Episode: 11-09-2021 | How To Avoid Retirement Planning Missteps

Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP®

Retirement Planning – Deferring Taxes

Allison Dubreuil, Wealthway Financial: So we do want to talk about retirement planning – might not be quite that sexy, but we want to talk about some common mistakes or common pitfalls that everyone should be aware of or on the lookout for when planning for retirement, making the transition to retirement, and all along the way in retirement. So there are many things that could derail your plan. Things can go awry. Mistakes can be made. It can cost you tens of thousands of dollars. And we want to try to head some of those off. Because if you do your planning, right, you can avoid many of these pitfalls that we’re going to talk about. And your retirement can be the walk in the park that you’ve dreamed of.

Kevin Zywna, Wealthway Financial: Some of these are the more common mistakes we hear about either on the radio show or when we first meet with a client. Some of the situations that they get themselves in, or misconceptions that they also have. So we’ll try to straighten some of the big ones out and you file those away. And then, hopefully, put yourself on a better path to a more secure retirement.

Allison Dubreuil, Wealthway Financial: And these are, by no means, exclusive. There are many pitfalls, but we’ll try to point out a few of them that you can at least be aware of and be on the lookout for. And the first one we want to talk about is deferring taxes. So I know most people don’t enjoy paying for taxes, paying their taxes. Many people want to defer them as much as possible and the biggest way to defer taxes while you’re working and saving is contributing to a pretax retirement plan. So that’s your traditional IRA or your 401K. If you’re putting pre-tax money in, then you’re getting a decent tax deduction on your current income.

But what many people don’t realize is that in retirement, when you go to take the money out of your retirement account, it is taxable income. So, hopefully, you didn’t think Uncle Sam was just giving you a free pass indefinitely. The IRS is definitely going to come after their tax money and it will be taxed as ordinary income when it comes out of your IRA or 401K.

Kevin Zywna, Wealthway Financial: So as opposed to a regular taxable bank account or brokerage account where interest dividends, capital gains, are taxed in that account in the year that they are accrued, that activity typically occurs in an IRA tax sheltered account -but it is deferred into the future. The difference of that brokerage account, that’s not in that tax protected wrapper is that some of those activities have lower tax treatment.

And/or if you use the right investment vehicles, you can really minimize the amount of interest dividends and capital gains that are even subject to taxation in a brokerage account. All of that activity, when it’s in an IRA, when it comes out, is taxed as ordinary income. So you do get a short-term benefit.

And for most people that’s typically the right thing to do. But eventually if you get more sophisticated, if your dollars get higher, the dollar amounts in these accounts get higher, then know that everything that comes out of your traditional IRA or your 401K account or your TSP, or your 457 is all going to come out as ordinary income.

You do a trade off – some of the lower taxation of a brokerage account for the advantage of the tax deduction today. But eventually you do pay for it, later. So it’s something to be monitored managed and analyzed as you go along, if you want to maximize your overall financial situation.

Allison Dubreuil, Wealthway Financial: So big picture, it’s not just about deferring as much of your tax bill as possible, which most CPAs, I think that is their, focus. How do you defer as much income or taxes in the current tax year as possible. But when you look at the big picture, to have flexibility, and to be able to manage your tax bracket properly in retirement, you need to build different buckets. So it’s beneficial of course, to have some of that pre-tax savings because you do benefit from years and years of deferred taxes on the growth, but it is just as important to be building that bucket.

You were just talking about, Kevin, the brokerage account that is subject to taxes on an ongoing basis. But it’s subject to the lower capital gains tax rates. Another bucket that will give you tax diversification and more options in retirement are Roths. Roth IRAs or Roth 401Ks are set up so that you don’t take a tax deduction when you make the contribution.

So you contribute after tax dollars, but the account then grows tax free. And if used in retirement, after you meet certain requirements, the growth comes out, tax free in retirement. So if you were building these three different buckets, you would have a pre tax, a non-qualified or a capital gains tax bucket, and then your Roth bucket could be your tax free bucket. And that’s how to achieve true tax diversification in retirement.

Kevin Zywna, Wealthway Financial: So that’s exactly what I was going to say. So what we’re going for here is tax diversification. If you want to maximize your overall net worth, don’t put all your eggs in one tax bucket. Typically take advantage of the three different types of buckets that you have: the traditional, 401k to company sponsored retirement plan, the Roth IRA or the Roth 401K, and a regular old  – what we would cal,l a brokerage account. You have those three different buckets. Then when it comes time, when you get into the withdrawal – the distribution phase. When it’s time, then, for your nest egg to pay you back, then you have three different buckets from which to pull, and then you can manage your tax bracket.

So if you know when tax brackets were to go up dramatically, that’s the time to pull them from the Roth bucket. If they’ve kind of maintained, the middle of the road, then you can maybe take from the brokerage account – pay a little bit of capital gains tax along the way. And if they happen to be the lowest you’ve ever seen in your lifetime, then maybe that’s time to draw from the traditional type of IRA or 401K.

And by having those three different buckets, you can manage your taxes. And withdraw money as tax efficiently as possible and keep more money in your pocket and less out of Uncle Sam’s.

Allison Dubreuil, Wealthway Financial: Of course it depends on your current tax situation, how you might decide to contribute to your 401k. Whether you’re going to do pre-tax or post-tax. I was really surprised when I pulled up some statistics to learn that not many people are taking advantage of that Roth option. Out of, this is low to0 – only 23% of taxpayers have a traditional IRA. I guess that could be because many people just use their employer sponsored plan. So that may be kind of skewed. Only 10% have a Roth IRA. So even less people take advantage of a Roth IRA.

Kevin Zywna, Wealthway Financial: A lot of companies don’t even have that option. So that’s a handicap. Plus it’s a newer type of IRA. That’s only been introduced in the last, I want to say, 10, 15 years. It hasn’t been well-known in the course of human history. That is relatively recent. It takes a long time for some of these things to gain traction.

Allison Dubreuil, Wealthway Financial: Oftentimes it’s determining, ‘Should I take my tax break now or should I expect to take my tax break in retirement?’ While it’s really determined that you’d have to know a couple of unknown variables.  You’d have to know what your tax bracket is going to be in retirement, which you can probably get a general sense of. You’d also have to know a future tax law. No one knows at this point. There are some unknowns and there are some options. If you find yourself where you have significant or the majority of your nest egg, if it’s in pre-tax buckets. So if it’s an, a pre-tax IRA or pre-tax 401K, you can start converting funds to Roth. So you can take it out now, pay the tax on it and get it in the Roth bucket so that it grows tax-free. That’s a little more of a sophisticated strategy and some deserve some extensive thought and planning to determine whether that would actually benefit you long-term or not.

Transferring From Retirement Accounts

Kevin Zywna, Wealthway Financial: Right now we’re going to go out to Chesapeake and speak with Eugene. Good evening, Eugene you’re on Dollars & Common Sense.

Eugene, Caller: Good evening. Thanks for taking my call.

Kevin Zywna, Wealthway Financial: Welcome. Thanks for the call.

Eugene, Caller: Yes, I did a direct rollover 403B to my brokerage account. I have an IRA and the brokerage, so I just rolled it over to the brokerage account IRA.

And I’m thinking that I probably should have waited until after the new year. Why I didn’t consider this beforehand – it was just a slip, I guess. I probably gave up some capital gains that typically go to mutual funds. Because the mutual fund usually reported or given at the end of the calendar year.

I’m kind of kicking myself because I should have waited maybe till January.  Because next month the 403B garnered some capital gains. I got an S&P 500 index fund. So I think I gave up some capital gains. And I’d just like for you, maybe to confirm the possibility of that. Maybe I should have waited and maybe someone else can benefit from this call. Thank you.

Kevin Zywna, Wealthway Financial: All right. Well, thanks for the call, Eugene. No, I mean, I don’t think you gave up any capital gains necessarily. First of all, let’s clarify, you kind of used rollover into IRA and brokerage account interchangeably. What I’m gathering happened – you went from your 403B directly into an IRA, preserved the tax protection wrapper there and did not come out of that and therefore was not subject to taxation. Correct.

Eugene, Caller: Yes.

Kevin Zywna, Wealthway Financial: So then you’re fine. In that regard, you didn’t pull it out of that tax protected wrapper. So none of it was subjected to taxation. Now, your comment about the capital gains distributions that come from mutual funds, primarily, some come maybe there might be a little bit in some ETFs, but they typically come when you sell an investment at a profit. The mutual fund, themselves are a basket of anywhere between 25 to say over 500 stocks. And if they’re actively managed mutual funds, then you have a manager there who’s behind the scenes, pulling the levers, buying and selling those 25 to 500 individual stocks throughout the course of the year.

Then, at some point during that year, there are guidelines in place that require the mutual funds to distribute the capital gains that may have been realized throughout the course of the year. And it usually happens towards the end of the year. For most funds, some funds do a quarterly, most funds wait till the end of the year. Some do it sometime late November/early December. Some wait until December 31st – and that’s a pain.

Then they distribute those capital gains. Now the reason you didn’t lose anything necessarily is because, built into the share price of that mutual fund, are those unrealized capital gains. And when they get distributed, there’s a corresponding offset of the amount that gets distributed and a reduction in the share price. So it’s really just a financial accounting transaction that occurs when capital gains distributions, whether they’re long-term they’re short term pent up dividends in a mutual fund, those, you know, might get paid out on a monthly basis from many of the stocks quarterly basis, but only distributed once a year.

That’s all embedded in the share price of that mutual fund. So when they then get distributed to the shareholder of the fund on that same day or overnight, the amount that you got distributed is a corresponding amount that your share price goes down. So it’s really a wash at that point in time. And it’s a taxable, if you don’t have it in a taxable protected account – like an IRA, then it becomes taxable at the end of the year.

So just know you didn’t do anything wrong. You couldn’t have advantaged yourself any better in that situation. As long as, assuming you reinvested, whatever cash came over from the 403 B into the IRA and you got back in the market, then it was pretty much a non-event.

Investing In Gold And Silver

Rick, Caller: Yes. I was wondering if I cash out my IRA for gold or silver how does that affect the government and the taxes? Do they want the taxes on the IRA or are they going to come after my gold?

Kevin Zywna, Wealthway Financial: When you say cash out the IRA, do you mean sell the investments inside the IRA and then purchase gold or silver? Are you talking the physical metal?

Rick, Caller: Yes.

Kevin Zywna, Wealthway Financial: So. Then you’re going to withdraw the money out of your IRA and use the money to then purchase the physical gold and silver, right?

Rick, Caller: Yes. Yes.

Kevin Zywna, Wealthway Financial: Okay. Well know that whatever comes out of that IRA, assuming it’s a traditional IRA, is going to be subject to ordinary income tax rates. Ordinary income tax rates are those that you pay on your paycheck or on your social security or on any earned income.

They are the highest rates that we pay on an income. So you can do that, but you’re going to pay tax on every dollar that comes out of the IRA. Now, one of the things you can do to try to minimize that bite a little bit, I don’t know how big it is. Don’t really need to know. You can break it up over two tax years, so you could say take half of it and do it in 2021. And then in the end of January of 2022, you do the other half. That helps you spread out the dollar amount over two years. And that way you don’t go too high up the tax bracket ladder. Does that make sense?

Rick, Caller: Yes, sir.

Kevin Zywna, Wealthway Financial: Now, let’s talk about why you want to buy physical gold or silver.

Rick, Caller: The Democrats have scared me to death.

Kevin Zywna, Wealthway Financial: What about gold and silver is going to make you feel better?

Rick, Caller: I got it in my hand and instead of somebody else trying to access it, because right now they’re doing mandates on everything and I don’t want them to you know, get overboard there.

Kevin Zywna, Wealthway Financial: Right. Okay. Well then I’ll give you this little general advice. Just know that no matter how bad it feels, how bad tax law feels or I should say – it’s not law yet – there’s no tax law. There’s been no changes yet. How the tax debate goes in Congress, it typically gets watered down and compromised. By the time it actually gets turned into law.

Those people are concerned about the over printing of money. Which I know that’s a big concern for a lot of people. It’s concern for me. That in and of itself does not necessarily lead to an inflationary environment and a devaluation of the dollar. So I would just caution you before you did anything as rash as withdrawing all the money out of your IRA and then buying physical gold and silver, which to my knowledge, can’t really be exchanged for Starbucks coffee or milk at Kroger, or even a car at the dealership. You know, you still would have to convert that back to dollars at some point, probably.

Kevin Zywna, Wealthway Financial: That’s an extreme type of decision. I would caution you against it.

Rick, Caller: I understand. Okay.

Kevin Zywna, Wealthway Financial: All right, Rick. Well, thanks for the call and good luck to you. We appreciate it.

Rick, Caller: Thank you, sir.

Kevin Zywna, Wealthway Financial: All right. Take care.

Kevin Zywna, Wealthway Financial: Can I follow up on that because I’m sure there are other people that will have a similar question for you Kevin on the same topic. Because I’ve heard that argument for a number of years. Well, I don’t know what the value of a dollar is and at least gold is worth something. And I hold it in my hand. I believe it was Dan who sat across the table and said  how much bread can you buy with that hunk of gold, if we’re in line for bread.

And it made me realize, well, that might be completely useless. If we come to a spot where the dollar ain’t worth anything. So a hunk of rock ain’t worth anything. There’s other commodities that tend to be worth more at those times. And I’m not going to get into those, but where would you, what would you say if somebody wanted to have a asset to where if we were to have to wait in line for bread hypothetically, they have something worth of.

When gold may not really be exchangeable,

Allison Dubreuil, Wealthway Financial: Obviously it’s cryptocurrency.

Damian, Radio Host: I was going to say guns and ammo.

Kevin Zywna, Wealthway Financial: Right. I know crypto is becoming the new gold and silver because it’s, it’s not the dollar and dollars are manufactured pieces of paper by the federal government and the federal government can manipulate how many of these pieces of paper and while you know, it’s bits and bytes. Now it’s all, it’s all computer money primarily, but it’s currency. And so the concern is, well, the more the government prints, the less valuable it is. And that is it. That is generally a true statement, but it is not, it does not necessarily follow that because the government prints a lot of money that the dollar will – it’s not like a seesaw or a lever where there’s a direct correlation – a direct relationship. There are other factors that work on the devaluation of dollar that work on inflation in the economy. That is the, amount of debt of the federal government or the amount of printing of money.

That is just one lever. That can potentially, but not necessarily lead to the valuation of the currency and inflation. So to answer your question though, Damian, yes. For people who are, concerned sort of the, the dooms day scenario type of situation. Say they want to hold physical gold and silver because it all goes to hell tomorrow. Then at least I got that. Well, if it all goes to hell, then you have bigger problems. You know the worst case I can think of is a nuclear attack by a foreign enemy that, you know, that was probably be the most disruptive thing that could happen to the U S and the world’s economy.

In that instance, then you could see massive failures of corporations, shortages of distribution lines, food and everything. No one is going to care about your dollars. And if you are truly concerned about that hypothetical doomsday event, what you need to be investing in is: land cattle, chickens, sheep, probably tractors and probably some guns and some ammo to protect that because you will be on your own to fend for yourself. That’s what ultimately, no one is going to care about your gold. No, one’s going to care about your silver. That will not be available to eat and survive. That will be the bottom line.

So whatever you can do, whatever you invest in to eat and survive is what you want to do in those situations. Golden, silver will not do it, so right. Chickens and ammo.

Allison Dubreuil, Wealthway Financial: There you go. Well, let’s talk about gold. Not as a currency, but as an investment. So we get asked about gold and silver often as, you know, investments. I think if you watch daytime or late night TV, you might be seeing ads, you know, buy gold and as golden, silver as not a currency, but as an investment. So typically you hear, ‘oh, buy gold. It’ll protect you in times of inflation.’ Yeah. In times of crisis, the value of gold does spike or does increase. But if you look at the longtime horizon. If you look at the past 20, 30 years of what an investment in gold has done, it has barely kept up with inflation.

Kevin Zywna, Wealthway Financial: It’s less than inflation – stretch it out to 20, 30 years, You can find decades, a ten-year block, where it has outpaced inflation. In the worst case like the 2008, 2009, when the US stock market was near the bottom. If you took that point and went back 10 years and compare the S&P 500 to the previous 10 years of gold, I think gold would have outperformed at that very small sliver point in time. But overwhelmingly it is historically a bad long-term investment.

Allison Dubreuil, Wealthway Financial: Right. It doesn’t produce anything. It doesn’t produce any value. So we’re not, not big fans of investing in gold and silver. I mean, we believe in investing in commodities and natural resources as a part of a well diversified portfolio, but not in physical gold or silver.

Kevin Zywna, Wealthway Financial: And that should also be noted. The companies that produce, manufacture, or mine, the physical commodities -those are the ones that have the produce, the profit that makes the company valuable, the commodities themselves. They’re typically too volatile and it’s unnecessary for the typical person’s investment profile.

Planning For Early Retirement And Transitioning To Retirement

Kevin Zywna, Wealthway Financial: All right. We’re going to go up to Yorktown and hear from Diane.

Kevin Zywna, Wealthway Financial: Good evening, Diane you’re on Dollars & Common Sense.

Diane, Caller: Hi, I wanted to get an idea as far as where I should possibly consider putting some midterm-investments. Maybe five to seven years?

Allison Dubreuil, Wealthway Financial: Is this money earmarked for anything in particular or what are you basing your time horizon on?

Diane, Caller: I’m thinking about possibly retiring a little bit early. I’m thinking about doing an early retirement in about five years.

Allison Dubreuil, Wealthway Financial:How old will you be at that point? Diane?

Diane, Caller: I would be 55.

Allison Dubreuil, Wealthway Financial: And what type of account is this money in? Is it a non-qualified account or is it in retirement savings?

Diane, Caller: It’s a, it’s a non-retirement account. Non retirement.

Kevin Zywna, Wealthway Financial: Okay. All right. Well, Diane just know that retirement is not the end. So the idea that you might be five to seven years away from retiring is not the end of your investment time horizon, at least from our perspective. And so most your time horizon is the rest of your life.

Hopefully with good health, that’s going to be at least another 30 years past your retirement date. So we would say, ‘don’t try to invest for the medium term, continue to invest for the term. And that means a well balanced, diversified growth-oriented portfolio of primarily – stocks.’

Diane, Caller: Well, I’ve got retirement accounts forfrom the time that I turn 65 beyond. So what I’m really looking for is the money that’s going to get me from the age of, 59, 60 until 65 – when I would be wanting to start pulling on my actual retirement accounts.

Allison Dubreuil, Wealthway Financial: That is a good point. Diane, you do have to plan strategically when you plan an early retirement because you can’t necessarily access your retirement accounts without penalty. All retirement accounts, in general though, can be accessed without penalty by the age of 59 and a half. So you’d likely only be looking at trying to find years 55 to 59 and a half with that bucket of money. And it’s likely that you would be trickling it out right. A little bit each month and, and not using it all at once.

So again, investing for growth will actually help you bridge that gap to 59 and a half better than if you were too conservative and, you know, keeping that money in the bank, for example.

Diane, Caller: So would I still be looking at like stocks or is there a better investment considering that I’m not looking at 10 or 15 years-worth of growth?

Kevin Zywna, Wealthway Financial: Well, you are looking at that long. You are just going to start to draw from your stock portfolio. And by stocks we mean, it can be stocks, individual stocks, stocks of individual companies. It could be stocks that are in the form of mutual funds. It could be the stocks that are in exchange, traded funds. And there’s almost no cost nowadays to sell off shares and create the income that you need to spend and live on.

You still would be.  We would say, invest for long-term growth and then shave off the shares that you need from your investment vehicle to then create the income that you need to live off of. And when you stretch it, if you have at least a five year, closer to 10 year, time horizon, the odds are overwhelmingly high that you’re going to have a lot more. Seven to 10 years in the future, than you do today. If you employ that strategy.

Allison Dubreuil, Wealthway Financial: And I would add just one thing on top of that strategy though, Diane. We would typically recommend keeping a higher than normal amount in the bank when you transition to retirement.

So normally the general rule of thumb while you’re working is three to six months worth of living expenses, but you might want to have a year’s worth of living expenses in the bank to give you a buffer, to give you some flexibility. And then trickle out from the investments on a monthly basis, knowing you have a whole year’s worth of living expenses in the bank to fall back on if you needed to.

Diane, Caller: Alright. Well, thank you.

Kevin Zywna, Wealthway Financial: All right, Diane. Thanks for the call. Yeah, it’s a little bit more of a nuanced type of situation. When you’re trying to retire early, before the age of withdrawal from your retirement accounts. And so you’ve got to make that money work through that phase. But to restate it again,  stay invested for long-term growth.

Shave off the shares that you need. We, and this is our bread and butter, by the way, I, as a firm and for our clients, this is our bread, our meat and potatoes, our bread and butter – we create this retirement paycheck for our clients out of their investment portfolio and set up an electronic link from their investment account, into their bank account and boom. On the first, the fifth, the 15th of every month, whatever day we set up, they get a direct deposit right into their bank account. Just like they were getting with their paycheck, except it’s their investments. Now they are providing that income instead of an employer.

And as long as you remain invested for long-term growth and you’re trickling money out of the account, your odds are exceptionally high, that with a minimum of five-year time period, you’re going to have more money in the future (depending on your withdrawal rate, of course) but more money in the future than you do today. You will have to weather some occasional downturns, but that’s why Allison was saying, we like to have our clients build an extra amount in their bank account so that we can reduce or suspend what we’re pulling out of the investment accounts if we go through a significant amount of a downturn. Then you can purposefully draw down on that overfunded bank account and your lifestyle doesn’t miss a beat. And you don’t have to overly fixate on what the market is doing on any given day, week, month, or heck even year, sometimes. You just go about your business and live your life.

Allison Dubreuil, Wealthway Financial: Yes. And I would add that this is just an example of the complexity that’s involved with transitioning the accumulation phase to the distribution phase. So I’m not going to say it’s easy, cause it’s not easy to accumulate. You have to make the right decisions all along the way.

And we can add a lot of value there, but this is where I think it really makes sense to align yourself with a certified financial planner that can help you. Guide you through a comprehensive financial planning process and come up with a distribution plan to give you confidence so that you can see how you are going to live and maintain your current standard of living during that initial period of retirement and well beyond.