again at Decker Retirement Planning our practice is extremely math-based. When you draw income out of a fluctuating account you are compromising gains when the markets go up. You’re accentuating losses when the markets go down, and you are committing financial suicide by doing that.
BRIAN: And so what we do is make sure that you’re drawing income from principal-guaranteed accounts which are non-risk investments. When we drop your risk so dramatically another thing that is a benefit to you, as a new client of Decker Retirement Planning, is that the fees that you’re paying go down by about 75 percent, so when we’re only charging on management on 20, 25 percent, and the banks and brokers were charging you on 100 percent, well guess what? You just have tremendous savings in your fees right out of the shoot, but you don’t need to take risk or as much risk, so that’s the first thing that we do is dramatically reduce your risk.
BRIAN: The second thing is I had mentioned that 85 percent of our clients do have to take risk to accomplish their goals, but we shrink that risk, and then we shrink that risk further by using two-sided models that we’ve talked about in this show. The stock market is a two-sided market. It goes up and it goes down. It makes no sense to us at Decker Retirement Planning to have a one-sided strategy in a two-sided market where the bankers and brokers tell you to ride it out, hold on, be a long-term investor and just take those 30, 40 percent hits every seven or eight years.
BRIAN: And when there’s technology that allows you to participate in markets when markets go up and make money when markets go down we’re fiduciaries. We’re simpletons. Why wouldn’t we use that? So that’s what we do, so we shrink your risk that does need to be at risk, but I want to talk about the 15 percent of the people or so in our practice that don’t have to take any risk. These are people that have assets and sources of income. Say they have large pensions plus Social Security, and they might have $800,000 to $2 million on top of that, and they can’t spend the amount of money that they could draw.
BRIAN: Well those people have several nice options. One is they don’t have to take stock market risk ever, for the rest of their lives. We mathematically calculate how much money can be produced without taking any stock market risk, and we show them that they have that option, and most clients take that option, because they don’t want that uncertainty, and they do want that peace of mind that no matter what the Dow Jones does day-to-day it does not affect them, so that’s tremendous peace of mind.
BRIAN: The other thing is they know that they might have some money that they’re not going to spend for the rest of their lives, and that money is called legacy money. Legacy money is money that they have access to and is liquid to them, but it’s typically invested differently, and we set that aside, and it shows on their plan in a separate column, and it accumulates. It’s there if they need it. It’s there for emergencies.
BRIAN: It’s there for gifting to their children, and it’s there to be invested, if they want, to produce tremendous tax advantage if they choose, by using other options to bring their taxes down. For example there’s trusts that allow you to participate in tax benefits while you’re alive, instead of having as a beneficiary a charity where… well you’re dead. You can’t really apply those charitable deductions after you pass away, so that gives you charitable remainder trusts and other types of strategies to bring your taxes down when you mathematically know that you’re really not going to spend that money for the rest of your life.
BRIAN: So at Decker Retirement Planning we’re very math-based. We make sure that you can visually see how much income that your assets can produce, and that allows you to make decisions on strategies that make sense, instead of looking at this ridiculous pie chart that has you diversified, has all your money at risk, and you have no clue how much money you can draw from it for the rest of your life. All right, Mike. I’m going to take a breath. That’s what we do regarding risk, and risk management and comprehensive risk reduction.
BRIAN: So Mike, we’re about halfway through the program. If someone feels like they’re taking way too much risk, they should call and come in, and we can put a calculator to see how much money they should draw, they can draw, and how much money they should have at risk and the typical strategies that are available to them with our practice.
MIKE: Brian that’s very kind of you, and this will be at no cost to our callers, correct?
BRIAN: Correct.
MIKE: Let’s put the calculator… let’s put your plan to the test, because chances are you are taking too much risk.
MIKE: All right Brian. Hopefully that was a long enough breath for you. I know… I’m looking at the list of our topics we’re going through. We still have a lot to cover here, so let’s just keep going.
MIKE: And for those that are just tuning in right now this is Decker Talk Radio’s Protect Your Retirement broadcasting on KNRS 105.9 and KVI 570 in the greater Seattle area.
BRIAN: Okay on this next topic we, because we’re fiduciaries, we have gone through, and because we’re independent we’re not going to go with subpar mutual funds or money managers. No. We’re going to do the homework, and we’re going to go to the databases of Wilshire database. The largest database of money managers.
BRIAN: We’re going to use Morningstar. The Morningstar database; the largest database of mutual funds, and include timer track and theta, and we’re going to review to see what the top performing net-of-fee money managers mutual funds are, ‘cause why would we do anything different? Mike, if I’m a fiduciary to you, and you’re coming to me for my opinion on how to invest my risk money, well guess what? Wouldn’t you expect me to do my homework and present to you the highest-performing models and managers that also protect you when the markets drop?
BRIAN: Wouldn’t that be a common sense assumption?
MIKE: That would seem common sense, but it doesn’t happen as much as we’d like to admit I would say.
BRIAN: Oh yeah. Not only doesn’t it happen, but sadly it’s the worst, so if I’m an Oppenheimer broker guess what mutual funds you’re going to get?
MIKE: It’s going to be Oppenheimer.
BRIAN: Right. If I’m a Merrill Lynch broker guess what mutual funds you’re going to get?
MIKE: It’s Merrill Lynch. I mean don’t they… they make more money on what the house is promoting than what will actually make people better or make them more money.
BRIAN: Right so they’re incented. These brokers, advisors and planners are financially incented to direct you to different mutual funds or money managers. We’re not. We don’t do that. We’re fiduciaries. We look at the top net-of-fee performers, and then on top of that guess what, Mike? Of all the different ways that our firm makes money, and there’s just three of them, well actually two where we charge. We charge a risk… we charge for our risk money, if you want us to manage it.
BRIAN: We charge 1.3 percent, net of fees the current managers that are in place. Net of fees. Have not lost money since January 1 of 2000 and number two, net of fees have averaged 16.5 percent, so let’s put that in perspective. $100,000 in the S and P which by the way Vanguard trots the statistic out that 85 percent of money managers in mutual funds underperform the S and P every year, so to statistically beat the S and P over a three-to-four year period is very…
BRIAN: The odds are very much against that. Statistically impossible. Our managers $100,000 in the S and P since January 1 of 2000 to present it grows to about $230,000. Average annual return is 4.5 percent. $100,000 with the current managers we’re using grows to over $900,000 average annual return, net of all fees, is 16.5 percent. So we make most of our money by managing client accounts, and yet two things are very interesting, on a fiduciary’s part.
BRIAN: Number one, unlike the banker/broker model where they keep all your money at risk, we recommend that you only have around 25 percent of your money at risk. That’s not in our financial best interests, but that’s in your best interests, and then on top of that we say, “Hey we are very respectful that this is your funds. You don’t even have to have us manage your money.” That’s not a requirement at Decker Retirement Planning. If you want to manage your own money or you have someone that you feel is very, very good then you don’t have to use the models that we have.
BRIAN: All right. The next part, as a matter of fact probably the rest of the show, Mike, is going to be focused on tax minimization.
MIKE: I would say so.
BRIAN: So comprehensive tax reduction. In any plan there’s five different key parts of your plan. One is to make sure that you’re dealing with a fiduciary; someone who has your… by the way Decker Talk Radio listeners, you want to jot this down. I would tell you that there’s five key foundational components to your income plan.
BRIAN: I’m not going to elaborate on them. I’m going to spend the rest of the show on the comprehensive tax minimization part, but number one is to deal with a fiduciary. Someone who has your best interest and is required to have your best interest in mind. Second is to make sure you have the income you need and want for the rest of your life. Third is to make sure that you have comprehensive tax reduction; tax minimization. Fourth is comprehensive risk reduction, and five is to make sure that you have the liquidity that you need, so those are the five.
BRIAN: I hope you wrote that down. Now let’s go focus on comprehensive tax minimization. There are several parts. The first thing we do is called placement. Placement looks at the amount of money that you’ve got that is in retirement plans, so this is your 401K, your IRA, your 403b, your SEP IRA, your Roth IRA. Any of your retirement accounts area called “qualified money.” Qualified money is different from non-qualified money in this way.
BRIAN: Non-qualified money is already tax money. It’s non-retirement money. If you have $1,000 in the bank, and you pull out $100, you’re not taxed on that because it’s already taxed money. It’s non-qualified. If you pull $100 out of your IRA, it’s taxable as income for that calendar year; that taxable year. So qualified money is retirement money that is not yet tax money. Non-qualified money is already tax money, so what we do is we take a look and see what percent of your retirement assets are qualified and non-qualified.
BRIAN: If all of your money is qualified in retirement accounts, then we have a set of strategies to deal with that. if all of your money is non-qualified, we have a set of strategies to deal with that, and that has to do with what we’re going to talk about right now called placement. Typically what we see is 70/30. 70 percent in retirement accounts, qualified, and 30 percent in non-qualified or already taxed money, so here’s what we do.
BRIAN: In the planning we do, we put your already taxed money in the front part of your plan. Let’s say that you’re 65 years old. You’ve got $1.5 million. You’ve got two-thirds of your money that is in retirement accounts and one-third of your money that’s in already taxed status; non-qualified. Yeah we’re going to put your already taxed money, your non-qualified, that $500,000 near the front of your plan, so in the first 10 years when you’re drawing income guess what?
BRIAN: From 65 to 75 years old, because of placement strategy, you’re not going to be charged much tax on your investments, because it’s mostly principal coming back to you, and how much are you charged on principal that’s returning? Nothing, so this allows a 10-year window where your AGI, your adjusted gross income, goes way down. Way down, so that allows a 10-year window where you’ve got your Social Security taxes, if they are taxable, goes way down because on the books you’re seen as someone who is in poverty.
BRIAN: Yeah you’ve got $1.5 million. You’ve got a beautiful home, and because of the strategies we use, tax-wise you’re showing up as someone with an AGI that’s very low, so your taxes on your Social Security for the first 10 years go almost to zero, and that creates a 10-year window for us to do something very important and that is convert some of your money from an IRA to a Roth, so the amount of money that you have at risk… let’s say that we grow that money.
BRIAN: Let’s say we have $300,000. Mike, let me ask you this question. You know the answer to this. Let’s say we grow your IRA at 65 years old from $300,000. In the next 20 years we grow it to $1.2 million. Are you happy with this?
MIKE: I would say by the rate of return absolutely.
BRIAN: Okay, but now on that IRA you could have paid tax on $300,000. Now we’re having you pay tax at $1.2 million. Are you happy with this?
MIKE: No. That’s the… I mean that’s a huge tax bracket. That’s a huge burden that’s completely unnecessary, if you do the preparations beforehand.
BRIAN: Right and so we proactively make sure that our clients know mathematically how much money they can convert. How much money it makes sense to convert from an IRA to a Roth, and it’s just the risk money, because with returns like 16.5 percent, net of fees, we can justify having you pay 20 percent tax. We don’t do it all at once.
BRIAN: We do it over five to seven years, and we do it in a way where each year we find out what your income is for the year. We estimate your deductions. We look at your brackets, and without raising your tax bracket we convert that year what we can from an IRA to a Roth. So over five to seven years we get it done. The beauty of a Roth account is three things. It grows tax-free, so now Mike, would you be happy with us if we grew your $300,000 Roth IRA to $1.2 million?
MIKE: Oh yeah. Oh yeah. That would be…
BRIAN: ‘Cause now…
MIKE: Roth is gold. I mean Roth is amazing.
BRIAN: Yeah so that Roth account grows tax free, number one. It produces income back to you tax free, number two, and it passes to your beneficiaries tax free. It’s a golden account. We use it, and mathematically we know to the dollar how much our clients should be converted from an IRA to a Roth, so that’s very, very important to our clients.
BRIAN: We don’t convert IRAs to a Roth in buckets one, two or three because those returns are too low, and you’re taking the money too soon. It’s only in the risk account. Now we know mathematically to the dollar how much money you should convert from an IRA to a Roth. Ask your banker or broker that question, how much money you should convert from an IRA to a Roth, and that’d be an interesting answer whatever they say.
BRIAN: So that’s going to be, in most people’s lifetime, the biggest tax-saving strategy, because the difference of paying 20 percent tax on $300,000 and a difference of paying 20 percent tax on $1.2 million is absolutely huge.
BRIAN: All right. One last thing on Roth conversions. We talked about justifying mathematically paying 20 percent tax. What if your banker or broker is averaging just four percent? That means it takes five percent to break even. That doesn’t make sense.
BRIAN: That’s hardly justifiable, for each of your Roth conversions to take five years just to break even. All right, so we talked about placement. We talked about Roth conversions. Those, for most people, are the biggest tax-saving strategies. Now for the larger accounts, over $3.5 million, this is very important that at Decker Talk Radio… that you guys listen to this. If you have your larger estates, and you own rental real estate, you should explore the benefits not only of liability protection but of tax reduction on that income using LLCs.
BRIAN: If you have a company that you want to continue to work and draw income, you should explore for extensive tax minimization on your income using Nevada corporations, and finally, if you have charitable intent and you have an estate larger than $3.5 million, and your income requirements are fairly small, you should explore the benefits of foundations, so those are very important. We work with your CPA in getting the strategy in place and knowing how much to fund.
BRIAN: All right. We talked about… oh now let’s talk about required minimum distributions. RMDs or required minimum distributions are… once you’re 70-and-a-half or older you’re required by IRS law to draw a certain amount of your money from your IRA, and the IRS wants to get their taxes from that IRA. Now imagine that they’ve taken… the IRS wants you to fatten the pig as much as possible, and then they get to feast on it with the required minimum distributions.
BRIAN: Once you’re 70-and-a-half, you’re required by law to do the calculation where… let’s say, Mike, you’re 70-and-a-half this year. This is a one-time option that you have with RMDs. You don’t have to pay RMDs when you’re 70-and-a-half in the first year, but that means you pay double for next year, so most people just pay this year, and then they pay next year, but what you do is you take your 1231 balance of the previous year. You take your age, and you go online, and you see what required minimum distribution factor is for your age, and you divide your total IRA balance.
BRIAN: Not just one account, but all of your IRA balance. Divide by that factor, and you have the dollar amount that you’re required by law to send in as required minimum distributions. Something to be aware of is if you’re working, and you still have an active 401K, and you’re past 70-and-a-half, that 401 does not have to be part of the calculations for your IRAs. It does not become an IRA until you roll that 401 into an IRA which at certain age limits you’re required to do anyhow.
BRIAN: The other thing is if you under-draw that IRA, there’s a 50 percent penalty for under-distributing your IRA, so this is a big deal, and you want to make sure that you know your RMDs and that you’re on top of this. This is kind of stressful for people over 70-and-a-half. Every year they have to deal with this. We at Decker Retirement Planning have RMDs, required minimum distributions, mathematically calculated and on autopilot to roll into you as income for the rest of your life, so that you never need worry about this.
BRIAN: You never have to think, “Have I done enough?” ‘Cause we’re on top of that, so it’s a stress that we get rid of for our clients, Mike, by doing the calculations ourselves. Other people that we know outside of our practice… they stress about this every year, and they have to do the calculations, hunt it down, make sure that they do it themselves, so this is something we do for our clients. Now something that… one last thing I just want to cover on RMDs.
BRIAN: It’s a great idea, but here’s something you can’t do. You can’t take an RMD, convert it to a Roth, and put it into your Roth account. You can’t do that. It’s just a law. You just have to deal with it. Another thing I want to say about Roths is a lot of people think that, “Hey I make too much money. I can’t convert from an IRA to a Roth.” I want to say this differently. You can’t contribute to a Roth if you make over, joint income, $190,000 or individual income of over $130,000.
BRIAN: You’re phased out with those income levels, but you can convert from an IRA to a Roth. There’s no income restrictions on that, so I just want to clarify that. So Mike, we’re heading down the list. We are at a point where we need to talk about dynasty trusts, at this point.
MIKE: Okay.
BRIAN: As we move now into the trust part, and we’ve covered the tax minimization strategies that we use that if people are out there and think that they’re paying way too much tax, and they have a tax inefficient plan, they should call us so that we can grab our calculators, and go through comprehensively and give them our opinion on the tax minimization strategies that we would recommend for them.
MIKE: Absolutely, so Brian, can we do dynasty trusts in the next six minutes? I know we’re wrapping up the show here. Running out of time.
BRIAN: Yeah I think we can, so there are some clients that say, “You know I want to include my grandchildren as beneficiaries.” Well if you do that, then you incur a generation-skipping trust of… a generation-skipping tax of 49 percent, so it’s something that to avoid your generation-skipping tax you can use your exemption.
BRIAN: What’s your exemption? Your federal estate tax exemption is $5.4 million, so let’s say that you have $800,000. You don’t have to worry about it, but if you have over $5.4 million per spouse, you have an exemption of $10.4 million. You use some of your exemption if you’re moving assets to your grandchildren. Not a big deal for most people, but it’s just something to be aware of. The dynasty trust is also called a generation-skipping trust.
BRIAN: Let’s say that, Mike, you have… you’re 65 years old. You’re married. You have three children. You want to… and your three children have two children each. You love your grandchildren, and you want to see them have some of your inheritance. Well you can do that by using what’s called a generation-skipping trust or a dynasty trust. And by the way, this is very popular, especially for those where their sons and daughters say to you, “Mom, Dad, I don’t need your money. I am just making so much money in business that I really don’t need your money. Pass it on to the grandkids,” or whatever.
BRIAN: So a dynasty trust, Mike, for you is where you would take your three kids, and instead of dividing your estate by three you might divide it by four, so instead of your children getting a third, a third, a third now everyone gets 25 percent. The 25 percent of your estate that goes in your dynasty trust is a trust that’s created while you’re alive but funded upon your death. The last to die between you and your wife and those assets go in the account, and typically it’s a blank slate, but it typically can be used for whatever you want.
BRIAN: The most popular use for a dynasty trust is education, so two things about this trust. It’s perpetual, and it’s per stirpes. “Per stirpes” means bloodline only, so if your grandchildren or great-grandchildren when they marry, if their spouse divorces, they don’t get access to this trust. It’s per stirpes. It stays blood line only. Now when we talk about an education trust, education or a dynasty trust is perpetual, and every generation has access, for college years, to pay for a portion of tuition and books. Whatever you want it to do.
BRIAN: It can also incent responsible behavior, so you can dictate from the grave how your legacy funds help for a first purchase of a home, for the help of the first marriage, for any children that come by. It’s a blank slate for you to have a percentage of the trust go to your bloodline, and they honor and reverence your name generations, because of your dynasty trust. So that’s what a dynasty trust is, how it works and how it’s set up.
BRIAN: Mike, do we have any more time left?
MIKE: We’ve got one-and-a-half minutes. Any last things before we wrap up?
BRIAN: Okay we’ll just say that we recommend that clients, when they have a choice of how their beneficiaries receive their money today, at death or a combination, we recommend a combination. That instead of just getting it at death that if you see… oh Mike, this is going to take longer than I thought.
BRIAN: When our clients see if they’re ahead we recommend that they use the extra that they’ve got for… to help distribute to their children. Actually Mike, I’m going to run out of time here, but when a flight attendant says before the plane takes off that when an oxygen mask comes down you do something that’s not intuitive. You’re supposed to put yours on first, and then you help your children. Our clients, we want to make sure that they have what they need, and then if they have extra they do the gifting or do whatever, because financially they can’t really be of help to their children if their house, their financial house, is not in order themselves.
MIKE: Thank you so much for listening. Stay tuned next week, and we’ll talk to you then.
