The Long View: Mike Piper - Delaying Social Security Not Always a Good Deal

please stay tuned for important disclosure information at the conclusion of this episode hi and welcome to the longview i'm jeff attack chief ratings officer for morningstar research services and i'm christine benz director of personal finance for morningstar our guest on the podcast today is mike piper mike is the author of several personal finance books including can i retire social security made simple taxes made simple and accounting made simple mike also writes a wonderful blog called oblivious investor which you can find at www.obliviousinvestor.com he's also developed a free tool for exploring social security claiming decisions called open social security mike is a cpa and he's a fountain of wisdom on social security and tax planning matters mike welcome to the longview thank you for having me your books are really inexpensive your your social security calculator is free your website is free you clearly operate with the philosophy that you want to give people easy access to your expertise can you discuss your thinking and in your business model sure um as far as a business model it's very straightforward it's just selling books on amazon bringing in traffic through an assortment of places and then selling books on amazon as far as the line of thinking a lot of the best financial advisors out there cost a lot of money which makes sense right because they can provide a lot of value to their clients but i was just hoping to be able to provide value to people who might not be able to afford 450 an hour sort of thing are you mainly serving individual investors do you think through your books or do you think financial advisors are also reading your books and your other content can you tell who's consuming your products it's definitely both by percentage it's primarily individual investors which makes sense just because there's a lot more individual investors out there than advisors but there's quite a lot of cfps and cpas who will email me with questions about a particular social security situation or just want confirmation about how a particular tax provision works or the financial planning implications of that once you have to talk about social security which is one of your areas of expertise everyone who pays even passing attention to social security has heard the advice to delay filing for social security until some later date so let's discuss the benefit one gets when delaying can you talk about that sure it's pretty straightforward the longer you wait the larger your monthly benefit will be if you wait all the way until age 70 your monthly benefit will be roughly three quarters more than it would be if you filed as early as possible at age 62 but of course that's a trade-off right the longer you wait the fewer the number of months that you'll be collecting that larger benefit we sometimes hear the benefits increase you get by delaying social security described as a return in fact you even called me on this bike one time you said stop saying that people may have heard you pick up an eight percent benefits increase for each year you delay past full retirement age why do you think that's the wrong way to frame it as some sort of a return pick up and even just plain wrong that you get that eight percent return increase how can people quantify the benefit enhancement they get from delaying yeah it's the reason it's not a return is because in order to calculate a rate of return we need to know how long you're going to be receiving the series of cash flows in question right and if you think of an easy example imagine somebody who decides to wait until age 70. so they don't file for benefits and then they die at age 69. well they obviously didn't get an eight percent return they got a negative return because they never collected any cash flows they gave up cash flows that never received any cash flows in return so it's clearly not a positive return at all and so we can calculate expected rates of return given various mortality assumptions or in hindsight we can calculate what a person's rate of return would have been once we know how long they ended up living but the only way for it to be at eight percent rate of return would be if you lived forever then it would be an eight percent rate of return so i sometimes hear people talk about break-even analysis for social security so you know the thinking is well if i live until x age then delaying will have been worth it is that sort of a constructive way to think about social security filing i think i would say yes it's constructive um it's intuitive right it's pretty easy to understand but it's not the best way because by definition a breakeven analysis you're only comparing two options at once you're comparing filing at one age as opposed to filing at another age and what you can do instead is just use a tool that does the present value calculation of all of the possible filing options and that's going to be a much more thorough analysis also of course by doing a present value analysis you're including foregone investment returns right because if you delay filing that means that you are probably spending down your portfolio at a faster rate so those dollars that are no longer in your portfolio you're missing out on the returns that you otherwise would have earned from them so a present value calculation accounts for that and so that's a tool you've developed and made available is that correct um my calculator open social security does do that it's not the only calculator that does that social security solutions and maximize my social security or two other calculators that both follow the same approach of doing present value calculation what are some situations when it makes sense to claim sooner rather than delay sure the most obvious one is imagine a single person who is in very poor health right if you're a 62 and you have a particular diagnosis that says that you're unlikely to live until age 70 well you probably don't want to wait until age 70 to file for benefits another very common example is just that frankly in most married couples the lower earner it usually doesn't make sense for them to wait all the way until age 70. the reason for that if you want to get into it is that when the lower earner waits to file for benefits it increases the household benefit as long as both people are still alive so in other words the larger benefit that results from this person delaying from the lower earner delaying that larger benefit will end as soon as either person has died and so we're looking at a joint life expectancy but it's a first to die joint life expectancy which is by definition shorter than either of the two individual spouse's individual life expectancies and so because it's a shorter life expectancy it's a shorter period of time that we're on average going to be receiving this benefit so it's not usually advantageous for that person to delay for very long but of course the age differences between the two spouses and other various factors can come into play well that's helpful mike and you've referenced just now a couple of situations when it might not make sense to delay let's talk about a couple of other common scenarios how about a single person who's in pretty good health would it usually make sense to delay in that situation yes yes it does um for a single person in average health even it typically makes sense to file anywhere from age 68 to 70. and that's purely looking at it actuarially so we're not accounting for the fact that it's usually advantageous from a tax standpoint to delay benefits it's also not accounting for the fact that delaying benefits is helpful from a risk reduction standpoint because you're getting longevity risk protection when you delay benefits so for a single person and better than average health yes almost always is going to make sense for that person to wait until 70. there are some uncommon exceptions but it will usually make sense for that person to wait until 70. what about married couples and how they should approach this you just brought up one scenario where there's a disparity in the earnings level of the of the couple but what about earnings histories age health how does that fit in sure the earnings history i think broadly speaking a good default plan is for the higher earner to wait all the way until age 70 and for the lower earner to file early not necessarily as early as possible but usually not waiting all the way until age 70 and often not waiting even until their full retirement age the reason for that is that when the higher earner delays benefits it increases the amount that the couple gets as long as either person is still alive so in this case we're talking about a joint life expectancy but it's a second to die joint life expectancy it's a longer joint life expectancy and so this makes it especially advantageous for that person to wait for benefits in other words we're increasing that person's own retirement benefit but we're also increasing the survivor benefit that the other person the lower earner would get if the lower earner or to outlive the higher earner so it's especially advantageous for the higher earner to wait but that exact fact is the reason why it's less advantageous for the lower earner to wait so that's just dealing with respective earnings histories once you look at age differences essentially the younger your spouse is relative to you the more advantageous it is for you to delay benefits right because if we think about let's imagine you are age 62 if your spouse is 10 years younger than you their age 52 well that makes the applicable joint life expectancy somewhat longer if they're 10 years older than you so they're age 72 that makes the applicable joint life expectancy somewhat shorter so again just the older you are relative to your spouse the more advantageous it is for you to delay benefits and then as far as health with that it's a question of again how long will it be before one spouse has died that's the question that's relevant for the lower earner whereas for the higher earner the question is how long will it be till both spouses have died so for the lower earner if either person is in poor health that's a point in favor of that person filing early whereas for the higher earner to want to delay both people would have to be in very poor health so delayed filing doesn't mean that you're doing this in a vacuum you have to get your money from somewhere assuming that you're retired so let's talk about how this works with an actual investment portfolio so if someone's delaying filing that means that their portfolio withdrawals early on in retirement might be higher what happens if that scenario coincides with a bad market environment how would you suggest that people approach that i mean obviously you'd tell them to de-risk their portfolio so they're not in the situation where they're having to withdraw from depreciating equity assets but what's your counsel there and thinking about how the portfolio interacts with these withdrawals with filing from social security what a lot of people have started to talk about in the last few years steve vernon for instance is an actuary who has talked about this concept is creating a social security bridge with the idea being that in advance if you know you're going to be retiring at a certain age and then not starting social security until some later age in advance you'll allocate a portion of your portfolio to safe assets to very confidently be able to provide that extra spending from the portfolio until that social security benefit kicks in so for instance if it's going to be seven years between the date you retire and the date your social security benefit is going to start then you might create a seven year bond letter or a seven year cd ladder to be able to very safely provide that additional level of spending from the portfolio so that way you're not risking this very bad outcome where you're spending from an equity portfolio at a high rate and at the same time the equity portfolio is declining rapidly just because you get unlucky in terms of the timing of a bear market so by creating a portion of the portfolio that's specifically dedicated to the extra level of spending until social security kicks in you're essentially alleviating that risk and i would actually point out that steve vernon someone you just mentioned we interviewed him on a previous episode of the long i think it was episode 73 so those interested in his work and listen to episode 73 and hear more about some of the strategies that he has uh written about and talked about previously i wanted to switch gears and talk about variables your calculator which you referenced earlier maybe that it factors in that some of the other calculators that you mentioned before wouldn't factor in um you know maybe sort of what some of your secret sauce so to speak when it comes to your calculator there's a lot of calculators out there that frankly are not very good at all that's what most of the free ones are for instance a lot of them don't account for survivor benefits at all which it's effectively worthless for a married couple but there are two very good ones other than mine that i know of they're both paid one is social security solutions and the other is maximized by social security and they're both created by people who are very knowledgeable about social security and they account for all various complications that my calculator accounts for the windfall elimination provision government pension offset minor children or adult disabled children and so on the one thing though that i think my calculator does better than any of the other calculators at least that i have seen is that it doesn't force you to pick the age at which you're going to die it lets you use an option basically you can pick different mortality tables and so it can account for the fact that you don't know when you're going to die it can account for the uncertainty involved for a single person frankly this difference isn't terribly important because what you can do is you could just look up your life expectancy and then use that as the assumed age at death in one of the other calculators but for a married couple an intuitive way to use the other types of calculators where you pick how long you're going to live an intuitive way to use that is to look up your life expectancy and look up your spouse's life expectancy and plug those in as the ages at which you're going to be assumed that you're going to die but what that does is that it dramatically understates the value of the higher earning spouse delaying benefits and it dramatically overstates the value of the lower earning spouse delaying benefits and the reason for that there's one example that i use frequently just because the numbers are easy to remember if you imagine a same-sex couple let's say they're both men and they're exactly the same age and now they're exactly age 62 so they're trying to decide whether to file benefits or not for this couple for a male and average health at age 62 the remaining life expectancy is pretty much exactly 20 years so until age 82. so if you put that in you assume that both spouses are going to die at age 82. that's not actually the most likely outcome most people don't die exactly at their life expectancy right and what's actually more likely is that once 15 years have elapsed so once they are 77 it's more likely than not that one of the two spouses has died by that point but on the other hand the most likely outcome is that one of the two spouses is alive at least for 25 years so at least until age 87. so the lower benefit is going to be collected on average until age 77 and the higher benefit is going to be collected on average until age 87 and if you're just using the individual life expectancies you're assuming that both of those benefits end at age 82 and in each case that's going to be off by approximately five years on average so if calculated that forces you to pick the age at which you're going to die it just it can't really accurately reflect joint life expectancies unfortunately that's interesting i want to talk more about taxes later on and mike you know a lot about taxes but i wanted to talk a little bit about social security taxes specifically because i think that many people do not know how this works so what should people know as they're thinking about social security with respect to taxes and also what should they know about whether they can manage the taxes in any way that will eventually come due on their social security benefits sure the thing to know about social security and the way it is taxed is that if your income is low enough then none of your social security benefits will be included in your taxable income but as your income proceeds through a certain range and that range depends on whether you're single or married filing jointly and then also the size of that range depends on the amount of your benefits as your income proceeds through this range then every additional dollar of income causes either 50 cents or 85 cents of social security benefits to become taxable and the reason this is so important is because it means that during this window of income this range of income your marginal tax rate is way higher than just the tax bracket that you're in because every dollar of income is causing the normal amount of income tax due to your tax bracket but it's also causing some social security to become taxable so it's causing even more income tax so your marginal tax rate through this range of income is considerably higher than just your tax bracket which has an assortment of tax planning amplifications if maybe we'll switch gears and talk retirement planning for the next few minutes you have a book called can i retire a lot of people in their 50s and 60s are probably asking that question these days because balances have grown thanks to the market but there's also a fair bit of concern among planners that new retirees could be walking headlong into a very difficult environment given valuations are very full and yields are low and so forth do you share that concern yes unfortunately i think it would be hard not to just with valuations being as high as they are and interest rates real interest rates being as low as they are it's hard to imagine anything other than poor to modest expected returns so unfortunately yes i would not be as confident in a particular percentage of spending today as i would have been several years ago can we talk about the tools that you think retirees have to confront what you expect will be a challenging environment the tools as far as ways to increase the amount they could spend from a portfolio yeah just the strategies that they could employ to figure out how to address maybe a lousy market environment occurring early on in their retirements sure so there's we've been talking about social security that's one of them for single people as well as higher earners and married couples delaying social security is anywhere from a pretty good deal to a very good deal and the part of your portfolio that you end up spending down essentially in order to delay social security it'll end up funding a higher level of spending than it would have been able to fund if you just kept it invested in typical fixed income assets beyond that there's obviously the option of lifetime annuities single premium immediate lifetime annuities the unfortunate thing there is that since 2019 i guess it hasn't been possible to buy an inflation-adjusted lifetime annuity so you're going to be stuck with inflation risk if you purchase one of them but they still can be useful because of mortality credits essentially risk pooling they are still going to allow you to spend a greater amount than you could safely spend from a non-annuitized fixed income portfolio you've researched all the main systems for in retirement withdrawals from the fixed real consumption method that bill bengan initially used to more flexible methods do you have a favorite method for withdrawal rates so not just should it be three percent or four percent but but also how flexible you should be i wouldn't say that i have a favor method i don't think that there's any one method that's best really it's just the trade-off back in 2016 i think colleen jaconetti of vanguard wrote a paper talking about a spectrum of retirement spending strategies with at one end of the spectrum you have the classic four percent rule the idea that you pick an initial dollar amount of spending and then you either keep spending that same dollar amount or you keep spending that same dollar amount adjusted for inflation and so with that type of strategy you're not adjusting your spending at all based on how the portfolio performs and then all the way at the other end of the spectrum you have strategies where you really do spend a percentage of the portfolio per year so with that type of strategy a four percent spending rate means that every year you spend four percent of the portfolio so your spending is going up when the portfolio goes up and it's going down when the portfolio goes down and so the advantage of the constant dollar amount spending strategies like the classic four percent rule is that they make it easier to plan right it's easier to budget when you know how much you're going to be spending this year and next year and the next year but the disadvantage is that you're more likely to deplete the portfolio because you don't cut spending when the portfolio declines and then at the other end of the spectrum with the more flexible strategies the advantage is that you're less likely to deplete the portfolio the other advantage is that assuming the portfolio does grow over time which is what typically happens if you start with a conservative initial spending rate then your spending would be allowed to grow with it so those are the advantages and the disadvantage is that your spending isn't going to be very predictable it can move quite a bit from one year to the next and so i don't think there's a best strategy because it's just a trade-off and so what's best for one person would not be best for another person how about the asset allocation in retirement i think that there's been a lot of discussion about what retiree portfolio should look like today obviously if you maintain a really high allocation to safe assets today you're kind of setting yourself up for poor returns but what do you think about in retirement glide paths what should they look like especially if we're concerned about maybe an equity market shock and its implications for decumulation yeah that's unfortunately an especially tricky question there aren't a lot of great answers right now with valuations high it makes sense to be concerned about a bear market but on the other hand you move more into bonds and there's not going to be great returns there either i think it does make a lot of sense as i was talking about earlier to dedicate portions of the portfolio to essentially alleviate the risk that comes from higher spending in early retirement right because most people they retire at a given age and perhaps they don't start social security until later so there's higher spending from the portfolio during the early years for that reason but then for a lot of people there's also just the fact that people want to spend more in the first years of their retirement so for those additional um amounts of spending that are going to be coming from the portfolio during the early years i think it makes sense to dedicate assets in something low risk so cd ladder bond ladder something that's a good fit for the length of time in question and so you you will be depleting that portion of the portfolio that's the plan but it's not then an additional source of risk because you're not relying on equity returns for that portion of the portfolio to satisfy this piece of spend essentially so what that ends up resulting in is often a increasing equity allocation over time but that's not necessarily because that's the goal the goal isn't increasing equity allocation over time it's rather just that you have specific fixed income assets that you are intentionally spending down during the early stage of retirement and because you're spending down fixed income assets at a faster rate then it typically does result in the percentage of the portfolio that is in equities going up over time in what area of retirement planning would you say you go against the grain where you think the conventional wisdom doesn't hold water this is a tricky one i think the biggest one i wouldn't necessarily say that this is conventional wisdom but it drives me bananas how often you'll see people say that if you're married that's a point in favor of delaying social security and it's just like we've been talking about for half of married people that's a point in favor of delaying social security but for the other half of married people that's the point against delaying social security i tend to focus on social security that's what comes to mind just because that's what i deal with the most another thing that i really think is just nonsense a lot of people you'll see sometimes and i don't see this among financial planning professionals frankly very often but you'll see it on the mobile heads forum for instance is this idea that social security is longevity insurance that's its purpose and therefore you should get the most of it that you can you should automatically delay until 70. and i've always found that to be nonsensical on its face because just the fact that a type of insurance exists doesn't mean that you want to buy it right you can think of a million different examples where that's not true but somebody in their early 20s for instance they're not married they have no dependents they could buy life insurance but it doesn't mean that they should we talk about long-term care insurance all the time most people in retirement are exposed to long-term pair risk but that doesn't mean that everybody should be buying that insurance or just when you buy a television at best buy or on amazon they're going to try to sell you essentially a tiny insurance policy on that television but probably it doesn't make sense to buy it because it's profitable for them and you don't need insurance on your television most likely you're going to be fine if the television dies and you need to buy a new one so just because the type of insurance exists doesn't mean you want to buy it we need to assess the need that you have for that type of insurance and whether or not it's a good deal and in a lot of cases delaying social security is a good deal but in a lot of cases it isn't it's a minority of cases but we're not talking for one percent or two percent of people it's a significant number of people for whom delaying social security is not a good deal and sometimes it's a terrible deal i just think it's important to actually do that analysis rather than making assumptions that you should automatically buy this insurance because it's available to you you mentioned bond or cd ladders mike and i hear about them a lot and i get that they're precise that they could address you know sort of a specific time frame but i guess the question is do you think they're worth the complexity or could i get there by holding cash and maybe a short-term bond fund and maybe not have the precision but also just take some work out of the picture for myself sure um i think it would be reasonable to hold a bond fund that has a average duration that approximately matches the average duration of the spending in question so if you for instance if it's a five-year period of spending you're going to be spending more from the portfolio during these five years instead of a five-year bond letter or five year cd ladder you could use a fund with an average duration of about two and a half years and it won't be as precise just like you said but it will be close and it will be less work so sure let's switch over to discuss the intersection between taxes and retirement planning one of the key decisions for retirement savers is whether to fund traditional or roth accounts you've written that you shouldn't bother trying to compare your marginal tax rate today with what it's likely to be in the future so what should people do instead to back up the stuff i do think that that is the analysis that you should be doing how does your current marginal tax rate compare to your future marginal tax rate but i think it's important to be realistic and that if you are in your 20s or you're in your 30s any detailed analysis to calculate what your marginal tax rate will be in your 60s or 70s it's pointless it's just a guess because there's so many you don't know how your career is going to go you don't know what level of savings you're going to accumulate you don't know how your portfolio will perform and so you don't know what size the portfolio will be for that reason you don't know what legislative changes will happen between now and then you don't necessarily know what your filing status will be for instance um there's so much uncertainty involved that when we're talking decades in the future there's really no way to say this is exactly what my marginal tax rate would be i think it's entirely reasonable to just make a reasonable guess rather than even bothering with anything that you could call a calculation and on the flip side a lot of people ignore the actual calculation for this year a lot of people just assume that i'm in a particular tax bracket i'm in the 22 tax brackets so that means that i must have a 22 marginal tax rate but that's not how it works necessarily there's all kinds of cases where your marginal tax rate is different or often very different from the tax bracket that you're in because our tax code is filled with provisions where a particular credit or deduction phases out over a certain income range or a new type of tax kicks in once you hit a certain income range and your marginal tax rate is going to be different than your tax bracket one example is the american opportunity credit it's a 2500 credit for paying higher education expenses for somebody in their first four years of college basically and for a single taxpayer it phases out over a ten thousand dollar window of income so you're losing a twenty five hundred dollar credit over a ten thousand dollar window of income in other words your marginal tax rate through this range of income is whatever it would normally be plus 25 and the kicker is that this tax credit is per student so if you have let's say a freshman and a junior in college and you're paying college expenses for both of them then your marginal tax rate through this window of income would be whatever it is normally plus 50 and if you're married then the credit phases out over a 20 000 window rather than a 10 000 window so it's half of the percentages we just talked about but it's still quite significant and a lot of people just don't even bother with that analysis they only look at the tax bracket that they're in they completely miss out on the fact that if they for instance did a little bit more tax deferred contributing this year instead of roth contributing then maybe they'd qualify for some other credit or some other deduction or something like that and so i think people spend not enough time on the analysis for this year doing a really good detailed thorough analysis and too much time trying to calculate what their tax rate will be 20 years from now when really that calculation is not any more useful than just a guess well in terms of that going back to the question about should i make roth should i make traditional ira 401k contributions what do you think of a strategy where you just say i'm not going to try to overthink this at all i'm just going to put money in both and have tax diversification on my side and hope for the best is that a sane way to approach it is it same yes i i definitely think it's sane i wouldn't criticize anybody for doing that there probably will be some years in which doing entirely tax deferred would have been preferable because you would have been able to qualify for something that you won't qualify for if you had just reduced your income by a little bit by doing entirely tax deferred contributions and then there's also for a lot of people this is less of a thing now because so many 401ks offer roth contributions but that's relatively newer so for a lot of people the tax deferred balances are way higher than the existing roth balances right because they've been saving tax deferred for so many years and much smaller amounts in roth and so for those people i would just say that it probably makes sense not necessarily but if you're going to do a no calculation sort of plan just to pick something easy and do it sort of plan i would just go all the way in favor off but again you're likely going to be missing out on some things in certain years and there's there's no way to know that without actually doing an analysis if you had to generalize how can people figure out whether it makes sense to convert traditional ira balances to roth i know that you've sort of been speaking to sort of different elements of the thought process that goes into that but maybe you can speak more specifically to that question if that's okay sure it is primarily a question of marginal tax rates it's essentially the flip side of the contribution question in other words if your marginal tax rate right now is lower than you expect it to be when these dollars would come out of the account later if you were not converting them then it is advantageous to do a roth conversion of these dollars and on the other hand if your marginal tax rate is higher then you expect it to be later whenever these dollars will come out of the account then it doesn't make sense to do roth conversion in most cases there is one exception which is if you are using money from a taxable account to pay the tax on the conversion then that's the point in favor of doing the conversion aside from the marginal tax rate analysis so if you are many many years away from spending this money and you think of course that's a huge question mark for all the reasons i've been talking about but if you think that your marginal tax rate later is roughly the same or possibly even a little bit lower it could still make sense to do a roth conversion if you're paying the tax on the conversion by using taxable dollars because essentially what you're doing when you're using taxable dollars is you are using non-retirement account money to buy more space in your retirement accounts and that in itself is advantageous so in some cases that can outweigh the marginal tax rate analysis how about ira conversions later in life i sometimes hear older adults say oh i'm probably too old to convert my traditional ira to roth what sort of thinking should go on if an older adult maybe even one who is already subject to required minimum distributions what should factor into their thinking yeah the analysis it's the same idea it's about current marginal tax rate versus future marginal tax rate and admittedly it's less common for roth conversions during that age window to make sense the age window when they most often make sense is somebody who is already retired but they haven't yet started social security and r ds haven't yet started so there's this period of time where their income is relatively low and so it often makes sense to take advantage of roth conversions during those years but it can make sense even after rmds have started to do raw conversions one example that i see probably more often than any other example that would make it make sense during those years is if you're pretty sure that this portfolio is not going to be spent down during your lifetime so you're pretty sure that you're going to be leaving it to your kids or grandkids or whoever it is well then you're no longer comparing your current marginal tax rate to your future marginal tax rate now the comparison should be your current marginal tax rate as compared to the marginal tax rate that your heirs would have when they would be taking the money out of the account so if your tax rate right now is something relatively modest and let's say you'd be leaving it to your kids who are both very highly paid physicians for instance well then it likely makes sense to be doing roth conversions now because you'll be leaving them a smaller account but it's a roth account and in this case they would prefer to receive that roth account because they have very high tax rates and so that way then they they won't have to pay tax at their high tax rate you are paying tax now at your lower tax rate instead of them paying tax later at their higher tax rate some of our listeners are likely in the fortunate position of having all the assets they'll need for their own lifetimes so they're saving and investing for the next generation what strategy should they consider to ensure that their assets will pass to their heirs while paying the last amount of taxes owed well one is exactly what we were talking about thinking about roth conversions through the duration of your life another thought is thinking about which assets to be spending every year typically tax planning is always case by case but in most cases taxable accounts are the least tax efficient accounts so they're generally the ones that you would want to spend down first and the reason they're the least tax efficient in most cases is because you have to pay tax on the interest and dividends that you earn in those accounts so they grow at a slower rate and so it often makes sense to spend down those accounts first while prioritizing leaving the other accounts to your heirs but one major exception is if you have assets in a taxable account that have significantly gone up in value from when you bought them so you have big unrealized capital gains then it often makes sense to try not to spend those assets right leave them to your heirs and then they will get a step up and cost basis follow-up question on that mike is one of the proposals under i don't know if it's formally under consideration but the idea that that step up would go away and i want to broaden out the question just to discuss prospective tax changes how much should people be spending time thinking about changes in the tax code before they're actually turned into law what do you think about that this is i love this question because so many people ask this question and when i talk to tax professionals overwhelmingly they we so myself included we struggled sometimes just to keep up with the current tax law there have been so many changes this year that it's hard just to keep up to date with current law we're not creating a million different analyses for what if this changes what if that changes and what if that changes because there's so many different possible changes that could happen and the reality is that it's the details that matter right one example we talk about social security benefit taxation and the thresholds that apply for that they're not indexed for inflation they've been what they are i think since 1983 if i'm remembering correctly and so that's the thing that people mention sometimes well maybe they'll increase that threshold well in terms of tax planning you would need to know what they're going to increase the threshold to and the details make all of the difference and so there's not really a lot to be gained from trying to guess what's going to be done with our tax code because even if you get it 80 right the 20 you got wrong could make the planning that you did harmful rather than helpful so i i don't think it makes a lot of sense frankly to be guessing at what changes are going to be made and in fact it's extremely hard it's just like with the stock market where people think in hindsight oh yeah i saw that bear market coming okay but were you predict so the 2008 2009 bear market if you were predicting it from three years in advance that's not really useful you had to get the timing right it's the same thing here if you're predicting particular change but you're predicting it every year for 10 years and then they do it well that's still not that helpful you have to get the timing right and so it's so hard to guess at these things and unless you can somehow successfully guess what they're going to change and when it's not really very productive to be spending time on it in my opinion point taken but in terms of sort of overall trajectory taxes are quite low relative to where they've been in history so is it reasonable to expect that they'll go higher and if so what kind of adjustments to a financial or portfolio plan might make sense realizing that you know one wants to avoid kind of false precision sure yes it's reasonable to think that taxes will be higher in the future but it's hard to know what to do with that it doesn't make sense likely to do somewhat more roth conversions now or tax deferred spending now yes likely or rough contributions yes likely but exactly how much there's no way to know so much uncertainty involved that i really i don't think it's worth spending a great deal of time on that's like i was saying with this analysis it makes sense to be pretty precise with your calculations this year because it's actually calculations you know what the tax code is for this year but if we're talking about 20 years from now there's no such thing as a calculation it's just a guess wanted to ask about a really small bore tax question um in retirement there's this medicare surcharge called irma irmaa that comes into play especially for higher income retirees this one seems to catch a lot of people off guard what should they know about it with respect to their retirement plans yeah that's a great question medicare irma income related monthly adjustment amount what this is is it has to do with your medicare premiums and every year your premiums depend on your income level from two years prior so persons 2021 premiums are based on their 2019 income level and the critical thing to know about this is that it's not a gradual effect there's just specific thresholds and once your income crosses that threshold your medicare premiums two years from now go up dramatically by several hundred dollars or more than a thousand dollars over the course of the year so you can have cases where the one dollar of income that puts you over that threshold costs you hundreds or literally thousands of dollars in some cases so it's another one of those things that when you're doing your tax planning from one year to the next if you can keep your income just below that threshold rather than just above it that would be very advantageous to do so lots of financial experts recommend target date funds or other simple solutions for the masses so to speak but but then have more complicated personal portfolios you on the other hand have a single holding can you tell our listeners what that is and and what your thinking is behind that sure my portfolio our portfolio is entirely vanguard life strategy growth fund and it's not as if i think that the underlying allocation there is exactly the perfect asset allocation it's good enough for us it's close enough for us and yes our expenses would be somewhat lower if we were using individual etfs but i really like the behavioral finance behavioral economics advantages that it provides by which i mean i don't ever have to think about it really i never have to go rebalance so that's helpful when the market's going down right it might be hard to rebalance it's doing it for me i never have to think about whenever we make contributions there's no no thinking necessary and i remember before using this fund that's when i would always be tempted to tinker so to speak right like thinking well okay so i'm about to make this contribution should i just put it exactly according to my investment policy statement or maybe doing it a little bit differently like this and one way or another would make sense and that's when i was always tempted so to speak to straight from the path i guess you could say and this it's just so easy you just put the money in the same fund every single time nothing really to think about and it's lower stress it's less work and for me that's worth the extra cost that we are paying how about a target date fund why would you opt for kind of a static allocation fund versus one that will definitely get more conservative as you get closer to your retirement date yeah i think target date funds are great so it's not a knock on them sorry i should preface that as long as they're low cost target date funds and they have a reasonable asset allocation but for us prefer the static asset allocation because i don't particularly anticipate broadly shifting the whole portfolio towards bonds as we get closer to retirement but instead building a separate piece of the portfolio or separate pieces just like we were talking about separate pieces to allocate towards specific amounts of spending so it's more of an asset dedication approach and this piece of the portfolio will still be the equity piece of the portfolio and it's still be there doing its thing so i don't anticipate a need to gradually shift the portfolio towards bonds over time according to our own personal plan but that's not to say that target date funds are not a good idea i think they're a great idea for a lot of people well mike this has been a really informative and enjoyable conversation thanks so much for sharing your time and insights with our listeners we really appreciate it thank you for having me thanks for joining us on the longview if you liked what you heard please subscribe to and rate the long view from morningstar on itunes google play spotify or wherever you get your podcasts you can follow us on twitter at s youth1 which is s-y-o-u-t-h and the number one and at christine underscore benz george cassidy is our engineer for the podcast and carey gretchek produces the show notes each week finally we'd love to get your feedback if you have a comment or a guest idea please email us at thelongview morningstar.com until next time thanks for joining us [Music] this recording is for informational purposes only and should not be considered investment advice opinions expressed are as of the date of recording such opinions are subject to change the views and opinions of guests on this program are not necessarily those of morningstar inc and its affiliates morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated morningstar does not guarantee the accuracy or the completeness of the data presented herein jeff patak is an employee of morningstar research services llc morningstar research services is a subsidiary of morningstar inc and is registered with and governed by the u.s securities and exchange commission morningstar research services shall not be responsible for any trading decisions damages or other losses resulting from or related to the information data analyses or opinions or their use past performance is not a guarantee of future results all investments are subject to investment risk including possible loss of principal individuals should seriously consider if an investment is suitable for them by referencing their own financial position investment objectives and risk profile before making any investment decision you

Channel: Morningstar, Inc.

Views: 16,985

Keywords: morningstar, investing, stocks, funds, etfs

Id: 0LvrYDSPlM8

Length: 51min 12sec (3072 seconds)

Published: Wed Apr 28 2021