Tariffs and Inflation on Investments, Smart Real Estate Moves, and Roth Strategies
On this week’s Money Matters, Scott and Pat break down the latest global market dynamics - tariffs, inflation, and their impact on your investments. Then, they dive into real estate strategies, capital gains taxes, and how smart investors can minimize tax liabilities. Plus, a caller shares their rental property experience, leading to an insightful discussion on portfolio optimization, Roth conversions, and securing your financial future in uncertain times.
Join Money Matters: Get your most pressing financial questions answered by Allworth's co-founders Scott Hanson and Pat McClain live on-air! Call 833-99-WORTH. Or ask a question by clicking here. You can also be on the air by emailing Scott and Pat at questions@moneymatters.com.
Man: 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: Pat McClain. Thanks for joining us.
Scott: Glad to have you with us as we talk about financial matters and a little bit of what's going on in the marketplace, and answering your questions and talking about what's on our mind, I guess, is kind of how sometimes the program works.
Pat: It is what it is. It is what it is.
Scott: Yeah. So good to have you with us as we talk about financial matters. And we like to say we try to stay apolitical, but in this environment, it's pretty difficult to not tiptoe in some areas because of the amount of chaos that is happening, not just economically, with what tariffs are going to be in place, what aren't going to be in place, but, of course, the whole political environment with the global environment with Eastern Europe, it's an amazing time. And then you look at the markets, they're kind of all over the place.
Pat: Day by day.
Scott: People are trying to figure out, what's this all mean?
Pat: What's inflation going to look like and how these tariffs are going to affect things and eggflation.
Scott: Eggflation. My daughter said to me this morning, "Dad, how come we don't have any eggs in the house?" I said, "Well," I said, "there might be some in the garage, in the garage fridge, but," I said, "there's a shortage."
Pat: Your daughter doesn't know how to go to a store?
Scott: She's 14.
Pat: Oh, I was thinking of your older daughter.
Scott: They don't buy their own groceries.
Pat: I was thinking your older daughter was visiting you.
Scott: Oh, my 29-year-old.
Pat: Correct.
Scott: Oh, I could see her complaining about something too. When she's visiting, I'd laugh her out of the house. Yeah. But it's just an interesting time. And then I got to tell you, from a financial planning standpoint, I think if you've listened to this program long enough, you understand our premise on investments, and so much is that nobody can predict what's going to happen. And if your objective is to try to navigate in and out of the top sectors and in and out of the stock market, we believe, over the long term, you will lose. You will do better if you have the right kind of strategy from the start and maintain that strategy through various market cycles.
Pat: Right? Yes. Well, especially if you have a diversified portfolio, it's very difficult to choose the right sectors, if not impossible.
Scott: And studies show that the average investor will do worse by trying to do that.
Pat: Yeah. So a diversified portfolio always has sectors in favor.
Scott: But I think what's interesting right now is not necessarily the asset allocation question. It's the future tax situation. Because you're starting to hear more and more chatter about a flat tax using tariffs and other types and sales tax.
Pat: Like a value-added tax?
Scott: National sales tax. I mean, that could be a real thing in the future.
Pat: Yeah.
Scott: We could see a time when the top rate is 50%. In federal, we could see a time when the top rate is 20%.
Pat: Or a combination of the two, right, where you actually have a value-added tax and national sales tax.
Scott: And slightly lower income taxes.
Pat: Yes. And look, sales tax is regressive. There's no question about the fact that the sales tax is regressive.
Scott: Yeah, because wealthy people don't spend most of their income.
Pat: That's right. And people of less economic needs...
Scott: How much Elon Musk spends of his billions of dollars every year as a percentage of his wealth?
Pat: Nothing. He just had another kid.
Scott: There are some means I don't even know how. I don't think he's father of the year award. Are you kidding? Or traditional family values. Are you kidding?
Pat: Can you imagine living up? Well, I guess it'd be like you've got nannies and dad, you see him on TV.
Scott: Anyway, I don't want to talk about Elon Musk's parenting strategies, but...
Pat: All right. I'd like to take some.
Scott: But what were you saying? You were going somewhere with that topic.
Pat: Oh, I said a regressive tax is...it's pretty hard to swallow, I'm going to tell you.
Scott: And national sales tax?
Pat: A national sales tax for... It's such a large change from where we have been with a progressive tax rate.
Scott: Historically. Correct. But I'm just stating, as you focus on your portfolio, your life savings, and structuring things...
Pat: Assume that what you're living in today will not be the same when you're taking the money out.
Scott: Correct. And say, "If it's different, how can I structure things today to be prepared for a variety of different scenarios?"
Pat: A diversified tax strategy.
Scott: Correct. And who knows exactly what's all going to come down the pipe. But my guess is something's going to change. We can't, clearly, we can't...you know, the government spends about 35% more than it brings in on an annual basis.
Pat: You could never run a business or a household like that.
Scott: Oh, your income is $100,000 a year and you spend $135,000.
Pat: You could do it for a while.
Scott: A few years until no one wants to loan you money anymore.
Pat: Which is what the problem is.
Scott: Which is not quite yet. All right, let's take some calls. 921, what am I talking about, 921? I almost said 921-1530.
Pat: You're going back 10, 15 years, Scott.
Scott: We've been on this program almost 30 years. Questions@moneymatters is your best way if you want to be part of the program.
Pat: Or 833-99-WORTH.
Scott: Yeah, 921-1530.
Pat: You're going back at least 10.
Scott: Star or pound 1530.
Pat: You're going back at least 10 or 15 years.
Scott: Yeah, that's right. All right, we're in a...
Pat: Are you okay?
Scott: Huh?
Pat: Do you have a mini-stroke? Are you all right?
Scott: What do you mean a mini-stroke?
Pat: Where did that come from?
Scott: I don't know.
Pat: I wouldn't be able to remember that number until you mentioned it.
Scott: Thousands of times, tens of thousands of times we've given out that number. All right. We're in Wisconsin, talking with Matthew. Matthew, welcome to Allworth's "Money Matters."
Pat: Thank you. Good.
Scott: What can we do for you, Matthew?
Matthew: Oh, hi. Thanks for taking my call. And I just had some questions about capital gains tax.
Scott: Yep.
Matthew: Regarding the house, we currently own our house but rent it, and we've been renting for four years. We paid that house off in 11 years, our 30-year mortgage in 11 years, and decided to rent it. So currently, we're actually living in a house in my dad's name. He owns that. And we're kind of living outside our means as far as being able to pay the mortgage. So we're looking at the...
Scott: I thought you said the mortgage was paid.
Matthew: On our house that we bought.
Pat: Okay.
Matthew: But my dad's house, we pay the mortgage on it. So we're looking at buying the house from him, the one we currently live in, and selling the rental.
Pat: Okay.
Matthew: So it's been difficult for us to find the information about capital gains. We'd like to avoid paying the capital gains, if possible, because it can be as high as 20% from what I understand.
Pat: Yeah, okay. So let's just go through the timeline here. How long ago did you purchase this now rental home?
Scott: Fifteen years, 11 plus 4, is that right?
Matthew: Yeah, 2010, I believe, yeah.
Pat: Okay. So 15 years. And what did you pay for it?
Matthew: Seventy-nine.
Pat: And what does it work today?
Matthew: I believe it's going for 200 to 240.
Pat: And when did you turn it into a rental? What year?
Matthew: That would have been 2001.
Pat: 2001? So it's been a rental for 21.
Scott: That's 21.
Matthew: Sorry, 21, yeah.
Pat: So it's been a rental for four years.
Matthew: Four years, yeah.
Pat: And would you move back into this house, this rental?
Matthew: I'd prefer not to.
Pat: Okay.
Scott: It might save you all of your capital gains.
Pat: It may save you all of your capital gains.
Scott: The challenge is a personal residence...we sell a personal residence that has gain in it, we're entitled to exclude $250,000 as a single, $500,000 as a couple of capital gains. So if this was your primary residence and you sold it, there's no capital gains to worry about. You don't have to worry about anything.
Pat: And what are the rules about taking a primary residence?
Scott: Is it two or three of the last five years?
Pat: It's three of the last five.
Scott: Yeah. So this needs to be your primary residence for three out of the last five years.
Pat: So what happened is, when you converted it to a rental, in all actuality, you would have been better off selling that house.
Scott: And buying the house next door.
Pat: Buying the house next door. Because you would have reset the basis on the house, the property, and then you could have avoided that capital gain. Bought the rental next door, right, and then you would have reset your basis. But the way you did it, right, the IRS looks back to the original purchase price, not the value of the property the day it was converted to a rental.
Scott: Plus the depreciation that you've taken over the last...
Pat: You've got a recapture.
Scott: ...four years.
Matthew: Okay.
Pat: So your gain on this is going to be significant.
Scott: How close is it to where you are?
Matthew: It's three miles.
Pat: And what was the thesis behind buying your father's house? Why that house? Was it to help him out? Is he living with you?
Scott: Or is it giving a big discount?
Matthew: No. So they helped us buy this house. It's a nicer house. It's a nicer neighborhood. And it was just kind of like the idea that it would be a better investment if we rented the house we had just paid off instead of selling it.
Pat: So you said that you're making the mortgage payment. Is the house that you're living in now in your name or in your parents' name?
Matthew: It's in my parents' name. But the idea is, you know, instead of buying that house because we own the other one, that they would put the money down to buy the new house and we would pay the mortgage, eventually, turning it into our house one day.
Pat: Well, there were multiple mistakes made there, right? Your parents would have been better off, because now they're going to have to turn around and actually either gift or sell that house to you. In which case, if they gift it, that's fine. If they sell it to you, then they're going to incur some capital gains.
Scott: Are you able to qualify for the mortgage? So the mortgage is in your dad's name, right?
Matthew: Right.
Scott: If they gift the house to you, could you get your own mortgage?
Matthew: I believe so.
Pat: What's the interest rate on your current mortgage?
Matthew: The current mortgage under my dad's name is 2.99.
Pat: Yeah.
Scott: Yeah. I mean, you don't want to change...suddenly refinance into paying 7% on a new mortgage in your name. That doesn't make sense either, right?
Pat: Do you have siblings? Do you have siblings?
Matthew: I do.
Pat: Okay. So mom and dad pass away. What happens to the disposition of this house? Is it in the trust or in your parents' will? Is it a carve-out that goes directly to you? Is it part of their estate? Does anyone know?
Matthew: I'd have to ask. Yeah, I don't know. But the idea was that we would own the house.
Pat: Oh, I understand what the idea is. The idea doesn't matter unless it's actually identified in your parents' estate.
Matthew: Sure. Yep.
Pat: Wow. Well, what we do know is that unless you move back into that rental house, you're going to pay capital gains. And you're correct.
Scott: Maybe 30 grand.
Matthew: Yeah.
Pat: Plus state.
Scott: Yeah, I don't know what Wisconsin is on capital gains.
Pat: Yeah. And then you have the other issue of that house not being in your name, but it's a 2.99% mortgage.
Matthew: Right.
Pat: And when you say you cannot afford...
Scott: How much is the mortgage balance?
Matthew: Well, when we moved in, they bought the house a little over three years ago, it was 1,500. It's gone up to 1,700. And actually, just now, we got a letter that it's going up to 1,800.
Pat: Oh, variable interest rates? You got an adjustable rate mortgage on this?
Matthew: Yeah, it was because of the... I forget the term. But yeah, it did increase by that much.
Pat: Did you know?
Scott: How much is the balance of the mortgage?
Matthew: I believe it's around 250.
Pat: And so, is this an adjustable rate mortgage, or were these planned increases where you got a teaser rate and then it was going to accelerate? Or is this always going to be adjustable?
Matthew: I can't remember. The escrow changed, I believe.
Pat: So, I mean, look, here's what you could do. You could sell the rental. Let's say you get 240 for it. You've got some real estate commissions. You've got capital gain tax. Let's say you net 200, 210 after it's all said and done.
Matthew: Yeah.
Scott: You could then pay that mortgage way down. Essentially, buy the house from your father and have a new mortgage of $40,000, $50,000 at a higher interest rate.
Matthew: Right.
Pat: How much money does your family make?
Scott: And you paid the mortgage off in 11 years in your last house, so my guess is you can get this thing paid off in a few years.
Matthew: Well, that house was worth $79,000, so that was a lot easier to pay off, put a lot on the principal each year. And this new house, we bought it for...well, my parents bought it for 310. So in 4 years, though, it's increased to 480, I believe.
Pat: How old are you?
Matthew: Forty-three.
Pat: And are you married? How many kids?
Matthew: I'm married with four kids.
Pat: And what's the family income?
Matthew: Well, with the rent, we're around 75,000, 80,000.
Scott: And how much rental income do you receive off that house on a monthly basis?
Matthew: Monthly, 1,900.
Scott: But then you've got expenses. So, what do you think after expenses?
Matthew: You know, we've...
Scott: We lost him.
Matthew: Some other maintenance, I would have to guess probably 1,500 a month.
Scott: Okay. And then, what is your mortgage payment that you're paying to your dad now, 1,900 you said?
Matthew: That just went up to 1,800. So our income from the rental is 1,900, subtract the maintenance. But the rental...I'm sorry, the current house that we're living in, mortgage is at 1,800.
Scott: So, I mean, here's a couple options you have. One is you continue to go with the path you're going down, which, as time goes on, it's just going to create bigger problems.
Pat: Well, we don't know. Because he just said that it was in the...the impound account was what went up. So I don't know whether...
Scott: No, not about that. I mean, the capital gains on the other house is going to increase.
Pat: Okay, fair enough.
Scott: And then when the parents had you gift this house to the kid when you've got other siblings. So you could continue down the same path, number one. Number two, you could move back into your old house for 3 years and save about 30 grand on capital gains taxes. Or three, you just say, "Well, we didn't do the best planning. Let's bite the bullet. Let's sell that rental house. We're going to end up with about 200, 210 after capital gains taxes and expenses. Buy that house from dad and have a new mortgage of around $40,000 or $50,000. Yes, the rates going to be higher, but the payments are going to be tiny. And we won't have the rental income anymore, but the payments are going to be tiny."
Matthew: Yeah.
Scott: Those are your options.
Matthew: Yeah. And I like the idea of paying off the new house because it eliminates that interest.
Scott: How old are your kids? How old is the oldest?
Matthew: Sixteen.
Scott: Yeah. I mean, the expenses are, as you know, as the kids get older, the expenses get worse.
Pat: I agree. I would take the...I'd sell the house.
Scott: You're my brother. I'd probably say sell the house. I mean, the only way to rectify this is to move back into it.
Pat: Oh, the thing I would worry about most is mom and dad pass away and...
Scott: Problem with all the siblings.
Pat: It's a problem with all the siblings.
Scott: Nice and clean if it's in your name.
Pat: That's a big deal.
Scott: Oh, my guess is your parents are relatively young if you're early 40s.
Pat: Anyway.
Scott: All right, Matthew.
Pat: Appreciate the call.
Scott: Glad you called. You know what's interesting, Pat, is, listening to this, there's a couple of things that came to mind. One is, look, a lot of parents want to help their kids, and it's almost impossible. Like, my daughter is 29. I helped her with the down payment on a house. She says she doesn't know...all of her friends have all had assistance from their parents. She says, "I don't know anyone who owns her own home that didn't have some sort of assistance from their parents."
Pat: Kind of depends where you're living in the United States.
Scott: Fair enough. Okay.
Pat: Your daughter lives in Denver.
Scott: Near downtown. Okay, she could probably... But even still. But the reason I'm bringing on the follow-up on this call, like, there's a lot of planning that needs to go into before you just gift your kids some dollars or own a home and let them suddenly take it over. The planning needs to happen ahead of time.
Pat: This was filled with not major mistakes but mistakes, this whole transaction.
Scott: Yeah. So if you're the parent who want to help your kids, like, do the right kind of planning, make sure you talk to the right kind of people ahead of time, because it's hard to unwind, if you could just tell off of this call, some of the challenges.
Pat: Yes.
Scott: And then if you've been in a primary residence for years that has huge capital gain internal and you move, we've always encouraged you to sell that. And if you want a rental, buy something very similar because you're going to lose that one time.
Pat: Yes.
Scott: I mean, not one time because you can do it every three years or two years, whatever was. Is it two out of three or two out of five?
Pat: You had to live in the house three of the last five years.
Scott: I had a client, they owned, like, four rentals. Yeah, they took a decade and kept moving house to house to avoid the capital gains. They have a lot of money, too.
Pat: I imagine.
Scott: And don't spend anything.
Pat: I imagine.
Scott: Really interesting.
Pat: I imagine. Well, flippers do that all the time. Like, I know this couple that they flip homes, and they move in them. They rehab them while they're living in them. Sounds miserable to me, but they rehab them...
Scott: Yeah, I would have done the same thing.
Pat: ...while they're living in.
Scott: I mean, it's good. It's actually not bad if you can...
Pat: Yeah. You can live with it.
Scott: That's a good thing if you can live with it.
Pat: But one other thing, the thing that we see often is people who are getting older worry about how the assets they're going to pass to their kids will take appreciated assets, including stocks, and put it in someone else's name and lose a step-up in basis.
Scott: That's right.
Pat: I see it all the time. And don't come in after mom or dad pass and say, "Oh, mom and dad gave me these stocks..."
Scott: Or gave me this house.
Pat: "...a year ago because we didn't want to have to deal with the probate." You know, Michael, that was a very, very costly mistake.
Scott: Yeah, probate is not that big a deal.
Pat: That's not that big a deal.
Scott: Let's talk now with Don in California. Don, you're with Allworth's "Money Matters."
Don: Hi, guys.
Scott: Hi, Don.
Don: So I got a question. We've got a new federal administration. How do I plan for investing when I live here in California and the news is somewhat tilted for California-centric news? How do I make a good decision? Because the stock market and other investments really should be looking nationally or even globally to make your decisions.
Pat: So we are residents of the state of California.
Don: Right.
Pat: So you're worried...
Scott: I'm not sure of the question because I personally don't watch local news. I look at a couple of websites to see what's going on in California, but...
Pat: So, what is your concern? Tell me what your concern is.
Don: Well, again, I don't watch the news that often. I'm getting ready to roll over into retirement and have to readjust a lot of my investments. Like you, I live here in the Sacramento area, and I know from what little national news I watch and the industry I follow, I know that the local news is tainted, tilted for California. Let me ask this. What news sources do you use to make your decisions?
Pat: So it's noise. A lot of it is just noise, right? So you got to remember, the job of a news site is to deliver an audience.
Scott: And same thing with social media sites.
Pat: It's to deliver an audience. That is their objective.
Scott: So they can sell advertising.
Pat: Yes, that is their objective.
Scott: If they have no eyeballs, there's no advertising.
Pat: And so, how do you actually deliver an audience to an advertiser? Well, you sensationalize. You hype things up. You make the world either look so bright and cheery that people are attracted to it or you look like it's doom and gloom so that eyes are attracted to it, right? That's...
Scott: Usually the doom and gloom. People want to watch the car crash, right? I mean, it's a...
Pat: Yes. I mean, there is...look, you see it every day, right? Gene Hackman dies a couple of weeks ago, and now it's, you know, like, look, whatever happened in that house happened in that house. But it doesn't mean...
Scott: It is a little interesting.
Pat: It is interesting, but it's not going to affect any of us. But they're delivering an audience, and they're tracking it too, by the way. So if someone clicks on Gene Hackman, then they know, "Look, we should run more stories on Gene Hackman." If someone clicks on, "Hey, look, your IRA and 401(k) is coming to an end because it's the new administration," and you click on it...
Scott: My son is a commercial pilot, and in the news, there's been all these near misses, right?
Pat: Yeah.
Scott: And I asked him, I said, like, "Is this anything?" He says, "It's not really any different than normal. It's just everything is being reported." It reminded me of when I was in high school, I lived in the Los Angeles area. And remember the drive-by shootings? Every day in Los Angeles, there was a news story of another drive-by shooting. It was this epidemic of drive-by shootings. And after a while, the news cycle kind of died down. And you look at it statistically, there was no...nothing had changed. There was no increase in drive-by shootings, right? So some of the news cycle is a bit of that right now. It's all the sensational. Let's put a flashlight on all this and spotlight on this, and let's drive people to our sites and our TV shows.
Pat: And, I mean, it's such a divided, you know, right and left in the country right now. So they say, "But it was a pretty close election."
Scott: I know, yeah. Yeah, yeah. I don't know about a landslide, yeah.
Pat: Right.
Scott: Seventy percent might be a landslide.
Pat: So the thing that harms your portfolio the most is you.
Scott: Your reaction.
Pat: How you react to it. So if you talk to an institutional...
Scott: The hardest thing about being an investor.
Pat: If you talk to an institutional pension fund manager, right, if we went and interviewed an institutional pension fund manager and you asked them how they're reacting to the news...
Scott: Preferably an apolitical one. Because the political one, they start making weird investment decisions based upon...
Pat: Yeah. Well, ones that are normally governed by boards of state and local have a tendency to actually sway.
Scott: Yeah.
Pat: But if you went and talked to, you know, someone who's managing the United Auto Workers pension or the...
Scott: Whatever.
Pat: ...whatever institutional pension, and you ask them, "What are you doing to your portfolio in light of the current political and economic environment?" Scott, what would their answer be?
Scott: Well, they might be looking for some opportunities to... They move things around the edges. So they might, for example, they might have had 28% in publicly traded securities and 12% in privately held securities, private equity, and a small portion in venture stuff. And they might tweak those percentages a couple of points here or there. But by and large, they're not having wholesale changes.
Pat: They're sticking to the portfolios that are typically 65. Look, I will tell a story. I was on an investment committee for a foundation. And before I joined, this was...I joined in...
Scott: Those are really difficult.
Pat: I joined in 2010. 2011. Before I joined, in the height of the crisis, the Great Recession, they lowered their equity portfolio in the middle of the downturn.
Scott: And you were on the board?
Pat: I was not on the board. I joined soon after. But then I got back on the board and I said, "Well, this makes no sense. We shouldn't be reacting to that." So we got them back to 65%. And then the big question was, should it be 63% equities or 66% equities? You're laughing. Why are you laughing?
Scott: It's not going to make any difference long-term.
Pat: That's what I said.
Scott: Come on.
Pat: I said, "So we've spent two hours talking about..."
Scott: Well, those boards, I mean, those small foundations...
Pat: Because everyone wants to show that they're the smartest guy in the room, right?
Scott: They all want to add some value, but they don't really know what they're talking about.
Pat: These were filled with investment professionals, but everyone wanted to show how smart they were. And I said, "Look, over the next 5, 10 years, whether we make it 66% stock or 64% stock, the most important thing is that we're in the range of the stock that we should be."
Scott: Yeah. So you're marching towards retirement. When do you retire, Don?
Don: This summer.
Scott: Okay. You're retiring this summer.
Pat: How old are you?
Don: Sixty-five.
Pat: So, are you married?
Don: Yes.
Pat: Okay. So one of you is going to live statistically to be 95 years of age.
Don: It'll be her.
Scott: Is she going to kill you? Being home too much?
Pat: Your investment timeline...
Scott: ...is long.
Pat: ...is 30-plus years. And we see this often where people actually go into retirement and all of a sudden feel that they need to make major, major changes in their investment portfolios in order, normally, to be too conservative. And doing that creates all kinds of problems. What you should have been doing is titrating your risk down closer to retirement. So if you were in your 30s and 40s and even early 50s, you might have 100% equities the whole time, and as you get closer to retirement, maybe it goes 90%, 80%, 70%. And then it depends on your net worth. So if your net worth is really high, right, let's say you're worth $10 million and you're taking income of, you know, a couple of hundred grand a year, then you can do whatever you want.
Scott: And I think it's one of the things that's really hard as we approach retirement and particularly once we go into retirement, your whole career, you've been used to having some money set aside for the future, right? So you're putting money, presumably into your 401(k) and other savings, you've been saving. So even though things have fluctuated, you're still adding to that every day. You're, like, putting logs on the woodpile, so to speak. Now you go into retirement, now you're not saving anymore. Now you're starting to take wood off that woodpile. So you don't have the money going in, which is putting a different kind of pressure on the portfolio. And then, secondly, now you've got time to sit and monitor all this stuff. And maybe you feel like you've got a fiduciary responsibility. This was the wise thing to do, is to spend a lot of time on it. And you could drive yourself nuts.
Pat: So let's talk about your own financial situation. Do you have a pension coming in?
Don: I will, yes.
Pat: How big is your pension?
Don: Roughly 65% of my income.
Pat: Okay.
Scott: And do you have money saved in a 401(k), IRAs, that sort of thing?
Don: Yes.
Pat: And how much is there?
Don: About 250.
Pat: Two hundred and fifty thousand.
Scott: And are you going to receive Social Security as well?
Don: Not if I go and do some consulting because I don't want to lose...don't want to have to pay them.
Pat: And your 250,000, how is it allocated today?
Don: Mostly in large and mid-cap stocks.
Pat: Is it all equities?
Don: Pretty much.
Pat: All stocks.
Scott: That's served you very well.
Pat: Yes. You should probably lower that, right, to probably...
Scott: And do you have money in savings, CDs, money market, that sort of thing, to speak of?
Don: Just about a month's worth of salaries.
Scott: Okay.
Pat: Okay.
Scott: And so your plan is to do some consulting. At some point in time, you're going to take Social Security, which is you're essentially going to have 100% of your income made up between your pension and Social Security, right?
Don: Pretty much.
Scott: And so the 401(k) is probably going to be for different things. Need a new car, want to take a trip.
Pat: Yes.
Don: Right.
Scott: So one way to look at this is, say, of this 401(k), what do we plan on spending out of this in the next five years, or what do we want to budget for expenditures out of it for the next five years, have those dollars be in conservative investments, and anything five-plus years continue having equities?
Don: Okay.
Scott: One of the benefits of time, getting older, is we've had our own...we've lived through all these different times, right? So if we think back to the dot-com bust, and we all remember that, pets.com, everything was going crazy, and then they went big. So the Dow Jones Industrial Average in the year 2000 hit 10,000. This was at the height of Greenspan's talk about irrational exuberance, right? It was a couple of years after that. We hit 10,000. We went through the dot-com bust, stock market declined 45%. We had 9/11 in the middle of all that. We had some recovery. Then we went through the financial recession, the Great Recession, stock market was down about 50%. And today, the Dow is over 40,000...
Pat: And we went through all that.
Scott: ...4x over 25 years. To Pat's point, odds are one of you are going to still be alive in 45 years. So if you can pull back...
Pat: Thirty years. Thirty years.
Scott: Thirty years. If you can pull back and say, "Of these dollars, these are long-term dollars. I'm not going to focus on the value of these on a daily basis because I'm more concerned about what these are going to be worth 10, 15, 20 years from now," then you could say, rationally, "Oh, markets are going to go through their cycles. They're going to recover. Things are going to go up." and then have those dollars that you want to rely upon in the next 5 years or so in something very conservative. And if you can get your mindset in the right way, then you're not going to worry about it when the market goes through a 20% correction, which it will.
Pat: Yes, it will absolutely happen. And remember...
Scott: We don't know when.
Pat: ...media, it's not your friend. You are being sold, right?
Don: Right.
Pat: That's what happens. And so they want to engage you as much as possible. So don't pay too much attention to the price.
Scott: Yeah. Appreciate the call, Don, and hope you have a fantastic retirement.
Pat: I watched an incredible documentary yesterday on Katharine Graham from "The Washington Post."
Scott: Who's Katharine Graham?
Pat: Her father bought The Washington Post in 1933, and she ended up being the owner. Her husband killed himself, Richard Graham. And she ran The Washington Post in the '70s, did the whole Watergate thing. Fascinating documentary.
Scott: Oh, really?
Pat: It was great. And by the way, the funny thing was, is The Washington Post, actually, that was when it was, like, real newspapers, it couldn't make any money. They couldn't deliver. She owned two radio stations.
Scott: The paper didn't make any money.
Pat: None at all. But the four television stations actually, that they owned, made money.
Scott: Well, I mean, you look at the Post today, it tends to be on the left side of things, right? But I don't know if you saw Jeff Bezos' comment a week or two ago, talking about their changing opinion to line up more like "The Wall Street Journal," it sounds like.
Pat: It's a fascinating documentary.
Scott: Yeah.
Pat: But the media back then is not the media today.
Scott: Well, no. And I think one of the challenges in today's environment, you know, you can sit on X for hours on end and they keep delivering content that already aligns with your viewpoints, right? And it's this kind of circle.
Pat: Yeah, I'm not on X.
Scott: You never look at X?
Pat: No.
Scott: You should find it a great way to get news. Because you can just get quick little clips here and there and search around for certain articles and follow different media outlets.
Pat: I'm not going to do it.
Scott: Good for you. You're wise not to.
Pat: A couple of weeks ago, you were telling me, myself, and the audience how you were going to start taking media fast.
Scott: Yeah. Now I listen to it all night long instead. I wake up with Fox News. I'm joking. I can't stand television news personally. I don't watch it.
Pat: But you told me that you were going to take one or two days a week and start doing a media fast. Have you?
Scott: No, I said I took a weekend.
Pat: Oh, you're not going to...that's not part of...
Scott: Maybe another five years from now, I'll try it again.
Pat: That's not part of your... I thought you were going to make it part of your normal routine.
Scott: I should. There's lots of things in my life probably would be healthy disciplines. That might be one, actually. Like, taking a true Sabbath Sunday rest would probably be a good one, and not having any news on that day would probably be healthy discipline in my life as well.
Pat: Oh, I've got a list.
Scott: And waking up in the morning and make a list of all the things I'm grateful for, ways I can serve my wife and children and my loved ones in my life, how I can be a better business partner to Pat.
Pat: This scroll will be long.
Scott: So there's lots of disciplines that would be probably really good.
Pat: It's a four-foot scroll.
Scott: Then my human nature takes over and I don't feel like it. All right. Let's continue on here. We're talking with Gary. Gary, you're with Allworth's "Money Matters."
Gary: Hello. How are you guys doing?
Scott: We're good.
Gary: Okay. So I am retired for about eight years now, and I have two pensions. I have a small pension and a tiny pension.
Scott: Okay.
Pat: All right.
Scott: Those are all relative.
Gary: They're all relative. Last year, the tiny pension, I got notification that the company in their infinite wisdom went out and purchased an annuity for me in lieu of the pension.
Scott: Okay.
Gary: And that seemed to go off pretty smoothly without a hitch. They matched up.
Pat: Gary, can I ask you a question? Did they offer you a lump sum at that time, or did they just say to you, "This pension is now coming to you from X insurance company?"
Gary: They just announced that they had purchased the annuity.
Pat: Okay, perfect. Okay.
Gary: They matched up the survivor benefits, you know, with the pension. So that happened very smoothly.
Scott: So it was a wash. So instead of this pension fund sending you a check each month, they said, "We outsourced this to an insurance company. We gave them the pile of cash in exchange for it. Now they are responsible for providing you that monthly check." Is that right?
Gary: That's right.
Scott: Okay.
Gary: So last month...
Pat: Wait, I'm sorry, one more question here. What is the monthly amount?
Gary: The monthly amount for the tiny pension...
Pat: The one that we were just talking about, what was that? Is that the tiny pension?
Gary: Yeah, that was under 1,000 a month.
Pat: Okay.
Scott: Like I said, relative. I don't think...
Pat: Yes. So here's the...I'm just going to go off here. Did they mention anything about the pension benefit guarantee corporation there?
Gary: No.
Scott: Okay. So tell us. So this went smoothly. Continue on with what's happened. Is this the same organization, or is this a union plan?
Gary: No, it's not a union plan. The tiny pension was...that company was a spinoff from the other company.
Scott: Okay.
Pat: Okay.
Scott: So tell us what's transpired since.
Gary: So what's transpired since is that the parent company, you know, the small pension as opposed to the tiny pension. Now, the small pension wants to do the same thing.
Scott: And how much are you receiving from the small pension?
Gary: The small pension is about three grand a month.
Pat: That's not small, by the way.
Scott: I don't think...
Pat: How old are you?
Scott: And you first said that it's all relative.
Gary: It's all relative.
Pat: How old are you?
Gary: I am 68.
Pat: So that's hundreds of thousands of dollars, by the way, if I use the net present value of your life expectancy, hundreds of thousands.
Gary: I know I am a blessed person to have these. So the small pension, the one that's about three grand a month...and those pensions, the two together, you know, that's a third of my needs.
Scott: Yeah. So, what's happening with the company in the small pension?
Gary: Well, it's going to go into the annuity later in the year. But now I do have...I did make some payments into that pension plan.
Pat: Okay.
Gary: So the payments that I get from them, you know, maybe 5% is...
Scott: De minimis then.
Gary: Okay, 5% is return of principal.
Scott: Okay.
Gary: I don't know if that's the exact term. But I'm just really wondering, with these pensions, in lieu of or with the annuities in lieu of the pension, that no longer falls under PBGC.
Scott: That's right.
Pat: I don't know.
Gary: I'm pretty sure that no longer falls under the PBGC.
Scott: Do they give you the opportunity to take a lump sum?
Pat: Did they, at any point in time...?
Gary: When I retired, they did.
Scott: Okay. And how about now?
Pat: Yes. How about now? Because you elected the pension.
Scott: Because what I've seen in the past is when these happen, they give the retiree an opportunity to take a lump sum. The company is just trying to...they don't want to risk anymore. They're like, "We're going to outsource this. We'll just give you a lump sum. If not, we're going to buy an annuity."
Pat: We're going to sell this to an insurance company.
Gary: Right. And the company has done this selectively over the years. I've been just aware of it from talk with the other people where they'll take a chunk of retirees and they'll say, "This chunk of retirees are going to get the annuity in lieu of the pension." And like you say, to move that off their books. But I'm wondering, how should I think about it in terms of, like, should I make any changes to my overall portfolio?
Pat: So the question I have, which I asked early on, on what you called the tiny pension, which is, would the PBGC still come across? And if you didn't get the election for a lump sum...
Scott: Then you would think that the company can't just shed the liability.
Pat: That's right.
Scott: We're not the rest of attorneys. We're not pension attorneys. We're not...
Pat: But that's what...
Scott: But usually, I mean, when I've seen this in the past, there's always been the opportunity, because insurance, the company doesn't care.
Pat: That's right.
Scott: They just assume you'd take the cash and get out of here if they're trying to dissolve this.
Pat: Yeah, because they might be backstopping the annuity on a risk pool at some point. So the question is, what are the annuity companies they sold them to? I mean, was it Blackwater Insurance Company, or was it...?
Gary: No, no. They were both... One is rated A or A-.
Scott: You could tell us the name.
Gary: Well, one is American United Life, and the other one is MetLife.
Scott: Well, MetLife is massive.
Pat: Yeah.
Gary: Yeah. And American United Life is this sort of regional.
Pat: Yeah.
Scott: But is the small one, the 3,000, is that going to MetLife?
Gary: Yes. I'm not worried about that. But the question is, how do I think about that in relation to my other?
Scott: Well, here's one way to think about it. So years ago, there was an insurance company called Executive Life that they went and bought a lot of pension plans. This was back in the '80s. Remember this, Pat?
Pat: Ivan Boesky.
Scott: Was he part of that investment?
Pat: Michael Milken.
Scott: Michael wasn't part of Executive Life.
Pat: I know. That's what they were selling the pensions to. So they were some...
Scott: Oh, it's junk bonds.
Pat: Yeah.
Scott: Yeah. So what happened is these insurance companies, yeah, that's right, they were buying a bunch of junk bonds.
Pat: They were raiding the pensions, which is if you watch the movie, "Wall Street," when Gordon Gekko says greed is good, and they were actually going in and bought Bluestar, the airline, to raid the pension...
Scott: They were doing this exact thing.
Pat: ...they were doing the exact thing.
Gary: They had an overfunding.
Scott: Yeah. And Pan Am went, I think Pan Am...was it Pan Am that went to Executive Life or one of those?
Pat: Yes.
Scott: And then when the insurance companies went bust because they weren't diversified and they were all in one particular area, and so, as a result of that, regulations changed dramatically for the insurance companies on how they had to invest their own reserves. They couldn't just go willy-nilly. And so they had a lot of restrictions going forward, which added a lot of protections for policyholders, annuitants, life insurance holders. And then, secondly, most states, there's some sort of insurance pool where they...not like FDIC insurance, but the insurance companies all kind of agree to insure one another.
Pat: And the smaller the annuity amount, the more the insurance actually kicks in, not the other way around.
Gary: But those state guarantee associations, don't they have a limit?
Pat: That's right.
Scott: That's right. It's like 250 grand or something.
Pat: Yeah. That's why I said the smaller the amount, the better the insurance, not the larger. So your question is, how should you view the rest of the portfolio? How big is the rest of the portfolio, and are you taking income from it?
Gary: Yeah, I am taking some income from it. It's about 2.5.
Pat: And how is it allocated now?
Gary: About 70% equity.
Scott: And how much income are you taking from this 2.5?
Gary: I'm taking, like, 1% or 2%.
Pat: I wouldn't change a thing.
Scott: I wouldn't either. I mean, assuming... One of the challenges, Gary, as your account balance goes up, the swings on a percentage basis result in much bigger dollar swings, right? So when you've got 250,000 saved and there's a 10% swing, it's 25 grand. When you have 2.5 million saved and there's a 10% swing, that's 250 grand. So we just need to make sure we've got eyes wide open, realizing that the markets, as they go through their cycles, and historically, we've had a 20% pullback every 3.5 years if you go back about 100 years, so these are very normal, that account is going to swing a lot. Now, if you only pull in 1% to 2% a year, you've got income coming in from pensions.
Pat: And you've got Social Security coming in.
Scott: This has the highest probability of great long-term success.
Pat: But in saying that, I would make some changes.
Gary: I'm listening.
Scott: I am, too. What changes?
Pat: I would look at doing Roth conversions.
Gary: You know, I looked at Roth conversions, and I kind of decided, you know what, it's a wash.
Scott: Was 2.5...is it all in the 401(k), IRAs, 401(k)s?
Gary: Pretty much. It's like 90%.
Scott: And how old are you again?
Pat: Sixty-eight.
Gary: I'm 68.
Scott: Yeah, I would too.
Pat: I would absolutely be... You're the perfect candidate for it.
Scott: Because your withdrawals are going to double at 73.
Pat: Yeah.
Scott: Seventy-three, 75, whatever it is.
Pat: Seventy-five. It's 68. Yes. If you were 68 years of age.
Gary: Oh, you're talking about RMD.
Scott: Yes.
Pat: Yes. So what happens is that I'd look at this and I'd go, "Okay, I'm at 2.5. I'm taking a 2% distribution today," right?
Scott: And now I'm going to be at a 3.8%, a 3.6%, or whatever the number is. At 75, it's probably closer to 4%.
Pat: Yes. So then I would actually extrapolate out a return. I'd just throw an 8% return in there, minus the 2%, compound that 6%, right? We're going to go out seven years. You look at that account, it's $4 million. You're going to start taking 160 grand a year out of there rather than 50 grand a year, right? And then we've got Social Security on that. All of a sudden, your income is over $200,000 a year. And so you're going to drive your Social Security tax up, your Medicare premiums up. There's all kinds of things. Your income will more than double in those years. And so the time between the age of 68 and your required minimum distribution, it's the golden hour for Roth conversions.
Gary: Well, that's a whole different thing for me. I looked at it, and the way I looked at it, it was a tax arbitrage. It was kind of a wash. But I do some conversions mainly just to have a pile of money that I can get to without any tax cuts.
Pat: How much conversions do you do?
Gary: I try to do 15 a year or 30 a year.
Pat: Okay. I'm just telling you...
Scott: But then...
Pat: Look, I don't care what you looked at, Gary. I don't really care. You called and asked us about your situation.
Scott: That's the one thing I would recommend as well.
Pat: I think you're fine on the annuities, right, and in the pensions. You're just missing an incredible opportunity.
Gary: Okay.
Pat: An unbelievable opportunity.
Scott: And it's because you've got a significant amount in retirement account assets, and you're barely taking any income from it.
Pat: Look, if you were a client of mine, and I'm sitting in a room, and you push back at me like that, you know what I'd say to you, what are you paying me for? Why are you paying? I'm giving you great advice here, and you're not taking any of it? And yet you pay me? You took the time to call our program, ask for advice?
Scott: Pat, you sound like you're taking this personally.
Pat: He just completely discounted it, Scott. You just said, "Oh, I looked at it in just a pile of money." I'm just telling you, you're wrong.
Gary: Well, I'm listening. I'll take another look at it. I appreciate...
Scott: I would take another look at it. And run some long-term projections.
Pat: You have to run the long-term projections so that...
Scott: What does my financial life look like 5 years, 10 years, 15, 20 years out?
Pat: And you said the right thing. You said, "Well, I just saw it as some tax arbitrage." And I said, "Exactly right." And you're doing some tax arbitrage. You're just not doing as much as you should be.
Gary: Well, so when you talk about doing Roth conversions, what I have heard is that you convert up to whatever tax bracket you're in.
Scott: Your tax bracket, yeah.
Pat: Maybe sometimes more.
Scott: Maybe.
Gary: Well, in my case, it would have to be more because I'm at the top of a bracket.
Scott: That's right.
Gary: I think I'll be in a lower bracket when I retire.
Pat: I'm just telling you, you won't.
Scott: Are you working today?
Gary: No. When I'm fully retired...
Scott: How much income are you earning today?
Gary: I'm not earning any income today.
Scott: Okay, then you're fully retired.
Pat: You're fully retired.
Gary: You know, you're right. I am. My wife is still working, though.
Pat: What does your wife make?
Gary: She's around 120.
Pat: Okay. All right, that's new information.
Scott: Some new information, yeah.
Pat: That's some new information. The minute your wife quits, you should do Roth conversions. You probably shouldn't be doing any at all now, not even 15 grand.
Gary: So you mean I've been doing it right?
Pat: Yeah, correct. I don't think you should probably even be doing...maybe if you had a little room in that tax bracket, but that's new information. We were under the assumption that there was no earned income coming in the family.
Gary: Got you, got you, got you. Yeah.
Pat: Right? But the minute your wife quits, the minute she quits working, by the way, you should have her work as long as you possibly can.
Scott: Yeah. Appreciate the call.
Pat: Anyway, Gary, appreciate the call. We're running out of time here.
Scott: That's all the time we have. We'll see you next week. This has been Scott Hanson and Pat McClain, Allworth's "Money Matters."
Man: 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.
Scott: Welcome to Allworth's "Money Matters." Scott Hanson.
Pat: Pat McClain. Thanks for joining us.
Scott: Glad to have you with us as we talk about financial matters and a little bit of what's going on in the marketplace, and answering your questions and talking about what's on our mind, I guess, is kind of how sometimes the program works.
Pat: It is what it is. It is what it is.
Scott: Yeah. So good to have you with us as we talk about financial matters. And we like to say we try to stay apolitical, but in this environment, it's pretty difficult to not tiptoe in some areas because of the amount of chaos that is happening, not just economically, with what tariffs are going to be in place, what aren't going to be in place, but, of course, the whole political environment with the global environment with Eastern Europe, it's an amazing time. And then you look at the markets, they're kind of all over the place.
Pat: Day by day.
Scott: People are trying to figure out, what's this all mean?
Pat: What's inflation going to look like and how these tariffs are going to affect things and eggflation.
Scott: Eggflation. My daughter said to me this morning, "Dad, how come we don't have any eggs in the house?" I said, "Well," I said, "there might be some in the garage, in the garage fridge, but," I said, "there's a shortage."
Pat: Your daughter doesn't know how to go to a store?
Scott: She's 14.
Pat: Oh, I was thinking of your older daughter.
Scott: They don't buy their own groceries.
Pat: I was thinking your older daughter was visiting you.
Scott: Oh, my 29-year-old.
Pat: Correct.
Scott: Oh, I could see her complaining about something too. When she's visiting, I'd laugh her out of the house. Yeah. But it's just an interesting time. And then I got to tell you, from a financial planning standpoint, I think if you've listened to this program long enough, you understand our premise on investments, and so much is that nobody can predict what's going to happen. And if your objective is to try to navigate in and out of the top sectors and in and out of the stock market, we believe, over the long term, you will lose. You will do better if you have the right kind of strategy from the start and maintain that strategy through various market cycles.
Pat: Right? Yes. Well, especially if you have a diversified portfolio, it's very difficult to choose the right sectors, if not impossible.
Scott: And studies show that the average investor will do worse by trying to do that.
Pat: Yeah. So a diversified portfolio always has sectors in favor.
Scott: But I think what's interesting right now is not necessarily the asset allocation question. It's the future tax situation. Because you're starting to hear more and more chatter about a flat tax using tariffs and other types and sales tax.
Pat: Like a value-added tax?
Scott: National sales tax. I mean, that could be a real thing in the future.
Pat: Yeah.
Scott: We could see a time when the top rate is 50%. In federal, we could see a time when the top rate is 20%.
Pat: Or a combination of the two, right, where you actually have a value-added tax and national sales tax.
Scott: And slightly lower income taxes.
Pat: Yes. And look, sales tax is regressive. There's no question about the fact that the sales tax is regressive.
Scott: Yeah, because wealthy people don't spend most of their income.
Pat: That's right. And people of less economic needs...
Scott: How much Elon Musk spends of his billions of dollars every year as a percentage of his wealth?
Pat: Nothing. He just had another kid.
Scott: There are some means I don't even know how. I don't think he's father of the year award. Are you kidding? Or traditional family values. Are you kidding?
Pat: Can you imagine living up? Well, I guess it'd be like you've got nannies and dad, you see him on TV.
Scott: Anyway, I don't want to talk about Elon Musk's parenting strategies, but...
Pat: All right. I'd like to take some.
Scott: But what were you saying? You were going somewhere with that topic.
Pat: Oh, I said a regressive tax is...it's pretty hard to swallow, I'm going to tell you.
Scott: And national sales tax?
Pat: A national sales tax for... It's such a large change from where we have been with a progressive tax rate.
Scott: Historically. Correct. But I'm just stating, as you focus on your portfolio, your life savings, and structuring things...
Pat: Assume that what you're living in today will not be the same when you're taking the money out.
Scott: Correct. And say, "If it's different, how can I structure things today to be prepared for a variety of different scenarios?"
Pat: A diversified tax strategy.
Scott: Correct. And who knows exactly what's all going to come down the pipe. But my guess is something's going to change. We can't, clearly, we can't...you know, the government spends about 35% more than it brings in on an annual basis.
Pat: You could never run a business or a household like that.
Scott: Oh, your income is $100,000 a year and you spend $135,000.
Pat: You could do it for a while.
Scott: A few years until no one wants to loan you money anymore.
Pat: Which is what the problem is.
Scott: Which is not quite yet. All right, let's take some calls. 921, what am I talking about, 921? I almost said 921-1530.
Pat: You're going back 10, 15 years, Scott.
Scott: We've been on this program almost 30 years. Questions@moneymatters is your best way if you want to be part of the program.
Pat: Or 833-99-WORTH.
Scott: Yeah, 921-1530.
Pat: You're going back at least 10.
Scott: Star or pound 1530.
Pat: You're going back at least 10 or 15 years.
Scott: Yeah, that's right. All right, we're in a...
Pat: Are you okay?
Scott: Huh?
Pat: Do you have a mini-stroke? Are you all right?
Scott: What do you mean a mini-stroke?
Pat: Where did that come from?
Scott: I don't know.
Pat: I wouldn't be able to remember that number until you mentioned it.
Scott: Thousands of times, tens of thousands of times we've given out that number. All right. We're in Wisconsin, talking with Matthew. Matthew, welcome to Allworth's "Money Matters."
Pat: Thank you. Good.
Scott: What can we do for you, Matthew?
Matthew: Oh, hi. Thanks for taking my call. And I just had some questions about capital gains tax.
Scott: Yep.
Matthew: Regarding the house, we currently own our house but rent it, and we've been renting for four years. We paid that house off in 11 years, our 30-year mortgage in 11 years, and decided to rent it. So currently, we're actually living in a house in my dad's name. He owns that. And we're kind of living outside our means as far as being able to pay the mortgage. So we're looking at the...
Scott: I thought you said the mortgage was paid.
Matthew: On our house that we bought.
Pat: Okay.
Matthew: But my dad's house, we pay the mortgage on it. So we're looking at buying the house from him, the one we currently live in, and selling the rental.
Pat: Okay.
Matthew: So it's been difficult for us to find the information about capital gains. We'd like to avoid paying the capital gains, if possible, because it can be as high as 20% from what I understand.
Pat: Yeah, okay. So let's just go through the timeline here. How long ago did you purchase this now rental home?
Scott: Fifteen years, 11 plus 4, is that right?
Matthew: Yeah, 2010, I believe, yeah.
Pat: Okay. So 15 years. And what did you pay for it?
Matthew: Seventy-nine.
Pat: And what does it work today?
Matthew: I believe it's going for 200 to 240.
Pat: And when did you turn it into a rental? What year?
Matthew: That would have been 2001.
Pat: 2001? So it's been a rental for 21.
Scott: That's 21.
Matthew: Sorry, 21, yeah.
Pat: So it's been a rental for four years.
Matthew: Four years, yeah.
Pat: And would you move back into this house, this rental?
Matthew: I'd prefer not to.
Pat: Okay.
Scott: It might save you all of your capital gains.
Pat: It may save you all of your capital gains.
Scott: The challenge is a personal residence...we sell a personal residence that has gain in it, we're entitled to exclude $250,000 as a single, $500,000 as a couple of capital gains. So if this was your primary residence and you sold it, there's no capital gains to worry about. You don't have to worry about anything.
Pat: And what are the rules about taking a primary residence?
Scott: Is it two or three of the last five years?
Pat: It's three of the last five.
Scott: Yeah. So this needs to be your primary residence for three out of the last five years.
Pat: So what happened is, when you converted it to a rental, in all actuality, you would have been better off selling that house.
Scott: And buying the house next door.
Pat: Buying the house next door. Because you would have reset the basis on the house, the property, and then you could have avoided that capital gain. Bought the rental next door, right, and then you would have reset your basis. But the way you did it, right, the IRS looks back to the original purchase price, not the value of the property the day it was converted to a rental.
Scott: Plus the depreciation that you've taken over the last...
Pat: You've got a recapture.
Scott: ...four years.
Matthew: Okay.
Pat: So your gain on this is going to be significant.
Scott: How close is it to where you are?
Matthew: It's three miles.
Pat: And what was the thesis behind buying your father's house? Why that house? Was it to help him out? Is he living with you?
Scott: Or is it giving a big discount?
Matthew: No. So they helped us buy this house. It's a nicer house. It's a nicer neighborhood. And it was just kind of like the idea that it would be a better investment if we rented the house we had just paid off instead of selling it.
Pat: So you said that you're making the mortgage payment. Is the house that you're living in now in your name or in your parents' name?
Matthew: It's in my parents' name. But the idea is, you know, instead of buying that house because we own the other one, that they would put the money down to buy the new house and we would pay the mortgage, eventually, turning it into our house one day.
Pat: Well, there were multiple mistakes made there, right? Your parents would have been better off, because now they're going to have to turn around and actually either gift or sell that house to you. In which case, if they gift it, that's fine. If they sell it to you, then they're going to incur some capital gains.
Scott: Are you able to qualify for the mortgage? So the mortgage is in your dad's name, right?
Matthew: Right.
Scott: If they gift the house to you, could you get your own mortgage?
Matthew: I believe so.
Pat: What's the interest rate on your current mortgage?
Matthew: The current mortgage under my dad's name is 2.99.
Pat: Yeah.
Scott: Yeah. I mean, you don't want to change...suddenly refinance into paying 7% on a new mortgage in your name. That doesn't make sense either, right?
Pat: Do you have siblings? Do you have siblings?
Matthew: I do.
Pat: Okay. So mom and dad pass away. What happens to the disposition of this house? Is it in the trust or in your parents' will? Is it a carve-out that goes directly to you? Is it part of their estate? Does anyone know?
Matthew: I'd have to ask. Yeah, I don't know. But the idea was that we would own the house.
Pat: Oh, I understand what the idea is. The idea doesn't matter unless it's actually identified in your parents' estate.
Matthew: Sure. Yep.
Pat: Wow. Well, what we do know is that unless you move back into that rental house, you're going to pay capital gains. And you're correct.
Scott: Maybe 30 grand.
Matthew: Yeah.
Pat: Plus state.
Scott: Yeah, I don't know what Wisconsin is on capital gains.
Pat: Yeah. And then you have the other issue of that house not being in your name, but it's a 2.99% mortgage.
Matthew: Right.
Pat: And when you say you cannot afford...
Scott: How much is the mortgage balance?
Matthew: Well, when we moved in, they bought the house a little over three years ago, it was 1,500. It's gone up to 1,700. And actually, just now, we got a letter that it's going up to 1,800.
Pat: Oh, variable interest rates? You got an adjustable rate mortgage on this?
Matthew: Yeah, it was because of the... I forget the term. But yeah, it did increase by that much.
Pat: Did you know?
Scott: How much is the balance of the mortgage?
Matthew: I believe it's around 250.
Pat: And so, is this an adjustable rate mortgage, or were these planned increases where you got a teaser rate and then it was going to accelerate? Or is this always going to be adjustable?
Matthew: I can't remember. The escrow changed, I believe.
Pat: So, I mean, look, here's what you could do. You could sell the rental. Let's say you get 240 for it. You've got some real estate commissions. You've got capital gain tax. Let's say you net 200, 210 after it's all said and done.
Matthew: Yeah.
Scott: You could then pay that mortgage way down. Essentially, buy the house from your father and have a new mortgage of $40,000, $50,000 at a higher interest rate.
Matthew: Right.
Pat: How much money does your family make?
Scott: And you paid the mortgage off in 11 years in your last house, so my guess is you can get this thing paid off in a few years.
Matthew: Well, that house was worth $79,000, so that was a lot easier to pay off, put a lot on the principal each year. And this new house, we bought it for...well, my parents bought it for 310. So in 4 years, though, it's increased to 480, I believe.
Pat: How old are you?
Matthew: Forty-three.
Pat: And are you married? How many kids?
Matthew: I'm married with four kids.
Pat: And what's the family income?
Matthew: Well, with the rent, we're around 75,000, 80,000.
Scott: And how much rental income do you receive off that house on a monthly basis?
Matthew: Monthly, 1,900.
Scott: But then you've got expenses. So, what do you think after expenses?
Matthew: You know, we've...
Scott: We lost him.
Matthew: Some other maintenance, I would have to guess probably 1,500 a month.
Scott: Okay. And then, what is your mortgage payment that you're paying to your dad now, 1,900 you said?
Matthew: That just went up to 1,800. So our income from the rental is 1,900, subtract the maintenance. But the rental...I'm sorry, the current house that we're living in, mortgage is at 1,800.
Scott: So, I mean, here's a couple options you have. One is you continue to go with the path you're going down, which, as time goes on, it's just going to create bigger problems.
Pat: Well, we don't know. Because he just said that it was in the...the impound account was what went up. So I don't know whether...
Scott: No, not about that. I mean, the capital gains on the other house is going to increase.
Pat: Okay, fair enough.
Scott: And then when the parents had you gift this house to the kid when you've got other siblings. So you could continue down the same path, number one. Number two, you could move back into your old house for 3 years and save about 30 grand on capital gains taxes. Or three, you just say, "Well, we didn't do the best planning. Let's bite the bullet. Let's sell that rental house. We're going to end up with about 200, 210 after capital gains taxes and expenses. Buy that house from dad and have a new mortgage of around $40,000 or $50,000. Yes, the rates going to be higher, but the payments are going to be tiny. And we won't have the rental income anymore, but the payments are going to be tiny."
Matthew: Yeah.
Scott: Those are your options.
Matthew: Yeah. And I like the idea of paying off the new house because it eliminates that interest.
Scott: How old are your kids? How old is the oldest?
Matthew: Sixteen.
Scott: Yeah. I mean, the expenses are, as you know, as the kids get older, the expenses get worse.
Pat: I agree. I would take the...I'd sell the house.
Scott: You're my brother. I'd probably say sell the house. I mean, the only way to rectify this is to move back into it.
Pat: Oh, the thing I would worry about most is mom and dad pass away and...
Scott: Problem with all the siblings.
Pat: It's a problem with all the siblings.
Scott: Nice and clean if it's in your name.
Pat: That's a big deal.
Scott: Oh, my guess is your parents are relatively young if you're early 40s.
Pat: Anyway.
Scott: All right, Matthew.
Pat: Appreciate the call.
Scott: Glad you called. You know what's interesting, Pat, is, listening to this, there's a couple of things that came to mind. One is, look, a lot of parents want to help their kids, and it's almost impossible. Like, my daughter is 29. I helped her with the down payment on a house. She says she doesn't know...all of her friends have all had assistance from their parents. She says, "I don't know anyone who owns her own home that didn't have some sort of assistance from their parents."
Pat: Kind of depends where you're living in the United States.
Scott: Fair enough. Okay.
Pat: Your daughter lives in Denver.
Scott: Near downtown. Okay, she could probably... But even still. But the reason I'm bringing on the follow-up on this call, like, there's a lot of planning that needs to go into before you just gift your kids some dollars or own a home and let them suddenly take it over. The planning needs to happen ahead of time.
Pat: This was filled with not major mistakes but mistakes, this whole transaction.
Scott: Yeah. So if you're the parent who want to help your kids, like, do the right kind of planning, make sure you talk to the right kind of people ahead of time, because it's hard to unwind, if you could just tell off of this call, some of the challenges.
Pat: Yes.
Scott: And then if you've been in a primary residence for years that has huge capital gain internal and you move, we've always encouraged you to sell that. And if you want a rental, buy something very similar because you're going to lose that one time.
Pat: Yes.
Scott: I mean, not one time because you can do it every three years or two years, whatever was. Is it two out of three or two out of five?
Pat: You had to live in the house three of the last five years.
Scott: I had a client, they owned, like, four rentals. Yeah, they took a decade and kept moving house to house to avoid the capital gains. They have a lot of money, too.
Pat: I imagine.
Scott: And don't spend anything.
Pat: I imagine.
Scott: Really interesting.
Pat: I imagine. Well, flippers do that all the time. Like, I know this couple that they flip homes, and they move in them. They rehab them while they're living in them. Sounds miserable to me, but they rehab them...
Scott: Yeah, I would have done the same thing.
Pat: ...while they're living in.
Scott: I mean, it's good. It's actually not bad if you can...
Pat: Yeah. You can live with it.
Scott: That's a good thing if you can live with it.
Pat: But one other thing, the thing that we see often is people who are getting older worry about how the assets they're going to pass to their kids will take appreciated assets, including stocks, and put it in someone else's name and lose a step-up in basis.
Scott: That's right.
Pat: I see it all the time. And don't come in after mom or dad pass and say, "Oh, mom and dad gave me these stocks..."
Scott: Or gave me this house.
Pat: "...a year ago because we didn't want to have to deal with the probate." You know, Michael, that was a very, very costly mistake.
Scott: Yeah, probate is not that big a deal.
Pat: That's not that big a deal.
Scott: Let's talk now with Don in California. Don, you're with Allworth's "Money Matters."
Don: Hi, guys.
Scott: Hi, Don.
Don: So I got a question. We've got a new federal administration. How do I plan for investing when I live here in California and the news is somewhat tilted for California-centric news? How do I make a good decision? Because the stock market and other investments really should be looking nationally or even globally to make your decisions.
Pat: So we are residents of the state of California.
Don: Right.
Pat: So you're worried...
Scott: I'm not sure of the question because I personally don't watch local news. I look at a couple of websites to see what's going on in California, but...
Pat: So, what is your concern? Tell me what your concern is.
Don: Well, again, I don't watch the news that often. I'm getting ready to roll over into retirement and have to readjust a lot of my investments. Like you, I live here in the Sacramento area, and I know from what little national news I watch and the industry I follow, I know that the local news is tainted, tilted for California. Let me ask this. What news sources do you use to make your decisions?
Pat: So it's noise. A lot of it is just noise, right? So you got to remember, the job of a news site is to deliver an audience.
Scott: And same thing with social media sites.
Pat: It's to deliver an audience. That is their objective.
Scott: So they can sell advertising.
Pat: Yes, that is their objective.
Scott: If they have no eyeballs, there's no advertising.
Pat: And so, how do you actually deliver an audience to an advertiser? Well, you sensationalize. You hype things up. You make the world either look so bright and cheery that people are attracted to it or you look like it's doom and gloom so that eyes are attracted to it, right? That's...
Scott: Usually the doom and gloom. People want to watch the car crash, right? I mean, it's a...
Pat: Yes. I mean, there is...look, you see it every day, right? Gene Hackman dies a couple of weeks ago, and now it's, you know, like, look, whatever happened in that house happened in that house. But it doesn't mean...
Scott: It is a little interesting.
Pat: It is interesting, but it's not going to affect any of us. But they're delivering an audience, and they're tracking it too, by the way. So if someone clicks on Gene Hackman, then they know, "Look, we should run more stories on Gene Hackman." If someone clicks on, "Hey, look, your IRA and 401(k) is coming to an end because it's the new administration," and you click on it...
Scott: My son is a commercial pilot, and in the news, there's been all these near misses, right?
Pat: Yeah.
Scott: And I asked him, I said, like, "Is this anything?" He says, "It's not really any different than normal. It's just everything is being reported." It reminded me of when I was in high school, I lived in the Los Angeles area. And remember the drive-by shootings? Every day in Los Angeles, there was a news story of another drive-by shooting. It was this epidemic of drive-by shootings. And after a while, the news cycle kind of died down. And you look at it statistically, there was no...nothing had changed. There was no increase in drive-by shootings, right? So some of the news cycle is a bit of that right now. It's all the sensational. Let's put a flashlight on all this and spotlight on this, and let's drive people to our sites and our TV shows.
Pat: And, I mean, it's such a divided, you know, right and left in the country right now. So they say, "But it was a pretty close election."
Scott: I know, yeah. Yeah, yeah. I don't know about a landslide, yeah.
Pat: Right.
Scott: Seventy percent might be a landslide.
Pat: So the thing that harms your portfolio the most is you.
Scott: Your reaction.
Pat: How you react to it. So if you talk to an institutional...
Scott: The hardest thing about being an investor.
Pat: If you talk to an institutional pension fund manager, right, if we went and interviewed an institutional pension fund manager and you asked them how they're reacting to the news...
Scott: Preferably an apolitical one. Because the political one, they start making weird investment decisions based upon...
Pat: Yeah. Well, ones that are normally governed by boards of state and local have a tendency to actually sway.
Scott: Yeah.
Pat: But if you went and talked to, you know, someone who's managing the United Auto Workers pension or the...
Scott: Whatever.
Pat: ...whatever institutional pension, and you ask them, "What are you doing to your portfolio in light of the current political and economic environment?" Scott, what would their answer be?
Scott: Well, they might be looking for some opportunities to... They move things around the edges. So they might, for example, they might have had 28% in publicly traded securities and 12% in privately held securities, private equity, and a small portion in venture stuff. And they might tweak those percentages a couple of points here or there. But by and large, they're not having wholesale changes.
Pat: They're sticking to the portfolios that are typically 65. Look, I will tell a story. I was on an investment committee for a foundation. And before I joined, this was...I joined in...
Scott: Those are really difficult.
Pat: I joined in 2010. 2011. Before I joined, in the height of the crisis, the Great Recession, they lowered their equity portfolio in the middle of the downturn.
Scott: And you were on the board?
Pat: I was not on the board. I joined soon after. But then I got back on the board and I said, "Well, this makes no sense. We shouldn't be reacting to that." So we got them back to 65%. And then the big question was, should it be 63% equities or 66% equities? You're laughing. Why are you laughing?
Scott: It's not going to make any difference long-term.
Pat: That's what I said.
Scott: Come on.
Pat: I said, "So we've spent two hours talking about..."
Scott: Well, those boards, I mean, those small foundations...
Pat: Because everyone wants to show that they're the smartest guy in the room, right?
Scott: They all want to add some value, but they don't really know what they're talking about.
Pat: These were filled with investment professionals, but everyone wanted to show how smart they were. And I said, "Look, over the next 5, 10 years, whether we make it 66% stock or 64% stock, the most important thing is that we're in the range of the stock that we should be."
Scott: Yeah. So you're marching towards retirement. When do you retire, Don?
Don: This summer.
Scott: Okay. You're retiring this summer.
Pat: How old are you?
Don: Sixty-five.
Pat: So, are you married?
Don: Yes.
Pat: Okay. So one of you is going to live statistically to be 95 years of age.
Don: It'll be her.
Scott: Is she going to kill you? Being home too much?
Pat: Your investment timeline...
Scott: ...is long.
Pat: ...is 30-plus years. And we see this often where people actually go into retirement and all of a sudden feel that they need to make major, major changes in their investment portfolios in order, normally, to be too conservative. And doing that creates all kinds of problems. What you should have been doing is titrating your risk down closer to retirement. So if you were in your 30s and 40s and even early 50s, you might have 100% equities the whole time, and as you get closer to retirement, maybe it goes 90%, 80%, 70%. And then it depends on your net worth. So if your net worth is really high, right, let's say you're worth $10 million and you're taking income of, you know, a couple of hundred grand a year, then you can do whatever you want.
Scott: And I think it's one of the things that's really hard as we approach retirement and particularly once we go into retirement, your whole career, you've been used to having some money set aside for the future, right? So you're putting money, presumably into your 401(k) and other savings, you've been saving. So even though things have fluctuated, you're still adding to that every day. You're, like, putting logs on the woodpile, so to speak. Now you go into retirement, now you're not saving anymore. Now you're starting to take wood off that woodpile. So you don't have the money going in, which is putting a different kind of pressure on the portfolio. And then, secondly, now you've got time to sit and monitor all this stuff. And maybe you feel like you've got a fiduciary responsibility. This was the wise thing to do, is to spend a lot of time on it. And you could drive yourself nuts.
Pat: So let's talk about your own financial situation. Do you have a pension coming in?
Don: I will, yes.
Pat: How big is your pension?
Don: Roughly 65% of my income.
Pat: Okay.
Scott: And do you have money saved in a 401(k), IRAs, that sort of thing?
Don: Yes.
Pat: And how much is there?
Don: About 250.
Pat: Two hundred and fifty thousand.
Scott: And are you going to receive Social Security as well?
Don: Not if I go and do some consulting because I don't want to lose...don't want to have to pay them.
Pat: And your 250,000, how is it allocated today?
Don: Mostly in large and mid-cap stocks.
Pat: Is it all equities?
Don: Pretty much.
Pat: All stocks.
Scott: That's served you very well.
Pat: Yes. You should probably lower that, right, to probably...
Scott: And do you have money in savings, CDs, money market, that sort of thing, to speak of?
Don: Just about a month's worth of salaries.
Scott: Okay.
Pat: Okay.
Scott: And so your plan is to do some consulting. At some point in time, you're going to take Social Security, which is you're essentially going to have 100% of your income made up between your pension and Social Security, right?
Don: Pretty much.
Scott: And so the 401(k) is probably going to be for different things. Need a new car, want to take a trip.
Pat: Yes.
Don: Right.
Scott: So one way to look at this is, say, of this 401(k), what do we plan on spending out of this in the next five years, or what do we want to budget for expenditures out of it for the next five years, have those dollars be in conservative investments, and anything five-plus years continue having equities?
Don: Okay.
Scott: One of the benefits of time, getting older, is we've had our own...we've lived through all these different times, right? So if we think back to the dot-com bust, and we all remember that, pets.com, everything was going crazy, and then they went big. So the Dow Jones Industrial Average in the year 2000 hit 10,000. This was at the height of Greenspan's talk about irrational exuberance, right? It was a couple of years after that. We hit 10,000. We went through the dot-com bust, stock market declined 45%. We had 9/11 in the middle of all that. We had some recovery. Then we went through the financial recession, the Great Recession, stock market was down about 50%. And today, the Dow is over 40,000...
Pat: And we went through all that.
Scott: ...4x over 25 years. To Pat's point, odds are one of you are going to still be alive in 45 years. So if you can pull back...
Pat: Thirty years. Thirty years.
Scott: Thirty years. If you can pull back and say, "Of these dollars, these are long-term dollars. I'm not going to focus on the value of these on a daily basis because I'm more concerned about what these are going to be worth 10, 15, 20 years from now," then you could say, rationally, "Oh, markets are going to go through their cycles. They're going to recover. Things are going to go up." and then have those dollars that you want to rely upon in the next 5 years or so in something very conservative. And if you can get your mindset in the right way, then you're not going to worry about it when the market goes through a 20% correction, which it will.
Pat: Yes, it will absolutely happen. And remember...
Scott: We don't know when.
Pat: ...media, it's not your friend. You are being sold, right?
Don: Right.
Pat: That's what happens. And so they want to engage you as much as possible. So don't pay too much attention to the price.
Scott: Yeah. Appreciate the call, Don, and hope you have a fantastic retirement.
Pat: I watched an incredible documentary yesterday on Katharine Graham from "The Washington Post."
Scott: Who's Katharine Graham?
Pat: Her father bought The Washington Post in 1933, and she ended up being the owner. Her husband killed himself, Richard Graham. And she ran The Washington Post in the '70s, did the whole Watergate thing. Fascinating documentary.
Scott: Oh, really?
Pat: It was great. And by the way, the funny thing was, is The Washington Post, actually, that was when it was, like, real newspapers, it couldn't make any money. They couldn't deliver. She owned two radio stations.
Scott: The paper didn't make any money.
Pat: None at all. But the four television stations actually, that they owned, made money.
Scott: Well, I mean, you look at the Post today, it tends to be on the left side of things, right? But I don't know if you saw Jeff Bezos' comment a week or two ago, talking about their changing opinion to line up more like "The Wall Street Journal," it sounds like.
Pat: It's a fascinating documentary.
Scott: Yeah.
Pat: But the media back then is not the media today.
Scott: Well, no. And I think one of the challenges in today's environment, you know, you can sit on X for hours on end and they keep delivering content that already aligns with your viewpoints, right? And it's this kind of circle.
Pat: Yeah, I'm not on X.
Scott: You never look at X?
Pat: No.
Scott: You should find it a great way to get news. Because you can just get quick little clips here and there and search around for certain articles and follow different media outlets.
Pat: I'm not going to do it.
Scott: Good for you. You're wise not to.
Pat: A couple of weeks ago, you were telling me, myself, and the audience how you were going to start taking media fast.
Scott: Yeah. Now I listen to it all night long instead. I wake up with Fox News. I'm joking. I can't stand television news personally. I don't watch it.
Pat: But you told me that you were going to take one or two days a week and start doing a media fast. Have you?
Scott: No, I said I took a weekend.
Pat: Oh, you're not going to...that's not part of...
Scott: Maybe another five years from now, I'll try it again.
Pat: That's not part of your... I thought you were going to make it part of your normal routine.
Scott: I should. There's lots of things in my life probably would be healthy disciplines. That might be one, actually. Like, taking a true Sabbath Sunday rest would probably be a good one, and not having any news on that day would probably be healthy discipline in my life as well.
Pat: Oh, I've got a list.
Scott: And waking up in the morning and make a list of all the things I'm grateful for, ways I can serve my wife and children and my loved ones in my life, how I can be a better business partner to Pat.
Pat: This scroll will be long.
Scott: So there's lots of disciplines that would be probably really good.
Pat: It's a four-foot scroll.
Scott: Then my human nature takes over and I don't feel like it. All right. Let's continue on here. We're talking with Gary. Gary, you're with Allworth's "Money Matters."
Gary: Hello. How are you guys doing?
Scott: We're good.
Gary: Okay. So I am retired for about eight years now, and I have two pensions. I have a small pension and a tiny pension.
Scott: Okay.
Pat: All right.
Scott: Those are all relative.
Gary: They're all relative. Last year, the tiny pension, I got notification that the company in their infinite wisdom went out and purchased an annuity for me in lieu of the pension.
Scott: Okay.
Gary: And that seemed to go off pretty smoothly without a hitch. They matched up.
Pat: Gary, can I ask you a question? Did they offer you a lump sum at that time, or did they just say to you, "This pension is now coming to you from X insurance company?"
Gary: They just announced that they had purchased the annuity.
Pat: Okay, perfect. Okay.
Gary: They matched up the survivor benefits, you know, with the pension. So that happened very smoothly.
Scott: So it was a wash. So instead of this pension fund sending you a check each month, they said, "We outsourced this to an insurance company. We gave them the pile of cash in exchange for it. Now they are responsible for providing you that monthly check." Is that right?
Gary: That's right.
Scott: Okay.
Gary: So last month...
Pat: Wait, I'm sorry, one more question here. What is the monthly amount?
Gary: The monthly amount for the tiny pension...
Pat: The one that we were just talking about, what was that? Is that the tiny pension?
Gary: Yeah, that was under 1,000 a month.
Pat: Okay.
Scott: Like I said, relative. I don't think...
Pat: Yes. So here's the...I'm just going to go off here. Did they mention anything about the pension benefit guarantee corporation there?
Gary: No.
Scott: Okay. So tell us. So this went smoothly. Continue on with what's happened. Is this the same organization, or is this a union plan?
Gary: No, it's not a union plan. The tiny pension was...that company was a spinoff from the other company.
Scott: Okay.
Pat: Okay.
Scott: So tell us what's transpired since.
Gary: So what's transpired since is that the parent company, you know, the small pension as opposed to the tiny pension. Now, the small pension wants to do the same thing.
Scott: And how much are you receiving from the small pension?
Gary: The small pension is about three grand a month.
Pat: That's not small, by the way.
Scott: I don't think...
Pat: How old are you?
Scott: And you first said that it's all relative.
Gary: It's all relative.
Pat: How old are you?
Gary: I am 68.
Pat: So that's hundreds of thousands of dollars, by the way, if I use the net present value of your life expectancy, hundreds of thousands.
Gary: I know I am a blessed person to have these. So the small pension, the one that's about three grand a month...and those pensions, the two together, you know, that's a third of my needs.
Scott: Yeah. So, what's happening with the company in the small pension?
Gary: Well, it's going to go into the annuity later in the year. But now I do have...I did make some payments into that pension plan.
Pat: Okay.
Gary: So the payments that I get from them, you know, maybe 5% is...
Scott: De minimis then.
Gary: Okay, 5% is return of principal.
Scott: Okay.
Gary: I don't know if that's the exact term. But I'm just really wondering, with these pensions, in lieu of or with the annuities in lieu of the pension, that no longer falls under PBGC.
Scott: That's right.
Pat: I don't know.
Gary: I'm pretty sure that no longer falls under the PBGC.
Scott: Do they give you the opportunity to take a lump sum?
Pat: Did they, at any point in time...?
Gary: When I retired, they did.
Scott: Okay. And how about now?
Pat: Yes. How about now? Because you elected the pension.
Scott: Because what I've seen in the past is when these happen, they give the retiree an opportunity to take a lump sum. The company is just trying to...they don't want to risk anymore. They're like, "We're going to outsource this. We'll just give you a lump sum. If not, we're going to buy an annuity."
Pat: We're going to sell this to an insurance company.
Gary: Right. And the company has done this selectively over the years. I've been just aware of it from talk with the other people where they'll take a chunk of retirees and they'll say, "This chunk of retirees are going to get the annuity in lieu of the pension." And like you say, to move that off their books. But I'm wondering, how should I think about it in terms of, like, should I make any changes to my overall portfolio?
Pat: So the question I have, which I asked early on, on what you called the tiny pension, which is, would the PBGC still come across? And if you didn't get the election for a lump sum...
Scott: Then you would think that the company can't just shed the liability.
Pat: That's right.
Scott: We're not the rest of attorneys. We're not pension attorneys. We're not...
Pat: But that's what...
Scott: But usually, I mean, when I've seen this in the past, there's always been the opportunity, because insurance, the company doesn't care.
Pat: That's right.
Scott: They just assume you'd take the cash and get out of here if they're trying to dissolve this.
Pat: Yeah, because they might be backstopping the annuity on a risk pool at some point. So the question is, what are the annuity companies they sold them to? I mean, was it Blackwater Insurance Company, or was it...?
Gary: No, no. They were both... One is rated A or A-.
Scott: You could tell us the name.
Gary: Well, one is American United Life, and the other one is MetLife.
Scott: Well, MetLife is massive.
Pat: Yeah.
Gary: Yeah. And American United Life is this sort of regional.
Pat: Yeah.
Scott: But is the small one, the 3,000, is that going to MetLife?
Gary: Yes. I'm not worried about that. But the question is, how do I think about that in relation to my other?
Scott: Well, here's one way to think about it. So years ago, there was an insurance company called Executive Life that they went and bought a lot of pension plans. This was back in the '80s. Remember this, Pat?
Pat: Ivan Boesky.
Scott: Was he part of that investment?
Pat: Michael Milken.
Scott: Michael wasn't part of Executive Life.
Pat: I know. That's what they were selling the pensions to. So they were some...
Scott: Oh, it's junk bonds.
Pat: Yeah.
Scott: Yeah. So what happened is these insurance companies, yeah, that's right, they were buying a bunch of junk bonds.
Pat: They were raiding the pensions, which is if you watch the movie, "Wall Street," when Gordon Gekko says greed is good, and they were actually going in and bought Bluestar, the airline, to raid the pension...
Scott: They were doing this exact thing.
Pat: ...they were doing the exact thing.
Gary: They had an overfunding.
Scott: Yeah. And Pan Am went, I think Pan Am...was it Pan Am that went to Executive Life or one of those?
Pat: Yes.
Scott: And then when the insurance companies went bust because they weren't diversified and they were all in one particular area, and so, as a result of that, regulations changed dramatically for the insurance companies on how they had to invest their own reserves. They couldn't just go willy-nilly. And so they had a lot of restrictions going forward, which added a lot of protections for policyholders, annuitants, life insurance holders. And then, secondly, most states, there's some sort of insurance pool where they...not like FDIC insurance, but the insurance companies all kind of agree to insure one another.
Pat: And the smaller the annuity amount, the more the insurance actually kicks in, not the other way around.
Gary: But those state guarantee associations, don't they have a limit?
Pat: That's right.
Scott: That's right. It's like 250 grand or something.
Pat: Yeah. That's why I said the smaller the amount, the better the insurance, not the larger. So your question is, how should you view the rest of the portfolio? How big is the rest of the portfolio, and are you taking income from it?
Gary: Yeah, I am taking some income from it. It's about 2.5.
Pat: And how is it allocated now?
Gary: About 70% equity.
Scott: And how much income are you taking from this 2.5?
Gary: I'm taking, like, 1% or 2%.
Pat: I wouldn't change a thing.
Scott: I wouldn't either. I mean, assuming... One of the challenges, Gary, as your account balance goes up, the swings on a percentage basis result in much bigger dollar swings, right? So when you've got 250,000 saved and there's a 10% swing, it's 25 grand. When you have 2.5 million saved and there's a 10% swing, that's 250 grand. So we just need to make sure we've got eyes wide open, realizing that the markets, as they go through their cycles, and historically, we've had a 20% pullback every 3.5 years if you go back about 100 years, so these are very normal, that account is going to swing a lot. Now, if you only pull in 1% to 2% a year, you've got income coming in from pensions.
Pat: And you've got Social Security coming in.
Scott: This has the highest probability of great long-term success.
Pat: But in saying that, I would make some changes.
Gary: I'm listening.
Scott: I am, too. What changes?
Pat: I would look at doing Roth conversions.
Gary: You know, I looked at Roth conversions, and I kind of decided, you know what, it's a wash.
Scott: Was 2.5...is it all in the 401(k), IRAs, 401(k)s?
Gary: Pretty much. It's like 90%.
Scott: And how old are you again?
Pat: Sixty-eight.
Gary: I'm 68.
Scott: Yeah, I would too.
Pat: I would absolutely be... You're the perfect candidate for it.
Scott: Because your withdrawals are going to double at 73.
Pat: Yeah.
Scott: Seventy-three, 75, whatever it is.
Pat: Seventy-five. It's 68. Yes. If you were 68 years of age.
Gary: Oh, you're talking about RMD.
Scott: Yes.
Pat: Yes. So what happens is that I'd look at this and I'd go, "Okay, I'm at 2.5. I'm taking a 2% distribution today," right?
Scott: And now I'm going to be at a 3.8%, a 3.6%, or whatever the number is. At 75, it's probably closer to 4%.
Pat: Yes. So then I would actually extrapolate out a return. I'd just throw an 8% return in there, minus the 2%, compound that 6%, right? We're going to go out seven years. You look at that account, it's $4 million. You're going to start taking 160 grand a year out of there rather than 50 grand a year, right? And then we've got Social Security on that. All of a sudden, your income is over $200,000 a year. And so you're going to drive your Social Security tax up, your Medicare premiums up. There's all kinds of things. Your income will more than double in those years. And so the time between the age of 68 and your required minimum distribution, it's the golden hour for Roth conversions.
Gary: Well, that's a whole different thing for me. I looked at it, and the way I looked at it, it was a tax arbitrage. It was kind of a wash. But I do some conversions mainly just to have a pile of money that I can get to without any tax cuts.
Pat: How much conversions do you do?
Gary: I try to do 15 a year or 30 a year.
Pat: Okay. I'm just telling you...
Scott: But then...
Pat: Look, I don't care what you looked at, Gary. I don't really care. You called and asked us about your situation.
Scott: That's the one thing I would recommend as well.
Pat: I think you're fine on the annuities, right, and in the pensions. You're just missing an incredible opportunity.
Gary: Okay.
Pat: An unbelievable opportunity.
Scott: And it's because you've got a significant amount in retirement account assets, and you're barely taking any income from it.
Pat: Look, if you were a client of mine, and I'm sitting in a room, and you push back at me like that, you know what I'd say to you, what are you paying me for? Why are you paying? I'm giving you great advice here, and you're not taking any of it? And yet you pay me? You took the time to call our program, ask for advice?
Scott: Pat, you sound like you're taking this personally.
Pat: He just completely discounted it, Scott. You just said, "Oh, I looked at it in just a pile of money." I'm just telling you, you're wrong.
Gary: Well, I'm listening. I'll take another look at it. I appreciate...
Scott: I would take another look at it. And run some long-term projections.
Pat: You have to run the long-term projections so that...
Scott: What does my financial life look like 5 years, 10 years, 15, 20 years out?
Pat: And you said the right thing. You said, "Well, I just saw it as some tax arbitrage." And I said, "Exactly right." And you're doing some tax arbitrage. You're just not doing as much as you should be.
Gary: Well, so when you talk about doing Roth conversions, what I have heard is that you convert up to whatever tax bracket you're in.
Scott: Your tax bracket, yeah.
Pat: Maybe sometimes more.
Scott: Maybe.
Gary: Well, in my case, it would have to be more because I'm at the top of a bracket.
Scott: That's right.
Gary: I think I'll be in a lower bracket when I retire.
Pat: I'm just telling you, you won't.
Scott: Are you working today?
Gary: No. When I'm fully retired...
Scott: How much income are you earning today?
Gary: I'm not earning any income today.
Scott: Okay, then you're fully retired.
Pat: You're fully retired.
Gary: You know, you're right. I am. My wife is still working, though.
Pat: What does your wife make?
Gary: She's around 120.
Pat: Okay. All right, that's new information.
Scott: Some new information, yeah.
Pat: That's some new information. The minute your wife quits, you should do Roth conversions. You probably shouldn't be doing any at all now, not even 15 grand.
Gary: So you mean I've been doing it right?
Pat: Yeah, correct. I don't think you should probably even be doing...maybe if you had a little room in that tax bracket, but that's new information. We were under the assumption that there was no earned income coming in the family.
Gary: Got you, got you, got you. Yeah.
Pat: Right? But the minute your wife quits, the minute she quits working, by the way, you should have her work as long as you possibly can.
Scott: Yeah. Appreciate the call.
Pat: Anyway, Gary, appreciate the call. We're running out of time here.
Scott: That's all the time we have. We'll see you next week. This has been Scott Hanson and Pat McClain, Allworth's "Money Matters."
Man: 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.