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Announcer: Would you like an opinion on a financial matter you're dealing with? Whether it's about retirement, investments, taxes, or 401(k)s, Scott Hanson and Pat McClain would like to help you by answering your call. To join Allworth's "Money Matters," call now at 833-99-WORTH. That's 833-99-WORTH.

Scott: Welcome to Allworth's "Money Matters." Scott Hanson.

Pat: And Pat McClain. Thanks for joining us.

Scott: That's right. We'll talk about financial matters, little bit about what's going on in the current economic world, lot about longer-term planning stuff, and...

Pat: How government legislation can affect your financial planning. Another example, this week...

Scott: Holy smokes.

Pat: ...we talked about this on the...we've had questions about this over the years from both our clients in our office or future clients that were coming to visit with us, as well as people on the radio show, around student loans. We're going to discuss that after we take a couple calls. And we'll dig into it a little bit. But before we...we can't do it, Scott.

Scott: Can't what?

Pat: We gotta take these calls.

Scott: Yeah, I know.

Pat: We were waiting [inaudible 00:01:35]. We can't talk about the student loan thing yet. I know you want to.

Scott: And we don't want to get too political either. Just...

Pat: But it is...

Scott: I do want to, it's been very [inaudible 00:01:45].

Pat: Look, we'll talk about how legislative issues can affect your personal financial planning.

Scott: It's not legislative.

Pat: Okay. Executive.

Scott: I would feel better about it. Anyway...

Pat: Let's just say executive. It was the executive branch, not the legislative branch.

Scott: But, you know, so, we're looking forward to taking some calls. We've got some calls today.

Pat: We're gonna talk about money. Your 401(k)s, IRAs, you have questions about life insurance. Someone's pitching you a product, a big, fat, you know, non-traded real estate investment trust or some sort of fancy life insurance policy that can do double backflips and make you rich overnight, bank on yourself. That's the one that I love the most, bank on yourself. Borrow money from yourself. What? You don't have any. And, by the way, why do you need a life insurance to borrow from? Can't you just keep money in the bank and not borrow at all, and spend that when you need it?

Scott: Anyway...

Pat: Anyway...

Scott: Well, usually those...

Pat: Look, there was a thousand ways to put lipstick on a pig, and financial services industry is...I mean...what if we were chefs, we would, "Oh, no, this is..."

Scott: Yeah. We'd all be [inaudible 00:03:01].

Pat: Yeah. If financial services industry was the food industry in America, most of Americans would be dead, right? And by and large, look, there are many, many products that there are things wrong with, there are many, many products that there is nothing wrong with but they're sold to the wrong people in the wrong way.

Scott: Yes, for sure.

Pat: I mean, most specifically, look, there is a place for annuities in the industry in some consumers, but the way they're sold and how they're used...anyway, if you'd like to join the show, 833-99-WORTH. That's 833-999-6784. And if you're listening in a podcast, give us a call, we'll schedule you and us to be together in the near future.

Scott: That's correct. Let's go to Brian. Starting off here with Brian. Brian, you're with Allworth's "Money Matters."

Brian: How you doing?

Scott: We're great. How you doing, Brian?

Brian: Good, good. Okay, my question is, my mother is 84 years old, and she's attempting to sell her only house that she's owned. She bought it in 1960 for $15,000.

Pat: Wow.

Scott: Okay.

Brian: She's attempting to sell it for $750,000, and she she's moving to another town, and she wants to immediately buy another house for the $500,000 range.

Pat: Okay. And was your...

Brian: Go ahead.

Pat: So I'm looking at this thinking capital gains tax here.

Brian: Exactly.

Scott: Is she moving closer to you? Not that often you see someone who's been...

Brian: Yeah. She's moving from the Bay Area to Modesto where I live.

Scott: Okay. So she's moving to be closer to you. Not very often you see someone been in the same house 50 years at 84 decide to move.

Pat: And, did your father live in there at any point in time?

Brian: Yeah, he did. He passed away about 17 years ago, I think, 18 years.

Pat: Okay. So 2005. What do you think the house was worth in 2005?

Brian: It's really hard to say. I would say it was probably closer to $500,000.

Pat: Okay. So...

Scott: Let's assume the house is worth $500,000 when your father passed away.

Pat: Let's assume it was worth $250,000. It's worth $750,000 today, right?

Brian: Yeah.

Scott: We can assume whatever. Let's assume it's worth...whatever. So, what happens in community property, assets held in community property, which I'm assuming this was, a surviving spouse receives property with a tax basis that has stepped up to the fair market value at that time.

Brian: Okay.

Scott: So, whether it's a primary residence like this or it's a stock in Chevron that they've owned since 1960 or whatever, that asset is stepped up in value...

Pat: In most circumstances if it is...

Scott: Yes.

Pat: ...properly titled. And we will make the assumption that this was properly titled.

Scott: Titled in order to accomplish that, because it could have been in a bypass trust that...anyway, but odds are, assuming that...so, any sort of capital gain would only be based upon what the value of the home was worth when your dad passed away, the difference between that plus any improvements, and what she nets out of the sale today.

Pat: So, my guess is there will be no capital gains on this. In fact...

Scott: Well, if it's worth $500,000, there won't be any.

Pat: Well, but he said that right now it's worth $750,000, correct? Is that what you said?

Brian: Yes.

Scott: Yeah. So she gets $250,000 exemption, personal exemption.

Pat: Yep.

Brian: Yeah.

Pat: They might have a little.

Scott: Yeah. I mean, find out from your mother what was done when your father passed away, and how everything's titled, see if she has any recollection and...

Pat: It might have a little.

Brian: Yeah. I don't think she did anything, you know.

Scott: Except remove his name?

Pat: Yeah, remove his...

Scott: Well, I mean, look, it used to be that we were only permitted $600,000 of exemption before we had estate taxes due upon our death. So there were trusts that were written really in the '90s, oftentimes that would create what's called a bypass trust automatically with half the assets when the first spouse passed away. So it could have been such that when your dad passed away, this house went into a bypass trust.

Pat: Yeah.

Scott: And maybe it wouldn't qualify for the primary exemption she would have otherwise. That's only...I mean...

Pat: That would be pretty rare for...

Scott: I've seen it, personally seen that situation.

Pat: [inaudible 00:07:44].

Scott: Yes. But, yeah, there's some outliers, though, so you want to make sure...

Pat: Yeah. So what you need is a good-quality accountant to kind of walk you through this.

Brian: Yeah. Okay. That's what I thought. She was just worried that she'd be paying the capital gains on $750,000, and, you know, we didn't know exactly.

Pat: There might be something there. There could be $100,000 or so, or $200,000 in capital gains. There might be a little bit there. She's moving out of the Bay Area to Modesto? Is that what you said?

Brian: Yes.

Pat: And her house is only worth $750,000 in the San Francisco Bay Area?

Brian: Well, in Hayward.

Pat: Okay.

Brian: Not in the greater San Francisco area.

Pat: All right. But she's moving to Modesto, which is, what? Is it Wealth Water Contentment? Is that Modesto's?

Brian: Yeah. That's what they say.

Pat: That's what they say. But, yeah, they got to think about these people when they're putting this. So, I've driven through Modesto. It's a small town in the Central Valley. And right over, there's this big arch that looked like it was made in the '50s. And it says "Wealth Water Contentment," and I'm thinking, "Man, that is one big, bold statement right there." You're driving into town just telling everyone, "There's wealth here. There's water. And you'll be content, dang it."

Brian: Yeah.

Scott: Anyway, appreciate the call, Brian. I hope it works well with your mother moving...

Brian: Okay.

Scott: ...to see you.

Brian: Thank you very much. Appreciate it.

Pat: Thanks.

Scott: You know, it's interesting how, Pat, our cities change. My wife and I were in Austin, Texas over the weekend, Saturday. Actually, we met with this couple that...she lived with us when she was 25. I think she babysat our kids when she was in high school. And then had moved back to the area, and was finishing college. And so she lived with us for, like, two years. We've had a few of these [inaudible 00:09:24].

Pat: Like, your wife goes around collecting these young [inaudible 00:09:29].

Scott: Totally. Anyway, so she met her fiancé. Anyway, she lived with us. They got married. We hosted the reception at our house. But we hadn't seen 'em in eight years. We went and visited 'em. They had their house, just had their third son. And it was really...anyway, that's a completely different story. But it's just...

Pat: That's kind of funny, you know, like, "Man, I'm old now."

Scott: Well, there was that. I did kind of think about the circle of life and all that. But Austin, Texas, I hadn't been there in several years, and that town is on fire. I mean, the amount of cranes there, and I was just thinking it's interesting how different cities, they tend to go through these seasons. Some never do, like poor Modesto we just talked about, but others will have...they'll run for a while, there's a hot place. I mean, right now, Austin's hot, Denver's hot, Nashville's hot. [Inaudible 00:10:19].

Pat: Now.

Scott: Now, probably...

Pat: San Francisco was, what? In the late '90s, early 2000s, when the dot-com boom, up until three, four years ago, it was absolutely on fire. You know...

Scott: [Inaudible 00:10:34].

Pat: Economics change, countries change, cities change. People change, but not a lot, okay?

Scott: Yeah. We get better at controlling our impulses that aren't necessarily healthy. Like, do you not think so? I mean, look at a 2-year-old, it's quite obvious, the selfish nature. You get all these...you [inaudible 00:10:57] learn how to control it that low.

Pat: Okay, I'll go with that.

Scott: We're probably still with [inaudible 00:11:01].

Pat: Okay, well, enough of the psychology and onto the clients.

Scott: We're talking to Vanessa in California. Vanessa, you're with Allworth's "Money Matters."

Vanessa: Hi there.

Scott: Hi, Vanessa.

Vanessa: I'm good. How are you guys doing?

Pat: Good. What can we do for you, Vanessa?

Vanessa: Yeah. So, I have a question in regards to my student loans.

Scott: Oh, perfect timing.

Vanessa: I know. I couldn't have come at the perfect time.

Scott: No. I know. We just started the show and everything.

Vanessa: Yeah. So, I have a massive student loan amount, so I'm in debt a massive amount. I have two master's degrees, and so I went to college abroad, and then came back and went to USC. So, as you can imagine, it's a large amount. But I recently came into some money and I was debating whether or not I should pay them off directly because I do have a really high interest rate for student loans right now.

Scott: How much do you owe in student loans?

Vanessa: Current payoff would be $146,000.

Pat: Okay. And how much money did you come into?

Vanessa: It's a settlement, around, like, $400,000.

Pat: Okay. And are you currently...?

Scott: Is the settlement taxable or non-taxable?

Vanessa: Non-taxable.

Scott: Okay.

Pat: Okay. So you got a net of $400,000. Are you employed?

Vanessa: I'm currently employed, yes.

Pat: How much do you make?

Vanessa: I make $90,000.

Pat: Okay.

Scott: And how much of this $146,000 is government loans?

Vanessa: It's all government. So, the tricky thing, too, is I was on the Public Service Loan Forgiveness, and there were counting payments. And then something happened once the new administration came in. They took away some of the payments, so I was like, "Oh, my God." So I haven't been paying on the principal. It's just been interest. So it started off with $100,000, like, once, like, I got out of grad school, and then it's grown on that amount. So it's like...

Scott: And have you made payments the last two-and-a-half years since COVID when they put a pause on payments?

Vanessa: I believe the payment was paused but it still counted, so [inaudible 00:13:17].

Pat: So the interest continued to accrue? Is that what you're saying?

Scott: But were you making payments or not making payments?

Vanessa: I wasn't making any payments. But the interest wasn't occurring at that time, so I was like, oh...

Pat: It was not?

Vanessa: Yeah.

Pat: Okay.

Vanessa: It's zero.

Pat: How old are you?

Vanessa: I'm 37.

Pat: And what are the prospects for...?

Scott: Wait, was the interest still accruing or not accruing?

Vanessa: Not occurring during the pause.

Pat: Okay. And what are the prospects for your income to go up in the future?

Vanessa: Pretty good. Like, in terms of career?

Pat: Yeah. Like, in five years, are you gonna make $200 grand a year, or $150,000? What do you think?

Vanessa: Probably when...hopefully, $200,000, but maybe $150,000.

Pat: Okay.

Scott: I mean, so what was just announced this week, the Student Forgiveness Loan...there's a number of things in there. So one was...

Vanessa: Yeah [inaudible 00:14:07].

Pat: Yeah.

Scott: One was $10,000 for just about anybody that has federal loan, as long as your income was less than $125,000, single, or $250,000 of married. But then there was another $10 grand for Pell Grants. Did you qualify for that?

Vanessa: I do qualify for...

Scott: Okay. So you got $20 grand, was just forgiven for.

Vanessa: [inaudible 00:14:25].

Scott: But the bigger issue in there...and we'll see if this stuff doesn't get challenged in court. But the real nugget in this, that I've only seen written about in one place, is that you're only required to make payments of 5% of your discretionary income.

Vanessa: Exactly. Yeah.

Scott: And after 10 years, that's forgiven.

Vanessa: Yeah. I think it's dependent on the payment plan that you choose. So some are, like, 10 years, some are 20 years.

Scott: That's [inaudible 00:14:57].

Pat: That's what it used to be.

Vanessa: Okay.

Scott: Now, I'm not a legal expert. I haven't read the actual executive order.

Pat: So it's being dripped out a little bit, and, you know, we're taping this thing on...what day is it? Thursday.

Scott: Thursday afternoon.

Pat: And it was announced Wednesday, so yesterday. So we haven't dug into it too much. But here's what it looks like.

Scott: And the discretionary is not all income, it's income above a certain amount.

Pat: Yeah. So, Scott, before we answer this question...

Vanessa: Okay.

Pat: ...I'm gonna have to do a disclaimer to the rest of the listeners so that we don't get tons of hate mail.

Scott: Well, we're conflicted, right? We're conflicted.

Pat: Look...

Vanessa: I'm conflicted, as well.

Pat: Okay. Look, first of all, we were gonna talk about this later on, and this was just happenstance...

Scott: Perfect timing.

Pat: ...that you actually called in, and maybe you could join in the conversation. The disclosure to the listeners is, look, Vanessa called in about her own situation asking for our help. And our job is to help Vanessa, regardless...I shouldn't say how we feel morally, because there are lines in the sand.

Scott: Well, no. I think it's, I mean, we're taxpayers, number one, we're financial advisors, also, right? So...

Pat: Yeah.

Scott: And whether it's this student loan issues or it's how to maximize your social security...

Pat: Or how to pay less in taxes.

Scott: Or how to pay less in taxes.

Pat: Not to cheat.

Scott: Or how to maximize your government pension. We're in the military, how do you bridge some of these things?

Pat: Yeah. It's not to cheat.

Scott: It's not to not follow the rules.

Pat: It is to exploit the rules to the maximum benefit for the client.

Scott: When you play Monopoly, you sit down, "What are the rules? What do we...?" You abide by the rules and you try to take out your...that's just how the game's played.

Pat: That's how it's played. So, how I feel about the advice I'm going to give you, I'm conflicted.

Scott: So, Vanessa's your younger sister, Vanessa's your daughter.

Pat: Okay. I had children quite young. I would have had children quite young...

Scott: That's [inaudible 00:17:02].

Pat: ...if Vanessa was my daughter.

Scott: You're what, 59?

Pat: Yeah. So I was 22?

Scott: She could easily be. Many parts of the world, you would have had many by this [inaudible 00:17:08].

Pat: Yeah. And she loves her dad. So you would state, don't pay a dime. Pay as little as you possibly can.

Scott: Pay that 5% of the discretionary income.

Pat: And especially if you don't think you're gonna be making...you know, you said hopefully $150,000, maybe $200,000.

Scott: How high is the highest interest rate?

Vanessa: My interest rate, once it goes back, once the pause ends, it's 7.9%.

Pat: Well, who knows what's gonna happen now, though? I mean it's just everything...

Vanessa: True.

Pat: So, I would apply for everything that absolutely applied to these loans in terms of forgiveness, deferral, every part of it.

Scott: And there's a chance that there's a lawsuit, the judge puts a pause on this.

Pat: Scott...

Scott: But I don't know who's gonna file the lawsuit.

Pat: ...she owes $146,000. You know, unless they go back and start looking at the assets, I wouldn't dive into those assets to pay down these loans. And this isn't new advice we've been giving to clients. I remember sitting down with the children of an existing client, and he was 26, and married a young lady, and they both had $150,000 in student loans. And I said, "Pay as little as possible."

Scott: Yeah, here's the challenge as you're stating this. Because as a taxpayer...and I guarantee this is so...

Pat: Anyway, I'm sorry, Scott, let's finish up with Vanessa and we'll let you go, Vanessa, when we continue this conversation. But apply for everything, then what you most likely are gonna end up doing is paying this 5% of discretionary income. And these numbers will come out the next week. Don't at this point in time plan on using any of that $400,000 to pay down this loan. Not a penny.

Scott: I would wait.

Vanessa: Okay.

Pat: And, in fact, I would invest that money for the long term. So I would maximize your 401(k) or 403(b) at work, and I would actually then start funding a Roth IRA. And it might make sense for you to sit down with a qualified advisor and do a little bit of financial planning.

Scott: Yes, particularly with this...

Vanessa: Yeah. That's my next step because I'm like, I don't know what to do with this money. I'm like...yeah.

Pat: Yeah. Sit down with someone that's qualified. This is life-changing for you and your retirement, and you should treat this as retirement money.

Vanessa: Okay.

Pat: All righty? Yeah.

Vanessa: That's good advice.

Pat: I appreciate.

Vanessa: Cool.

Scott: Thanks, Vanessa.

Pat: Thanks.

Scott: And this a perfect segue into the conversation about this because, look, it is painful for me to even state that.

Pat: To answer that question.

Scott: Correct.

Pat: Look, and Vanessa is...

Scott: And, frankly, I'll be totally...I was so upset yesterday about this. My wife was, kind of, like, "What is...?" I'm like, where does this stuff end? You look at the education system, they keep...I read 9,000 new master's degrees have been created in the last 20 years. So these educational institutions, they have all kinds of crazy degrees regarding nothing. It's not gonna help you get a job. And taxpayers, "Oh, no problem. Here, sign up, young kid. Go get yourself a dorm. Have a kegger [SP] party. Go study the humanities, whatever..."

Pat: No. But Vanessa went overseas, she studied abroad. Do you think studying abroad...look, sure, it's culturally enlightening.

Scott: It's wonderful. It's a luxury.

Pat: It is a luxury. Not the luxury the government should be paying for.

Scott: I would have felt better if they dealt with the problem. The root problem is the fact that we allow these kids at 18 years old to sign up for tens of thousands dollars' worth of student loans when no one cares if they actually have the ability to finish college, number one. They may not be...some people just...it's hard. Yeah. They may not be able to finish college, number one.

Pat: It took me twice.

Scott: Number two, we don't care what kind of degree it's in.

Pat: It doesn't [inaudible 00:21:03].

Scott: It could be basket weaving degree. We don't care. And we just give 'em all this money. And then, oh, wow. What do you know? They've racked up $120,000 in debt and they can't get a job. That's really sad. We should forgive their loan.

Pat: Yeah.

Scott: And the worst thing of what happened this week was not the $10,000 or $20,000. It's the fact that it's new, you only have to pay 5% of your disposable income, and after 10 years, it's forgiven. And some estimates say this is a trillion-dollar transfer.

Pat: Well, Scott, look, it is...

Scott: And think about this, so a married couple, $250,000.

Pat: It's a lot of money.

Scott: I don't know what percentage of families are making $250,000 or more.

Pat: It's a lot of money.

Scott: But there's a whole lot of...there's families that are making $80,000 that are the ones given the...

Pat: Yeah. They're paying taxes.

Scott: And it's not like the government has any money.

Pat: So, Scott, here's the...

Scott: With $30 trillion in debt.

Pat: Look, we have been saying this for years and years, and years, that, look, if the cost of money is cheap, the cost...

Scott: Or free.

Pat: ...of the product goes up.

Scott: Goes up. Which is why we've seen the inflation in colleges, right? Which is...

Pat: Which is why we've seen inflations in colleges, is because of the student loans and the grants, because...

Scott: They got all kinds of crazy departments. You've all read 'em, and they're crazy.

Pat: Yeah. So, it's the same thing, like, look at home prices dropping right now. Why are home prices dropping? Anyone out there? Why are home prices dropping?

Scott: Because the cost of money went up.

Pat: The cost of money went up.

Scott: Mortgages are more expensive. Buys, less.

Pat: Buys, less. So, we saw this in every, you know, commodity pricing. If there appears to be, first of all, no risk...

Scott: Which is why we saw the housing boom in the 2000s.

Pat: Cost of money got really low.

Scott: Zero.

Pat: And before then, they would lend anyone money without any underwriting.

Scott: It wouldn't matter if you had the ability to repay.

Pat: That's exactly what happened here.

Scott: It's 100% the same.

Pat: Hundred percent the same.

Scott: And think about this, so, by the way, if you're still listed as a dependent on your parents' tax return, you don't qualify. So, think about this. You got three students, all graduated at the same time. Two are employed at jobs, are doing well. One is not. But the one still claimed as the dependent, that person does not have the forgiveness. The two that have great jobs have the forgiveness of debt.

Pat: Yes. Well, actually the kid that's the dependent...oh, it's because it's based on last year's tax return.

Scott: And your parents'.

Pat: But think about this. Scott, you know my brothers. There's four of us and then my sister in the family. Two of them did not go to college. One is a heavy diesel mechanic. He works his butt off. Works for a large utility...

Scott: Heavy diesel makes a good living.

Pat: He makes a good living. But he worked as a tradesman as an apprentice for years in order to become the job he's got. We all love to chase our path. I spoke at a high school recently, and this kid...don't, by the way, have me come and speak at your high school, because it's not necessarily the message the high school students want to hear.

He said, "You know, I heard that if you do what you love, you'll be successful." And I said, "Define success." "Like, you know, money, nice living." "That's garbage. That's absolute garbage." I said, "Most people end up in jobs that they don't do what they love. They do what works. If they're lucky, they do what they're good at, and that they kind of have an interest in or some sort of a passion. But if you just chase your dreams, come on. Are you out of your mind? How many musicians are playing small-town bars on Friday and Saturday nights, that wanted to...?"

Scott: That's what you told all these poor kids?

Pat: Angry McClain.

Scott: Yeah.

Pat: [Inaudible 00:25:08].

Scott: I was already feeling bad about my future, and then McClain comes in and talks to me.

Pat: I was not gonna continue the story of, "Just follow your passions, do what you love, which is...look, that's what a lot of the college...just take whatever class you think might interest you into graduating with a degree..."

Scott: That's a luxury.

Pat: That is a luxury.

Scott: This whole four years, that whole concept, it's broken.

Pat: Anyway, student loans. Look, let's relate to...

Scott: I remember a couple years ago, someone called, "Should I get a student loan?" Like, "If you qualify, get a loan."

Pat: Absolutely.

Scott: "Because it might be forgiving." Here we are.

Pat: And, look, that, financially...you hear our advice about social security, if you don't need it, take it. If you don't need it, take it.

Scott: The same concept.

Pat: Same concept.

Scott: I don't like giving this advice, but, you know, anyway, we'll be right back. This is Allworth's "Money Matters."

[00:26:00]

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[00:26:15]

Man: Can't get enough of Allworth's "Money Matters." Visit allworthfinancial.com/radio to listen to the "Money Matters" podcast.

Scott: Welcome back to Allworth's "Money Matters." Scott Hanson.

Pat: And Pat McClain. Thanks for sticking with us. As we veer back into the topic of personal finance, we talked about economic finance. But, quite frankly, I try to veer back into personal finance, there is no way you can separate national finance from your own personal finance in any country in which you live.

Scott: Oh, 100%. You really...

Pat: You cannot. It is a large driver of decision-making...

Scott: How you conduct business.

Pat: How you save for retirement.

Scott: Who you work for.

Pat: And, you know, if you're thinking, you know, "How could you get away with saying that?" Taxation, or lack of taxation has a large ability to actually influence or discourage types of behavior, which...

Scott: They use the tax code for that sort of thing.

Pat: Which is why you actually see lots of taxes on alcohol...

Scott: And cigarettes.

Pat: ...and cigarettes, and other things, and even petroleum products, gasoline in order to discourage that use, and you see tax breaks on things where they try to encourage, like a mortgage deduction, or deferral of taxes, deferral in [inaudible 00:27:39].

Scott: Solar panels, green...electric cars, windmills.

Pat: All those things. And so, we've moved one step beyond taxation in terms of encouraging and discouraging behavior, which are grant programs, or programs that you pay into and then take money out of. Student loans, government grants, business grants, social security is program that you pay money and take money out of. And now what we're seeing is it has moved past the tax code and further and further into this...

Scott: Administrative and legislative.

Pat: And legislative, direct funding of particular businesses. By the way, oftentimes it's the government...

Scott: I was troubled by the CHIP bill that had broad support on both sides of the House. Like, the chip industry is already kind of solving this problem, and now the government's gonna decide which company gets billions of dollars?

Pat: Yeah. Let the market...but, so...

Scott: By the way, I had to go to the DMV. Did I mention this?

Pat: No.

Scott: I went to the DMV, and I was already expecting a bad experience. I had to go twice. That wasn't a good experience. Kind of my bad. I actually had a good...I barely waited. They were so friendly. I could not believe it, because I would usually use that as, there's government at its finest, and I had a nice experience at the DMV.

Pat: Thank you.

Scott: I'm going again next month maybe.

Pat: Hey, if you need your car registered, call Hanson. He'll go down and register your car for you.

Scott: I was terrified of going.

Pat: It's like, listen, you need some errands done? Scott opened this new business called DMVs "R" Us. And you just give him. He's...

Scott: Yeah. Limited power of attorney, I'll do the DMV work for ya.

Pat: He enjoys the DMV so much. Anyway, so personal...

Scott: Maybe my expectations were so low it didn't take much to exceed 'em.

Pat: That's right.

Scott: Because I felt beat up last time I was there.

Pat: [Inaudible 00:29:38]. Anyway, so personal finance. We are a personal finance show. If you'd like to join the show, 833-99-WORTH. That's 833-999-6784.

Scott: Yeah. And we want to talk about target-date funds because they are massive. They are in just about everyone's 401(k) plans, and they're used quite a bit. So we've asked Brian James to join us. Brian is a certified financial planner with Allworth Financial, and he's a regional director with our Cincinnati office. So, Brian, glad you're with us.

Brian J.: Thanks again for the chance to talk to you a little bit.

Scott: Yeah. So, briefly, what's a target-date fund and, you know...?

Pat: And what other names do they go by?

Scott: Yeah.

Brian J.: Target-date funds have a lot of fun names, don't they? There's a lot of marketing slathered on top of it. So these are the ones where you log in to your company's 401(k), or your 403(b), or what have you. Even the federal TSA has some cutesy names for 'em. But they'll be like the LifePath funds, or the glide path, or target-date, or...you know, there's a number of different things they go by, but the whole point of them, they're intended to be what I like to call the Kellogg's Variety Pack of investments, based on what you're looking for. So there's a couple ways [inaudible 00:31:01]...

Scott: My kids love the Kellogg's Variety Pack, though it's like once a year, I buy 'em for 'em.

Brian J.: Absolutely. It was a big treat for me. I'm 48 years old and I still remember the vacation [inaudible 00:31:08] a box of those and...

Pat: On vacation, right?

Scott: You're thinking about fighting with your siblings over who gets what.

Pat: Over who gets...

Scott: "I don't want the Corn Pops."

Pat: Oh, listen...

Scott: "You take the Corn Pops."

Pat: ...the Cocoa Krispies, you go in the night before. It's the only time ever that you'd actually get up early and hit the kitchen. I guess we lost our train of thought again, so...

Brian J.: But we all agree that nobody liked the Apple Jacks. Throw those away.

Pat: Okay.

Brian J.: But, yeah, so a target-date fund is a fund of funds usually. In other words, it is one mutual fund that owns a bunch of different ones. The name of the target-date fund will usually have a year in the title, so 2045, 2050, 2055, something like that. That number is roughly coinciding with the year that somebody who might want to invest in that fund, the year that they might retire. So the whole point is it's one place where you can put your money and it will already be geared from a risk standpoint toward when you might need to touch those dollars.

Pat: Okay. So, bringing that theory forward, the closer you get to retirement, the more conservative the fund becomes, which means the more bond that we'll have in the portfolio regardless of market conditions at the time that you're actually making that change?

Brian J.: Correct. Whenever we talk about risk in the investment world, I mean, there's lots of ways to slice and dice it, but the most common way of referring to it is, how much stock do you own versus how much on the bond side, on the fixed income side? Because bonds tend to be safer than stocks. This is a crazy period of time where right now it feels like everything's a little bit scary.

But over the long haul, which is what we're talking about with retirement, generally bonds are something you use as a way to tap the brakes on an aggressive equity portfolio. So if you mix, you know, half stocks and half bonds, that's a good solid portfolio that will get you a decent amount of growth, but won't necessarily keep up with the overall stock market. You're sacrificing something to get there.

But, anyway, a target-date fund, the idea is it's a way to throw just to have one fund. It's to prevent you from having to choose, build your own portfolio from this fund, that fund, 10% here, 5% there, all those confusing things that really cause people to say, "Forget it, I'll deal with this another time." And then what happens is you've never set up your 401(k) and you've missed just a year or two of market growth and contributions, and so forth. So target-date funds were intended to be a place where you could easily push a button and get what you needed.

Scott: When my daughter was 16, her first job, I funded her Roth IRA for at the end of the year. I used a target-date fund, so I got broader diversification. It was a tiny investment relative, you know.

Pat: But it sounds perfect. Why wouldn't I use a target? Or, why would I or why wouldn't I use a target? Give me argument for and against.

Brian J.: Yeah. So, the argument for is what Scott just said. I did the same thing for my now 21-year-old. When you got a few thousand dollars, not that much going on, we just need to get started, you can't put $22 into this fund and $5 into that fund. Target-date is a great way to do that. And you're generally safer on the more aggressive ones. They're just gonna own all stocks. If you're looking at a 2050, 2060, it's gonna be an aggressive fund. But when you get closer to your retirement goal, that's when you want to be more fine-tuned.

The way I always explain this to my clients is if you're a young person, you're basically standing on the tee box of a 600-yard golf hole. There is little question which club you're gonna pull out. You're gonna pull out the fat one and swing out of your shoes. When you get closer to the green, you might need your 9-iron, you might need your chipping wedge, you might need your sand wedge. You might need to be more specific. That's when a target-date fund may not make sense, because you gotta really look under the hood.

A lot of times, as I mentioned earlier, these are a fund of funds, so therefore there are multiple mutual funds involved, whether you know it or not. A lot of times, those funds underneath can have really high built-in expenses. Again, not a big deal for a 16-year-old with a few thousand bucks in. But when you're talking a couple hundred, maybe you have over 1 million bucks in these things, then that adds up to an awful lot of money where you can save yourself, you know, almost sometimes a 5-digit number over time by simply being more specific and using the individual choices that you have available.

And if you're confused by that, that's what a financial advisor and a financial plan will help you figure out, "First of all, what are my options with those target-date funds? Are they worth it? And if not, can I be more specific and benefit from building my own portfolio from scratch?"

Scott: I got it. And, you know, they really don't work well outside of retirement plans.

Pat: And they work terrible outside of retirement plans.

Scott: Because you have no control over any withdrawals. There's no tax control of your taxation...

Pat: And, yeah, when they rebalance the portfolio, you have no control over...in fact, there was a large settlement with one of the big companies...

Scott: Think it was Vanguard.

Pat: Recently.

Scott: Yeah. They were trying to be helpful by bringing down the minimum for their lower cost...anyway, they switched...whatever.

Pat: And what happened is people turned around and said, "Well, why did we pay these taxes?" And they're like, "Well, this is how the fund's designed. I mean, it's gonna make this move every year whether you pay taxes or not." Anyway, I kind of felt bad for Vanguard there, but there's probably a lack of disclosure to the consumers.

Scott: They were trying to do something good for the shareholders.

Pat: Yeah. But the other thing that I will point out that I don't like about the target-date funds is inside of that particular fund is typically all the mutual funds of that fund complex. And some...

Brian J.: Yeah. It's multi-layers of...it's just, "Here's a bunch of stuff we already do. Let's bundle a bunch of 'em up and call it something, 2045 or 2050 fund." It's not much different than what you could do on your own, but a lot of times, there's an extra-layered fee for a service that really isn't necessarily a service.

Pat: That's right. And you wouldn't necessarily...you know, I wouldn't go to, let's say, an equity shop that manages great equity or stock portfolios and ask them to put me in a high-yield bond, because they don't really specialize in that. And mutual fund complexes have a tendency to specialize in certain sectors of the marketplace. So, I actually, you know, as I tell my clients, is you get over $20,000, $25,000 in your IRA, you step away from the target-date funds. It's time, you know, to own this a little bit. And, by the way, Brian, I love your analogy about the golf course and 600 yards. And I hate golf, but I love the analogy. I shouldn't say...

Brian J.: I do, too. I can pull that big, fat club out and I can shank majestically into the woods. I'm better with financial planning than I am with [inaudible 00:37:43] analogy.

Pat: Thank you. So, I appreciate...

Scott: Yeah. Thank you.

Pat: I shouldn't say I hate golf. I'm just...

Scott: You tried for a while.

Pat: Yeah.

Scott: You did, right?

Pat: I did.

Scott: You joined a club and everything.

Pat: My wife joined a club, and then I went along with her.

Scott: It's a nice thing to do with your wife, right?

Pat: Yeah. That was the thought, but most of the time it didn't [inaudible 00:38:00] after [inaudible 00:38:02].

Scott: Swearing at each other?

Pat: It's supposed to be relaxing, and for some, it is. But, anyway, Brian, thanks for joining us.

Scott: Yeah. Thanks, Brian.

Brian J.: You bet. Take care.

Scott: And, by the way, I did, like, the Apple Jacks as a kid. Cocoa Krispies, same thing, first ones we would fight over, right?

Pat: Yeah. Well, how many kids...?

Scott: Corn Pops.

Pat: There were four of you?

Scott: Sort of. I had four...my parents divorced and remarried, and so I had three stepsiblings. So I had a couple years, there were six of us in the household.

Pat: And you get the Variety Pack.

Scott: And finances were tight. My mom would slip the powdered milk in with the rest of the milk, like, mix the two and then deny it.

Pat: Oh, she would deny it?

Scott: Oh, yeah.

Pat: Oh, we lived it. My mom made us mix it. But then we'd mix whole milk with the powdered milk, and it really wasn't that bad.

Scott: But if you're having the Cocoa Krispies, you want the real milk. We had to drink goat's milk, too, which was...

Pat: Really? Well, you were hip before your time.

Scott: Is that hip?

Pat: It is now.

Scott: I'm like, oh, yeah.

Pat: [Inaudible 00:39:04] the goat cheese.

Scott: Oh, goat cheese. We didn't make cheese.

Pat: Huh?

Scott: We didn't have the patience for that. We were too poor. We just drank the milk. We didn't have time.

Pat: All right, let's go to the calls.

Scott: I'm glad we are entertained by ourselves. So [inaudible 00:39:23].

Pat: We used to dream about powdered milk.

Scott: Oh, God. That's how poor we were. We had to [inaudible 00:39:28] the powdered milk with just flour.

Pat: My mom and dad would say, "Only the rich people drink that powdered milk." We looked up people like you.

Scott: Oh, gosh. All right, let's talk to Cynthia in Arizona. Cynthia, you're with Allworth.

Cynthia: Hi. Thanks for taking my call.

Scott: Yeah, glad you joined us.

Pat: What can we do for you?

Cynthia: I had...

Scott: Bring us back on target.

Cynthia: Yeah. Sober up, guys. I have some questions about what cost-based method to use. I have a retirement and then a brokerage fund at Vanguard, and I have the choice of...I'm probably gonna pronounce this wrong, FIFO, which is first in, first out average, HIFO, H-I-F-O, which is high...wait, sorry, what does HIFO stand for?

Pat: FIFO, first in, first out, which means that the...

Scott: The first dollars you put in, when you sell, it's those first shares you're gonna sell.

Pat: And then the average cost, and then there's LIFO, which is last in...

Scott: Or specific. Do you have an opportunity for...?

Cynthia: Specific. Yeah. But then there's this HIFO. So that's the...to my understanding, is they will sell at the highest price that you've bought, whatever the funds are. But you can't tell them, "I want only long-term." So, yeah, they might sell something that's been in your portfolio for under a year, so then you have to [inaudible 00:41:11].

Pat: But that's when you said specific. They just gave it a different name.

Scott: But why would you sell something you held for less than a year? I'm assuming you're retired now, or you're about to retire and trying to figure out the way to structure your retirement income. Is that what this is about?

Cynthia: Correct.

Scott: Okay.

Pat: And you said you had a retirement plan. This doesn't apply to any part of the retirement plan, unless you have some individual stock in your retirement plan that were actually individual stocks from the company you worked at?

Cynthia: No. I have funds with Vanguard. I'm talking about my brokerage account.

Pat: Okay.

Scott: Yeah. But they need to work hand in hand, the retirement, right? So you pay the least amount of taxes?

Cynthia: Yes. I figure it's gonna take me a while to spend down the brokerage account, so I'll [inaudible 00:42:01].

Pat: But, wait, what are you gonna live on in the meantime?

Scott: Her brokerage account.

Cynthia: The brokerage account.

Pat: So you'll have no income?

Scott: Just the capital gains?

Cynthia: Yeah. I have capital gains and some dividends, and then I have social security and a pension.

Scott: Okay. So the way to answer your question is we really need to figure out not only what will your income be this year, but what's your projected income over the next many years, several years, maybe even decades? So, for example, if you have a large-size retirement account that you allow just to continue to grow, you're gonna be stuck with taking required minimum distributions at age 72. And those are taxed as ordinary income.

Pat: Yeah. So let's just walk through it. What's your pension amount on a monthly basis?

Cynthia: Oh, it's small. It's, say, $600.

Pat: Okay. And how much are you receiving in social security?

Cynthia: Two thousand.

Pat: Okay. And how old are you?

Cynthia: Sixty-five.

Pat: And is there any other income coming in?

Cynthia: Just the capital gains and dividends.

Scott: And how much is in your brokerage account?

Cynthia: I think there's about $700,000 in there.

Pat: And how much is in your IRAs or qualified pension plans?

Scott: 401(k)s, that sort of thing?

Cynthia: Yeah. Well, my total net worth is about $1.4 million.

Pat: Okay. So there's $700,000 in...

Scott: Wait, does that count...?

Pat: Does that include your home?

Cynthia: No.

Pat: Okay.

Scott: So your retirement accounts are about $700,000?

Cynthia: Seven hundred and five...yeah, about that.

Pat: And is your home paid for?

Cynthia: Yes, it is.

Pat: Okay.

Scott: I mean, the challenge with the strategy...and this is why...we're not answering your question because it's dependent on these other things. If you allow your retirement account, $700,000, to grow for the next 7 years, and let's assume you earn 6% on it at that period of time, by the time you reach 72, you're gonna have over $1 million there. You're required minimum distributions are going to be almost $40,000 your first year. And that's taxed as ordinary income.

Cynthia: Yes.

Pat: So when you line these up, and you said...this is why I dug into this, is you said, "I'm just gonna live off my brokerage account, until that's used up. And then I'm gonna start using my IRA." That's not the way I would play it. I would do it one of two ways, maybe three ways. One is I would take money out of my brokerage account, and maybe then I would convert money in my IRA to a Roth IRA, at the same time.

Scott: Which triggers taxable income. Which means that it might be better off selling those shares that have the highest cost basis as opposed to those with the lowest cost basis.

Pat: And those that are gonna be recognized for capital gain. But how much stock do you actually have in the brokerage account versus bond?

Cynthia: It's about 60% stock, 40% bonds.

Pat: Okay. So you got $420,000 in stock, or [inaudible 00:45:12].

Scott: Cynthia, you've done a great job saving. It sounds like you're quite educated and these portfolios are probably built quite well.

Pat: And, who does your taxes?

Cynthia: I do.

Pat: Okay. So here's what I'd like you to do. I'd like you to actually go into your tax return. And, by the way, you do wanna do HIFO, which are specific. They called it HISO [SP], which is highest, but you wanna go out and make sure that you're recognizing this capital gain, not ordinary income. So the question you asked...and Scott said specific. And what you're doing is you're just identifying the specific stock that you're selling rather than just taking the last in, first out.

Cynthia: So with these specific...if I go the specific ID way, then I need to keep really good records, because I can't sell stock twice, right?

Pat: That's right. Oh, absolutely. Yes. That is your responsibility in order to track the cost basis...

Scott: Or the software that can do that stuff for you.

Pat: Yeah. Or your brokerage account may have the...you may have the ability in your brokerage account. But, yes, it's your responsibility. But above and beyond that, when you do your taxes this year, I want you to do some hypotheticals of converting money from your IRA to a Roth IRA. It might be just $30,000, $40,000.

Scott: Or less.

Pat: Yeah. But the reason what we're doing is, you're at a really low tax bracket...

Scott: Really low.

Pat: And you're keeping your...

Scott: And your social security is probably not even taxable. If you didn't take any distributions from your retirement account, nor have any real major gains from your brokerage account, your social security is tax-free. Once you start doing, either selling some of these securities or taking a withdrawal, it's gonna start causing your social security to become taxable. So that's another factor.

Pat: Yeah. And so, the reason you're converting from an IRA to a Roth IRA, or even just taking money out of your IRA and living on it would be acceptable as well...

Scott: Not preferred.

Pat: Yeah. You'd prefer to actually convert from an IRA to a Roth IRA, is because if you don't and you allow the IRA just to continue to grow, you don't have as much control over your taxation after age 72.

Cynthia: Yes.

Pat: So what you're trying to do is to keep yourself in the lowest tax bracket, to pay the least amount of taxes over the next 20 years. You're worried about, you know, the next eight years, and then you have given up a lot of the choices that you will have in terms of controlling your taxation. What we're saying is you are in the sweet spot of addressing that now.

Cynthia: A complication is that I'm a cancer patient, and I doubt I'm gonna be around in 10 years.

Scott: Okay. Well, then it just changes some of the planning as well, because the reality is if you hold these assets 'til you pass away, whether that's 10 years or 30 years, any capital gain is gonna be forgiven by whoever receives those.

Pat: Which means that it gets a step up in basis. And so, who do you have as your beneficiaries on these accounts?

Cynthia: Most of the time, it's charities.

Pat: Okay. And most of the time, it is not.

Scott: What do you mean "most of the time?"

Pat: Or some of the time, it is not. So you said most of the time, it is charities.

Cynthia: I'd say it's 80...actually, I don't have any family. So about 20% is gonna go to friends and then 80% to charity.

Pat: So here's what you want to do, is...

Scott: This...

Pat: This does change everything...

Scott: Changes things entirely.

Pat: It changes everything. You want the IRAs to go to the charities as the beneficiaries.

Scott: Because then you avoid all the taxation.

Pat: They never pay taxes on anything. They're nonprofits. And you want the brokerage account to go to your friends.

Scott: Are you giving any money to charity now of any sort?

Cynthia: Not a significant amount, no.

Scott: I mean, because when you're 72 and have required minimum distribution, if these things continue to grow and your net worth's much larger, you can take your required minimum distribution and direct it to charities, and avoid the taxation at that time.

Cynthia: Yes. I figured that...not figured out, but I've learned that, and I think that's a really good way to do things.

Pat: Yes. If you can, psychologically.

Cynthia: Oh, I can. That's not a problem.

Scott: But the other end, if she finds herself seven years out, and is in great health, and her life expectancy is longer, the least of her concerns is her required minimum distribution. I mean, at that point it's like, who cares? It's a really...yeah. So, having said what we've stated before, like, I don't think you should be...

Pat: You should not be converting to a Roth. Forget all that great advice we gave you, because...no, look, this is financial planning because life expectancy has...

Scott: For us, it's all about probabilities of outcome. So when you just threw that wrench in there like, okay. So just sell what you need...

Pat: I would actually just...I'd live off as much of the bond portion of the portfolio.

Scott: I would try to avoid any capital gain.

Pat: Any of it.

Scott: Because your social security is tax-free right now.

Pat: Yeah. And live off the bond portion. And you're like, "Well, you know, is that gonna be enough?" Yeah, probably. And just quit reinvesting dividends on your...

Scott: Yeah, stop dividend reinvestment.

Cynthia: Yeah, I did that.

Pat: Okay. And live off the bond portion. And if you want to sell some equities, sell the highest price ones first. I assume your trust is up to date?

Cynthia: I don't really have a trust [inaudible 00:50:59].

Pat: Okay. All right. Well, then we need to get on that, like, right now. Like, boom. You need to get a living trust.

Cynthia: I wonder if I do, though, because my accounts are payable on death.

Pat: Yes. In your own home?

Cynthia: Yes.

Pat: And you have ancillary...?

Cynthia: And I did a deed transfer. In Arizona, you can do something called a beneficiary deed. So you just file papers [inaudible 00:51:28].

Pat: If you have had advice that says that these dollars are going to...?

Scott: Something tells me Cynthia's done a lot of research on this.

Pat: Yeah.

Scott: Based on what you've done thus far.

Pat: Based on what you've told us, you're doing it. Don't make any changes.

Scott: In your situation, I would sell that with the highest cost basis, with the minimum amount of capital gain. And I would do everything in my power to keep your taxable income as low as possible.

Cynthia: Yeah. Those are my goals. So you say I...?

Scott: But they wouldn't be your goals if you told me...if you had a normal life expectancy, or if you said, "The genetics in my family, I'm gonna live to 100," that would be completely different.

Pat: It would be completely different advice.

Cynthia: Yeah. Now I realize I should have started with the cancer.

Pat: Yeah. We probably should have asked the question either [inaudible 00:52:13]. All right, appreciate the call.

Scott: By the way, we hope we hear from you in several years and you're dealing with the required minimum distribution issues. Anyway, unfortunately, we're out of time. It's been great having everyone with us. If you haven't been to our website lately, allworthfinancial.com, I think you'll enjoy it. Take care.

Announcer: This program has been brought to you by Allworth Financial, a registered investment advisory firm. Any ideas presented during this program are not intended to provide specific financial advice. You should consult your own financial advisor, tax consultant, or estate planning attorney to conduct your own due diligence.