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Navigating Retirement Planning: Why Your Retirement Portfolio Needs Stocks

Navigating Retirement Planning: Why Your Retirement Portfolio Needs Stocks – Welcome to the Webinar (0:00)

Alek Johnson: Welcome, everyone. We’re just going to give it a minute here for everyone to get filed in. We had quite a few participants sign up, so we’re just going to give it a minute or two while everyone files in.

Daniel, while we’re waiting, do you have any good Easter plans coming up?

Daniel Ruske: Oh, we do. My wife’s cousins from Canada are coming down for Easter. They have the spring break off, so we’ll be showing them around Utah. We might go down to Manti and check out that open house. We might—my in-laws are heating up the pool, so at least we’ll get in the hot tub. Depending on the weather, we might get in the pool as well. What are you doing?

Alek Johnson: Oh, I’m just—we’re just pretty much hanging out at home. Easter egg hunt, all the good stuff. So nothing too crazy, but great.

Daniel Ruske: You wanna get this started a minute after maybe?

Alek Johnson: Yeah, I think we’re kind of slowing down on people flowing in, so I’m gonna go ahead and share my screen, and I think we will go ahead and get started here. Alrighty. Perfect. Well, good afternoon and welcome, everyone. I hope you’re gearing up for a fun Easter and enjoying the day so far.

My name is Alek Johnson. I am a Certified Financial Planner™ and one of the lead advisors here at Peterson Wealth Advisors. I’m excited to be here with you today to essentially make the case on why your retirement portfolio needs to have stocks. This is one of the presentations I’ve actually wanted to do for quite a while now, as it’s one of those topics that seems to always be on the mind of our current clients, those prospective clients looking to work with us. So anyway, I’m excited to go through it with you.

My goal today is to keep this presentation around 40 to 45 minutes long. It’s definitely a little bit longer presentation than I usually like giving, but there’s just a lot of great content to cover. Before we dive into things, as always, just a couple of housekeeping items.

First and foremost, if you do have any questions during the presentation, feel free to use the Q&A feature located at the bottom of the Zoom to ask any questions. As you saw my colleague Daniel, who’s also a Certified Financial Planner™ and one of the leads here at Peterson, he will be answering those questions as you go. And then at the end, I’ll take probably around four or five minutes or so and answer some general questions that come through that Daniel doesn’t have time to get to or that he thinks would be really good to address in front of everyone.

Also, at the end of the webinar, there will be a survey sent out to give me some feedback on how the presentation went, as well as suggestions for any future topics. So, please feel free to stick around and fill out that survey for us. As a side note here as well, there will be a recording of this webinar provided for you tomorrow.

Okay, so here’s a quick agenda of what I want to go through with you today. We’re going to start off by going through two big retirement challenges, and then I’m going to go ahead and make the case for why you need to invest in stocks within your retirement portfolio. Following that, I’m going to address some common concerns that we get when talking with clients, prospective clients about investing in the stock market. And then I’ll end just by giving a few insights and maybe quick tips on how to incorporate stocks within your portfolio.

A boring part here, but it has to be said before I jump in. I do need to say that this is not investment advice, but just for general purposes only. Obviously, I don’t know all of you, but I do know that you all have very unique financial situations. When it comes to investments, there’s no one-size-fits-all plan for everyone. So that being said, I do still hope you find this presentation informative and meaningful. And then I would encourage you to either reach out to your advisor if you’re a client, or just reach out to any member of the team if you’re considering working with us if you do have specific questions about your own financial plan.

So that being said, let’s dive on in.

Understanding Retirement Challenges (4:30)

So how I view it is there are two big challenges that retirees face when it comes to their investments. Now, this is not to say that retirees only have to worry about two financial issues in retirement. Obviously, there are other financial concerns, such as healthcare concerns, tax concerns, fraud, and so on. The list is definitely ongoing. But when it comes to your investments, these are two of the most common concerns that people want to discuss when they walk through the door. It’s longevity and inflation.

Over the last 200 years, life expectancy has increased dramatically due to advancements in public health, medical technology, nutrition, and really just general living conditions have gotten better. We are living better, and we are living longer. So naturally, as an investor, therein lies the problem, right? The question becomes, am I going to outlive my money, or is my money going to outlive me?

So let’s just take a quick glance at how long we’re expected to live. So this is a life expectancy table for those who are currently age 65. As you can see, a man age 65 has a four, let me grab my laser pointer here, make it a little easier. A man age 65 has a 44% chance of living until age 85, and a 23% chance of living until age 90. These odds rise significantly for females. A woman has a 55% chance of living until age 85 and a 34% chance of living until age 90. Here’s the scariest part of this table for me: There is a 49% chance that at least one member of a couple will live to age 90 and a 20% chance that they will live until age 95.

Retirement Challenge 1: Length of Life

Living too long has morphed from a risk into a stark reality, and retirement planning investment strategies have to accommodate this new reality. By the way, as a little side note here, predictions for children born today suggest that, as long as there are continued advancements in medical technology, they could live on average beyond 90 years. That’s an average number for children born today in countries with higher life expectancies.

Retirement Challenge 2: Inflation

Challenge number two is that of inflation. Inflation is really the thief in the night that steals your future day by day until the once prosperous retirement lifestyle that you worked so many decades for is just gone. In reality, most victims of theft by inflation don’t even realize they’ve been ripped off until it’s too late.

So historically, the average inflation rate has been about 3% annually. To put that in perspective, at a 3% inflation rate, a dollar’s worth of purchasing power today will only purchase 40 cents worth of goods and services 30 years from now. That’s a 60% cut in pay if you don’t keep your investments up with inflation over a 30-year retirement.

Another way of looking at inflation is that in 30 years, at just the 3% inflation rate, you’ll need to have $2.45 to equal the same purchasing power that a dollar has today. What that means for you is you’ll be paying $10.70 for a gallon of milk, $243 to put 20 gallons of gas in your car, $23 for your favorite combo meal at your local restaurant, and more than $118,000 for a new average-quality mid-size car.

Retirement Challenge 3: Healthcare Expenses

An additional inflation concern is that of healthcare-related expenses. Obviously, retirees spend more on healthcare than any other group, and inflation for healthcare-related items is growing at about double the national inflation rate. Like longevity, inflation is not a risk or something that may happen; it’s a reality and something that is happening. And I think over the last couple of years, with inflation being a little bit higher, it’s definitely caught more attention than it has in the past.

So given the one-two punch of longevity and inflation, it is imperative that retirees are mindful of that as they invest for their future.

Stocks (8:54)

Now that we understand those two challenges, I want to talk about a solution and why you need to invest in stocks within your portfolio.

Before I get too far, I want to make sure I clear the air on what I mean when I say stocks. A stock represents a share in the ownership of a company. When you purchase a share of stock, you become a partial owner of the company whose stock you purchased. As an owner of the company, you are entitled to all the profits and growth that are associated with that company according to the proportion of the company that you actually own.

The companies that you see on the screen here, and many others, are some of the most profitable companies the world has ever known. The stock market is simply the marketplace where buyers and sellers of these shares of the corporation come together. Think of it like your Facebook Marketplace, where all of your neighbors are selling their 35-year-old bikes and the poker table they hand-built 20 years ago. The stock market is where you go to buy and sell stocks. It’s really that simple.

Now, there are many different ways you can buy stocks. You can buy individual stocks, for example, you could go and buy Delta, Apple, or Microsoft’s stock and nothing else. Another way you can do it is through mutual funds or exchange-traded funds (ETFs), which invest in more than one company. Most of you are likely exposed to stocks through the mutual funds and ETFs that you own in your own 401(k)s.

For today’s presentation, when I refer to stocks, I am referring to the stock market in general, not any particular company. To clarify that even further, I’ll be mainly talking about the S&P 500 index, which you’ve probably heard of before. The S&P 500 is regarded as one of the best gauges of American equities’ performance and, by extension, the stock market overall. The S&P 500 essentially consists of 500 leading publicly traded companies in the United States. You’ll see it referenced all the time in the news and other prominent media outlets.

Here at Peterson Wealth Advisors, we are very much prominent believers in investing in the market as a whole. We passively manage our investment portfolios and use index funds, such as the S&P 500, to manage our client’s assets. So please do not come away from this saying, “Well, Alek told me to go buy Apple or Costco.” Because if my boss, Scott Peterson, catches one whiff of that, I’d probably be fired on the spot.

Alright, enough of the definitions. Some of you may already be thinking at this point, “Well, this stuff is way too confusing. Why does it matter anyway if I’ll just avoid stocks altogether and not even worry about any of this?” Well, you can’t do that, and let me explain why.

So, stocks have historically offered higher growth potential over the long term compared to other asset classes like bonds or cash equivalents. Although they come with higher volatility, stocks have consistently provided substantial returns to outpace inflation over extended periods, which is crucial for building and preserving your wealth.

So what we’re looking at on the screen right now is a chart showing what would have happened if you had invested one single dollar into the stock market back in 1926, which is essentially when we started tracking the markets, and what the result would have been at the end of 2022.

Since 1926, a single dollar invested into treasury bills would be worth $22 today, with a 3.2% rate of return. Since 1926, a dollar invested into long-term government bonds, getting a 5.2% rate, would be worth $131, and a dollar invested into large U.S. stocks or the S&P 500 would be worth $11,535 today.

Now, some of you may be thinking that I made a mistake, I promise you I didn’t. How could an account that averages 10.1% be worth 88 times more than an account that averaged 5.2%? The answer to that is compound interest. I’m going to talk about that here in just a minute.

But first, let me add this little wrinkle in here and show you the impact of inflation and demonstrate why stocks are so important. The end results that we just went through, you can see that 10.1%, that 5.2%, that’s $11,500 here up here. Those are based on what’s called the nominal rate of return or essentially the rate the actual investment received. So for example, the S&P 500 actually went up 10.1% year after year.

However, if we were to apply the effects of inflation, we would be looking at what’s called the real rate of return or an inflation-adjusted rate. So let’s just use the stocks and bonds here for our example. For bonds, instead of 5.2%, if we apply inflation, which it’s a little more difficult than just saying subtract inflation there, the calculation is a little more complex than that. But essentially you get 2.2% after inflation. What that means is instead of $131 at the end, you’d end up with a whopping $8.

Now let’s take a look at the stocks instead of 10.1%, as demonstrated it’s closer to 7% after inflation is accounted for. This means that instead of ending with that $11,535, you would end with $717. Inflation, as you can see, takes a major toll. We can’t avoid stocks because having a portion of our money in stocks is the best way I know to truly beat inflation.

Now, I mentioned earlier that the reason stocks can be worth 88 times more than bonds is because of compound interest. Albert Einstein said that compound interest was one of the most powerful forces in the universe and the eighth wonder of the world as he described it. Likewise, I’m also very impressed by compound interest. It’s really almost magical. Uh, so just so you know, compound interest is when an investment or a debt earns interest on top of interest, on top of interest, and so on.

Those who figure out how to harness the power of compound interest are wealthy. Those who are in debt and allow this power to work against them are typically forever poor. The key to a successful retirement income plan is to continue to have the magic of compound interest work on your behalf.

Now, a simple math calculation reveals how compound interest works. This is often referred to as the rule of 72. You’ve, you may have heard of it before. By the way, this is a great thing to teach your kids and grandkids, not only will they think you’re smart, but they’ll be forever grateful to you.

So what you do with the rule of 72, you take 72 and divide it by whatever return you get on your investment. What the result is, is the amount of time it would take your investment to double in value. So, for example, 72 divided by a 10% return would take 7.2 years to double in value.

So if I were to expect an 4.8% return on my $100,000 investment, then I would divide 72 by 4.8. And I know that it takes 15 years for my initial investment to double. So at year 15, you can see I’d have $200,000 in another 15 years, I’d end with $400,000 Using that same formula, we find that getting money twice the return of 9.6%, is equates to 7.5 years to double seven and a half years.

Now, none of this information may seem that spectacular until you look at the results over a long period of time. Uh, as you can see at the end of those 30 years, just by having double the return, you actually end up with four times the amount at the end of that 30 year period, not double. You end up with four times.

Now, I just wanted to remind you of this principle to drive home the importance of getting a good return on your investments throughout retirement. Historically, those great returns are harnessed through stocks.

Common Stock Market Concerns (17:35)

Now this sounds great, I know, just talking about the returns, but obviously there are concerns when it comes to the stock market, and I want to take some time to address those concerns right now. As you can all likely guess, the first and probably most feared concern is that of volatility. The stock market is very well known for its fluctuations where values can dramatically rise and fall in short periods of time. This unpredictability can be pretty intimidating for individuals who are risk averse or unfamiliar with how the market operates, which leads to fears of loss with their investment.

How to Deal with Market Volatility

So how do we deal with volatility? Well, to start, I think it’s important to first understand the differences between volatility and risk. The people who believe that stocks are too risky and must be avoided, oftentimes fail to discern the difference between these two. So properly understood, volatility is merely a synonym for unpredictability. It has neither negative nor positive connotations. It just means it’s unpredictable. Risk, on the other hand, refers to the chance of a loss occurring and the severity of that potential loss. Understanding the distinction between these two terms can help frame your investment strategies and expectations more accurately.

Imagine you’re planning a road trip from New York City to Los Angeles. The volatility in this scenario could be compared to the variability in weather conditions that you’ll encounter along the way. Some days might be sunny and clear, while others could bring heavy rain or even snow, depending on the route you take and the time of year you travel. This variability in weather affects your daily driving experience but doesn’t necessarily stop you from reaching your destination.

On the other hand, the risk of the journey involves the possibility of events that could significantly impede or halt your progress. Examples include your car breaking down in the middle of nowhere or running out of gas money along the way. These risks could lead to substantial delays, additional costs, or even force you to abandon the trip entirely. Again, risk is where there is the possibility of experiencing a permanent loss. Volatility only contributes to the permanent loss when poor decisions are made.

Many inexperienced drivers have wrecked their cars because they were not prepared for a severe storm on the road, or they lacked the patience to wait out the storm before continuing their drive. They made poor decisions in temporarily volatile situations and let their emotions override sound judgment.

Financial storms, such as stock market downturns, are similarly frightening but usually short-lived. The experienced investor is prepared for the frequent volatile gyrations that the stock market presents. In contrast, the unprepared and emotionally driven investor may turn a temporary volatile storm into a permanent loss by panicking and selling their stocks at a loss.

History of Bear and Bull Markets

Let’s take a closer look at the history of our financial storms. This chart shows the history of bear markets in the United States. Since World War II, a bear market, defined as a drop of about 20% in value from a market’s previous high, has occurred approximately 15 times. They’re very common, occurring about every five to six years on average, although the declines vary in their severity, frequency, and duration. On average, the stock market retreats about 31.7% in a bear market and lasts about 11.1 months, just under a year. After which, the stock market rebounds and reaches new highs.

Given the very real possibility that your retirement could span two or three decades, you’ll likely experience five or six bear markets. It’s important to become accustomed to them. You can’t abandon stocks when they’re down because as sure as bear markets come, the bull markets, or the good times when the market bounces back, will surely follow.

I’ve included a chart of the bull markets since World War II on the far right-hand side. Take a look at some of these returns: 267%, 228%, 582%, 400%. The average bull market rises by 148% and lasts just over four years. Most investors often miss the point by worrying about avoiding the next 30% drop instead of focusing on participating in the next 300% or 400% bull market.

It may also interest you to know that since the end of World War II, the S&P 500 has averaged an 11% annual return. In other words, if you had invested a thousand dollars in 1945, it would be worth 3.4 million dollars today.

Just to reinforce this, here’s a quick glimpse of how those returns look on a timeline. I know this may be a bit small on the screen here, but the blue shades represent the bull markets—the good times.

The yellow shades on the bottom represent the bear markets or the bad times. I would like to put this in perspective with the timeline because it really shows that the bull markets last a while and the bear markets are often short-lived.

Liquidity of Stocks and Misconceptions

Here’s another way of looking at volatility and how we can manage it. In this chart, we’re looking at the S&P 500, again, since 1937. What we’re showing here is the probability of receiving a positive return over the various periods shown at the bottom. For example, since 1937, if you had bought stock each day and liquidated at the end of the day, you would have made money 53% of the time and lost money 47% of the time.

If you had bought stock each month and liquidated at the end of the month since 1937, you would have made money 63% of the time and lost it 37% of the time. If you had bought stock at the beginning of each year and liquidated at the end of the year, the figures are 77% and 23%, respectively.

If you had bought stock every January 1st of every year since 1937 and kept your money invested for five years, you would have made money 93% of the time and lost 7% of the time. Over 10 years, the success rate is 97% with only 3% losses.

And here’s the kicker: There has never been a 15-year period where you would have lost money in the S&P 500. What does this mean? Well, it means that if you invest in stocks for the long term, you are very likely to make money on your investments. It also shows us that where you’re pulling income from in retirement probably shouldn’t be invested in stocks as if you look at it day by day. There’s no real certainty, a good chance of winning or losing on those days.

Another common concern we get is about wanting investments to be liquid, and this just makes sense, right? People’s financial goals change, their lifestyles change. And so here’s the good news: With stocks, they are extremely liquid. Mutual funds, stocks, ETFs—they trade day in and day out throughout the market. This liquidity provides flexibility, allowing investors to adjust their portfolios in response to changing financial goals or market conditions.

So the question then is, why is there always so much confusion surrounding the liquidity of stocks? Well, unfortunately, there are companies out there that seek to exploit your fear of the stock market to instead get you to invest your money in highly illiquid products. Here is one of those products: it’s called an indexed annuity, and I’m sure you’ve all probably heard the sales pitch before, right? They’re really good at it. How would you like to have a product that’s tied to the stock market and lets you participate in the gains?

But is it guaranteed to not lose money when the markets go down? I can tell you I would love that. I would be all for it. And as enticing as those sales pitches are, the devil’s always in the details.

First, these products have caps or limits on how much they will pay when the market goes up. For example, if the market went up 10, 15, 20, even 30% in a given year, these products only give you the prevailing market cap, often set between three to 7%. So if it goes up 30%, you might only get five percent, and they pocket the other 25%.

Second, index annuities don’t participate in the dividends of the underlying index they follow. This is significant because about a third of the S&P 500’s returns historically can be attributed to the dividends of the underlying companies of that index.

So if you choose to invest through an indexed annuity, you automatically slice your profits by foregoing future dividend payments. Third, here’s where the liquidity comes in. These products often have severe penalties if you liquidate your investment before the surrender period expires. Surrender periods are imposed because the insurance companies that create these products pay a large commission upfront to the agent who sold you the product.

If an annuity owner cancels their annuity before the surrender period expires, they can recoup the commission paid to the agent by taking it out of your investment. These surrender periods can typically last seven to ten years, and the charges run as high as 10%. So it’s important to be cautious about getting into them as well as getting out of them, as it can definitely be costly to you.

Now, rest assured, you can invest in the stock market in much simpler and more liquid ways, such as mutual funds, ETFs, or your 401(k)s. You are always participating in the market with these different funds.

The third concern we commonly get is that people are afraid to invest because they might let their emotions get the best of them. Previous generations of retirees received monthly pension checks. Most members of this generation, and definitely the next, will not be that lucky. Over the last couple of decades, the responsibility to provide a stream of retirement income has shifted from the employer to the employee. We’ve gone from pensions to 401(k)s and 403(b)s. So, you should consider yourself very fortunate if you have a pension.

The responsibility the employee has of saving, investing, and even distributing those funds in retirement is pretty daunting. Most employees are not prepared for the task. They lack the training, education, or experience to manage their investments effectively.

And then there are some people who become good at accumulating wealth and then find that distributing it in retirement is a whole new ball game. It’s a difficult task. Unfortunately, no matter your skillset, the responsibility to grow and properly distribute your retirement nest egg is yours. You all became investment managers, whether you like it or not.

As you can imagine, with little training, Americans have proven to be pretty awful investors. According to J.P. Morgan, the average investor achieved only a 3% return over the last 20 years. They would probably have been better off sticking to any one of these other asset classes shown on the left of this chart. The only factor that explains this blatant underperformance is the investor’s own irrational behavior—emotional decision-making. It appears they followed a herd mentality: buying when stocks were high and selling in a panic when they were low. Plain and simple, there is a lot of misconceptions and confusion when it comes to investing.

Incorporating Stocks into Your Retirement Portfolio (30:25)

So, this leads me to my final portion of the agenda today, which is incorporating stocks into your retirement portfolio. Hopefully, these next few slides will give you better ideas on how to invest in stocks and how to keep your emotions from getting the best of you.

The first and foremost plan of attack when looking to invest in stocks is to set your investment goals and know your time horizon. I stress this because oftentimes people don’t even understand why they are invested in what they are. It could be because a favorite news channel talked about it, a friend recommended it, or they set it up 30 years ago when they started working and never changed it. Having a clear goal creates a path for why you’re investing in a particular way.

Time horizon is the length of time you can stay invested before you need to access those funds. Longer time horizons allow for more aggressive investments, as there’s a higher potential for market fluctuations to smooth out as I demonstrated previously. Time horizon goes hand in hand with your financial goals. Someone who needs to access their money in a year or two will not want to invest in stocks, whereas someone who’s investing for a 30-year retirement will want to.

For this reason, I recommend matching your short-term money needs with short-term investments and your long-term money needs with long-term investments, and again, invest in stocks for the long term.

The next consideration is asset allocation. This involves deciding how much of your money you’ll invest in different asset classes such as stocks, bonds, or real estate. Studies conclude that the specific investment you choose within that asset class does not make as much difference over time as the asset class itself does. What does that mean? Well, it’s not about whether you own Coke or Pepsi; it’s rather about whether you own stocks or bonds.

Asset allocation is a huge factor that will determine your overall investment returns and the growth of your portfolio. It’s important when you’re trying to invest in stocks that you understand this because this is ultimately how you balance your risk and reward.

Next is diversification. Simply stated, this means don’t have all of your eggs in one basket, right? The intended result of diversifying your portfolio is to have a safer and less volatile investment experience. In a diversified portfolio, you’re not going to be hitting home runs, but you also won’t be striking out either.

We know about asset classes like stocks and bonds, but diversification takes it one step further. Investors might consider diversifying across different economic sectors like technology, healthcare, and energy, and even across geographical regions like North America, Europe, and Asia. Spreading your investments across these different sectors and regions helps to mitigate risk by reducing exposure to any single investment.

Now, this next topic can be triggering sometimes, but I want to talk about investing irrationally due to politics. Political cycles are relatively short compared to investment horizons, and market performance has historically been influenced more by long-term economic trends than by specific political administrations or policies.

I work with very conservative clients as well as very liberal clients from all over the country. It’s interesting to watch those whose party is out of power think that the end of the world is imminent. We can’t let our feelings about the current resident of the White House influence our investment decisions. Let me share some examples to illustrate this point.

This is XLE, an exchange-traded fund (ETF) that holds about 25 different oil and gas stocks, representing the petroleum industry as a whole. If I were to ask which president was the most oil and gas-friendly in our history, we would probably think of Donald Trump. Conversely, we might consider President Biden as the most unfriendly toward the petroleum industry.

Under Trump’s presidency, this ETF, which favors the petroleum industry, went down 28%. Under Biden’s presidency, it surged up 141%.

This cuts both ways. Here’s another example: TAN, another ETF, is essentially a solar energy fund with about 50 different stocks associated with solar energy. If I were to ask which president is the most environmentally conscious, you’d probably say President Biden. Well, during Trump’s presidency, this ETF surged 569%. During Biden’s presidency so far, it’s gone down 62%.

Although politicians can temporarily influence the markets, ultimately, it’s the earnings of corporations that drive the price of their stock. It’s the American entrepreneur. So, sometimes I like to bring it home by asking the question:

Who’s had the greatest influence in your own life? Was it the president at the time or the creators of the iPhone, Amazon, or Google—products you use every single day? It can save you a lot of heartache to divorce your stock investments from your politics.

Avoiding Market Timing

I also want to address the importance of avoiding what’s called market timing. Market timing is when someone tries to jump in and out of the market to avoid the bad days and capture the returns of the good days. However, it is impossible to predict when good and bad days will happen.

This chart on the screen shows the potential effect that pulling out of the stock market could have on a portfolio. Let me go through it with you. What we’re saying here is the growth of $10,000 invested in the S&P 500 from 1980 through the end of 2023. If you had put that $10,000 in back in 1980 and left it until the end of 2023, your portfolio would have been valued at a little over $1.3 million.

Now, what happens if you miss the best five days over that 43-year period? You just lost yourself half a million dollars, and now it’s valued at $847,000. What happens if you miss the best 10 days? Now, it’s cut by more than half, down to $610,000. If you miss the best 30 days, the best month of investing, that $10,000 grows to $219,000. If you miss the best 50 days, that $10,000 only grows to $96,088.

Problems with Market Timing

As you can see, an investor does not have to miss many good days to feel the financial impact over time. Market timing allows you to sit on the sidelines and avoid volatility, but it creates several other problems.

Knowing when to get out and when to get back in

First and foremost, it creates the problem of knowing when to get back in. You don’t just have to get lucky once; you have to guess correctly twice—you need to know when to get out and when to get back in. I can tell you, not many people have the ability, when the markets are at all-time lows, to say, “Now is the time I’m going to throw all my money back in.” It’s much easier said than done.

Missing potential rebounds

The second problem is that by going to the sidelines, you could miss the potential rebound. And third, beyond that, you’ll miss the potential rebound and all the compound interest and growth on that money going forward. So staying disciplined and not moving your investments will help you have a more successful approach when investing in the stock market.

Finally, a good plan brings it all together. A smart retirement plan ties in all of the considerations you see here on the screen: longevity, how to accomplish your financial goals, the amount of risk you can tolerate, your overall time horizon, and how to allocate and diversify your portfolio.

At my firm, Peterson Wealth, we use a proprietary process called the Perennial Income Model™ to help our clients create a retirement plan that meets their goals. Without that plan, it would be very difficult to know how to invest for our clients, specifically where stocks fit inside their portfolios. Goals are meaningless without the plans we make to accomplish those goals. Having that plan in place will make your stock investment decisions much easier and give you more peace of mind.

Okay, so just a quick recap here. Longevity and inflation are real challenges that you face as a retiree, and we have to do something about them. Stocks can often provide the higher returns needed to mitigate those challenges. You need to have some stocks in your portfolio. Although there are concerns when investing in the market, thoughtful planning and investing for the long term can create the positive outcomes we’re looking for.

Question & Answer (39:50)

So, I’ve done a lot of talking. I’m going to turn it over to Daniel for a couple of questions here, but before I do that, let me just say first and foremost, thanks again for tuning in and giving this a listen. Another quick plug for the survey that will pop up after the meeting ends—if you wouldn’t mind filling that out, our team would be very appreciative. It gives us some ideas on what you want to hear about next.

Daniel Ruske: there aren’t that many questions right now. I’m sure more will pop in now that we’re at the end. So, please stick around for just a few more minutes so we can get your feedback. Alek, we’ve had some really good questions. I’ve tried to answer them, and there are a few that I think will be beneficial for the group. I’ll start with this one: With money to do so, which is the better choice—one, increase my 401(k) contributions to the maximum amount each year, or two, invest the maximum amount into a Roth IRA each year?

Alek Johnson: That’s a great question. The reality is that I would probably recommend first and foremost you reach out to one of us so we can help you walk through it. It kind of depends on what tax bracket you’re in, at what point in time, and where you think you’ll be in the future.

I say that because if you are making a really high income right now and expect to make less when you retire, it probably makes more sense to increase your contributions to your traditional 401(k) so that you’re not being taxed at the higher rate right now, and when you pull it out of the 401(k), it’s taxed at a lower rate. The same thing applies vice versa. If you think you’re making less now than you will later on in your career, it might be beneficial to prioritize a Roth IRA.

Daniel Ruske: And then I’ll just highlight as well, you can do pre-tax and Roth on both the 401(k) and the IRA side. So that’s more of a tax question, and whether you contribute to one or the other, as long as you have good investments, it shouldn’t make a big difference. Would you agree?

Alek Johnson: Yeah, absolutely. Great point.

Daniel Ruske: Okay, moving down the list here. And they keep popping in, so thanks, guys. If we can’t get to them, please email us. I’m 15 years from retirement. I’ve been told to put all my personal retirement savings in the S&P 500 for the next 10 years and then start to switch to lower-risk investments. What are your thoughts?

Alek Johnson: Yeah, it’s a great question. You can definitely be more diversified than just the S&P 500. It’s a great index, but you can get other stocks in there with it.

As far as right now, I think 15 years out, it’s probably comfortable to have a majority of stocks. Over time, exactly as you’ve been recommended, you’ll want to get more conservative. Typically, we see most retirees have about 60% of their portfolio in stocks and 40% in bonds. If you’re in 100% stocks right now, you’ll likely want to get more conservative as the years go by, moving towards that 60/40 traditional retiree portfolio. Daniel, any follow-up thoughts on that?

Daniel Ruske: Yeah, well, this is a follow-up question: What are your thoughts on the S&P 500 versus a total stock market mutual fund with a little bit more equity diversity?

Alek Johnson: Yeah, they’re both really good options. For those total stock market funds, you’ll have not only large-cap stocks but also mid-size and small-size stock companies in there as well—still publicly traded. The large-cap portion will still significantly influence the movement and performance of that total stock index, but both can be great, valuable tools to have.

Daniel Ruske: I personally like the diversity of a total market; however, over the last 20 years, it wouldn’t have provided as good a return, but who knows what the future will bring. So, that’s what I’ll add there.

I retire in three years and am planning on working with your group. Do I roll my 401(k) over into the five-year/25-year stock program? When do I do that?

Alek Johnson: Yeah, that’s a great question. As far as the timing of it, oftentimes…We’re in no rush to formalize the official client relationship. We would probably recommend leaving the 401(k) with your employer until you retire. Then, when you retire, we can move that into the Perennial Income Model and start investing in that manner. Sometimes it makes sense to formalize the relationship beforehand. Again, this is more of an individual question, so I would recommend reaching out if you have more specific questions on that. Generally speaking, it’s okay to wait until retirement, but we will want to have at least some conversations beforehand, before you hit your retirement date.

Daniel Ruske: Awesome. I’ll just add that a lot of it depends on your comfort. If you’re comfortable managing it on your own until you want to do the income plan, we’ll let you do that. If you really want someone to take care of it, we’re also happy to talk.

Do you offer a fee-based financial planning option?

Alek Johnson: Great question. Right now, we are fee-only. We have an asset under management fee, meaning Peterson Wealth bills a fee based on what we’re managing. We don’t charge an hourly rate, but we do offer free consultations. That’s how these relationships even start in the first place. So definitely reach out; any of our advisors are more than happy to have a quick 15-20 minute chat with you to steer you in the right direction. Then we can look at formalizing the relationship when you retire.

Daniel Ruske: We don’t have an hourly fee. We just charge an asset under management fee right now. The hourly fee is not an option.

Questions keep coming, so I’m going to do two or three more here if that’s okay, Alek. A question about being almost 80 and how to allocate your investments. Please reach out so we can dive into specifics. It’s hard to give good guidance with just a paragraph question.

How much is the fee that we charge?

Alek Johnson: The fee depends on how much we’re managing. It’s typically around, or just a little over, 1% annually.

Daniel Ruske: I am retired and 76 years old. Do you keep adjusting the stocks and bonds in respect to my age?

Alek Johnson: That’s a great question. A lot of that depends on your goals—whether you’re using it for income, if you’re not using the money, etc. There are many variables, but we’ll definitely be looking to keep you rebalanced with the goals you have.

Daniel Ruske: Let me do one more. My husband has already retired and has his 401(k). I won’t retire for another two years. Should we convert his 401(k) into a Roth now and do mine later?

Alek Johnson: When it comes to Roth conversions, it’s hard to give a clear answer right here. I would say reach out to us on that one. There’s a lot more that goes into it than people often think. Sometimes it makes more sense to not convert. Please reach out to us; we’re happy to chat with you about your specific situation.

Daniel Ruske: Awesome. I think we’ve addressed every question that’s come through. If we missed one or if you want more details, shoot us an email and we can set up a time to talk, as Alek mentioned.

Alek Johnson: Thank you, Daniel, and thank you everyone for your participation. I hope this was informative for you. Please do fill out that survey if you have a moment, and we’ll talk to you again soon.

6 Investment Tax Traps in Retirement

6 Investment Tax Traps in Retirement: Welcome to the Webinar (0:00)

Carson Johnson: Let me start with an introduction and what we’re talking about today and introduce myself and Kaden. So we’re both excited here to talk about the topic today, which is ‘6 Investment Tax Traps in Retirement.

Learn more about our Retirement Planning Services

For those that don’t know me, you haven’t met me yet, my name is Carson Johnson. I’m a Certified Financial Planner™, one of our lead advisors here at Peterson Wealth Advisors.

Also with me today is Kaden, he’s another one of our Certified Financial Planners™ and advisors here, and he’ll be helping monitor the chat and the Q&A. So if you have any questions, feel free to use the chat and Q&A feature. It’s located at the bottom of your Zoom. So if you hover over the bottom, it should give you an option to click to chat or Q&A to be able to ask any questions along the way.

A couple of housekeeping items. First of all, thank you all so much for giving us feedback on the last webinar. Many of you mentioned that we’ve been going over some of the same material over the past few webinars, and I promise that we will be getting a little more detail into specific topics.

You may notice today that there are a couple of topics that may have some overlap from last time, but the main focus of today’s webinars is to focus on the tax traps or common mistakes that we see with investments. And so that’s the focus of today’s webinar.

And so there might be some overlap but there is also some new material that we haven’t gone over yet and I think will be helpful for you all.

We figured today’s presentation will be about 30 minutes with a short Q&A afterward. So if we don’t get to your questions throughout the presentation, we’ll stay after for just a few minutes in case you want to ask your question.

And if it’s something more pertaining to your own unique situation, feel free to set up a consultation that’s completely free. Happy to go over your situation and see how we can help these principles apply to your situation.

So with all that said, oh, and then at the end also, there will be another survey, and thank you for the ideas that you shared with us on future topics. Please send those to us if you want us to talk about any other topics that you’re interested in.

So with that being said, let’s get started.

So here’s a little overview of what we’re covering today.

We’ll go over short-term versus long-term capital gains and how you can manage that and the different applications of capital gains.
Consequences of ignoring what’s called step up in basis, and I’ll talk about that. But essentially it’s an important principle as it pertains to inheritance.
The impact of ignoring Required Minimum Distributions and the importance of having a plan for those.
Roth conversions, considerations to think about to avoid converting too much or too little to make sure you’re maximizing the benefit of conversions.
And then lastly, common charitable giving mistakes. Maybe not necessarily what the planning strategies are, but common mistakes that we see for those that are charitably inclined in retirement.

Capital Gains: When would they apply to me? (3:13)

So first, let’s talk about capital gains and when they would apply to you as a retiree. So first, what is a capital gain? A capital gain simply put, is when you sell a capital asset or an asset for more than what you originally paid for.

So for example, if you sold an investment property, that’s an example. There are some important and more unique rules when it’s an investment property, things like depreciation, and that makes it has a little more unique nuance to the sales and investment property. But, the sale of investment property does still qualify for capital gains.

Another example is the sale of an investment in a brokerage account. So for example, if you have a non-retirement account, you know, where you either got an inheritance or a sum of money that you decide to invest. And you can invest that in stocks, bonds, mutual funds, ETFs, a variety of different investments. And you sell those investments at a gain or for more than what you paid for, that would be an example of when capital gains would apply.

The other example would be the sale of a business. So oftentimes we run into retirees who are business owners and when they sell their business, some of it will be considered a capital gain because they purchased or put into the business a certain amount. It grew in value, they built up the business, now it’s worth more than what they paid for, and by selling it they also realize capital gains.

And there’s some unique nuances to that as well that we’re not going to be diving in for the webinar today, but it’s important to think through those aspects.

And then lastly, are mutual funds. Now I want to hit on this just a little bit deeper as it pertains to investment accounts and investment portfolios. You know mutual funds, they’re unique because they’re run by a mutual fund manager or somebody that’s in charge of that fund. And that fund will be investing in a variety of investments of stocks, bonds, options, things like that.

And what happens is occasionally if people either need money from their investment, from their mutual fund, they will ask to sell shares of their mutual fund and so the mutual fund manager has to free up some cash in order to get that cash to the investor. And so what happens occasionally is the mutual fund manager will have to sell investments within the mutual fund for a profit or for more than what they paid for. And so when those capital gains occur, the mutual fund manager doesn’t report those capital gains. He shares those or distributes that capital gains to all the investors or anybody that owns shares of that mutual fund.

So it’s important to know that mutual funds are notorious for this, especially at the end of the year, that mutual funds will issue out what’s called short-term capital gains, which we’ll dive into a little bit more detail, but just issue out these capital gains. And even if you don’t sell your shares of your investment, those capital gains may still be distributed to you that you may be required to report on your tax return.

So be cautious of that and how mutual funds can create extra tax consequences to you as an investor.

So now that we’ve gone over kind of a few examples of what is a capital gain, and in certain applications and how they can apply, let’s talk about the two main categories of capital gains, which is short-term and long-term.

Short-Term vs. Long-Term Capital Gains (6:56)

What is a Short-Term Capital Gain?

So simply put, a short-term capital gain is when you purchase an asset and within 12 months you sell it for more than what you paid for it.

What is a Long-Term Capital Gain?

A long-term capital gain is when you purchase an asset and hold it for one year or more and then you sell it.

Rules of Short- and Long-Term Capital Gains

There’s a few important rules on how this works with these categories that you should be aware of.

Both must be Reported on Your Tax Return

First, both short-term and long-term capital gains must be reported on your tax return. Most taxpayers don’t have to worry about figuring out if it’s short-term or long-term because if you have an investment account, for example, you’re just issued a tax form.

Or if you have a CPA, a CPA can help you with that. If it’s more unique for like a business, for example, might be harder to have, you know, there might not be a tax for that unless there’s K-ones and things like that that you could get. But a CPA can help you but for the most part, taxpayers don’t have to worry about it. It’s already taken care of, just have to get the tax form and report it on your tax return.

You Don’t Pay Capital Gains Until You Sell that Investment

Rule number two, capital gains occur in the year that you sell an asset for a profit. So if you buy an investment and you hold it, you don’t have to pay capital gains until you sell that investment. And that occurs in the year that you sell that asset for a profit.

Each Kind of Capital Gain is Taxed Differently

And then third, short-term and long-term capital gains are taxed differently. So this is where we start to dive into the more planning parts of capital gains and we’ll talk about that next on what are the differences in short-term and long-term capital gains.

So, let’s dive in. With short-term capital gains, short-term capital gains are taxed as ordinary income. So in other words, what that means is it simply means that the capital gains are taxed at your tax rate.

So I have listed on the slide the 2023 tax brackets for those that are single filers as well as those married filing jointly, and it shows you the breakdown of the tax bracket.

So for those that don’t understand or know how this works, depending on how much your combined income is, determines what tax bracket or tax rate that applies to.

So for example, if you’re combined income for a married filing jointly is between $89,000 and $190,000, that income is taxed at that 22% rate.

And so whatever rate that you’re, whatever your tax rate is depending on your level of income will determine how much your short-term capital gains are taxed at.

Now for many, as it pertains to long-term capital gains, long-term capital gains are taxed at either 0%, 15%, or 20%. And for many investors, those rates are a lot lower than the ordinary income tax rates.

Now, there’s exceptions of course for those that are maybe on the lower end of the income tax brackets, then capital gains could be higher. But for most retirees and taxpayers, they are at lower rates.

And so you can see with long-term capital gains, how it works is depending on your level of income, also determines your tax rate. So for a single filer who has income of less than $40,400, any capital gains are taxed at 0%. Now it’s important to keep in mind that capital gains adds on top of your other income. So let’s say the single filer has maybe $35,000 of income, but then maybe let’s say $40,000 of capital gains.

That $35,000 and the $40,000 capital gains adds on top of the $35,000 of other income that that filer may have. So really, their total combined income is going to be about $75,000 right? So then that would jump the capital gains tax rate at 15%.

So it’s important to keep in mind that your capital gains add on top of your ordinary income, and depending on your combined income determines what your long-term capital gains are taxed at.

For married filing jointly, for those that have income less than $80,800, capital gains are taxed at 0%. For those of income between $80,801 and $501,600, it’s taxed at 15%. And then those that have income above $501,601 capital gains are taxed at 20%.

So really to summarize it, short-term capital gains are taxed at your tax rate. Long-term capital gains are taxed at either 0%, 15%, or 20% depending on the level of income and what bracket that you are in.

Step Up of Basis – Inheritance (11:50)

Next, let’s talk about the step up in basis. And this particularly pertains to inheritance. We had a lot of questions regarding, you know, inheritance and how to handle inheritance in retirement. And so this was one of the common questions and planning strategies that we wanted to address today and to make sure that you’re using the effective use of the step up in basis.

So to simply explain what step up in basis is, it’s simply a way to adjust what the capital gains taxpayer will owe for selling a particular investment. So it’s very related to the capital gains discussion we just had.

When someone inherits a capital asset, things like stocks, mutual funds, bonds, real estate, investment properties, etc., the IRS will step up the cost basis or what you originally purchased those properties or assets for.

So for me, the purpose of the capital gains tax, the original cost that you had for any given investment is stepped up to the current value of when the asset was inherited. So let me give you an example to help solidify what I mean by that.

Let’s talk about Jack and James. Jack is James’s father and he’s a retiree. He owns Apple stock that he purchased back in 2010 for $20,000. He wants to give those Apple shares to his son James.

And so what he’s decided to do is rather than gifting the shares, he’s just going to sell his shares and give him the cash so that he can be able to do with the cash that he wants.

So Jack purchased the shares for $20,000. The sell price or the current value of those shares is $100,000, and Jack would realize that long-term capital gain of $80,000. And the tax rate on that, assuming a 15% tax capital gains rate on that capital gain, equals $12,000 of taxes that Jack would have to pay by selling Apple shares.

Now, let’s see how a step up in basis will work. So Jack purchased the Apple shares for $20,000. Jack passes away. James inherits the Apple stock at the current value of $100,000. If James decides to sell the Apple stock for $100,000, then James will then owe $0 in capital gains because James inherited that stock, and he received what’s called a step up in basis.

So instead of the $80,000 capital gain that Jack would have done if he sold the shares and just let James inherit that Apple stock, that original cost of $20,000, steps up to the current value of $100,000. So when James sells it, there’s no capital gains. It essentially wipes out the capital gain that the original or deceased owner had to the current market value.

And so it’s so important, this is probably one of the big misconceptions that retirees have and when they’re trying to distribute assets. Sometimes they’ll do that during their life and then they’ll think, hey, I’m just going to sell this and give it to my kids now.

It’s so important that you think about the tax implications when it comes to an inheritance because just this idea of letting your heirs inherit those assets and receiving that step up in basis, could save tens of thousands of dollars, by simply just being mindful and intentional about how you’re heirs receive those assets.

So, it’s such an important concept.

Now I want to just highlight a few takeaways about the step up in basis. Step up a basis can apply to stocks, bonds, mutual funds, real estate, and a lot more. Really, essentially any type of asset, capital asset. There are some exceptions that you have to be cautious of like things like jewelry, collectibles, that have different rules that apply to those.

But for the most part, a lot of the main assets and investment assets like these, a step up in basis does apply.

The step up in basis resets the cost like we’ve talked about. Spouses who inherit property from a deceased spouse may only qualify for half of the step up in basis. So, you know, coming back to you know, Jack and James. Let’s say Jack had a wife, and his wife inherited some of the Apple stock. Instead of receiving the full step up in basis up to $100,000, they may only receive up to $40,000 of that step up in basis which helps reduce the capital gains, but it doesn’t eliminate the capital gains entirely.

Now, there is one exception for this half step up in basis, which is for those that live in community property states. Those are states such as California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. If you live in any of those states, your surviving spouse may qualify for the full step up in basis. And so just be aware of that when you’re planning how you want to distribute your assets.

And then lastly, just have a plan on how you’re going to distribute your assets. You know estate planning is such an important aspect of a retirement plan. It’s not just about, you know, making sure somebody’s there to handle your estate or to make certain medical decisions. It’s also about how you want your legacy to be passed on to your future heirs.

The Impact of Ignoring Required Minimum Distributions (17:38)

Okay, next let’s talk about the impact of not having a plan for Required Minimum Distributions. Now some of you that are aware of this, Required Minimum Distributions is a law, that for those that have an IRA or 401k, are required to pull out a certain amount of money once you reach a certain age.

And we’ll talk about that in just a moment. Now in some cases, many of you may be living off of your IRA or 401k income and may satisfy that required amount each and every year. And so this may not be as big of an issue for you.

However, I’ve seen time and time again where retirees will have Social Security income, a pension, maybe rental income, or income from a business. And so they may not be pulling out the full amount from their IRA to satisfy the Required Minimum Distribution. What happens is that IRA, your investment account just continues to get bigger and bigger and bigger which creates a bigger Required Minimum Distribution later in retirement.

So I want to go over a few mistakes and things to think about when what happens if you ignore those Required Minimum Distributions.

As a reminder, since the passing of The SECURE Act 2.0 in December last year, one of the biggest changes was the change to the RMD age which will affect nearly every retiree. So the changes that were made is that the RMD will push back starting this year.

And for future years, I made a summary on this slide here of those changes. So for those that were born in 1950 or earlier, your RMD will continue to go on as normal. For those that were born in 1951 to 1959, your Required Minimum Distribution will be age 70, to start age 73. And those that were born in 1960 or later, your Required Minimum Distribution will start at age 75.

Now there are a couple important points to remember and to clarify. Those that are turning 72 in 2023 will not be required to take an RMD until next year. Also starting in 2033, that’s when RMDs will begin at age 75. So that’s why those born in 1960 or later will start at age 75.

So first, let’s look at mistake number one for ignoring RMDs. And first, it’s the penalties involved. So if an IRA account owner fails to withdraw the RMD, they may be subject to a 50% penalty tax. Now with The SECURE Act 2.0, there was also a change to this. So if you fail to pull out the required amount and you realize that and you say, oh I want to go ahead and fix that. And you fix that within that timely matter within two years, the penalty drops to either 25% or even 10% if you do it even sooner than that.

So you can work with the CPA or tax professional to help make sure that it’s reported correctly or corrected. But that’s something that’s so important. Do not miss the Required Minimum Distributions because there’s pretty hefty penalties.

Mistake number two, ignoring the impact of RMDs. So I want to share this PDF with you, let’s see if technology will work for us here. Okay, perfect.

So let’s focus here on this table on the left. What I’ve shown is an example of, let’s say you’re not necessarily needing as much investment income. You’ve got your income taken care of from Social Security, pensions, or other sources. And if you were to just let your IRA retirement account continue to grow, to show you the impact that it will have later on and retirement.

So in this case, if you’re a 60-year-old retiree, you have a million-dollar IRA, or retirement account, and assuming just a 4% growth rate by the time this retiree turns age 73, at Required Minimum Distributions, the RMD will be about $60,769. Pretty crazy how big that RMD can be.

Now I want to point out a couple of other things. If we continue to look at the Required Minimum Distribution, and assuming that we take out the full RMD each year, you’ll notice that the RMD still continues to get bigger.

Right, even though you’re still taking out the $60,000 about each year, you know, it still continues to get bigger. And the reason for that is because, how the IRS calculates your RMD is, it’s based on one how big your account balance is.

And two, if it’s based on your age. And so as you get older and as your account gets bigger, the bigger your RMD will be. And so that you can see how this could be a problem later in retirement, more taxes that you might have to pay, and we’ll talk about some of the strategies to avoid that.

But I want to show you this other chart here, which shows you the tax brackets. But let’s say this retiree has taxable income of about $130,000 from other sources things, like Social Security, pensions, or income from the business, rentals, etc.

By adding this $60,000 worth of RMDs, that ends up bumping this taxpayer from the 22% bracket to the 24% bracket. And so just letting that RMD ride and not having a plan for it could significantly increase the amount of taxes that you pay. And so being mindful how you do that whether it’s through Roth conversions or drawing a little bit each year and then putting that money into, even if you’re not spending it, putting into a non-retirement account to keep it invested, you know are some examples and ways you can manage your RMD.

So, now let’s move on to mistake number three, which is the impact on Medicare premiums. So if you think back on the previous side when I showed you how the RMD can possibly bump you up into a higher tax bracket, there’s also RMDs can also impact the amount of your Medicare premiums.

So the table that you see on the slide shows a summary of how your Medicare premiums are priced at, and they’re based off of your income.

How this works is Medicare looks at your income two years prior. And if your income falls within one of these categories, it will determine what your monthly premium is. So, for example, let’s say you’re married filing jointly and your combined income, or to be more specific, you’re modified adjusted gross income falls between $194,000 and $246,000. Your Medicare premium will go up to $230.80 per person, plus your Medicare Part D premium, which is your prescription drug coverage, will be an extra $12.20.

So the base Medicare cost is $164.90, but you can see depending on your income, it could increase by the amount of your combined income that you have. So, you know, if you have your income taken care of and all of a sudden you have this big Required Minimum Distribution, not only could it jump you up into a higher tax bracket, but also a higher IRMAA, or higher Medicare premium bracket, which would increase the cost for you on a monthly basis for your Medicare.

And so, such an important thing, you can see that especially if you have a bit, excuse me, let me go back here, a big event. If you’re selling an investment property later down the road or sell the business, this could really increase your Medicare premiums, so important to be aware of that.

Now there are some exceptions to, you know, if you have like a one-time event where if you’re like, I sold this property, or I’m just retiring I’m not going to have the same level of income that I am going to have going forward. There are ways where you can file a form with Medicare and it’s kind of a forgive me this one-time kind of form where you can ask for forgiveness for this one and be granted an exception.

So if you have questions about how to report that form, we can send you an email, send us an email, we can explain that process to you so that you can avoid having higher Medicare premiums going forward if it’s a one-time event. They kind of, IRS bases it off as a lifetime event, lifetime changing event. So, good.

Roth Conversions: Converting too much or too little? (26:31)

Next, let’s move on to Roth conversions. Now in our last webinar, Alek and I talked about what Roth conversions are, but we didn’t dive into great detail on how much Roth conversions you should do and the impact of converting too much or too little.

So I want to focus on that here today. But just really briefly, let me just explain what the Roth conversion is for those that are just new and jumping on to this. A Roth conversion simply means that it allows you to take money from a pre-tax account like an IRA or 401k and convert it to an after-tax account, which is a Roth IRA or Roth 401k.

By doing this Roth conversion, you’re essentially paying taxes on the amount that you’re converting at your current tax rate. And so, the big consideration of when to do a Roth conversion is to ask yourself, when do I want to pay my taxes? Does it make sense to pay taxes today based on current tax rates or will my tax rate be lower in the future? Maybe waiting just to pull that money out of your regular IRA rather than converting and paying taxes on it today.

So, I want to illustrate this by showing you again the tax brackets. So as we saw the impact of the RMDs, the Required Minimum Distributions, and the fact that we are in fairly low, tax rates today, any amount that you choose to convert becomes taxable to you, like I mentioned. And it’s taxed with you in the year that the conversion is performed.

So it is very uncommon to convert an entire account because what happens if you convert an entire account, especially if it’s a large account, it’ll likely push you up into a higher tax bracket. Every dollar you convert will add to your combined income.

And so if you convert, let’s say a million dollars, or even $600,000, $700,000 of Roth conversions, that will bump you up to the highest tax bracket and you’ll pay close to about 40% in taxes.

Generally, the advice we give to clients is to convert enough to get the future benefits of a Roth conversion, but not too much that it pushes you up into the next tax bracket. So for those that are still wondering if a Roth conversion is right for you, I’ve highlighted kind of the different brackets into groups.

You can see the first tax brackets are at 10% and 12%. And then there’s a pretty big gap or jump to the next tax bracket of 22%. So for those that are maybe a lower income tax situation, doing conversions at the 10% and 12% are at the lowest rates that we’ve had in a very, very long time.

And so doing a Roth conversion may make sense, especially if that Required Minimum Distribution is going to jump you up into a higher tax bracket. So you should definitely consider doing a Roth conversion if you’re in those lower tax brackets.

For those that are the middle-income earners, those that are in the 22% and 24% tax bracket, you can see that there’s a very little difference between the two. And so if your tax rate is going to be the same as it is today versus what it will be in the future, a Roth conversion may not be as convincing from a financial standpoint or mathematically, right?

Because if you’re going to pay the same rate today on the conversion as you will in the future, you might as well just leave it in the IRA.

However, there are some other non-financial aspects that you may still want to do the conversion. Even if the tax rates are going to be the same things like, you know, your heirs. If this money is going to be passed on to your heirs, one of the big changes that happened with The SECURE Act 2.0 is any heirs that receive an IRA may be required to withdraw or distribute all the money in an IRA within a 10-year time period.

And so you can see how that could have a big impact to heirs, your kids or nephews, nieces, the people that will be inheriting your IRAs because that could jump them up into higher tax brackets and essentially lose out the benefit of a Roth conversion.

For those that are in the higher tax brackets, you know the 32%, 35%, 37%, then a Roth conversion may not again be as convincing. That’s where it will be important for higher income earners to focus on pre-tax accounts and contributing to an IRA or 401K because that reduces the amount of taxable income that shows up on your taxes. Doing Qualified Charitable Distributions, which we’ll talk about later, which allows you to pull money out of your accounts tax-free may be more advantageous than a Roth conversion.

So I like to break it up into these different groups to give you an idea of when you might want to consider doing a conversion and also help give you the boundaries of when to know when too much when you do a conversion, is too much or not enough to really get the benefit out of it.

All right, so let’s talk about some other non-financial considerations. First, is where you will live in retirement. So even if you expect your federal tax rate to stay the same for those middle-income earners for example, where your tax rate may be the same. The difference that some states may partially or entirely tax that retirement income as well. And so from a state income tax perspective, and there may be a reason to do some Roth conversions.

If your future state of residence has a higher state income tax than that of your current one, it definitely makes sense to at least convert some of your assets to a Roth IRA before you move in the state that you have. Let’s say your current state doesn’t have state income tax, but you’re moving to a state that does have state income tax. That might make sense to do some conversions there. And as we keep in mind the other factors like Medicare premiums, tax rates, and things like that.

Another consideration is Required Minimum Distributions. We talked about this, if you ignore it and don’t have a plan for it, then that could create a bigger problem later in retirement. So it may make sense to do Roth conversions from now until you’re Required Minimum Distribution age to help reduce the impact that might have later down the road.

Consider tax rates in Medicare premiums. So just like the Required Minimum Distribution, Roth conversions for every dollar you convert, that adds additional income that you have to report. So that may also impact what your Medicare premiums are. So be careful, it’s a common mistake that we see with retirees as they end up, you know, they get carried away and saying, oh I want to convert all my IRAs.

I think that our tax rates are going to go up and although that may be the case, they may not realize the other costs that are going to happen with taxes and Medicare premiums and things like that.

Lastly, is leaving money to others, and I touched about this just a few minutes ago. But if you’re planning to leave a retirement savings to heirs, consider how it may affect their taxes over many generations.

And like I mentioned, where there’s new rules in play with The SECURE Act 2.0, and that they may be required to pull out all that money after 10 years. That could be a great reason especially if you’re in a lower tax rate in retirement to do some Roth conversions so that your heirs can receive more of your inheritance to them, then if they didn’t, if you ignored it.

Common Qualified Charitable Distribution Mistakes (34:29)

So, lastly is common Qualified Charitable Distribution and charitable giving mistakes. So with many retirees, especially those that we work with, are charitably inclined and plan to give in retirement.

A Qualified Charitable Distribution is a provision and tax code that allows you to withdraw money from your IRA tax-free as long as it goes directly to a qualified charity.

There’s huge tax savings that we talked about in the last webinar. If you think about it, you put money into an IRA or 401k and you didn’t have to pay tax on it. You didn’t have to pay tax on the compound interest or growth over maybe 20 or 30 years of your working career.

And then when you do this strategy, allows you to pull money out of that account now tax-free as long as it goes to charity. So you’re essentially getting triple tax savings by doing this strategy. I would recommend any retiree that is inclined to do and have charitable intentions in retirement should consider this. And we’ll talk about some of the rules and mistakes that we see and how to correctly process these in retirement.

So some of the four benefits and how it can benefit you. It can potentially reduce the taxes on your Social Security benefit. It will reduce the overall amount of income that is taxed and that may also impact your Medicare premiums like we talked about.

It’ll enable you to get a tax benefit by making the charitable contribution. And then Qualified Charitable Distributions count towards satisfying the Required Minimum Distributions later down the road.

So here are some important rules to be aware of. They are only available to people older than age 70 and a half. And to give this a little bit more specific, the IRS doesn’t allow you to do it a day earlier. So even if you’re in the same tax year as you’re 70 and a half birthday, if you do a QCD before your 70 and a half birthday exactly, the IRS could come back and say that that is ineligible. So you have to wait till the to the exact day of your 70 and a half birthday.

Second, they are only available from IRA accounts. Withdrawals from 401ks are not eligible for QCDs. So I’ve seen this time and time again as well, retires will try to withdraw money from their 401K. They’ll receive the check or cash and then send the cash directly to the charity. That is not eligible for QCD. And that could, the IRS could come back and deny that.

A QCD must be a direct transfer from an IRA to a qualified charity. And one example that I’ll give you to illustrate this point. I had a client of mine who actually had the ability to get a checkbook for their IRA. It’s pretty common for a lot of the broker-dealers and custodians like Fidelity Investments, Charles Schwab, TD Ameritrade. They typically have that as an option or a feature. And this client of mine was writing checks to the church directly, and so even though he was writing the check and the money was going to the charity. Essentially, that money was coming directly from him, not from the IRA account.

So you have to make sure when you’re working with your custodian, filling out the paperwork, that it is going directly from Charles Schwab or Fidelity Investments, wherever you’re investment accounts are held to the charity. Writing a check from your IRA does not count, is not a Qualified Charitable Distribution.

Then lastly, a QCD does not count as an itemized deduction. This is so important, or let me just reiterate what I kind of first started and explained the QCDs. QCDs simply allows you to pull money out of an IRA tax-free when normally it would have been taxable to you. It’s not a tax deduction, it’s simply not, you know, you’re just avoiding having to pay tax on that money that you pull out.

So a common mistake that we see some people say, you know, I’m going to exclude this from my income. But also, I’m going to count it as an itemized deduction. If you do that, then the IRS could come back and audit you for that and that could be a big mistake there.

So, when it comes to QCDs, one of the most important aspects is making sure you get the reporting right. So I’ve taken a screenshot of a sample tax return which shows you how it should be reported.

So for example, let’s say you’re retiring, you withdrew a total of $40,000 out of your IRA. But only $25,000 of it was a QCD or Qualified Charitable Distribution.

Then what you show on the tax return is you show the full amount, in box 4a, $40,000, but the taxable amount is the difference between the total and the charitable donations that you’ve made. And so that remaining amount, this $15,000, is the only amount that you’re taxed on because the difference was your charitable distributions.

You have to be, this is how you have to do it and actually write it in on your tax return. Some tax software may account for that. But you have to be very careful with tax software that it is reporting correctly. So if you have questions about making sure that it’s processed correctly, I’ve included this link here, and Everett will make sure that when he sends an email tomorrow that this link is included to make sure that you’re reporting it correctly.

Improper Use of a Donor-Advised Fund (40:04)

Okay, lastly I’ll just wrap this up here, is the improper use of a Donor-Advised Fund. So a Donor-Advised Fund simply is a tool and not an investment. It allows you to be able to make a large contribution to a Donor-Advised Fund and to get a tax deduction and then it allows you to distribute that money to your charities over time.

So for example, if you don’t need cash or even better, securities like stocks or bonds or any other type of investment to the Donor-Advised Fund, whatever year you do that you get a tax deduction. And then that money sits in that Donor-Advised Fund until you’re ready to distribute it to the charity.

So, there are some practical applications of how this could work. A Donor-Advised Fund is very helpful when you’re trying to get a larger deduction, warrant deduction for charitable purposes, or tax purposes. And it gives you more flexibility on how you can distribute that to a charity.

A Donor-Advised Fund helps you get a tax deduction when it’s needed most. Especially if you’re selling a business or property and you have a larger-than-normal income year. And then you can create a charitable fund for a legacy for your future family.

The ways that it can turn into improper use for a Donor-Advised Fund is when you decide to invest that money within the Donor-Advised Fund and you invest it improperly. A lot of times Donor-Advised Funds have a select mutual fund that you can invest in, and some people go maybe a little overboard and try to invest it too aggressively. And then if the market drops on any given day the value of that money could go down. So be cautious of what you’re investing in within your Donor-Advised Fund.

If you contribute too much to a Donor-Advised Fund, you may have left over. And especially if you’re eligible for Qualified Charitable Distributions, this may reduce the benefit that you’re getting from QCDs.

Because if you continue to just grant money or gift money to the charity from your Donor-Advised Fund and not take advantage of your Qualified Charitable Distributions, then you may still have big Required Minimum Distributions that you have to deal with.

So be cautious on how much you contribute to a Donor-Advised Fund.

And then lastly, if you’re planning on gifting the entire contribution to the charity, there’s no reason to set up a Donor-Advised Fund. The purpose is to make a large contribution, have that money sit in the account, and gift it over time gradually. But if you’re planning on just gifting the whole amount, you might as well just gift it directly in the same tax year and avoid going through the headache of setting up another account and worrying about how it’s invested.

Key Insights (42:45)

So I know that’s a lot of information. Let me just summarize the main key insights of what we talked about today. So first is capital gains are taxed at different rates and it’s important how you manage those properly and be aware of how long you hold those assets for.

Second, retirees should have a plan that addresses the impact of Required Minimum Distributions.

Third, carefully consider how the step up in basis can reduce the amount of taxes paid from one generation to the next.

Fourth, a Roth conversion strategy should consider all aspects of your retirement plan. It should not just be made in a vacuum. It should be carefully considered.

And then lastly, be wise on how you do your charitable giving strategies. Just those simple mistakes can eliminate the benefits that you get from those strategies.

Question and Answer (43:36)

Thank you all for attending today. I’m sorry I went a little bit over but we will stay on for the next five minutes to answer any questions. I see there’s a few there, and again, feel free to take that survey. Please rate us there and give us some more ideas of what we can talk about in future webinars.

So I’ll turn the time over here to Kaden, and Kaden are there any questions that you thought were great that we can answer with everybody?

Kaden Waters: Yeah, I saved a couple and then it looks like we had one that came in late. We’ll just have you answer a couple of these. The first two were about the Medicare IRMAA that you covered there.

Question: Are Medicare premiums calculated based on both spouses’ incomes or individual?

Carson Johnson: Yeah, great question. It depends on how you file your taxes. But if you’re married filing jointly, for example, the Medicare premiums since you’re filing jointly will impact both spouses. And so, you know, let’s say you jump up into the higher tax bracket, the Medicare bracket. Let’s say instead of $164.90, it jumps you up to $230. Then both of your Medicare premiums will be $230. So yeah, it’s a great question. It will impact both spouses if you’re married filing jointly.

Question: Do Medicare premium prices lock? Or are there price increases?

Carson Johnson: Oh great question. Yeah, so what happens is the IRS always looks at your income from two years prior. So it doesn’t lock it in, so let’s say you had a high-income year two years ago, but then so in 20, let’s say 2021, but then in 2022 your income went back down to normal levels.

Then you’re your Medicare premiums would drop back to the normal levels as you normally had it, so it doesn’t lock you in.

Question: Do you evaluate Roth conversions that are appropriate for an individual?

Carson Johnson: Absolutely, yep, that’s definitely part of our process when we’re working with people. We will look at all those non-financial aspects that I talked about, but also, you know, kind of doing that analysis looking at their last year’s tax return to see what tax bracket they’re in and just talk through that with them. See if it makes sense and if their Required Minimum Distribution will jump them up into higher tax brackets and things like that.

Question: If you do QCDs, will you likely take the standard deduction?

Carson Johnson: Yep, that’s exactly right. So because the IRS allows you to pull that money out tax-free, you can essentially double dip and also count it as an itemized deduction. So yeah, it’s just simply, it’s not a tax deduction. You just don’t get to be taxed on that income that you pull out.

Question: With capital gains, I understand them being capital gains are taxed at a capital gains rate. But the rest of ordinary income without capital gains is still taxed at your ordinary income tax rate without figuring in your capital gains, correct?

Kaden Waters: And yeah, that is right. So it’s just the portion of your capital gains that exceed that threshold will be taxed at the higher capital gain rate.

Carson Johnson: That’s perfect, and then I did see one other one, I’ll just answer this.

Question: Can you roll over 401K into an IRA and then make a QCD from the IRA?

Carson Johnson: The answer is yes. Doing that rollover is not taxable. So that’s a great way to roll it over to the IRA so you can be able to do that strategy.

Well good, well, if you have any other questions, feel free to send me an email or to our firm. Happy again to dive into more of your situation if you have more unique questions to you. But anything pertaining to what we talked about today, happy to help answer those questions for you and hope you find this helpful for you.

Kaden Waters: Yep, have a great rest of your day.

Carson Johnson: Thanks.