David Bezar, Bret Elam, and Karen Bezar discuss common tax mistakes, the importance of planning retirement early, and problems within the financial industry
Today we’re going to address one of the things that does have major impact on retirement, which is taxes. Before I get into that I want to share a quick story. Last week we were on vacation and the one afternoon I was ready for a nap, I laid down to watch a little TV and I found the but before we get into that, I’ll just comment real quick while we were away. Last week, right before we came back, the sun was incredibly strong. At about 3:30, 4:00 in the afternoon, I’m getting ready for a nap. So, before I fell asleep on one, I happened to catch this older movie. It’s probably maybe five years old now, four years old now, called The Big Short, and it was a drama.
Thank you. It was on what the financial crisis was all about, and they tell people, and people don’t tend to pay attention, but history tends to repeat itself. Things that they were addressing in that movie, which were the causes of the financial crisis in ’08 and ’09, are starting to appear again, and we’re seeing some of the same cause-and-effect issues. People forgot that there were people that weren’t really making a lot of money, but because they could qualify for these mortgages where they didn’t have to prove a whole lot, they would get involved in buying one home, two homes, three homes, four homes. Then when interest rates started to go up and these loans reset, the bankruptcy rate went through the roof.
That wasn’t a whole long time ago. Right? That was 10 years ago, and things are starting to present themselves again. We have those loans again, and people are jumping on the bandwagon saying, “ I can get in a much bigger house than I can really afford,” but at some point in the future, you have to pay the piper, and what we want to try to do on this show is keep people educated so those things don’t happen to them in retirement.
Karen, what do you have on your agenda this morning?
I think we kind of have a whole show geared towards this, but we’re going to talk a little bit about taxes in retirement, and how can they affect your nest egg.
Thrive Financial spends a lot of time at the weekly workshops. We’ll tell you about workshop coming up, and I believe, Bret, we will zero in on that very topic.
Yes. My concept, and we’ll talk about it today, is the big number of zero.
Again, when we talk about zero, it doesn’t normally sound like a good thing, but when we’re talking about today’s topic of taxes, one question we always ask during a workshop, Kraus, is how many people in here are a big fan of taxes. We have yet to see a hand go up yet. So, we’re going to try to go dig deep a little bit into paying their taxes in retirement.
As we begin, and you start to process, and you talk about 10 years ago and the changes and everything else, there is that uncertainty that if you’re not prepared for. I think that is what causes or creates that potential trouble or that pitfall. You need to get on the road. You need get a plan together.
Well, I really commend the people who do come out to our workshops, or visit our website, or give us a phone call, because it shows a proactive approach to finding out before it’s too late, and we’re big on second opinions. We’re very big on getting a second set of eyes. We run under this idea of a Thrive retirement roadmap review, and that review looks at four major areas of retirement, and the areas that we’ve decided from a business perspective to be specialists at, not general practitioners, but absolute specialists.
So, we address social security and Medicare, and 567 different election options in social security, somebody needs to help you decipher all of that and figure out what’s the best way to do it.
Medicare surcharges, things like that, lots of questions where people don’t even know about, and don’t know how to prevent themselves from getting surcharged. We address taxes from a dynamic perspective. Are there opportunities throughout your retirement that you may be able to get money out very tax-efficiently? Then we talk about risk, and whether you are going to have enough, and whether it will last.
But, after coming off our vacation, it really got us motivated to look forward to retirement. It’s something that is kind of abstract as you’re younger, but as you get older, Joe, I’m not going to say you’re around our same age, it’s something that you start to look forward to, and everybody has different ideas of what retirement’s going to look like. So, hopefully people are starting to plan earlier than later, but one of the things that people don’t always plan for is taxes and paying taxes in retirement.
When you think about retirement, everybody has their own ideas. We would like to maybe be on the beach, take our grandchildren that we don’t have, take them on big vacations or long vacations.
But where are you going to get that money from? Have you started planning? Is that going to come from your retirement savings?
Once you retire, guess what? You must still pay income tax. So, you’re going to have to pay taxes on that money that you’re planning your great vacations or whatever your retirement’s going to be. Are you going to buy a condo in Cape May, or are you moving to Florida, whatever that might be.
Well, it’s interesting you reference that, too. This show has put my wife and I on this mission of trying to understand, is Cape May the best place for us to be? Is the state of New Jersey the best place to retire? All the research that we’re finding, and all of our discussions tell me no, so that forces forward another conversation and another decision about what you do with the property there that you’ve enjoyed going to the shore on the weekends, and all of that, it’s amazing.
We’re going to the shore on the weekends, and all of that, it’s amazing how it all comes together.
Right. And that’s one of the areas we talk about in our workshops, and it’s one of the areas we focus on when you come in for your complimentary consultation. We have specified software that clarifies taxation during your retirement years. So, please take a look at our website. If you’re interested in coming in, do not hesitate.
It’s the main reason people come see us, right? That starts the conversation. The thing that confuses people the most, or people have the least understanding of, is what the tax rules are, and how they’ll be applicable during retirement.
One of the first questions I ask when I go up and start our workshop, is “How many of you have a complete understanding of how taxes will impact you during retirement?” There’s never a hand that comes up. That’s why I’m here. “How many of you have questions?” Every single hand goes up. So today, we’re going to address a lot of that. It’s something that you do have to plan for. Sometimes it’s too late, right? If you position your money improperly, you could end up paying the piper because of that.
Right, and another area we talk about is, “So is there anything I can do about it?” Yes, there are things you can do about it, but you have to start planning for that prior to when you turn 70 ½. You will also have to start taking what’s called Required Minimum Distributions. We talk about that in our workshops, and we talk about that with our people who come in and visit us for the first time and the second time. But it’s great if you’re saving your money in your 401K and your tax deferred accounts, but what happens when you start taking money out? You must start paying income tax. Are there different areas you could be saving money, that won’t have that effect? it's great if you're saving your money in your 401K and your tax deferred accounts, but what happens when you start taking money out? Click To Tweet
Yes, and sometimes we meet people that have already started. We’ll talk about Social Security in just a moment, and people that have already started their Social Security, where it’s kind of like it’s under the bridge. But Karen said it’s why we sometimes love to meet people before they’ve made that decision, or they’ve delayed it. It’s like, “I’m going to let my IRA bucket grow until I’m 70 ½ because I don’t have to touch it. I’m going to start my Social Security today.” Again, conventional wisdom tells us that, “The government’s running out of money. Take your Social Security before they run out.” We stop. Just stop.
We go through a scenario that we illustrate during the workshop, Crowsley, by just talking about the importance of people who don’t understand how their Social Security is taxed like no other income they’re ever going to receive.
Again, while you’re working, whether you’re getting a paycheck, a 1099, whether it’s rental income, incomes can typically come from almost anywhere, and it’s all going to be relatively taxed the same. When we talk about long-term capital gains, which we’re not going to talk about right now, but we will talk about Social Security.
Every day a couple, let’s say they have $70,000.00 of income on the tax return and retirement. The first couple, they said, “I’m turning on Social Security today, and I’m going to fill the gap for the rest of my life coming from my IRA bucket”. Let’s say $70,000.00 of income, or $50,000.00 of it’s coming from the IRA. Call it a pension, call it what you will, and $20,000.00 of it is coming from Social Security. The second scenario, which has the same $70,000.00 of income, but somebody has gone through putting all the pieces together again. That’s part of the Thrive Retirement Roadmap Review when we sit down with people saying, “Hey, what if we change things up a little bit to long-term,” same $70,000.00 of income, but now $50,000.00 is going to come from Social Security, and only $20,000.00 is going to come from that IRA.
In that very first scenario, we take people through it. It’s a lot of moving pieces, but again, these are things that we love to dive deep into people with, just really talking about U.S. people on the rim, asking “how many people like to pay taxes?” No hands go up.
So when you understand how Social Security is taxed differently, in the very first scenario, $50,000.00 coming from IRAs or pension, and $20,000.00 coming from Social Security, the amount of money you’re going to pay in taxes, and I’m not talking about the state, so forget Jersey, Delaware and Pennsylvania, for just a moment. But, you’re going to write a check with $70,000.00 of income for $4,467.00.
It sounds like a lot. $70,000.00 of income, but $4,467.00. So, we’re paying the government almost about $350.00-$370.00 a month is the government is inside your pocket. We take people through the educational piece of, “Okay, what if we waited on Social Security, and pulled from our assets a little bit earlier?” We’re low long-term. $20,000.00 is coming from IRAs and $50,000.00 is coming from Social Security. The exact same math, the exact same equations. What you find is you owe a check at the end of the year to the government for $25.00.
So, if you had a choice of $25.00 versus $4,467.00, which would you rather pay the government? You don’t have to answer, because everyone’s answering the same exact thing.
When you talk about whether you want to go spend time down in Florida, or Cape May, or Karen talking about, “I want to go spend some time and take the kids, the grandkids, on a big vacation.” What if I just found $4,400.00 a year for you by not paying the government, where you can go take the grandkids to Disney? Because nobody likes paying more than they have to.
What an unbelievable example. First of all, $4,400.00 is a significant amount of money.
That’s right. It’s all about coming up with that plan. Again, part of the Thrive Retirement Roadmap Review is that planning on the tax aspect side, so much it’s always your investments. Again, we talk about the dominoes. We’ve got to put all those puzzle pieces together to figure out when I should do what. The people that have become clients of Thrive appreciate what we go through with them on an annual basis.
And it’s just an illustration of reactive, which is most people do, versus being proactive about the education. There’s a big difference.
David, I know you’re taking a nap in the afternoon, but you must be sleeping well at night. That’s an unbelievable thing to be able to help somebody out.
We have another area where you can save money and taxes, so that’s good news, right? Even if all your money right now is currently sitting in tax deferred investments, because you that was the best thing to do, when you were working. So perhaps at this time, some retirees might have stopped working, but maybe they’re not 70 1/2 yet, maybe 60, 65. At this point your income has dropped. What that means is your tax rate is going to go down because you’re no longer bringing in an income. That makes early retirement a great time to pay tax on your deferred savings, transfer some money to tax-advantaged Roth IRA’s. I know Bret’s going to talk a little bit about that. People know that’s something they can do. You can convert money that’s in a traditional IRA, or a 401K into a Roth IRA, but they’re not sure how to do it. It sounds great, yeah, you can do it, but you have to pay income tax on that money.
When’s the best time to do that?
It’s very hard to be creative from a tax standpoint. Again, getting that W2 or that 1099, it’s showing up on the tax return no matter what. Nothing we can do. But again, cleats are hung up. Again, big difference between when we talk about the word cash flow, and when we talk about what’s taxable income. Cash flow is what we spend. Not all the money that we pool from, our different buckets are taxable showing up on a tax return. First, when we enter retirement, we can pick and choose and be almost as tax efficient as we can, especially during the decade of our 60s.
When we start talking about items like, “When should I sell my beach house down in Cape May,” “When should I sell maybe some of that stock?” Or, what Karen just talked about, “Maybe I should start converting some of my Roth IRA’s.” Again, I just shared again in the very first segment talking about zero. Who likes paying taxes? Nobody. How do we get our taxes to zero every year? A lot of times, we meet people as they enter retirement. We met a couple, and when we first met them, they had about $48,000.00, $4,000.00 a month coming between their two Social Security checks.
Then, they were pulling the rest of their money that they needed on a monthly basis from buckets that weren’t showing up on the tax return. So, what we soon realized is if they’re just drawing from Social Security, they’re paying no taxes whatsoever. That’s a good thing. No taxes. Zero. But what we had identified going through this process was they had some stock that they had been sitting on forever. They had inherited it a while ago, they had about $50,000.00 of long-term capital gains in that stock. We had identified with them that we should sell off enough of that stock that we want to show a $20,000.00 long-term capital gain this calendar year.
Again, if we did it last year while I was working, I was going to have a 15 percent tax. So, 15 percent of $20,000.00 is $3,000.00. Again, $3,000.00 doesn’t sound like a lot, but it’s not what? It’s not zero. So, we identified $20,000.00 being sold from their stock that they could realize on this tax return, on top of that $48,000.00 of Social Security income, in addition to that, they had some of those tax deferred buckets that Karen was just talking about. They’ve never paid taxes on it. Conventional wisdom says don’t touch it until 70 1/2. Don’t touch until 70 1/2. We said “No, we liked zero.” We had identified another $12,000.00 from their 401K/IRA’s that we said, “Let’s go convert that to a Roth IRA.”
And they could have done whatever they wanted to do with it. We just wanted that $12,000.00 to show up on the tax return.
So, let’s assume that we’re going to move it into what we call is a partial Roth conversion. What happened when we put all those puzzle pieces together? Again, they were already paying no taxes. $48,000.00 of income, now we’re adding $20,000.00 in long-term capital gains, plus an additional $12,000.00 they can pull from their IRA/401K. That means that we went from $48,000.00 on the tax return to $80,000.00 on the tax return. This sounded really good before, where I was paying nothing in taxes, but when we did that the amount of money, they owed in taxes going from $48,000.00 to $80,000.00, $161.00.
By simply doing things in the right order, when you should. Again, that’s part of that Retirement Roadmap Review. Sharing with people when to do what, in certain times of retirement. If you knew there was a way, how you could pull money from a long-term capital gain standpoint, and/or pull money from your IRA/401K, and never pay taxes on either of those events, does it make sense to figure out how that applies to me?
The only way you’re ever going to get to that result, and to understand that result, and feel that result, is to start. You need to start.
Yeah, and it gets me thinking a little bit. I remember hearing this story about how there are people who can leap over tall buildings, there are people who can leap over short buildings, and then there are people who can run into buildings.
The point of it is when we sit with clients or prospects, there are people who are self-directed, very educated, easily could leap tall buildings in a single bound, but we introduce them the ideas that they may not have heard of before, right? They’ll take our information, it’s complimentary, and they’ll go do it themselves, and God bless them, good luck. We’re fine with that. That’s what we’ve committed to, that we’ll provide advocacy, empowerment and education. If people want to be our clients, great. If they don’t want to be our clients, great. It just is what it is.
Then there are people who can leap over small buildings in a single bound. These are people who need the assistance of an advisor so that they can get educated, understand what’s happening, rationalize it, and then okay, that’s a good decision. I want to do that. Then, like me, I love cars, I love racing cars, I love driving cars, but I couldn’t fix a thing on a car.
So, we have clients like that who don’t know what the question to ask is. For those folks, we bring up the questions and then we help them answer. That’s why that Thrive Retirement Roadmap is really something that could apply to all people, for the person who can leap over tall buildings, the people who can leap over small buildings, and the people who could run into buildings.
We fit all of those types of people, and providing education empowerment, about these ideas like Bret just talked about. I mean seriously, the difference between paying a $4,400.00 bill for taxes a year in retirement versus one that you pay $25.00. It’s a no-brainer that you would want to learn how to find out if that’s applicable to you. And then you would want to learn how to find out if that’s applicable to you, and then number two, how you could increase your income from 48,000 to over 80,000, and only increase your tax consequence by $161. Who wouldn’t want to at least explore if that was something that could apply to their retirement plan.
Why is it, do you think, that many people don’t?
Joe, I’ll be honest with our audience, and I hate saying that, but I’m always honest with it, but what I recognize is that our industry does have a black eye, and it really puts a cautious tone in most people that are out there, because we’ve had the Bernie Madoffs, and we’ve had Wells Fargo issues, and the list just goes on, and on, and on, and on. When I was watching that movie, The Big Short, at the end, they said, “Not one financial executive had ever been charged with a crime or spent any time in jail for the biggest financial calamity that any of us have ever experience.”
To be quite honest, that makes me want to fight that much harder on a daily basis to right the wrongs that our industry has done to most consumers, and I hope through our offer of sitting down with an attitude, “If you want us, we’re there for you. If you want us for information, we’re there for you. If you want our information, you don’t necessarily want to be our client, that’s okay, too,” but I hope that we can impact many people in this tribe, get them educated, and have them share the word that we’ve passed on so that it improves people’s lives in retirement.To be quite honest, that makes me want to fight that much harder on a daily basis to right the wrongs that our industry has done to most consumers Click To Tweet
What are your thoughts on this, Bret?
That’s education of advocacy. It’s why we do our workshops. It’s why we’re not necessarily doing big steak dinners. How can we make an impact in this community to make a difference? It’s putting those puzzle pieces together.
I agree, and I’m looking forward to it, and to enjoy retirement, you have to start preparing now, and little things make a difference, and everybody should enjoy their retirement. They shouldn’t be worried about where they’re going to live or health insurance and all that. You prepare for it. Don’t stick your head in the sand.
How has Roadmap to Retirement, the book, been doing? you have given away copies, right?
We recieved fantastic feedback on that, and I tell people that come out to the workshops that if you call our office, we’ll get you a complimentary copy. It’s on Amazon for $19.95 and 100% of the proceeds of all the sales go to a charity called BeatCancer.Org, which I’m a board member of. However, I like to remind people that if they Just call our office, we’ll get you a complimentary copy.
So, a lot of what’s in the book is talking about mistakes, the mistakes that we see people making during retirement. What we had Karen and Bret talking about were missed opportunities, So, those are strategic. Those are oriented around planning, doing things in advance so that you can optimize taxation in retirement. What I’m going to share a little bit is some of the mistakes that we see people actually make during retirement. It has a lot to do with retirement plans, because people tend not to know all the rules that apply to what we call decumulation, distributing your assets versus accumulating.
So, some of those revolve around these things called required minimum distributions, and it’s a topic that we discuss heavily in our workshops and during our appointments with folks.
So, I ask people all the time, “Do you know how to calculate required minimum distributions across multiple tax-deferred retirement accounts?” I get that kind of raised eyebrow look and they say, “Well, what do you mean?” Well, the situation we typically see is many families today have four or five different IRA accounts. So, they may have been employed and either left that original employer or were laid off, and after they got laid off, they rolled over the 401(k) plan into a self-directed IRA with Vanguard or Fidelity or Schwab or something like that.
Then, they got reemployed, and that company happened to have a 401(k), and that’s where they actually retired from, and have yet to roll over. so on that employer-sponsored plan, they still have that IRA or a 401(k) plan, and then during the financial crisis back in ’07 through ’09, a lot of people left the markets. They had money sitting in IRA accounts, and they went to local banks and credit unions and opened up IRAs with CDs and money markets. So, we typically see four or five different IRA accounts when we review for folks, so I ask,“Do you know how to calculate your RMD across all of those? Especially if you’ve got some with brokerage and some without and some at the bank, you’re responsible for coming up and reporting how much needs to be distributed out to your family through those RMDs.”
So, we ask that question, then we ask the next question, “What if the calculation you made is wrong?”
So, I talk about that a little bit, and I let them know we have this benevolent organization called the IRS, and they’re kind and they’re sweet, and they let you get away with making mistakes. We know that’s all not true. So, what happens is there’s a penalty assessed, and what I try to share with people is a tax, a penalty, is a tax for doing something wrong. A tax is a penalty for doing something right. So, we want to make sure people understand what the effect of a penalty if you make the calculation wrong. So, Joe, do you know that If you take money out in early distribution before you’re 59-and-a-half out of an IRA, there’s an early withdrawal penalty. Do you know what that percentage is?
No, I do not.
Yeah. So, that’s a 10% penalty, which you would think, “Okay. I mean, no penalty is actually fair. It’s our money, but okay. They assessed the penalty. It’s 10%. So, maybe that’s somewhat reasonable.” The penalty for making a miscalculation on your required minimum distribution is 50% of the mistaken amount. So, that’s a big deal.
It is a big deal, and a big number.
That’s a big number, right? So, it really is in everybody’s best interest to make sure that they don’t make a mistake on the calculations. Now, some people will say, “Well, my financial advisor does that for me.” So, I’ll tell you a quick little story. We had a client, a prospect who came in and visited with us for our Thrive retirement roadmap review, and through our calculations, we calculated that he made a major mistake on his RMD calculation, and his response was, “Well, I’ve worked with my financial advisor for 25 years. There’s no way that I made a mistake on this,” and our response was, “Hey, look. We’re not going to argue with you. I mean, we did our calculations. We believe we’re right. If you don’t, God bless. Good luck.”
About two months later, we get a phone call from this gentleman, and he says, “You know what, guys? You were right. I made a huge mistake on my RMD, and it cost me 50%,” and when we dove into it a little deeper, what we found out was that this gentleman ended up having a second financial advisor, never told the first financial advisor that he took some of his money that he inherited and put it with another advisor, and the two advisors didn’t know which hand was doing what, and he always counted on the one advisor to provide the number for the RMD, never taking in the consideration that there was IRA money that needed an RMD from the second advisor. That’s where the mistake came from. So, my advice to our audience is full disclosure with your financial professional should be paramount. That way, you end up not making mistakes. So, those are two big things that we see.
That’s self-inflected, too, for sure.
That’s exactly it, and the second point of it is that we uncovered it before it actually could’ve and would’ve happened, but didn’t heed our instruction, because yeah, sometimes we understand that you don’t know who we are. You might not necessarily trust us, but that’s where that whole second opinion concept really comes in, and that’s something that’s so ingrained in me personally because of the medical experiences that I’ve had, and I try to convey that to the people that we talk about, is, “Yeah, you may love your doctor, but when you get a life-threatening condition, it’s probably not a bad idea to go get a second opinion from somebody who specializes in that specific condition.”
So, you may work with a financial advisor who’s done a spectacular job in helping you accumulate your wealth for retirement, but if you start to ask questions that are related to social security, Medicare, taxation, distribution of assets, and you don’t get answers that sound correct, or you get answers of, “Well, that’s not really my expertise. Why don’t you talk to your account, or why don’t you call the social security administration,” that is a huge red flag right at that particular point, being that you worked with that advisor who was a good starting pitcher, but you now need a relief pitcher to finish that game in a successful way for you.
it’s okay when you get to that realization of where you are in your life, that it’s now time to make a transition, selfishly, to be in your best interest.
Look, we appreciate loyalty, but the loyalty that you should most have is to your family and your money. So, those are some of the things that we basically go through to get people educated about distribution of assets, Joe, and all the things that we cover in that Thrive retirement roadmap consultation, and we want people to remember that’s a complimentary session with us, and they can schedule that by going to our website, and we have that start your journey right there. It’ll tell you how to do that, or you can call our office at 800-516-5861 to schedule that.
We thank everybody for tuning in. A special thanks to David, Karen and Bret for returning home from their vacation. Sometimes people go away, and they don’t come back, but at least for now, everyone is back On behalf of David Bezar, Karen Bezar & Bret Elam we certainly hope you have a great weekend. See you next time, everybody!