Allison Dubreuil, Wealthway Financial Advisors: If you heard the promos for the show today, you might be expecting us to talk about general rules of thumb for retirees and we are going to get to that. But first, we wanted to touch on a couple hot topics that we’ve been getting a lot of questions on recently, the first of which is I bonds. Everyone wants to know about I bonds, should they be moving money into I bonds? What are the rules in terms of I bonds? And does it make sense? So, we thought we’d give a rundown of what I bonds are and how they work. And if they should be for you.
Kevin Zywna, Wealthway Financial Advisors: Yes, they’re getting a lot of attention, because with the increase in inflation, so has gone the increase in the interest rates on I bonds. And those issued most recently from May through October 22 are paying a 9.62% annual rate of interest. So, that’s a juicy number, if it can be maintained. And if you can lock that in with a significant portion of your money, then it is appealing. So, that’s why it’s starting to garner a fair amount of attention.
Allison Dubreuil, Wealthway Financial Advisors: Right. So, I bonds do earn interest that does fluctuate based on inflation, but it’s not quite that simple. Part of the interest rate is fixed. So, when your bond is issued, there’s a fixed rate. In fact, bonds that were issued in the last set, I guess for lack of a better word, their fixed rate was zero. So, that’s not very attractive. But the second part of the interest rate is the part that adjusts every six months based on inflation. And that’s where you saw that 9.62%. So, know that if you’re going to purchase an I bond, part of your rate is fixed, and part of it is going to go up and down every six months, based on CPI.
Kevin Zywna, Wealthway Financial Advisors: CPI is Consumer Price Index, which is essentially a main measure of the inflation rate in the US.
Allison Dubreuil, Wealthway Financial Advisors: So, when you earn interest on an I bond, you earn it monthly. But it is not something that’s paid out to you. So, it just accrues. it’s added to the bonds principle value. Then when you cash the bond in, or once it reaches maturity, which is, after 30 years, that’s when you would accrue the interest. It is taxable, for the most part, at a federal level, but not taxed at a state or local level. So, that’s one of the benefits that the interest is free from state and local income tax. But you do still have to pay federal tax once the bond matures, or once you cash it in.
Kevin Zywna, Wealthway Financial Advisors: And there are some notable limitations. So, the first and the biggest being you can only purchase $10,000 of I bonds per person per year. With a little caveat, you can get another $5,000 if you use your tax refund to purchase an I bond, so at max $15,000 per year. Not a huge amount of money for most long term investors. Also, you must hold it at least a year. You cannot redeem an I bond in the first year. If you cash it in before five years, then there’s a small penalty, you forfeit the most recent three months of interests. So, generally speaking, they’re relatively low in value that you can purchase them. There are some restrictions on when you can get your money back. So, they don’t exactly work like an emergency fund. I wouldn’t say I bonds would be a good substitute for that at this point. Maybe a compliment to them could help a little bit. But given those limitations, they aren’t quite as exciting as they initially sound.
Allison Dubreuil, Wealthway Financial Advisors: One other interesting fact about I bonds that appeals to a lot of people is that they can be used to pay for certain higher education expenses. And if you do that, then the interest is federal tax free. Well, there’s a caveat to that. There are some rules and stipulations around that. It can only be for you or your spouse or your dependents. It doesn’t extend to grandchildren. You can’t just gift it to friends or family. It’s only you or your dependents. And there are some age restrictions and some income restrictions. So, it’s not a failsafe strategy.
Kevin Zywna, Wealthway Financial Advisors: Just like other government bonds. If you use them for qualified higher educational expenses, you can save some taxes on the interest, but you must fit into a relatively confined box. For that to be the case in terms of your income, the length of time that you’ve held the bonds and the age of the of the person you’re using the bonds for and so forth.
Kevin Zywna, Wealthway Financial Advisors: We’re going to go out to Virginia Beach and speak with Steve. Good evening, Steve. You’re on Dollars & Common Sense.
Caller: Hi, thanks for giving me your wise advice. So, I’m getting close to retirement age. And I hope that my situation isn’t too complex to fit into the show’s parameters. But I have been a relatively medium to high earning professional for my whole career. Going to be 64 soon. I cashed in a lot of my long term investments to buy a house with my new wife. Recently remarried a while ago. I think that was smart because I got out of the market at a perfect time. But now trying to figure out how to retire eventually, maybe in five years.
Kevin Zywna, Wealthway Financial Advisors: So, Steve, did you pay 100% cash for the house, no mortgage?
Caller: No, we do have mortgage. We got a pretty good rate. And we intend to probably after retiring move elsewhere, but that, as I say, about five years away.
Kevin Zywna, Wealthway Financial Advisors: And what rate on the mortgage?
Kevin Zywna, Wealthway Financial Advisors: Yes, that is fantastic.
Allison Dubreuil, Wealthway Financial Advisors: Is it a 30-year fixed? What are the terms?
Caller: Yes, it’s a 30 year fixed. It’s an expensive house in a good neighborhood. So, probably won’t go up a whole lot. But it should only go up. And we’ll make some money on it.
Allison Dubreuil, Wealthway Financial Advisors: Are you just making the minimum payment? Are you paying any extra?
Caller: So that was part of my question. I’ve been told that if we make two payments a month, not necessarily extra, but two payments a month, that lowers the average monthly balance, and therefore gets us more movement sooner. And of course, if we would, if we get some additional money, putting additional payment, there might be an option. I also have a business on the selling relatively soon.
Kevin Zywna, Wealthway Financial Advisors: Alright, so then your general question is: now that you’ve done this, where do you go from here? How do you set yourself up for retirement? Essentially, what are you going to live on after your income stops? Is that fair?
Caller: Perfect. Yes, I have a small retirement from the armed services. But it’s from a reserved retirement. So, it’s not that much. But I do have health care covered that way. And I have some long term disability benefits that way. I’ll have Tricare for life, relatively soon.
Kevin Zywna, Wealthway Financial Advisors: Okay, good to get that covered. All right. Well, you bring up a great point. We hear about this a lot on the show. We talk to our clients about it a lot. Like, what do you do when you purchase a house? So, when you can borrow at very low interest rates, which 2.9% is, what we could sell, consider a historically low mortgage interest rate when you can borrow at rates that low 3%, then typically, what you want to do?
If you’re looking to maximize your net worth, and provide the most flexibility for yourself going forward, you don’t want to put all that money down on the house, you’d like to make the minimum down payment and take as much as the bank will lend to you and stretch it out over 30 years. Take as long as possible to pay it back and leave the rest of your money at work, hopefully, earning higher rates of return over the long term through mainstream equities and investments. You’ve kind of done the opposite here, which is not the worst thing in the world. It’s just going to require now a little bit more of a reset and you express the problem well. Now your house rich, but cash poor and we like to say you can’t eat your house, you know.
So, couple options for you. You said that you’re going to move at retirement. You’re going to sell the house at that point in time. You’re going to keep the house in Virginia Beach.
Caller: Well plan to sell it and downsize somewhere.
Kevin Zywna, Wealthway Financial Advisors: Okay, selling the house and selling the business that you haven’t had an opportunity to do. That’s going to provide a fair amount of liquidity. Get that point. So, you have that option.
When the time comes, if for some reason that timetable didn’t work out, then it might be time to pull it up a bit of cash that you put into the house out of the house. And you can do that through conventional measures, like refinancing that mortgage, although you’re probably not going to get 2.9%. Now, if you refinance, so be careful there, home equity lines of credit, that you can open and draw on only as necessary. Those are going to be variable rate loans typically. So, you must determine rates, what rates are at that point in time, or there’s a reverse mortgage, which you may qualify for. And nowadays, we think most reverse mortgages are a good financial planning tool. Allows you to extract equity out of your house.
Liquidate a portion of that illiquid asset of the house, and then put money into your bank account and allow you to live off it and spend some of it. So, those are just some of the options you have at your disposal.
And of course, as you’re working, and as your soon to be new wife is working, you still can save, invest, build up the bank account, build up investment accounts, and use the time that you have to create additional liquidity. Were some of those ideas helpful?
Caller: Yes, I was going to specifically ask about reverse mortgages, but you mentioned that so. Excellent. And I’ll recommend that my kids go get some of those bonds.
Kevin Zywna, Wealthway Financial Advisors: Okay, Steve, thanks for the call. We appreciate it.
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Kevin Zywna, Wealthway Financial Advisors: We’re going to hear from Sean down in Moyock, North Carolina. Good evening, Sean, you’re on Dollars & Common Sense.
Caller: Hey, how are you guys doing? Just got a question on reducing tax obligations. I’m 58. My wife and I both do well. We work for a government contractor. Kids are grown, houses almost paid off. But we still file, for best bet as the standard deduction. CPAs do my taxes. But every year, my taxes just get worse and worse and worse. It’s like ridiculous. It’s astronomical, the amount of taxes I pay. We thought about buying another house to try and maybe rent it or do something to offset that. But even that, from what I can tell, can be risky too. So, just kind of don’t know where to go. We’ve saved a lot of money. We’re very conservative. And we’ve just, we’re kind of set up for retirement. But I just wish there was something we could do. We keep getting raises, and it seems like I pre plan, take more out of my paycheck, and then I still get a tax bill.
Kevin Zywna, Wealthway Financial Advisors: Yes, the more you make, the more they take. That’s baked into the tax code, John, you have access to company sponsored retirement plans, you, and your wife.
Caller: Yes, we both invest in our company, we both have put like 16%. We both get matches. Right now, we’re probably looking at 75% of our income, current income after retirement. I got about eight or nine years’ worth to work it. We’re both healthy.
Allison Dubreuil, Wealthway Financial Advisors: Are you considered self-employed contractors? Are you employees of a contractor?
Caller: I didn’t know if you wanted me to say here. Two different ones. But big defense contractors.
Kevin Zywna, Wealthway Financial Advisors: So, you have access to a 401 K plan. Okay.
Allison Dubreuil, Wealthway Financial Advisors: All right. Well, are you maximizing? You said you’re giving 16%. The maximum contribution you can add to a 401 K plan this year if you’re over age 50 is $26,000. So, are you both adding $26,000?
Kevin Zywna, Wealthway Financial Advisors: Not currently. I’ve been trying to go out and buy company stock and same with my wife. They sell it to us at a discount.
Allison Dubreuil, Wealthway Financial Advisors: Shawn, it sounds like you can take advantage of your company sponsored retirement plan by contributing, and I had said $26,000, but it’s actually $27,000 a year now. That can be sheltered from tax by you and your spouse. So, that’s if you’re not doing that. That’s $54,000 that would come off the top of your taxable income, right?
Kevin Zywna, Wealthway Financial Advisors: Reduce your taxable income, and then therefore reduce the amount of tax that you pay.
Caller: Every year they get a calculator on our thing, we kind of bounce between putting it towards an IRA and, whatever works best, but I know I’m not maxed out at that level.
Allison Dubreuil, Wealthway Financial Advisors: Now, are you talking about your company sponsored retirement plan? Are you doing IRA contributions because they’re two different things?
Caller: I do both through the company plan and so does my wife.
Kevin Zywna, Wealthway Financial Advisors: So, you do a Roth IRA?
Caller: Yes, a Roth 401K. Not an IRA.
Allison Dubreuil, Wealthway Financial Advisors: What percentage of your retirement savings is pretax versus Roth? Do you have any idea? Do you have a decent size Roth bucket?
Caller: It’s getting there. I would say it’s probably about 25%.
Allison Dubreuil, Wealthway Financial Advisors: That’s pretty good, then. I mean, it’s not a bad idea to try to balance the pretax and the after tax to have both buckets to pull from in retirement that will give you flexibility. But you should look at what you think your tax bracket will be in retirement if you guys are in your peak earning years right now. It’s oftentimes the case where we see clients drop into lower tax brackets in retirement, which would argue for more pretax contributions today.
Caller: Right, that’s where we’re heading. Further ahead than I thought it was going to be at this age, which is a good thing, I guess. But I just don’t want to get caught off guard when it comes time for retirement and still be paying massive tax bills.
Kevin Zywna, Wealthway Financial Advisors: We like the tax diversification that you get from the pretax contributions in the 401k and the after tax contributions to the Roth 401 K, that does give you flexibility on the back end. So, when this money needs to come out in retirement, whether voluntarily or through required minimum distributions, you can (a little bit) manage your tax bracket in retirement is not uncommon.
And for people who do a really good job of saving in their company retirement plan, where they’re required minimum distributions that start to kick in at age 72, can boost them into a higher tax bracket at that point in time now. Who knows what tax brackets tax rates are going to be 10-20 years in the future. They’re almost certainly going to be different than they are today. So, it makes it very difficult to plan for.
But if you can get your tax break today, for most people, that’s when you should take it. But well, let me say this, because I don’t want you just to cram all that money into your pretax 401 K at the expense of the Roth. You know, at the end of the day, what you should be trying to do, what most people try to do is build their net worth. That means saving and investing. It is a consequence of building your net worth, that you’re going to have to pay some tax. The more income you make, or the more income that you generate through investments, and so forth, the more tax you’re going to have to pay.
Yes, there are some strategies that you can employ to try to minimize that. But one of the problems that we see, and we get this a lot from CPAs, and tax preparers, they’re hyper tax focused. So, they look at the problem in a vacuum. And they just give their clients strategies to lower their tax bill. But it also comes at the expense of lowering their net worth, which is not the point. We grow our net worth to have more assets to be able to enhance our quality of life, not just to lower our tax bill. So, maybe we look at it philosophically through that lens, it makes it a little bit more palatable.
Allison Dubreuil, Wealthway Financial Advisors: I think going back to what you mentioned, you considered buying real estate to try to get additional deductions. That’s another example of what Kevin’s talking about. That we would only want to buy real estate. First and foremost, if you had a true desire to have a second home or a rental property, which comes with a whole host of other issues and does not necessarily mean your taxes will go down. So, we wouldn’t recommend making a big decision like that just for tax purposes.
Caller: Yes, I probably need to call you guys and talk more.
Kevin Zywna, Wealthway Financial Advisors: All right, Shawn, thanks for the call. You can look us up online at wealthwayadvisors.com. We have all our contact information there, our phone number, address, or you can reach out to us via email, if you want. First step with us is always we’ll mail you an information packet that tells you everything you need to know about us. Our investment philosophy, our core values, how we work with clients, and then you can help determine whether we’re a fit. Then we set an initial appointment after that. So, thanks for that call, Sean.
Allison Dubreuil, Wealthway Financial Advisors: We wanted to kick off the topic of general rule of thumbs for retirement. It’s a rule of thumb that you want to be cautious of or think twice about. I, like everyone else, like a real good rule of thumb. Just tell me what to do. I will do it. And I won’t have to think about it anymore. Black and white.
Kevin Zywna, Wealthway Financial Advisors: I love it. But rules of thumb are inherently not black and white.
Allison Dubreuil, Wealthway Financial Advisors: Right, nothing is black and white in retirement planning.
Kevin Zywna, Wealthway Financial Advisors: When it comes to financial planning almost nothing is. There are no hard and fast rules when it comes to individualize financial planning.
Allison Dubreuil, Wealthway Financial Advisors: Right? Almost everything is an “It depends.” It’s part art and part science. We always say that. Part science part art. But I would add its part human too – which makes it completely unpredictable. And a strategy may be most advantageous from a financial standpoint. But if you can’t implement it properly, or it’s not going to work for you, from an emotional standpoint, then it’s not the best strategy. So, we have to balance all those things. And tonight, we wanted to talk about some popular rules of thumb that you’ve probably heard and talk about and why they may or may not be advantageous for you. And we’ll kick things off with the very first rule of thumb that 60/40 portfolio.
Kevin Zywna, Wealthway Financial Advisors: 60% stocks 40% bonds. Historically, the traditional retirement portfolio that the industry has sort of anecdotally conclude on is the appropriate asset allocation mix. I will say specifically, we have rejected the 60/40 portfolio. We have rejected it for well, almost since the firm’s inception, probably over 20 years. Way back when we may have had a few clients hover around 60/40 – 60% stocks, 40% bonds. But that was probably more so due to coincidence than anything. We are firm believers that the 60/40 portfolio is antiquated, out of date, no longer applicable, relevant to good solid retirement planning.
So, you might read articles about the 60/40 portfolio, especially this year. It has dramatically wildly underperformed its expectations. Bonds have been down every bit if not more than stocks. We’ve been saying that for at least five, maybe 10 years that bonds are not going to be the hedge against volatility. The volatility of equities going forward than they have been for the previous 30 years. We’ve been telling anyone who would listen, bonds are not going to be the panacea of coming out of a low interest rate environment. And that has proven to be correct so far, in 2022. So, the 60/40 portfolio, I think that’s antiquated, outdated, and probably for most people, if you do your planning properly, going to lower your return probability going forward. Is that enough for you?
Allison Dubreuil, Wealthway Financial Advisors: Oh, I can add to that. If we haven’t convinced you yet. I think a lot of people are concerned with “reducing risk.” “Reducing short term risk.” The real risk is underperforming over a very long time period. Because that is what’s going to cause you to outlive your money. Losing that rate of return over the long run.
I think, if you think about bonds instead of as an investment, remember, they’re alone, I think this is a good way of thinking about it. A bond is like a loan. So, when you invest in bonds, and a bond, when interest rates are low, you’re going to basically hand over all your money and earn very little in return. And with our current inflation environment, and current interest rates, your dollars are going to end up being worth less than if you just invested for long term growth in the first place. So, there’s more to portfolio construction than just how old you are and your time constraints until retirement. There’s what kind of income do you need in retirement, and what kind of growth do you need on your portfolio to get you there, and to outpace inflation – that’s really what should be planned for.
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Allison Dubreuil, Wealthway Financial Advisors: The 4% rule of thumb. If you’ve done any research on retirement planning, you’ve probably come across this rule. It has been around for decades. It is based on the 60/40 portfolio. So, that shoots a hole in that right away. The 4% rule states that with a 60% / 40% portfolio, you are likely to be able to withdraw 4% from the initial portfolio balance and increase that each year based on the annual inflation. And you will have a high degree of certainty that your money will last for 30 years. So, the key things were 60/40 portfolio 4% 30 years.
Kevin Zywna, Wealthway Financial Advisors: So, on a Million Dollar Portfolio, you’re looking at $40,000 worth of pretax income coming from that portfolio. And the probability is exceptionally high, that your money will last at least 30 years, if not potentially longer and over the course of your lifetime. I have heard other commentators call this the 4% rule as if it is a hard and immutable fact. It is not. It is a ballpark number to get you into the arena of knowing about how much you can withdraw from an investment portfolio and ensure that it would survive your retirement without fear of running out of money. But there are some qualifiers. First off: the portfolio, it needs to be a well-managed, properly diversified growth oriented investment portfolio. That means primarily mainstream equities, not 60%, equities, 40% bonds, more like 90/10 or 100% equities, over a long period of time. And that, if you manage it properly, will help allow the income of the portfolio to be sustained over a 30 plus year period.
Allison Dubreuil, Wealthway Financial Advisors: Right, that research was done based on a 60/40 portfolio, which is why you’re going to hear some experts these days back off. Saying no, it’s not 4%, it’s probably closer to 3%. Well, that’s because the 60/40 portfolio is not holding up anymore, and we’re getting a little technical here. So, back to the big picture, I will say this, that 4% is a good general rule of thumb to see if you’re in the ballpark. When we do our deep, comprehensive financial planning based specifically on and custom to our clients’ lives, we often find that they can afford to spend more than 4% per year without fear of running out of them running out of money. That’s what deep financial planning can do for you, it can take a general rule of thumb and improve upon it to help you enhance your quality of life without fear. Doing it with confidence. And we have clients who are withdrawing 5% – 6% per year. We have a high degree of confidence that they’ll be able to maintain that throughout the rest of their life because we’ve done the planning around it.
Kevin Zywna, Wealthway Financial Advisors: Further, if you have some discretion over how much you pull from your investment portfolio each year, meaning you don’t need every dollar to live on, some of it is like fun money – for trips or for gifting or for charity. If you have a good investment year, you might give more, take more trips. But if you earn a down year, you’re able to pull back and still maintain and support your basic comfortable lifestyle. So, if you have that flexibility, then your annual withdrawal rate can potentially be even a little bit higher long-term. If you’re able to rein it in at the appropriate time.
Allison Dubreuil, Wealthway Financial Advisors: I can see how it would be scary to make those decisions without having a full financial plan. Have a professional help you with that because you won’t know if you’re derailing. So, a general rule of thumb, it’s not a bad starting place. But a comprehensive financial plan. There’s no substitute for a comprehensive financial plan. It can be so freeing for you. Where I think a lot of people are hesitant to go through the process because you must put all your skeletons out there. But it can be so freeing once you get through the process.
Kevin Zywna, Wealthway Financial Advisors: The process is slow. It’s a labor intensive process for somebody. It’s a labor intensive process for professionals like us. But that’s why we don’t do one without that. We integrate the investment management with the financial planning. The investment management only gives you a rate of return. The rate of return doesn’t tell you what you need to do about it. It doesn’t tell you if you can spend more, or if you need to spend less if you can. Are you on track to retire when you want? Or maybe you must work two or three more years. Or maybe you can work earlier, leave work earlier.
Investment management in a vacuum is about 25% of the equation. 75% of what we do now gets answered through deep analytical financial planning advice. It continues to stun me that you know, 90% of the population invest because they know that that’s important. Well, 90% of the population who invests does just that, because they know that it’s important. Only a small percentage of people who invest actually take the next step and get financial planning analysis. That’s where most of the value is and where most of the answers are.
Director of Financial Planning