Asset Location & Roth Conversion Retirement Spitball | YMYW Extra - 1

and Big Al Clopine CPA can't even handle them  all. So I've enlisted the help of senior financial advisor David Cook, CFP® from Pure Financial  Advisors’ San Diego headquarters to help out. And even though Joe and Big Al aren't  the ones doing the spitballing here, it's important to note that this is still just a  spitball, for educational purposes only. Even though you've given us a lot of details, we don't  know everything about your financial situation,

so don’t take this to the bank! Dave, thank you  so much for pitching in. I really appreciate it.

and about $2 million in property. So  that includes $4 million tax-deferred, that's broken out 85 percent equity and 15 percent  guaranteed; $2 million taxable; $400k tax-free, and then, like I said, $2 million in property  - that's home and rental value minus mortgage.

So then next we get into rate assumptions.  Sunshine is assuming a 5 percent rate of return for all investment accounts, a 3 percent  rate of inflation increase for rental income, spending, withdrawals from tax-deferred  and taxable accounts, saving into Roth; a 0.75 percent rate of increase for dividends, a  2 percent rate of return for the tax-free account, and a 50 percent effective tax rate  based on 30 percent ordinary incomes,

15 percent long term federal capital gains,  and 10 percent California state tax for the total of ordinary income and long term capital  gains. So right off the bat, I already know that at the end of this email, Sunshine asks,  what do we think of the rate assumptions?

it's better off to play that conservative game.  Her rate of inflation is a little bit low. I would probably push that up. We've been seeing 3 percent  rate of inflation assumptions for years. And never in my career did I ever think that we'd see the  CPI getting close to 10 percent - double digits. And I don't think we're going to get back to the  1 and 2 percent world. I would probably bump that up to maybe four or something. You know, here  at Pure we use something a little bit higher,

closer to four. We will use a higher  rate of inflation for medical expenses, for college tuition. We'll take some items  out and increase the inflation more than, say, general living expenses. So it's a little  low. When she says here the 2 percent rate of return for her tax-free account, that's,  that's bringing up some red flags.

of return on my Roth money. But that's, that's  something we can really get in the weeds there. Taxes, again, taxes are, right now, based  on her income, depends on if she's going to be spending a lot more money out of her  IRA while she's also doing conversions, which is something that she talks about.  She'll likely be close to that. She'll be in the 32 percent bracket for ordinary income,  but that also would push her capital gains

rates probably closer to 18 and a half. So  there's a few nuances there. She's doing a really good job at getting some assumptions and  really thinking about this, you know, and I, I have to give her a lot of, a lot of credit  for going through and looking at all the detail.

taking into consideration Roth conversion and  RMD.” Here we go! “Between the ages of 65 and 81, starting at age 65 in January of 2025, initial  annual withdrawal of $250K from the tax deferred, with 50 percent allocated for expenses, and begin  saving 50 percent into the Roth account. Then the RMDs start at age 73. Then between ages 65 and  82, starting at age 65, initial annual withdrawal of $120K from the taxable account for expenses.  Then, additional fixed ordinary incomes including:

rental incomes between the ages of 65 and  78 starting at $12k the first year. Rental starting at 49k at age 79 when the rental mortgage  will be paid off. Dividends and interest of $15k starting at age 65 from the taxable and tax-free  accounts. Gradual decrease based on values of the taxable and tax-free accounts. And Social  Security benefit of $57k starting at age 70.” So she's putting off Social Security until age  70. All right, next we've got “withdrawal from

at age 82, the tax-deferred account will be  depleted from prior years. Roth conversions and expense withdrawals yet retains a  balance of about $250k to sustain the ongoing RMD contributing to income. At age  82, the Roth account will have a balance of about $6 million. At age 85, the taxable account  will be depleted from prior year's withdrawals, and yet retains a balance of about  $17,000.” Any comments on that just yet?

She's got $2 million in a taxable account that  she's going to be in a very advantageous tax situation. If she leaned more into spending down  the taxable account, maybe not take as heavy of a distribution from her tax-deferred accounts, that  would leave her more room for Roth conversions.

So she could do a couple hundred thousand  dollars in Roth conversions and likely still be able to be in that 24 percent bracket, maybe  slightly getting in the 22, but I mean the 32, but what pushes her in the 32 would likely be  her dividends that come from the taxable account. And again, that would not be taxed at 32%.  It’d be taxed at the long term capital gains

rate. I think she'd probably better, if  she's really trying to convert while these tax brackets are a little lower, I would  probably lean a little bit heavier than the $120,000 out of her taxable account.  Spend a little bit more from the taxable, take less from IRA and spend it,  and more from IRA to convert it. But obviously, always looking at the  tax brackets. You know, you know, she's, you know, as I mentioned, that 24 percent  tax bracket is where you definitely want to try

to fill up as much. Then when you're starting the  32 percent bracket, it gets a little bit unsavory if you're gonna be converting. Especially with  somebody who doesn't have kids and she's not worried about grandkids and inheriting  these assets. She's talked about giving, giving some rental properties to charities.  So maybe you don't have to be as aggressive, but I would certainly try to slim down that $4  million tax-deferred pool, because she knows

there's going to be a big RMD down the future.  So convert it and then spend it, of course. Kind of moving into the, you know, she mentioned  Social Security at age 70. You know, I think that's, that's going to be the general, you know,  rule of thumb if you think you can live in your mid-80s. It would give her more room from a tax  perspective to do some things that she'd like to do from a conversion perspective. But yeah, I  think my only thing there was just focusing more

spending down maybe the taxable, because she's  got 2 million there. She did a really good job of, of accumulating there and she's got some  favorable tax treatment there. And then using that, that room that she's not using for IRA  distributions for income, she could convert more.

Big Al On Air. I’ll do my best to have the fellas  answer your question on Your Money, Your Wealth®, or I’ll feature you in a YMYW Extra segment  with one of the experienced professionals on Joe and Big Al’s team here at Pure Financial  Advisors, like Dave Cook, CFP®, from Pure Financial in San Diego, who is joining me today  to spitball for Sunshine in Orange County. Alright, so let's talk about what  her retirement planning strategy is.

Employ tax loss harvesting to potentially  reduce taxable account long term gains.” “Mitigate sequence of returns risk  during market downturns by, one, reducing or eliminating Roth conversions.  Two, reduce the rate of withdrawals. Three, reduce expenses. Four, avoid or minimize  withdrawals from market investments. Also, sell the rental, resort to a reverse mortgage,  or downsize in the event of financial depletion

or long term care need arises. And  then also, understand IRMAA concept, recognize my retirement income will affect my  premium for Medicare, built in this extra cost in living expenses.” So she's already planned for  that. “And understand Social Security tax torpedo concept, recognize up to 85 percent of benefit  will be taxed, built in this extra as ordinary income tax.” So, in terms of her retirement  planning strategy, what are your thoughts, Dave?

account. Again, this is where we get into asset  location. You know, so the 75 percent stock portfolio, 25 percent bond portfolio, and she  kind of breaks it down into growth, value, international. That's what you would call  asset allocation, right? That's the science of trying to build a diversified portfolio of  assets that don't correlate with each other, have a different correlation with  each other. So that gives you that,

say the only free lunch and investing they say  is diversification. So that's asset allocation. She's got some issues there,  but then she goes into asset location by saying she's going to  have all the accounts the same.

well, you don't get that qualified dividend  rate, you have to pay ordinary income tax. So, same thing with a bond. A bond is going to, for  the most part, unless it's a tax-free municipal bond, let's just say a standard corporate  bond, you, you're going to pay ordinary income on the interest that you earn. Now, the  art of asset location is saying, okay, if my, if I want to try to match my investments with how  those accounts are taxed, and we talk a lot about

on this podcast about the three pools of money:  your tax-deferred, taxable, and tax-free. All accounts have a different taxation to them. Well,  so asset location would mean you'd want your Roth, if you're going to get more growth, and this money  is not, she says she's not going to touch this Roth for many, many years unless she absolutely  has to. So she's got a long time horizon in that Roth. She can take more risk in her Roth and  own more equities. And get a benefit from it.

So same thing with an IRA, you know, she's worried  about the sequence of return risk. Another thing that she brings up here is, you know, that  sequence of return risk is if you retire, and it's the first couple of years of retirement,  we run into a nasty recession and the markets really go down. I had clients that were retiring  in January, February of 2020 going into COVID.

if you're, for the U. S. taxes. So, you're,  sure, great. Your IRA went up 20 percent last year. Fantastic. High five. But guess  who else is high fiving you? Uncle Sam, because he just got 20 percent  return on the taxes that you own. So, so asset location would say, well,  maybe have your IRA a little bit more

conservative. Yeah. maybe 40 percent stocks, 50  percent stocks. And then in her taxable account, where she gets long term capital gain treatment,  she can do the tax loss harvesting, that more heavy in equities. And of course, her Roth is  more heavy in equities. So I would definitely not allocate those across the same -  you'd want  to make sure that you have a household allocation

target of certain amount of bonds that gets you  through that sequence of return risk. You can rely on bonds for three to four years and not have  to worry about touching stocks if that's the case. And then that allows you to start putting  more bonds in your IRA. It's stable. You're not pushing your RMDs up faster and then you're  benefiting by able to tax loss harvest in your

taxable account if the market is volatile. And  in your Roth, if we do have a nice recovery and you have a long time horizon, that takes  a lot of the risk out of that particular allocation if you're heavy equities and you're  Roth, because you've got time on your side. So that would be the concerns, that  I would bring up is just, you know, is employ a better asset location strategy.

her Social Security is taxed. Well then the  following year, she adds a little bit more. Because what happens, let's say 50 percent  of your Social Security is taxed. And then you push above that 85%, well then, now 85  percent of your Social Security is taxed, but then you're adding other incomes in  other areas. And it's something that, if you, let's say you do a conversion, you're  adding taxable income on the conversion,

but then you're adding more taxable income on  Social Security. So sometimes you're adding $2 of taxable income, even if you're only adding  one real dollar of taxable income on the return. Her, she doesn't have to worry about it.  It's not even something that's even going to be in her ballpark to even worry  about. So it's more about, I think, knowing what tax bracket she's in year by year. I  know she's trying to match this thing out over 16

years. It's really looking every year, you know,  because we know the tax laws are going to change here in another couple of years. And it's just  making sure you have a process that allows you to go without diving in too deep into the tax code.  Just do a simple breakdown of your tax return. How are your rentals? You know, depreciation  that she's going to, you know, pay off her, rental here pretty soon. That's going to help  her with cashflow, but she's going to lose some

deductions. Just knowing year to year how to  under- how to read your own tax return and know how to apply that for the current year. Like  we're here at sitting in, in May of 2024. Most CPAs are looking or last year, we're looking next  year, also 2025. I'm looking at 2026. You know, going out 15 years, 12 years, that's a little  tough. But you want to have a long term vision, but you want to be able to strategically,  every year, know how to map it out.

covered all the bases here. “Goals: Ensure  financial security throughout my lifetime, assuming a life expectancy of 100. Maximize  retirement income without jeopardizing that goal, and then minimize any remaining funds at 100  with the exception of intended contribution of my properties to charitable organizations,” which you  mentioned earlier, and we hadn't even gotten to it yet, but you've done your show prep - which I'm so  not used to, because Joe and Al will just roll on

the fly. Al will sometimes do some calculations,  but I appreciate you coming prepared. Thank you.

I think, I think the asset location is one.  Asset allocation, she might be, probably, she doesn't need to take a lot of risk. Her  assumption for rate of return is 5%. She, her allocation of say 75 percent stocks,  25 percent bonds, that's probably close to a 7 percent target rate of return. That's  probably more risk than she needs to take.

wants to spend it, then she probably doesn't  need to even take that much risk. You know, so I'd probably readjust her allocation down  a little bit, especially as we're going into a situation where, you know, with this economy, I  think we are seeing a little bit of a slowdown and there's going to be likely some, some fallout  as, as interest rates kind of remain high, remain elevated. So it's probably a good time,  especially if she's looking to retire in January.

so she’s not going to worry about sequence  return risk. She can get rid of that by having more bonds in a place that she can get access to.  So those are some of the things that I just see.

convert as much as she'd like and she does have  a really nasty required minimum distribution, more than she needs, well, there's always  a QCDs, a Qualified Charitable Distribution that she can use when she gets to RMD age  to kind of gift some of those dollars out.

reduces her RMD by that $20,000. So it doesn't,  it's not taxable to her, but then she gets it as a deduction if she's itemizing. So it's kind of a  two for one tax step tax deal. So that helps if, you know, reduces her RMD and it  also gives the money to charity.

like I said on the we've talked  about that on inflation. Yeah, I think she's done a really good job of planning  and really getting ready for retirement. She did mention IRMAA. It's something to think about.  I don't know if there's going to be a lot for her. She's going to likely be in that 2.6  times limit. So IRMAA is that income uh…

she's going to be between $206,000 and probably  $300,000 AGI. So that's going to put her in that 2.6 times, you know, so that's roughly about $452  a month versus $174. But I think she's practical. She mentions in there that she doesn't necessarily  want to have the IRMAA drive her tax strategy.

lifestyle and it, it's one of those things  where it is, it's good to know. It's good to know where it's at and be mindful of it, but you  don't want it driving your retirement decisions.

she's done a good job there. She's at a  very reasonable distribution rate.  She's going to be taxed, unfortunately, as we all  are. There's no way around that. It's just a matter of how do we manage that the best,  where I, I don't think taxes are going to go anywhere but up. And so, taking advantage  of the lowest tax brackets we have in our lifetime now makes sense. But I'd say  yes. I'd give her a gold star for that.

that you put into it. But it's a great way to put  in the information and then you can tweak it and kind of see how that changes things further down  the line and what it's going to look like for you. And then, as you get to the point where you've  got that all mapped out, and of course, it's going to tell you, oh, yeah, you're 99 percent on  your way to retirement success. That's the point at which you want to talk to an advisor and get  some more strategies and do some more planning.

As you look at this, Dave, is there anything else  that we haven't covered? I mean, we've covered a lot. We've covered pretty much the whole soup to  nuts. But is there anything that we've left out?

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