Retirement Researcher Dr. Wade Pfau explores the 4% rule for retirement withdrawals – just how much can you really spend in retirement? Joe and Big Al take on Dave Ramsey’s advice to pay off debt before saving for retirement, and they loudly debate the merits of real estate versus bonds in a portfolio. Also, IRA planning for the rest of 2018 that can save big on taxes (and why you should use your RMDs for some QCDs.) Finally, if you’re able to work remotely, you might want to move to Vermont – and lifestyles of the middle class in a brand new segment called “Where Does Big Al’s Wife Anne’s Family Live?”
- (01:21) How to Earn Up to 11% On Your Money
- (06:41) Dr. Wade Pfau on the 4% Rule: How Much Can I Really Spend in Retirement?
- (17:41) Email: I Stopped Retirement Investing to Pay Off Debt Like Dave Ramsey Says, But I’m Concerned I’m Missing “Free” Matching Funds
- (25:00) Email: Joe and Big Al Argue Over Real Estate Vs Bonds in a Balanced Portfolio
- (32:52) IRAs, RMDs, and QCDs to Save On Taxes With the IRS for the Rest of 2018
The 4% rule actually is the strategy that creates the most sequence risk, because you never adjust your spending based on how your portfolio is doing. Being flexible helps a lot. If you can just reduce your spending a little bit when markets aren’t doing as well as you hoped, that helps you avoid selling assets at a loss. And that helps manage sequence risk, and that allows you to use a higher spending rate at the beginning of retirement than otherwise. So with some degree of flexibility there, whether it’s just changing your spending level or having some sort of buffer asset to draw from, yeah. You can be more comfortable. – Dr. Wade Pfau
Today on Your Money, Your Wealth, we continue our interview from a few weeks ago with Retirement Researcher, Dr. Wade Pfau. This time exploring the 4% rule for retirement withdrawals – just how much can you really spend in retirement? Plus, how a risk-filled burrito can earn you up to 11% on your money. Joe and Big Al take on Dave Ramsey’s advice to pay off debt before saving for retirement and they loudly debate the merits of real estate versus bonds in a portfolio. Also, IRA planning for the rest of 2018 can save big with the IRS – in taxes, that is. And you gotta tell Mom and Dad or Grandma and Grandpa about using their RMDs for some QCDs – trust me on this. Finally, if you’re able to work remotely, you might want to move to Vermont and lifestyles of the middle class in a brand new segment called “Where Does Big Al’s Wife Anne’s Family Live?” Now, here are Joe Anderson, CFP® and Big Al Clopine, CPA.
JA: Hey do you ever get… Kiplinjer? Kiplinger?
AC: We always say Kiplinjer, we were just corrected. I still like Kiplinjer. I think that sounds better.
JA: I do too. I’m gonna go with that. (laughs) You ever read that magazine?
AC: I’ve seen it, yeah.
JA: So I’ve got this magazine in the mail. “Earn up to 11% on your money.”
AC: Well that’s pretty good. That would get my attention.
JA: So, “here’s our top ways to boost your income.” So, of course, I’m curious, I would like to boost my income.
AC: Yeah to 11%? What are you earning right now?
JA: Probably six. Maybe a little bit more.
AC: Yeah. Because you have a globally diversified portfolio. (laughs)
JA: Yeah. I don’t have any bonds though, because I have real estate. (laughs) Stay tuned for this argument.
AC: Yeah let’s get into that later. (laughs) And your house doesn’t count.
JA: So right here Alan, it says, “how to earn up to 11%. We found 35 ways.” I’m like OK, sounds pretty good. Well, then I get into it and then the first thing it was like “short-term accounts, 1 to 2%.” I’m like, “well, that’s not 11. How do I get 11?”
AC: You add 10 to one. (laughs)
JA: Yeah. So I’m like OK that’s not 11 so I keep reading. Muni bonds, 2 to 3%. Getting closer That’s not 11, dammit.
AC: You’re not warm yet.
JA: Investment-grade bonds. Three to four. Wow.
AC: Isn’t the short term bond – could be an investment grade?
JA: I guess, yeah.
AC: So this would be like a midterm investment grade?
JA: I’m thinking this is even maybe a little bit longer. Or maybe a total bond market fund?
AC: That has blends of everything?
JA: Yes yes yes yes. Foreign bonds, 3 to 5%. I’m just reading this from the magazine. Don’t quote me on this, compliance. I’m not guaranteeing any type of returns. This is what Kiplinger is guaranteeing you. High yield bonds, 3 to 6%.
AC: Also known as junk bonds.
JA: Real estate investment trusts. Now we’re getting into some fun stuff.
AC: 4 to 9%.
JA: Yes 4 to 9%. Just lock up your money forever and pay a big fat commission and then at 4 to 9%, but you don’t know that 4 to 9% is probably a return of your own capital.
AC: Yeah, usually the ones I’ve seen are 6%, but in some cases, that’s exactly what’s going on.
JA: Now we’re getting into some other good stuff – how about some closed-end funds? Oh yeah, let’s put some leverage.
AC: Now you’ve got some high commission products – your broker would love to sell you that one!
JA: Let’s get some leverage inside a mutual fund that you have zero transparency.
AC: (laughs) Is that what it says?
JA: Yeah that’s what it says. (laughs) “If you like zero transparency and leverage…” if you don’t know what the leverage is, then you should not be buying closed-end funds. And then finally are master limited partnerships. 8 to 11%.
AC: That’s a broad term, Master Limited Partnerships.
JA: MLPs. Those were pretty popular until they blew up. (laughs) So we could cherry pick. Who’s the author of this??
AC: It depends, an MLP can be almost anything. Depends where they invest in.
JA: I guess it could be – well it’s a master limited partnership so it could be gas, it could be a family business. (laughs)
AC: Real estate. It could be Joe’s Garage that you talk about sometimes.
JA: Yes. Let’s see here.. Green Plains Partner. That’s an MLP of a brokerage firm. They like that, which owns and operates storage tanks.
AC: So let me ask a question. Have you ever seen anyone put money into a master limited partnership and lose everything they invested?
JA: Not everything. Just about everything.
AC: Yeah. Well, I have. I’ve seen them lose every penny. (laughs)
JA: I have not seen them perform all that great.
AC: Yeah. It depends like if you did an MLP and bought into real estate, in let’s say 2001 for example, and you sold out in 2006, you did great.
JA: You did great. But I think there’s good investments and bad investments. I’m not saying MLPs are awful or bad. You just have to take a look at the wrapper, understand what you’re investing in.
AC: Yeah because an MLP is a wrapper so it’s what’s the investments?
JA: What’s inside of it? If you have a burrito with rotten stuff in it, that’s not going to be very good, or you can have a California burrito from the Matador right by my house, it’s delicious.
AC: French fries?
Junk bonds, closed-end funds, REITs, and MLPs… Now there’s a financial burrito full of indigestion! Find out what rate of return you need to be getting from your portfolio, and how to get it without all the risk and lack of transparency and… bad gas! If you’re in Southern California or visiting soon, sign up for one of our two-day retirement courses, or learn Financial Strategies for Turbulent Times at our free monthly Lunch ’n’ Learn events in San Diego. Visit the Learning Center at YourMoneyYourWealth.com to sign up now. For personalized help, sign up for a free two meeting financial assessment with a Certified Financial Planner from Pure Financial Advisors. Get the tools and confidence you need to prepare for a successful retirement: sign up for our two-day retirement courses, a lunch ’n’ Learn, or a free financial assessment at YourMoneyYourWealth.com.
06:41 – Dr. Wade Pfau on the 4% Rule: How Much Can I Really Spend in Retirement?
JA: Welcome back to the show, the show is called Your Money, Your Wealth®. Joe Anderson, Big Al, hanging out here. Talking to Dr. Wade Pfau. Check him out of at RetirementResearcher.com. Wade, let’s talk about your new book, “How Much Can I Spend in Retirement?” So, there are multiple ways that I think people can create income. Let’s talk, high level, of what you believe is some of the pitfalls that people are facing as they approach retirement, in regards to, how much do they need, and how much can they spend, and what are some appropriate ways they should look at coming up with a spending plan, or a retirement income plan, for lack of a better term.
WP: Yeah. And so this book, “How Much Can I Spend in Retirement,” it’s specifically on the question of investments. With an investment portfolio, what’s the safe spending rate, and how much do you need then to be able to sustain your retirement. And the general rule of thumb that you’re quickly going to run across as soon as you start looking about retirement, is the 4% rule – that you can spend 4% of your investment portfolio and then not run out of money in retirement. And so if you believe in the 4% rule the amount you would need to save is just however much you want to spend divided by 4% – which is then 25 times whatever you want to spend. So if you want to spend $40,000 to keep things simple, 25 times that gets you to a million dollars. Well, 4% of a million dollars is $40,000. And that’s a very basic way of figuring out how much you can spend in retirement. Now, there’s a lot of further discussion to go from there, and that’s what the book is really about. It’s digging into all the assumptions that go into the 4% rule and explaining why it’s using these assumptions. For some reasons, maybe the spending numbers should be even less than 4%, but for other reasons, it could potentially be bigger than 4%. And then how to think about putting all that together into figuring out what’s a reasonable spending rate for your retirement from your investment portfolio.
AC: So Wade, the 4% rule’s been around for a long time. What are factors that some people should only spend 3%, some people could probably spend 5% – what are some factors to think about?
JA: Yeah, what’s behind that whole 4% rule? What are the assumptions? Why 4%?
WP: Yeah, some of the key assumptions behind it are, it’s assuming you’re going to hold 50 to 75% stocks in retirement – throughout retirement. So it’s a pretty aggressive stock allocation. And if you start going less than that, you’re looking at a number less than 4%. It’s assuming specifically that your retirement will last for 30 years. If your retirement is longer than that, or if you’re an early retiree in particular, the 4% rule was never meant to apply – it should be less. But if you’re already 80 years old, you could probably be spending at higher than 4% because 30 years, you probably don’t have to worry about lasting that long and that sort of thing. (laughs) It assumes you always want to adjust your spending for inflation, the Consumer Price Index, every year of your retirement. A lot of people may find that they don’t need to do that, and so they might potentially spend a little more. But it does assume you earned the underlying market returns, and if you’re underperforming the market for whatever reason, that also speaks against the 4% rule, that you should probably be considering something less. Though at the same time the 4% rule is based on just two simple asset classes large capitalization, like big company U.S. stocks, and intermediate term, about five-year maturity, U.S. government bonds. And if you build a more diversified investment portfolio, that could be a justification to use more than 4%. It’s also based on US historical data, which is really where I got my start. The basic idea is if you look at more international data, the 4% rule worked only about two-thirds of the time, internationally. Whereas in U.S. data, it worked 100% of the time. And I think, with the low-interest-rate environment that we have now along, with the high stock market valuation levels we see now, that international experience is probably a more reliable predictor of what today’s retirees should be thinking about. What the 4% rule does is it extrapolates the 20th century United States and says the 20th century US will be repeated for retirees today. And that’s on the optimistic side. Not to be pessimistic about the U.S., but it’s just the 20th century US was a really remarkable period in world history. The U.S. became the world’s leading superpower, and if you just reflect on the lower interest rates and so forth, I think it’s meaningful to make your estimates more in terms of an international average, rather than just the U.S. data.
AC: So should the average person used 3.5% or 3%? There’s a lot of factors, of course. But just talking about Mr. Joe Average.
WP: Well I think if you want to keep most of the assumptions of the 4% rule, and that would include the 50 to 75% stocks, the 30 years, the inflation-adjusted spending, the idea of having a high chance that your plan will work and you won’t run out of money. I think 3% is a lot more realistic than 4%, primarily due to the low rate environment, which hasn’t been tested.
JA: Right. How Al and I look at it – or maybe how I look at it. Maybe you can agree with me Dr. Pfau, because you’ve agreed with everything that I’ve said so far today – is that I think the 4% or 3% rule, whatever that you want to call it, is a really good stepping stone to figure out, are you close with the amount of money that you have saved for you to be able to retire? Because you’re probably well aware that people retire and they think that they can spend a certain dollar figure with a certain asset base, and they are way off base. “I have $100,000 and I think that I can take a 10% distribution from that each year at age 65 because on average, the stock market is done 10%.” So I think the 4% rule that they just reverse engineer it as you said, “I want to spend $40,000 a year,” and multiply that by 25 or divided by 4%. “I need a million dollars.” So at least that gets me in the ballpark of how much money that I should have as a nest egg once I retire. But then once I retire, I don’t think the 4% rule or 3% rule, really… You’ve got to shuck and jive a little bit because markets are going to happen. Life is going to happen. Things are going to change. So I think it’s based on, it’s not a strict rule once you start taking distributions – I think it’s a really good rule to help individuals figure out, “am I close to the nest egg that I need?” But once they retire, I don’t know how applicable it is.
WP: Right. Yeah, I can agree with that, certainly. (laughs) 4% a lot more realistic than 10%. No matter how you look at it, 10%, you’re going to have a good shot of running out of money within 10 or 15 years. But yeah, absolutely. It’s just people need to maintain some degree of flexibility, and being flexible helps a lot if you can just reduce your spending a little bit when markets aren’t doing as well as you hoped, that helps you avoid selling assets at a loss. And that helps manage sequence risk, and that allows you to use a higher spending rate at the beginning of retirement than otherwise. Or if you use a reverse mortgage for example as that buffer asset, you can use a higher spending rate, potentially, because you know that occasionally you can just cover some of your spending from this resource outside of your investment portfolio that’s not losing value when your investment portfolio goes down. So with some degree of flexibility there, whether it’s just changing your spending level or having some sort of buffer asset to draw from, yeah. You can be more comfortable. The 4% rule actually is the strategy that creates the most sequence risk because you never adjust your spending based on how your portfolio is doing, other than dropping your spending to zero once your portfolio had zero. Otherwise, you’re always just spending at the same level and playing a game of chicken, where if your portfolio is losing value, you never change your spending at all. You never reduce it. And that creates the most sequence risk. If you can make some spending reductions, it goes a long way towards helping that plan.
JA: And I think the opposite is true, and I think you’ve done some study on this as well, is that some individuals say, “hey, the first few years of retirement, I want to spend a little bit more. I want to go on more trips, or do different things, or spoil the grandkids. But then as I age, I feel that my spending is going to go down.” And so it’s just really taking a look at what the goal of the client is and figuring out exactly what’s feasible, and then making sure that they do the right actions at the right time.
WP: Yeah, and that’s where, if you’re working with a financial planner, they all now have software that will be able to model those types of scenarios. The 4% rule does just assume your spending is always growing with inflation. But if you think, “well I want to spend a little bit more on the first few years, and then after that, I’m willing to cut my spending for a while.” That’s a scenario not specifically designed for the 4% rule, but it’s easy enough to model and test, and the financial planning software can do that, as long as you’ve got a good advisor and the assumptions in the software about market returns are realistic and not overly optimistic, which sometimes happens. But then you can still get a pretty good idea about those sorts of strategies, and it can be OK to spend more early on because you have this built in understanding that you’re going to reduce that spending later on. And that’s a different assumption pattern.
JA: We’re talking to Dr. Wade Pfau. I know you’re a busy guy. We really appreciate your time today. You can find him at RetirementResearcher.com so he can continue his quest to write more books that I’ll end up purchasing more copies of. What are the other two books about?
WP: The two that are still coming, the next one is on annuities and insurance, and how pooling risk through insurance can also contribute, along with investments, so it’s bringing the power of insurance and investments together in a complete strategy. And then the final book after that will be more of a putting everything together in a more simplified, and I’m thinking a question and answer format, of really going through the full retirement plan, also adding more about Social Security and Medicare and estate planning and taxes and everything else.
JA: Very good. Well, thank you so much, Wade. It’s always a pleasure talking to you. And again, you can find Dr. Wade Pfau’s work at RetirementResearcher.com
If you missed the first portion of our interview with Dr. Wade Pfau on how a reverse mortgage can help protect your portfolio in retirement, go to YourMoneyYourWealth.com and search for Wade Pfau. While you’re there, listen to the latest episodes of the Your Money, Your Wealth podcast, read the transcripts and show notes, and learn how to defeat financial failure, become a better investor, and find out whether or not you can successfully time the market. Next week we’ll be talking about annuities and insurance, so subscribe to the podcast at YourMoneyYourWealth.com so you don’t miss a thing. Now let’s get to the email bag. If you’ve got a question for Joe and Big Al, email it to email@example.com or call (888) 994-6257.
17:41 – Email: I Stopped Retirement Investing to Pay Off Debt Like Dave Ramsey Says, But I’m Concerned I’m Missing “Free” Matching Funds
JA: This is Emmett. Washington D.C.
AC: Wow listeners all across the country now, right?
JA: I’m 57, yoa. Years of age.
AC: Yoa? (laughs) Years of age. I was wondering what that meant. YOA? All I got was years old – I didn’t know what the A was.
JA: 57 yoa. Years of age is what that means. He’s a Fed employee. He plans to retire at age 70. He’s got about $135,000 gross annual salary which will continue to grow. He’s got about $145,000 in debt with $100,000 of student loans. He only has about $20,000 in his TSP. So he goes, “I stopped retirement investing to pay off debt but concerned I’m missing free matching funds. Dave Ramsey says pay off the debt, then max out retirement savings, but I’m concerned about time.” What do you think, are you going to agree with your boy Dave Ramsey?
AC: No, I’m going to disagree. Well, let me explain. Dave Ramsey has this approach of how you pay things off. So he says get a $1,000 emergency fund. That’s number one. And then number two is…
JA: You’re a big follower of Dave Ramsey? (laughs)
AC: Yeah, I got it to memory. And the second thing he says is…
JA: You drink that Kool-Aid.
AC: I do. (laughs) Pay off all your debt. And then the third thing you do is then you go to your 401(k) and IRAs, and max that out. Then the fourth thing that you do is you make sure you set up a college education fund for your kids…
JA: What if you don’t have kids? (laughs)
AC: Well then you can skip that one. You go to number five, and number five is, if you still have money, then you can pay down your mortgage. That’s his order, and he’s very specific. You do one and then the other, you don’t do all at the same time.
JA: I don’t agree with Dave Ramsey at all.
AC: Well, I don’t agree with that either. And the main reason is the matching funds. In other words, you put in a dollar, and the Feds match a dollar. And so that’s free money. And so I would say a more balanced approach, in general, works better. It’s a lot of student loan debt for someone who is 57, you’re going to have to tackle that, but…
JA: What do you think, it’s his kids? University of Colorado, potentially? (laughs)
AC: (laughs) In Boulder. Is this me? Except I don’t work for the Feds.
JA: Did you disguise yourself here, Al, so you could answer your own question?
AC: Emmett? You’re right. I’m found out, it’s me. Instead of saying I’m a financial planner, I work for the government. (laughs) I only have $20,000 saved in my TSP. But I work for the Feds Joe, and I’m going to get a nice big pension plan.
JA: You got $100k in student loans so I don’t know, maybe it’s his own, it’s his kids. We’ve seen all over the board. A lot of retirees now, their Social Security’s is getting withheld because of student loan debt. They co-sign for kids or grandkids.
AC: Yeah. And typically with student loans, the student first gets the loans but only can borrow so much. And then it goes to a parent loan, parent plus, or private loan, or something like that. And so that’s in the parent’s name. I would agree, that’s probably what this is.
JA: So a few different unknowns here is that there’s still plenty of time for him to retire. He’s looking at retiring at 70. He works for the federal government. So there’s going to be a pension, plus Social Security. So I’m guessing at $135,000 of income, his Social Security at age 70 is probably going to be around $35,000, $40,000. And then his pension, depending on how many years he worked for the federal government, he’s probably, I don’t know, maybe another $20,000 of pension. If I’m guessing. So let’s say $60,000 of income. So that’s not bad. Because if he’s making $140,000, he’s halfway home, he’s got $20,000, and he’s got 13 years to save. And I understand his stress points. He’s like, “man, I’m putting all this money towards my debt because Ramsey’s telling me to do so,” but he’s got to look at both sides of the coin.
AC: Yeah I agree with that. And he’s living in Washington D.C. which is a very expensive area. And presumably with, let’s just call it $60,000 of fixed income over and above savings, then he could potentially retire to a little cheaper area, maybe over in Virginia or who knows.
JA: But here’s the point I think is that there’s a little bit more planning than these stupid rules of thumb. It’s like if he’s spending $70,000 a year. Let’s just say living expenses is $70,000. And if I’m looking at $70,000, well he’s going to have roughly 50 or $60,000 of fixed income, so he needs another $10,000 to come from his portfolio. He’s got $20,000, so he needs about, I don’t know $200,000, $300,000 saved. He’s got 13 years to save $300,000. That’s not a huge feat.
AC: No it’s not, especially with matches.
JA: Right. So you put the money in the TSP, you’ve got 13 years, plus the match. I don’t know. I think he’s close. And then you figure out what that number is, and then everything else you just throw at debt. He can’t forget about his retirement.
AC: Yeah. So you have to do some planning first. I think you bring up a good point, which is these rules that thumbs are for when you don’t do any planning. When you have no idea what you’re doing. Like when you’re 80 years old and you should take 100 minus your age and have 20% in stocks and 80% bonds. Well, in reality, that works for almost nobody. I mean, I guess if you do no planning at all, at least it’s something. But usually, it’s not the right answer. And that’s the problem with taking these really rigid game plans and assuming that that’s gospel.
JA: I don’t know. Eat. That’s what that’s telling someone to do. (laughs) You don’t want to starve, so eat. OK well, I’m going to have…
AC: Well Ramsey would say eat rice and beans until the $145,000 is gone. Which actually is plant based food, it’s actually not that bad for you. If you want to get into it. (laughs)
JA: Got it. So, hopefully that helps. I would not think all is lost. You’re probably freaking him a little bit, but at the end of the day, Al? $145,000 is not a ton of debt.
AC: No it’s not. And you’ve got a good salary. I know you’re living in an expensive area, but there are probably some ways to trim a couple of things. I think a really, really, really good goal is to, obviously, put enough into your TSP to cover the match, make sure you’re getting the match, and then try to work it out so that you’re saving enough, as you said Joe, whatever your fixed income need is, you kind of do that math, and then also try to figure out where you try to get that debt paid off by age 70 – and then you’re in great shape.
25:00 – Email: Joe and Big Al Argue Over Real Estate Vs Bonds in a Balanced Portfolio
JA: Totally. Really good shape. This is kind of a long one. “Hello there. I have a question about how to set up the correct asset allocation when a huge amount of our assets are in rental real estate. I’ve seen countless recommendations of having a diversified asset allocation, but have not seen any that incorporates rental real estate into it. We don’t have any bonds in our asset allocation because of our huge amount of rental real estate in our portfolios. Here’s our current breakdown.” You ready for this, Al?
AC: Yeah go ahead.
JA: “About 9%, $420,000 is in international stocks. $560,000 small caps. $1.3 million in large caps. Rental properties $2.2 million. And cash, about $200,000. So total assets is $4.7 million. We don’t have any bonds at all. Is that OK? I’m 48. My husband’s 53. We are thinking about retiring early, in about five years.” So what say you?
AC: We do hear that sometimes Joe, that people like to treat real estate as a proxy. I don’t really like the look at it that way. I would treat real estate as a fixed income source. I think that’s a smarter way to do it, because you can’t spend your real estate – unless you sell it. Unless you sell it or refinance it. The thing about a bond is yeah, it’s fixed income, just like real estate is fixed income, but you can always sell the bond, you always have access to that principal if you want to. The real estate, it’s much more difficult to turn right around sell a property. So personally, I would say, in this example, $2.2 million in real estate, $200,000 in cash, that’s a good amount of cash, so that’s probably a good thing. Then we’ve got about $1.2 million of other assets. I would do a well-diversified portfolio of stocks and bonds. As to how much you have in each?. That’s where a little bit more planning comes into play. But it would be common to have 60% stocks, 40% bonds, at least as a starting point.
JA: Boring. This definitely not what Alechi wants to hear. That is just so cookie cutter advice.
AC: But that’s the answer.
JA: No, it’s not the answer.
AC: Yeah it is. What do you got?
JA: That’s definitely not the answer. Here’s what she wants to hear. And this is what she needs. This is what she wants to do because they’re young – they’re 48 and 53, right? The problem is that we need a little bit more information once again because there’s $2.2 million in rental properties. Well what’s the cash flow on the rental properties? How much money do you think that’s generating? I have no idea where Alechi lives, but $2.2 million. Let’s call it what, what do you think is a good cap rate, cash on cash?
AC: Well if it’s in Southern California, let’s say 3 or 4%.
JA: So if it’s not in Southern California, we could probably see as high as five, right?
AC: Sure. Yeah like Arizona would probably five, in Texas it could be 8%.
JA: Right. So $2 million, you know 5% on $2 million is a pretty good number. $100,000.
AC: Yeah. But it depends. It all depends on what they’re spending.
JA: Exactly. So here’s what I think she’s asking. And this is very true too with pensions. So let’s say if I have a $100,000 pension, do I put that into my asset allocation as a bond? Because I have fixed income. It’s a pension plan to me. That’s covering a lot of my needs. So does a 60/40 portfolio make any sense at all? No, it doesn’t! The 60/40 portfolio means nothing! How do you develop a strategy or a portfolio is going to be based on the income needs, which we don’t have!
AC: Yeah. So you’re listening to me, what I said… (laughs)
JA: I listened to your answer, you said 60/40 globally diversified!
AC: …which apparently you didn’t hear me say…
JA: Because I was falling asleep!
AC: …so what I said is, you got $1.2 million in liquid assets, and that needs to have a bond allocation.
JA: Well she’s way more than $1.2 million of liquid assets!
AC: Well if you count the cash, I was leaving the cash out.
JA: Well she’s got $1.3 million in large caps.
JA: $560,000 in small caps…
AC: Yeah, you’re right.
JA: $420,000 in internationals.
AC: I thought it was $130,000. $1.3 million. Yeah. So yeah it’s a bigger number. But so I will agree and disagree with you. So what I’ll agree with is, you need a lot more information to figure out what the investment allocation should be. But I would not count real estate as a proxy for bonds because you don’t have access to the principal.
JA: Right. But I don’t think you want to use real estate as a proxy to bonds.
AC: Well that’s what she asked.
JA: What she’s asking is, “do I need bonds?” But what she’s asking is, “hey, I have a ton of real estate that’s generating income,” right?
JA: So if I don’t need income from my portfolio, should I have bonds. Now, what’s your answer with that? 60/40, globally diversified, low-cost index funds??
AC: No. And again, you weren’t listening to my answer because what I basically said is that a common allocation is that. That’s not necessarily the right answer. But let’s say there was no income need at all, now or ever. Then you would go 100% stocks?
JA: Well it depends. Because then you’re taking a look at well what is the portfolio for.
AC: Well that’s right.
JA: And we don’t know that answer.
AC: Of course not. But if there’s never going to be an income need, it’s for somebody else. That’s the presumption. Now if there is an income need, then you have to figure out, because stocks are volatile, what is that income need, and have enough bonds to cover that for a certain period of time.
JA: Yeah. But if you don’t ever need the income. Right? I guess we just need a lot more information.
AC: (laughs) Of course. Well, that’s true of every question.
JA: Exactly. But I think, where my point was, is that, should you look at real estate? Absolutely you look at real estate, in regards to creating an overall portfolio. Because we have clients that have a ton of money in real estate, so their portfolio is going to look a little bit different than someone that doesn’t have any real estate at all.
AC: Sure. I agree with that. So here’s here’s the formula. Which is you’re spending $100,000 dollars. The real estate is generating $80,000, let’s just say, so you need $20,000 from your portfolio. That helps you decide how that should be allocated. And it doesn’t have to be real estate. It can be Social Security, it could be a pension, it could be anything. But that’s the formula. And of course, it depends upon your age, and depends upon a lot of things, really. But that’s really how you come up with it. But where I took this originally – because this is what I’ve heard people ask me – I don’t think I need bonds, because I’ve got real estate.
JA: Okay well I disagree with that. And I agree with you.
AC: Yeah you agree with me on that point. Because it’s fixed income, it’s not a proxy for a bond in terms of how we think of bonds. And the main difference to me, yeah they both have fixed income, but the bonds you can easily sell to generate principal. Real estate you cannot.
JA: Totally agree.
AC: Finally. (laughs)
Whew! Glad they got through that! If you’d like to see if you can get Joe and Big Al to argue over your portfolio, or even if you have a less explosive money question, email firstname.lastname@example.org. But since the fellas rarely get enough information in an email, maybe you best call (888) 994-6257. You can ask your money question live on Your Money, Your Wealth®, and Joe and Al can get all the information they need to give the best advice they can. Though I can’t guarantee it won’t still turn into a debate. But hey, two financial minds duking it out, that’s half the fun of listening to this podcast, right? Call (888) 994-6257 and leave your question in a voicemail, or email email@example.com. That’s (888) 994-6257 or firstname.lastname@example.org
32:52 – IRAs, RMDs, and QCDs to Save On Taxes With the IRS for the Rest of 2018
JA: I got some stuff for you to do with IRAs for the rest of 2018. Few things. If you haven’t done any type of retirement planning, tax planning, or IRA – individual retirement account planning, here’s a couple of things to consider. Number one make IRA contributions now. The best long-term strategy is maximizing IRA wealth right now.
AC: So contributions for 2018.
JA: Yes, you can make those contributions for 2018 now, rather than waiting until April 15th of 2019, because if we have a good end of 2018, all of that growth is in the overall retirement account.
AC: Yep. Especially if it’s in a Roth.
JA: Especially. So number two is, make gifts to fund children’s IRAs early. Have you ever funded a kid’s IRA?
AC: Um, yeah I have. We did $500 for Rob.
JA: Don’t they have certain custodians that will not do that and some will with minors?
JA: But they said a child’s IRA stands to earn the longest period of compounding investment returns, because they’re children, right. (laughs) They have more time.
AC: You mean they’ll probably live longer than, say, you? Okay.
JA: Number three, plan a backdoor Roth IRA contribution. What’s a backdoor Roth?
AC: Wel,l that’s when your income is too high to do a regular Roth contribution. If you don’t have an existing IRA, you can contribute to an IRA. You don’t take a deduction. But then you turn right around and convert that. And since you did not get a deduction, it goes into the Roth tax-free.
JA: A couple different rules there too, you’ve got the pro-rata and aggregation rules. So you want to make sure that you understand those two rules. So if you have other IRAs, they’re going to take a look at the aggregate of all of your IRAs.
AC: Sure. As if it was one IRA.
JA: Yes. So even though you have one at Vanguard, one at Fidelity, one at T.D. Ameritrade and one at Charles Schwab.
AC: Yeah, so if you have a million dollars in an IRA and you do this, then it’s like $5,000 into a million, that’s a half a percent. That’s the only part that’s going to be tax-free. And some people think, “I can just set up a new IRA somewhere else because it’s not tainted with this other one.” But the aggregation rule says no, you’ve got to look at them as one.
JA: The IRS understands how much money that you have in all your IRAs.
AC: They actually learn about that every year, because it’s disclosed on a form. 5498.
JA: Yes, 5498 form. Another one is to correctly project the income tax on a Roth conversion. This has changed a little bit in regards to Roth conversions. A conversion is taking money from your standard retirement account. So your 401(k), IRAs, 403(b)s, that is going to come out ordinary income tax. But a strategy that a lot of you have utilized if you listen to the show for any period of time, is to take money from the retirement account and convert it to a Roth. The reason why you would want to do that is then all future growth of that account will never, ever be taxed again. So right now, Al and I believe that this is a phenomenal opportunity for a lot of you because we’re historically almost all-time low tax rates.
AC: Yeah. And for example, if you’re married, the 24% tax bracket goes to $315,000 of taxable income. Single is half of that, $157,000. And alt-min, Alternative Minimum Tax, is not affecting anybody, or very, very, very few people this year. So it’s actually a cheap tax this year. We talk about doing Roth conversions when taxes are on sale. Well folks they’re on sale right now.
JA: Right. So now you’re paying tax at these lower rates, potentially, depending on your circumstance, of course. And then the money now sits in the Roth and you’ll never pay tax on those dollars again. You put $10,000 into a Roth IRA, pay a few thousand dollars in tax this year, but that $10,000 grows to 15, 20, $25,000, $30,000, whatever the number is. You pull that money out, you’ll never be taxed on those dollars again. The change in Roth conversions is re-characterizations.
AC: Yeah, in other words, you used to be able to do a Roth conversion and then change your mind up until the filing date in the following year – April 15th, or if you extended, actually October 15th. But that’s gone. Now you can no longer do any kind of re-characterization. So you have to be more careful when you convert because you can’t really fix it up. If you convert too much, too bad – you are in a higher tax bracket. So what we’re doing Joe is, in a lot of cases, we’re doing our Roth conversions towards the end of the year when we know more about people’s income. Or in some cases, if their income is relatively steady, maybe at the beginning of the year we’ll do a partial conversion, but leave some cushion in case there’s some extra income, and then in November December, do a little bit more conversion – as long as it’s in the calendar year.
JA: Absolutely. That’s, I think, the best strategy. Because the time value money is important – the sooner you get the money in the Roth, the better.
AC: Yeah. The only time where you wouldn’t do that is if you’re a business owner and you have no idea. So then you’ve got to wait until November, December to see what the appropriate amount is for you.
JA: Right. It’s like, we’ve had a pretty steady year, but you have this contract looming that could either hit or not hit. Then you just wait. So a few other things here. Roll funds to a 401(k) from an IRA to reduce the tax on a Roth conversion. What do you think they’re talking about there?
AC: They’re talking about the backdoor Roth. Because what we’re saying is that when you do backdoor Roth, you contribute to an IRA. You do not get a tax deduction, and you can convert that to a Roth IRA without paying tax if you don’t have any other IRAs. But if you do have other IRAs, we just talked about the aggregation rules and how all this works. So what you can do is you can take your other IRAs, and you can roll them into a 401(k), and guess what? The aggregation rule doesn’t apply to 401(k)s, it’s only IRAs. And that’s a SEP-IRA, a SIMPLE IRA, or a regular IRA. Those are what is considered IRAs for this rule. So if it’s in a 401(k) or a 403(b), then it doesn’t count. So you wouldn’t have another IRA and you could do the backdoor Roth easily.
JA: Here’s another huge strategy for this year. QCDs. Qualified charitable distributions. If you are over 70 and a half and you give to charity, you have to take a look at this thing. If you know someone that’s 70 and a half and not listening, then you’ve got to tell them about a qualified charitable distribution. The reason for this is what? It’s that the standard deduction doubled. So if you’re married, your standard deduction went from $12,000 to $24,000, roughly.
AC: Yeah. Not only did it double, but you can only deduct $10,000 of property taxes and state taxes. And if your mortgage is paid off and you’ve got property taxes, state taxes of more than $10,000, you’re limited to $10,000. You would have to give $14,000 away to charity to get a single dollar of deduction. So what we’re saying then is, instead of taking your required minimum distribution and paying taxes on it, and then sending it to charity, which then you wouldn’t get a benefit, just do it directly from charity. And then you don’t have to pay taxes on the RMD. It’s a great strategy. When people find out about this Joe, it’s going to be used quite a bit going forward.
JA: So let me repeat what Alan just said. Most retirees might not file as Schedule A on their tax return. They might not itemize their deductions for the next few years given the new tax law. And because they’re not itemizing their deductions, charities were all up in arms because it’s like, “OK, well, we’re going to lose money here, because they’re not going to give us any cash, because there’s no tax benefit.” But the problem is the code says, yes, there are still tax benefits, you can still write it off on your tax return, but most people don’t give $25,000 to charity. They might give $3,000 to charity that year. If that’s the case, they’re not going to receive any tax benefit because they probably won’t file a Schedule A.
AC: Right. And again, it’s because the standard deduction $24,000, will be greater than their itemized deductions, which are probably $10,000 state and local taxes, plus whatever charity they did give.
JA: Absolutely. So this will just not even hit your tax return. So instead of taking the required distribution, you could take your RMD and give it directly to charity so you don’t have to pay tax on it. They get the money and then you get a lot better tax benefit by doing this. So it’s called a qualified charitable distribution.
IRA planning and tax optimization, as you just heard, can be some seriously complicated stuff. Visit YourMoneyYourWealth.com and click Special Offer for a free download of our Roth IRA basics white paper to help you get the ball rolling. Then, when you’re ready to make the most of every dollar in your portfolio and keep as much of it away from the IRS as legally possible, hit that Free Assessment button at the top of the page. That’s YourMoneyYourWealth.com
42:12 – Vermont Will Pay You to Relocate and Middle-Class Standards by City (AKA “Where Does Big Al’s Wife Anne’s Family Live?”)
AC: So Joe, you’re from Minnesota.
JA: I am from Minnesota.
AC: And you lived in Florida. You lived in Georgia.
JA: I have.
AC: And now San Diego California. So have you ever thought of moving to another state more recently? Because there’s an offer out there, this last Wednesday, there’s an offer to move to another state and get paid $10,000 to relocate.
JA: I’ve seen that. There’s a lot of areas that are hurting for labor.
AC: Right. So this is Vermont. The Green Mountain State. So peace and quiet, tranquil, beautiful. A little cold in the winter, which you’ve had some experience with. But this is Vermont Gov. Phil Scott, he signed a bill on Wednesday that will pay people $10,000 if they move to Vermont and work remotely for an employer out of state. So they don’t even care if you worked for an employer there because I guess they don’t have that many jobs. They just want people for the tax base. And so they’re budgeting 100 grants for the first three years, and then 20 additional grants to workers each year thereafter. And so $10,000 will be distributed to first come first served.
JA: I’ve never been to Vermont.
AC: Yeah I have not either. I have two cousins that live out there though. Actually, I should say Anne has two cousins that live out there.
JA: Huh. So ten grand and you don’t even have to work in Vermont.
AC: You have to live there, but you work for an out of state employer.
JA: You can.
AC: Yeah. Well, I think that’s that’s the requirement.
JA: Oh you have to? They have an out of state – what, Vermont’s now in the recruiting business?
AC: Yeah, they’re recruiting people so they get more tax dollars. So it’s a remote worker grant program. Takes effect January 1st, 2019. It will help cover moving, living, and working expenses. Grants can be used for relocation, computer software and hardware, broadband internet and access to a co-working space. So what this tells me, Joe, is they don’t have enough jobs and people are leaving. And so they want more people to come back, and so this is kind of a creative way – paying people to come live in their state, work for an out of state employer. But once they work in Vermont, then they’re going to make money in Vermont and pay taxes in Vermont. I think that’s the whole idea.
JA: Do you know what it takes to be middle class?
AC: In terms of income or what?
JA: Income, house.
AC: Well let’s see, income, I don’t know.
JA: It’s a little different anywhere you look here. I got the answers for you.
AC: OK. So California would be a lot higher I’m sure.
JA: Middle class for San Francisco, that that tops the charts here. For household income, the range for middle-class household income, San Francisco, California. What say you? Got a guess?
AC: $100,000 to $200,000.
JA: Yeah close. $70,000 to $203,000. What do you think the average home cost is in San Francisco? For middle class.
AC: I’m going to say $700,000.
JA: $750,000. Where would you like to live, Alan? You wouldn’t want to go to Hawaii I imagine.
AC: Yeah I would go to Hawaii. Yeah.
JA: Well, how does Pittsburgh sound?
AC: (laughs) I know my dollars would stretch further. Anne has a sister in Pittsburgh.
JA: You know what this show is called? “Where Does Anne’s Family Live?”
AC: (laughs) She’s also got a niece in Alabama. So you haven’t done that one yet.
JA: Pittsburgh P.A. Household income, $50,000 to $150,000. Home price though, $125,000.
AC: Oh really! You can retire like a king there.
JA: Bakersfield California is $200,000.
AC: Middle class? Or that’s the home? Not the income.
JA: Home. Income is $50,000 to $150,000.
AC: OK. Two hundred, Bakersfield? Sure. My aunt and uncle live in Fresno. So we passed by there to get there. Plus we’ve been to Yosemite many times.
JA: So across the board, looks like the income is about $50,000 to $150,000. Of course New York, San Francisco, they hit the $200,000 mark. The low end on the spectrum was Mississippi with $40,000 to $140,000. But that’s middle-class America right there.
AC: I don’t have it in front of me, but do you know what the one percenters, how much they have to make?
JA: One percenters. Well if you don’t have it in front of you, how am I supposed to know? If I give you an answer, you’re going to be like, “yep, that’s not right!” (laughs) I’m going to say the top 1% of wage earners – married? Single? I don’t know, it’s going to have to be $400,000, $500,000
AC: Yeah I think from memory a couple of months ago, I think it was probably five to $700,000 something like that.
JA: I don’t think a lot of people make more than that.
AC: That’s right. That’s why only one percent do.
JA: And then they look at average. Yeah, you got some people that make like $30 million a quarter.
AC: Right. And the truth is, on either coast, it’s a lot higher than say, in Middle America. But I think that was kind of an average – five, six, $700,000 if I’m remembering properly.
JA: Well you know the top 5% was if you made over $100,000. Because I think the average is like $40,000, $50,000 for a household of four. I could get my calculator out – household of four! All right, that’s it for us, for Big Al Clopine, I’m Joe Anderson. The show’s called Your Money, Your Wealth. Thanks for listening.
Special thanks to today’s guest, Dr. Wade Pfau. For his books on reverse mortgages and retirement withdrawal rates and more of Wade’s financial wisdom, visit RetirementResearcher.com
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