Tax-Efficient Investing, Retirement Choices, and Market Shifts
On this week’s Money Matters, Scott and Pat dive into market shifts—tariffs, AI-driven productivity, and surprising earnings—and explain why chasing predictions fails while fundamentals like tax-efficient investing deliver results. Next, a caller shares his career-change dilemma: should he leave a higher-paying job for a teaching role with a pension? Scott and Pat weigh in on how retirement savings, insurance coverage, and college funding fit into the bigger picture.
Later, another caller with a $9 million stock portfolio reveals his struggle with taxes from heavy dividend income. This leads to a deep dive into tax-efficient investing, where Scott, Pat, and Allworth’s Head of Wealth Planning, Victoria Bogner, break down strategies like gifting stock, using net unrealized appreciation (NUA), and leveraging direct indexing for smarter portfolio management.
The episode closes with actionable insights to help you apply tax-efficient investing in your own financial plan—so you can keep more of what you’ve worked hard to build.
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Scott: Welcome to Allworth's "Money Matters", Scott Hanson.
Pat: Pat McClain. Thanks for joining us.
Scott: You know, it's funny, Pat, we've been in the show a long time. And as I'm driving into the studio today, I'm thinking, "Oh man, I've been in this a long time." And I started thinking about all of the shows that eventually ended. And I thought... But now that I'm here, I'm having a great time.
Pat: Isn't that so much about life? Not just radio show, work in general, some relationships, Christmas with the family.
Scott: I remember talking to my daughter. She was debating how she was going to go to some event. It was a church youth group thing. "I don't know if I want to go tonight. Should I go down? Should I not go? I don't know if I want to go." And I said, "When was the last time that you we're going through this and you went and you were regretted going?" And she said, "I can't think of any." "So, well, then maybe you should go."
Pat: Perfect.
Scott: You'll see all your friends. It's a good, wholesome atmosphere, and all that kind of stuff.
Pat: It's kind of the same way I work, gym. What's the life?
Scott: What's the life?
Pat: So, Scott...
Scott: Anyway, we're financial advisors. That's what we're going to talk about. Not our daughters or our gym life.
Pat: Yes. So, well, I did want to talk about the markets. Just reflecting on the year, the effective tariff rates, tariff rates on import, highest they've been since the 1930s, right? That's the effective tariff. No one...
Scott: That's amazing, isn't it? It is starting to come. It is working its way through.
Pat: Oh, it will work its way through.
Scott: Yeah, for sure.
Pat: But it could change in minutes, truly in minutes.
Scott: No, Trump is so predictable. What do you mean?
Pat: It just, the biggest companies out there, their S&P 500, largest companies in the S&P 500, they feel like they're a little bit insulated from...
Scott: You look at the earnings growth, Pat. People are expecting Q2 to be about 5% for the broad stock market. We're coming in north of 10, like 12%.
Pat: This quarter, more than 40% of companies in the S&P 500 index raised their earnings estimate, 40%. In the first quarter this year, 17% raised. And so, what all that is, is a company actually giving guidance to the stock market.
Scott: They always sandbag a little.
Pat: Really?
Scott: Right?
Pat: Yes.
Scott: You think you're going to earn $100 million. Where you're like, "Let's say we think we're going to earn $92, and that way if we do better...?
Pat: We look great.
Scott: ...we get rewarded as opposed to being punished."
Pat: Yes. So, at the end of the first quarter, 17% of companies raised their expectation. The end of this last quarter, 40%. And it's hard to point to. The retailers and restaurants are really struggling with the tariff situation, but certain industries are, most certainly.
Scott: For sure.
Pat: But the implementation of AI is really, really actually taking place.
Scott: Well, it's what's fascinating, Pat. So, like NVIDIA and the companies, some of these companies that call themselves AI companies, you look at the market caps of these things, right? Then you look at these pay packages that...
Pat: They're paying you.
Scott: ...these hot shot engineers are getting paid to come work for Mark Zuckerberg or whomever, it's kind of crazy money. But it all going to have to trickle down into more productivity and more profits for the companies that are paying for the services, right?
Scott: That's right.
Pat: Because you're not going to pay for a technology unless it's going to give you a return. No matter how cool the technology is, if it can't give you a return, you're not going to bother spending the money as a business.
Scott: That's right. That's right.
Pat: It's all a business.
Scott: But it just it's...
Pat: The bet is that the pull through on this is going to be substantial. And then you think, well, is this the dot-com all over again?
Scott: Well, certainly. It doesn't feel...
Pat: There might be some companies priced that way, but where there...
Scott: But even the dot-com is transformational.
Pat: It was.
Scott: Look how we buy and sell. I mean, my oldest daughter, she's in Denver thinking about moving back to Truckee. We met with a real estate agent not too long ago in his office, and kind of curious about different neighborhoods. All on a screen there, different neighborhoods, all of course, in line.
Pat: Then you get in the car then go around.
Scott: No, no. And well, then it's on this part. Then here's the houses that are available. Here's the ones that had sold before. And in an hour, what we accomplished in an hour, sitting in the office, looking at a big screen, would have taken us a few days 25 years ago.
Pat: Yeah, at least, for the initial screen.
Scott: That's not even a AI induced, it's a...
Pat: It's interesting. I just I was just reflecting this morning on it. And I just thought, and then I just remind myself, this stuff happens all the time. I just forget about it. What's the...
Scott: Then the markets just like the beginning of COVID, how quickly the market fell, and how quickly it recovered.
Scott: Well, it's been an amazing time because our downturns have been so short lived, right?
Pat: And what do you think is it? What do you think, Scott? Is it by the dips that the investing public is just...?
Scott: Well, if you think of the last two major downturns, right, so the dot-com, what we had there is overhyped companies that there was no there, there. It was all hype. They had a web presence dot-com. They hardly had any employees. They had no revenue. They had no real business model.
Pat: And then it hyped up the rest of the market.
Scott: And there were mutual funds that was still big mutual fund day, where grandma in Kansas City would put money into mutual fund. Essentially, it was a wealth transfer from individual savers to some of these dot-com creators. When that blew over, that created a big downturn. Add 9/11 on top of that. Because that was about halfway through, then suddenly, we had 9/11. So, there were there were some real headwinds. And same thing with the financial crisis. That was real.
Pat: I mean, that wasn't an emotional reaction to something that was going on.
Scott: No, no, no. There were millions of homeowners that had mortgages that became worth more than their homes.
Pat: Oftentimes, from the day they purchased them.
Scott: But it created this downward spiral. But so, we've not had anything quite like that. We had COVID, but that was short lived. Government stimulus kind of helped bridge that gap. We knew we weren't going to all die from the virus. So, once that was clear, things rallied back up. And then, you know, this tariff thing, I think people realize pretty quickly that whether you like the tariffs or not, and the way it's being implemented, it's not going to blow up the economy. And you can always reverse them.
Pat: Yes, you can pull them back.
Scott: Things get slow, you can reverse them. It's not like the housing crisis that's in a free for all. So, I think that's a...
Pat: Until we have some structural issue, that the markets, there'll be buybacks.
Scott: My guess.
Pat: These were like emotional reactions to the marketplace..
Scott: But as soon as I start to believe I have some idea of what's going to happen in the future...
Pat: Yes. As I...
Scott: ...you'll become a terrible investor.
Pat: This real estate agent a couple of days ago...
Scott: He told you.
Pat: Well, no, we'll see interest rates next year. And he said...
Scott: He said that to you, where they were going to go?
Pat: And I stopped and I looked at him and I said, "You know where interest rates are headed?" What he said, he cannot back.
Scott: Because I almost said because if that's the case, if I knew where interest rates are going, show us the biggest house here.
Pat: Like, why are we stopping? Let's look at the $50 million houses.
Scott: Did he have the interest rates going down?
Pat: Of course, yeah. They were going to be. If you need a loan, you can be able to refinance a few months for less.
Scott: It's, no. By the way, when someone tells you the interest rates are going to go up or going to go down, it's no different than someone tell you where the stock market is going to be in 6 or 12 months.
Pat: This guy was pitching me a real estate portfolio. A friend of a friend was trying to tell me, "Okay, he's buying all these houses in Idaho." He said, "Yeah, we're going to refinance these homes in three years at 4%."
Scott: That's their business model.
Pat: Yeah. I said, "Yeah, yeah."
Scott: What if you what if the interest rates are 10% then?
Pat: Scott, it can't be. You realize interest rate, like mortgage interest rates, if you go back 50 years...
Scott: They're historically still low.
Pat: Yeah. But any time that they throw out these projections...
Scott: I remember my first home, we bought a home in 1992. I believe it was seven and 3.25%, if I'm not mistaken.
Pat: Mine was north of nine, my first home.
Scott: It was a couple of years before I even did. That's when the rates were coming in. But why are we talking about our homes?
Pat: Home mortgage is not...
Scott: But I think the thing to always remember about the markets, you cannot predict the future. And just because things feel great right now, nasty times are going to come.
Pat: That's right.
Scott: We don't know when.
Pat: Whether you're Democrat or Republican, whether you're guy is in office or not in office.
Scott: Something bad's going to happen. The markets are going to go down.
Pat: And then the U.S. economy is going to take a hit. And then everyone's thinks it's going to be...
Scott: And it's different this time.
Pat: ...a reset a little bit. And then smart people are going to figure out how to go back and make money.
Scott: And the market's going to recover.
Pat: Again, again.
Scott: And we'll hit new highs.
Pat: Again. The Dow Jones Industrial Average is what? Roughly $45,000. When I started in the industry, 1990, July of 1990, it was roughly twenty $2,600.
Scott: Yep. That's a lot. It's increased quite a bit.
Pat: It's increased, yeah.
Scott: Because if you joined the industry...
Pat: Phenomenal.
Scott: ...in what? 1920?
Pat: 1990, July of 1990.
Scott: There we go.
Pat: Good reminder.
Scott: Was it August?
Pat: July of 1990.
Scott: You crawled a wall of worry. Is what they call it, investing.
Pat: Yeah. Well, all right. Let's get the calls.
Scott: Why don't we go to...? Yeah. Let's take a... And if you want to join us, you can send us an email, questions@moneymatters.com. By the way, we like taking calls. And if you've got a decent question, we'll take your call. It's not like we vet out 100 calls for every one we take. If it's a good question, there's a high probability...
Pat: If we were vetting, you think we'd have much better calls?
Scott: Well, we might. Wait till you get this next one. We're talking with David. David, you're with Allworth's "Money Matters".
David: Hey, gentlemen, how are you doing today?
Scott: We're doing outstanding. How could we be of help.
David: I got a two parter for you, two parter. First one is how are we doing so far? And then the second one is where do we go from here?
Pat: All right. Give us a breakdown.
David: Yeah. So, I'm 36, married. We have four kids.
Scott: By the way. You're doing well. The fact that you're 36, listen to the financial program and call for advice, that tells me you're doing well. So, you're 36, married, and four kids.
David: Four kids, yeah. We got started young, yeah. So, I work full time in professional industry. My wife is a part time engineering consultant. Together, we bring in about $200,000. About $170,000 is me, $30,000 for my wife. Primary caregiver, of course, in the home. We've got a house.
Scott: Is she employed somewhere or she's self-employed. Is she a contractor of sorts?
David: Self-employed contractor. Yep. We have a house. We've got about $215,000 left on that. About 10 years on the mortgage left. And it's worth maybe $800,000. We have about P0,000.
Scott: The interest rate is what?
Pat: How old is your oldest kid?
David: Oldest kid is 12, and interest rate 2.25%.
Scott: Okay.
Pat: All right, thanks.
David: Yep. For savings, we've got $500,000, $30,000 in retirement. Most of that is 401(k). I have a little bit like $15,000 in a Roth IRA. And then we've got some cash and checkings and cash and emergency fund. And that's kind of snapshot so far.
Scott: How much life insurance do you have on yourself?
David: I've got a million. And it was a 20 year policy we did maybe five years ago. And I think we have about $500,000 on my wife.
Pat: I'd double it on both of you.
Scott: Yeah. I don't know if...
Pat: I'd double it on both.
Scott: Yeah, you would need people to drive your kids around everything else should something happen to your wife. And it's so inexpensive.
Pat: Yeah, double it. Yeah, double it. And how old is your youngest?
David: Five.
Pat: I would double it. And I'd probably buy...
David: Ten, fifteen?
Pat: Yeah, that's actually... I'd probably buy...
Scott: Yeah, have a look at it.
Pat: ...a 15-year level term.
Scott: That gets your five-year-old at 20.
Pat: Yeah, I'd buy a 15-year level term.
Scott: By the way, in 15... In your financial situations, look, you're phenomenally good shape here, right? You've been in the workforce... Did you graduate college in '22, '23, somewhere in there, right? So, 12, 13, 14 years you've been working here. You're married. You guys have four children. Your home is almost paid for relative to the value of the house. You've got half a million dollars in savings. You've got no debt. You've got emergency reserves.
Pat: I'd buy a disability policy as well. What do you have offered through your employer?
David: I'd have to check it out. I've never really considered it. I'm sure we have something.
Pat: You want to buy as much as they sell you through your employer, because it's cheap through the employer. It's very expensive in the in public markets. But you should buy as much...
Scott: My next door neighbor is a surgeon. Fully disabled. He's 40. I mean, he can't do his surgeon, he can't. He has had something in his neck. Quit being a surgeon.
Pat: He's still a doctor, though.
Scott: Yeah, he's got five kids.
Pat: Wow.
Scott: Had some good disability insurance. And he's trying to figure out, you know, his next chapter and all that stuff. But...
Pat: Yeah, because it...
Scott: It happened.
Pat: It happens. Yeah. So, you want to buy as much disability as they will sell you through your employer, and then I would... As long as it covers 75%, anything less than that, I would actually consider going to the market. You give me a look, Scott.
Scott: No, I'm thinking. I mean, I did at this age, when I was that age.
Pat: Oh, I had... Yeah, a lot.
Scott: Yeah, I did as well at that age.
David: Okay. That's great.
Pat: All right. And then double the term life insurance.
Scott: And if you end up with some disability, get something with a really long waiting period. You don't care about it at six month or a year. I mean, you don't. That's not financially devastating, a six month or a year disability. A lifetime disability is disastrous.
Pat: Yes. You want, at least, a year waiting period, and then lifetime coverage. Okay, and the...
Scott: How much are you saving?
David: Per month, I'm putting away about 8% of my salary. And it was a pretty fair matching program.
Pat: You were putting a lot more away at one point in time.
David: Well, so there's... I was putting 10% to 12%. We paused that a little bit for starting kids college funds and some other thing.
Pat: What do you have in the college fund?
David: About $60,000 between all the kids. And we're doing about 100 bucks a month for each of them. So, we're going into the 401(k) is, like, about $2,000 a month.
Pat: Can you afford to put a little bit more into the 401(k)?
David: I think so. And I guess, this kind of gets into my next question, the second part, the where do we go from here? In the big context behind that is actually contemplating a career move. I've been teaching part time. So, that's where a lot of the some of the extra cash comes from that we can put away for saving for kids college and other things. And this career move would actually take me full time into teaching at the university level. I've been doing that part time for about six years.
Scott: And what's that mean for your pay?
David: Pretty significant cut.
Scott: How big?
David: Well, for me, about half. But I need to pick up some part time work in industry, you know, through the summers and through the school year. And then my wife getting to a point where she can take on more work. So, it's, you know, mine cuts in half, but we're going to try to build up from there now that the kids are a little bit older in school.
Pat: What type of university would it be?
David: Be at Cal State, CSU.
Scott: Okay.
Pat: And would you get a pension?
Cal State: He would.
David: I would. Yeah, there'd be a defined benefit plan. So, you know, let's assume that I work for the next 26, 27 years there, I'd be 62 or so.
Scott: You've got a... You're in a good place right now, right? It's not like you're starting out with zero and four kids. You don't have a time safe retirement. You've got to... It's a decent amount for a 36 year old. Life's about the journey. Well, you would be able to take up contract work. Have you talked to your existing employer?
David: I could talk to them, and I also have quite a few industry contacts that I think would we be willing to introduce my part time job.
Scott: I got to tell you, look, I can't tell you how many people I've talked to, Pat, and you have as well.
Pat: Their early 50s, mid 50s, and they come in and they say..."Pat, I hate my job. How many more years do I have to do this before I can retire?" You heard that 100 of times.
Scott: If you were my son, this is what I would tell you, figure out how to make it work.
Pat: Yeah, I would too. First of all, that advice I gave you about the disability policy, the university has a great disability policy.
Scott: That's right. You don't need to worry about it.
Pat: They might have a great life insurance as well.
Scott: That's right.
Pat: My guess is that the health insurance is probably better than what you get in three years if you're still employed.
Scott: You'll make it work anyway. You'll make it work.
Pat: At least you've got the financial discipline.
David: Yeah, I think we're going to make it work. And we're going to figure out how much we need to make. So, the big question is, you know, obviously, we have to continue to contribute. So, is it just we max out our IRAs and...?
Pat: David, you're going to hire an advisor. They're going to tell you exactly, exactly what to do. And they're going to model this...
Scott: And you might say, for the next 18 months, the next two years, you got a 5-year-old, right? I don't think the kids in full time school, yet, is he, she?
David: Yeah, kindergarten.
Scott: Okay. Full time?
David: Yeah.
Scott: Okay. So, you just hit that point. You're talking about your wife being able to work more because you got kids in school full time. But if it means that you pause retirement saving for a year or so, so be it.
Pat: David, look, if you were my son, right, you're a little bit older than my oldest, I would hire a financial advisor for you and make you actually go to a Zoom meeting, make you, ask you nicely to go to a Zoom meeting to figure out how it works. Because what they'll be able to do is give you some clarity on how much income you need to make up so that you're not out there thinking, "Oh, I need to land every contract." And they'll give you clarity about what your retirement will look like when you're at 60 or 65.
Scott: Well, and if you're a professor, I mean, you might know these guys.
Pat: I have a friend I spent a couple of weeks with ago. I spent the weekend with him, a friend from high school. And I just remember... He's a college professor. And he always told us when he was in high school, he wanted to be a college professor because it was the only job he could think of where he didn't have to get up before 10 a.m.
Scott: He's still he's still teaching?
Pat: He loves it. Loves it. He's 62. Pay for advice. I'll tell you what, I'm going to have someone... I'm going to do this. I'm going to do this for free, Scott. Just listen, right?
Scott: We've got your contact.
Pat: We've got your contact. I might have someone call you and they'll walk you through a free financial plan.
David: Yeah, that'd be that'd be awesome, guys. Really appreciate that.
Pat: The anticipation is because, like, how do I take care of my family and make this to sleep, right? Which is really scary.
Scott: Of course. You've got four kids. They got to play sports and all that stuff. It's going to...
Pat: The better visibility that you have into what the future looks like, the better you'll do.
Scott: And not being so stressed like, "Oh, I better go find another little contract to make some more side money." And maybe you'll be an point saying, "I'm just going to see how I make myself more valuable at Cal State."
Pat: Who knows? You're 36. Are you an engineer?
Scott: I think it's cool.
Pat: What kind of a professor will you be? You'll be engineering?
David: Yeah, engineering construction. It's kind of a crossover.
Pat: There we go. Good for you.
Scott: Yeah, seriously.
David: Thanks, guys. I really appreciate it.
Pat: All right, David. Good for you. Keep it up.
Scott: You know, it's interesting, Pat, my favorite kind of...literally...
Pat: Oh, by the way, I'm sorry, Scott, let me give this disclaimer. Don't call the show looking for a free financial plan.
Scott: My favorite kind of planning is working with someone mid-career, whether they're this young or older, that is trying to say, how do I do something that I really love to do with less money and still have financial independence?
Scott: And he's teaching on the side, so he knows what it's like. Because, I mean, we're financial guys, right? Wealth managers, financial advisors, calls, whatever. But it's not it's not necessarily about the highest dollar amount. Obviously, that's not what life's not about for most people. Oh, I did read AM. I think it was last week, there was an opinion piece in "The Wall Street Journal" about this, and I agree with the headlines. It was pretty much, forget work life balance in your 20s.
Pat: Oh, yeah, I read that article.
Scott: And I kind of agree with that. You got to figure your career out. But then the more I read it, he, like, limited his relationships. How many people in his life? And he was hoping to be a billionaire. And then once he had the billion dollars, he was going to change and start saving the world or something.
Pat: I read the article. He seemed a little unhinged.
Scott: I didn't agree with it at all, but after I read the thing. But...
Pat: He hired he hired someone that would... Anything that was less valuable than his time to his employer, he had someone else do for him. Like, what's the humanity? What's it?
Scott: His goal was to accumulate a billion dollars. Maybe he will, maybe he won't. For most people, what's the point?
Pat: What do you think the chances of accumulating a billion dollars?
Scott: How many billionaires are in the world? A couple hundred. Not a lot. And don't forget hard work. And there is...
Pat: Luck.
Scott: There's luck. There's a lot of luck too, come on.
Pat: There's luck.
Scott: Of course, there's a lot of luck.
Pat: There's luck.
Scott: Yeah, for sure. Anyway. Pat, there are a lot of people in their 50s that hate their job, that don't have quite the financial independence to just call it quits. But there are times, instead of hating your job and quitting at age 60, go do something you love to do and work till 65 or 70. Anyway...
Pat: Let's hear...
Scott: ...let's continue on here. We're going to talk with Ed in Philadelphia. Ed, you with Allworth's "Money Matters".
Ed: Yes. Thanks for letting me call in.
Scott: Thank you.
Ed: I have a question for you, guys. I am retired. I got, I believe, more money than I need for retirement. And most of my income from retirement is in dividends. I have an IRA, a traditional IRA that's worth over $500,000. My question for you two is, I have a lot of money, I believe a lot of money sitting in my checking account at the end of the year. And for the last 30 years, I've been reinvesting most of that back into the dividend paying stocks. And my tax bill is getting pretty big.
Pat: How old are you, Ed?
Ed: I'm 63.
Scott: Are you married?
Ed: Yes.
Scott: And how much do you have in stock? What's your stock portfolio value that are paying these dividends?
Ed: Just under $9 million.
Pat: And you only have four or five hundred thousand dollars in your IRA?
Ed: Yes.
Pat: And why dividend stocks? Just out of curiosity.
Ed: I've been factuated with dividends ever since I was like a teenager.
Scott: It's worked for him.
Ed: Oh, they have, they have.
Scott: Yeah. I'm not going to try to get you changed on that one. It's clearly worked for you. And what's the problem?
Ed: My problem is, is at the end of the year, when I'm done paying all bills and the taxes and everything, I still have a lot of money, I believe too much money sitting in my checking account. And for the last 40 some years, I've been taking a lot of what's left over at the end of the year and putting it back into the dividends, to reinvest into the dividends. But my tax bill now is getting to be pretty big.
Pat: Well, if I gave you a solution, you're not going to like it. I'm going to tell you that you should quit buying dividend-paying stocks.
Ed: And do what? Just leave the money sitting...
Pat: How about buy some stocks that don't pay dividends.
Scott: Buy some growth stocks.
Pat: Some growth stocks. My guess is that your portfolio is highly tilted towards value companies. You could just buy an index. You're not managing this portfolio in a tax efficient manner.
Scott: No, not at all.
Pat: Not even... There's been no attention paid to the tax efficiency of your portfolio, none. Because I would make the argument that you should have 50% of your portfolio and non-dividend paying stocks. And the reason behind that is, obviously, for current taxations, also because at death, not appreciated assets under current law receive a full step up in basis.
Scott: So you can avoid the tax.
Pat: Completely. So, I appreciate the fact that this investment philosophy has worked for you. It would have worked for you if the portfolio been growth stocks as well. In fact, it would have worked better. How much you have in cash?
Ed: Excuse me, right now, I got about $90,000.
Pat: Oh, well, that's not bad.
Scott: No.
Pat: Have you started gifting...? You have children?
Ed: Yes.
Pat: Have you started gifting to them?
Ed: Yes.
Pat: And the maximum amount?
Scott: You gave them stocks?
Ed: I give them money right out of my checking account.
Pat: Are they in a lower tax bracket than you?
Ed: Yes.
Pat: Why not give them stocks?
Scott: I'd give them stocks.
Ed: Never thought about that. Okay.
Pat: Well, you did call.
Scott: Financial show.
Pat: One idea. You did call a financial show to get an idea of something that you're not doing, right? So, what happens, here's the reality, if you came into our office today, we would look at this portfolio. And the first thing we do is we'd look at the allocation. My guess, as Scott says, is mostly...
Scott: Highly allocated towards value stock. Then there was a thing...
Pat: And large cap value would be my guess.
Scott: Large cap.
Pat: So, we'd look at the portfolio. And the first thing we do is say, okay, where are the risk in the asset allocation itself?" Well, you know, if I had a square with nine different squares inside of it, yours would be mostly concentrated in the top left hand. We'd say, let's try to actually mimic more of what the market is, which is growth, mid cap, small cap. Then after we said, okay, this is really how it should look, how can we build this so it's as tax efficient as possible? So that...
Scott: And I'd use a direct index technology on this.
Pat: That's right.
Scott: You build a synthetic index that and it's managed for tax. You do some tax lost harvesting.
Pat: That's right. And so, what happens is that... And by the way, if some of these terms are new to the listeners or yourself, it's because they weren't around 10 years ago,
Scott: Three years ago.
Pat: And the reason they weren't around was, is the cost of friction, which is the cost of trading, was oftentimes more expensive.
Scott: Yeah. Now, it costs nothing.
Pat: It costs nothing. What we call friction was the cost of buying and selling. And the other thing is that we use technology today that didn't exist five years ago. Certainly didn't exist 10 years ago. We use that to actually manage portfolios. So, you know, technology in the investment advisory world has changed. It's the democratization of investments by the use of technology. It brings private office-type services to the middle class or the high net worth, which you would be. You wouldn't be ultra-high net worth, but you'd be considered a high net worth client. So, what you're doing, and you're probably doing all of this yourself, correct?
Ed: Correct.
Pat: And you probably don't want to turn this on to anyone else. My advice to you is, you're missing out on technologies.
Scott: Not only that. I mean, so we've mentioned one idea. You're gifting your children. That's an easy one. Just give stocks now, appreciated ones. They're in lower tax bracket. If they plan it right, they have no capital gains when they sell it. But you also might say, maybe we take some portion of this and use a charitable remainder trust. And get a nice big tax deduction from that.
Pat: Today
Scott: Today, with a guaranteed income tomorrow. And as we do that, the tax deduction, we can turn around, and sell some of the existing stocks that we have now, encourage the capital gain... I mean...
Pat: Encourage.
Scott: ...realize the capital gain, but have them wash out each other. And then we can invest in something that's much more tax efficient. You got a lot of options here in front of you.
Pat: But it would be moving a little bit away from large cap value.
Scott: A hundred percent value.
Pat: Yeah, large cap value, which what you're investing in.
Ed: Well, I do have a lot of growth stocks in the IRA.
Pat: Which, by the way, is exactly opposite. You've got to completely...
Scott: Opposite.
Pat: You've got to completely wrong. Like if I said, let's make this tax efficient, I'm like, "Let's call Ed." Or, "Let's lose tax efficiency in this portfolio. Let's call Ed." Because your growth stock should be in the IRA. And the dividend...
Scott: You mean, and your dividend should be in the IRA.
Pat: Excuse me. The dividend should be in the IRA, and the growth stock should be in the brokerage account.
Scott: And I think it got it. Look, Ed, you've done a great job.
Pat: You've got a great saver. Good saver. This has worked for you, right? But it's at a point now, now you've created a new problem for yourself. And it's the taxation of this, right, because you've got what? You probably got... Depending on what kind of dividend stocks, you might have $400,000 coming on, you have to pay taxes on each year, and dividends, right?
Ed: A little bit more than that, yeah.
Pat: It tells us, it's even worse than we suspected in terms of large cap value, right? And...
Ed: So, you suggest that I...
Scott: Here's what I would do. You're my brother, I'd say, "Hey, Ed, go interview two qualified financial advisors, certified financial planners. Go meet with two different ones and just hear what they have to say. Hear about their ideas. And if one resonates with you..." And I'd just say, "Look, once you do a financial plan, pay for them to do a financial plan that they can come up with all these strategies to show you the impact it could have on you financially."
Pat: The money you would actually save in taxation would more than pay for the cost of a professional asset management on this account. That's a promise.
Scott: Oh, yeah, for sure. I mean, you manage this account for what? Four tenths, five tenths of a percent, and cut your tax bill in half, promise, promise.
Ed: That's good. I'm glad I called.
Pat: Well, I'm glad you are, too. And by the way, you've done well so...
Scott: Listen, if you did nothing, you're still going to be fine. You're still going to be fine.
Pat: That's right.
Scott: You did not nothing...
Ed: I'm not worried about outliving my money. I'm worried about what you guys... What I called in about is my tax bill is huge.
Pat: Well, I get it. And...
Scott: You have to take a different approach than the approach that you're taking today. And truly, you could get this tax bill...
Pat: And you might choose to take some portion, some of your stocks each year, and put them in a donor advised fund.
Scott: Or you can do a lot of some charities in the future, if you like.
Pat: And you may actually choose to actually accelerate how you're actually giving the money to the children and use up part of your unified credit, right? I mean, no one says that you can't go in and give the kids a million dollars today because you can't. It's just less money that you could pass on at your death.
Scott: Well, hey, we're going to take a little time to... We've got a special guest in our studio, special to us anyway, Victoria Bogner, who is our head of wealth planning at Allworth. You're going to... We were chatting, and she has just some good planning with the client we thought it'd be interesting for her to talk about. So,
Pat: And they bring you in, head of financial planning, but...
Scott: Head of wealth planning.
Pat: Wealth planning. So, more complicated, like super complicated?
Victoria: So, complicated, yes. We see it all. Let me tell you.
Pat: Give us your educational background just for basis to start with.
Victoria: Sure. I've been in the business since 2005. Started as a temp worker, actually. But my background is in mathematics, originally in computer science. So, I stumbled into this career, and along the way, became a financial advisor.
Pat: You have a degree in mathematics?
Victoria: I do. That's my true passion spreadsheets. So, I got a degree in mathematics, computer science. Then I joined McDaniel Knutson Financial Partners in Lawrence, Kansas, became a temp for them, then became an advisor. Then I became the Chief Investment Officer because of my math background, and eventually, became the CEO of the company. And in that time, I got my certified financial planner designation, my chartered financial analyst designation, and an accredited investment fiduciary designation. All over the span of 20 years.
Pat: The CFA, though, is rough.
Scott: It a tough one.
Victoria: It is rough. We got marital counseling after that one. Three years being in the trenches.
Pat: That is a rough... Well, and then you joined us, what? Three years ago?
Victoria: Two years ago.
Scott: Two years?
Pat: It's only two years?
Victoria: It's only been two years.
Pat: Goodness gracious.
Victoria: I know. It feels like I've been here for 20 years.
Scott: It does.
Victoria: Just two years.
Scott: Feels like old.
Pat: Well, when you joined the firm, I remember saying to you, you're going to love it here.
Victoria: Oh, and I do. It's fantastic. I mean, I went from working for a small boutique firm to a large boutique firm. I mean, Allworth is large, but still has that very personal feel. And I love that. I found that that's pretty rare in our industry, too.
Pat: We're glad you joined us. And I don't see you very often. Just kind of...
Victoria: I know. I was looking into your eyes right now.
Pat: We're no longer the CEOs of the firm. We brought in someone more experienced than ourselves, which, by the way, if you're a business owner, it's hard to do. It's been the right thing for our clients and the right thing for our advisors. There's no question.
Scott: Yes, he does such a better job than we did.
Pat: Absolutely, he does.
Scott: In three years.
Victoria: He's pretty great, yeah.
Pat: You've got to give up that. Anyway, back to this client story, bring us through ages, count size, complications, solutions, the whole bit.
Victoria: You got it. Okay, so we got two clients, married couple, 62 and 60. They came to us with... You know, he worked for a company that I won't name, because then if he's listening to this podcast, he'll be like, "Oh, yeah, that was me." But ABC Company, basically, his whole career. I mean, he's one of those people that got a job at 22 and worked there for 40 years. But in that time, he participated in the Employee Stock Purchase Plan. And then he was also purchasing company stock inside his 401(k). So, they come to us. They now have a net worth of $7 million dollars, $3 million of it is an ABC stock.
Scott: Wow.
Pat: Wow. And in ESOP and a 401(k).
Victoria: Employees Stock Purchase Plan, so ESPP. So, that means that he was purchasing this stock at a 15% discount. It's in a tax...
Pat: And never sold it?
Victoria: Never sold it.
Pat: Because sometimes you can sell it every six months or whatever. People do that old strategy.
Victoria: Never sold it. No. So, he's got a lot of stock with a little bit of cost basis.
Scott: By the way, how has that stock done the last 10 years versus the broad market?
Victoria: Now, it's not Apple. Okay, I'll tell you that. But it's a good blue chip stock. So, it's done pretty well.
Scott: So, total has outperformed the market.
Victoria: It's performed pretty much in line with the market, but still...
Scott: So, the only reason I ask, it's an example of taking on more risk without being compensated for it.
Victoria: Correct. Absolutely. Because inside of his 401(k), he's got, you know, $1.5 million of it. And then in the Employee Stock Purchase Plan, he's got another $1.5 million.
Pat: Were they matching with the company stock, or was he purchasing it?
Victoria: Inside the 401(k), it was part of his contribution. So, they were matching his contribution into the 401(k). He was just choosing to allocate some of that to companies.
Pat: Got it. Got it. Got it. Got it. Okay. And so, $7 million.
Victoria: $7 million.
Pat: What kind of income did this family make?
Victoria: He made about $250,000 a year.
Pat: Wow. Easily going to be able to replace...
Victoria: Yes, easily.
Pat: Standard of living would go up significantly.
Victoria: Right So, they can absolutely retire. But of course, the number one question is, and this is very common, you know, "I have so much of my net worth three sevenths of it in this company stock, but it's a ticking tax time bomb. I can't just sell it, and then pay...
Scott: And what about the 401(k)? I mean, that's an easy one, right?
Victoria: Well, there's something special that you can do with the 401(k) if it makes sense. And in his case, it did. He had both preferred shares and common shares inside the 401(k). With the preferred shares, that's where the bulk of this was, he only had a cost basis. Meaning that he actually put money in the 401(k). His own money purchased $100,000 worth of the stock, and the preferred shares were worth about a million dollars.
Scott: All right. So, we had $900,000.
Victoria: Of...
Pat: Net Unrealized Appreciation.
Scott: And I assume we're going to get to what we call NUA here.
Victoria: Correct. So, what we recommended is for those preferred shares, the common shares, he had, you know, very high cost basis. So, this doesn't make sense for that. But it made sense for the preferred shares. What you do is you take that million dollars, you move it into a taxable brokerage account. You move the rest of the 401(k)...
Pat: In shares.
Victoria: In shares, yes.
Scott: And this only works if the company actual shares in the 401(k), not some sort of fund that mirrors the preferred.
Victoria: Correct.
Scott: Or units.
Victoria: It's got to be the actual...
Pat: Or units.
Victoria: Correct.
Scott: Because, listen, you might work for a company that you have money in the company's 401(k) and that your company stock, but it's you don't technically own the shares, you own some sort of...
Victoria: Right. So, this is if you own the shares. So, you move those shares in kind to a taxable brokerage. You move the rest to an IRA. You got to do it all in one year. You got to empty the 401(k) in one year. You can't stagger it. But so, you take that million dollars, you move it to a taxable brokerage in those shares in kind. Then what happens is you're only taxed on the $100,000 of basis, that's ordinary income. On day one, that $900,000 of gain is long-term capital gain. Then any growth beyond that million, that short term capital gain until you hit the 12 month mark. So, you've got three kind of tax buckets going on in that account at the same time.
Scott: And...
Pat: Why wouldn't you just... I'm sorry, Scott.
Scott: I knew this at one point in time, but do you still get a full step up basis upon death too with that? Is it forgiven?
Victoria: Yes, you do. Yes, you do.
Pat: And would you just hold for 12 months and then put collars around it? Use options in order to get some downside protection?
Victoria: Well, here's what we were able to do. So, to see the story through a little bit further...
Scott: Oh, we're getting ahead of ourselves.
Victoria: You're getting little ahead of yourselves.
Scott: A little excited about this. Well, Net Unrealized Appreciation, an example like that, he doesn't have to worry about requirement of distributions anymore.
Victoria: No, that's exactly right.
Scott: He's taking something that went from ordinary income when he withdrew to now he's got dividends tax at favorable event, capital gains tax at favorable event.
Victoria: Exactly. On day one, that 900,000 grand is a long-term capital gains, which the top bracket for that's 20%, ordinary income tax top bracket is 37% as of today. So, by doing that, and since he's retiring this year, that we'll factor in in a second, we moved the IRA or the 401(k) money, the bulk that was left into an IRA. And then he's also got this Employee Stock Purchase Plan with a bunch of this company stock in it with a very low basis. So, what we're able to do then is say, all right, we want to go ahead and minimize the amount of time you have to be glued to the earnings report of this company. Because if something happens to it, you're going to be sunk, right? So, how do we enroll...
Scott: Let's say if he retire from GE.
Pat: WorldCom or GE, Intel.
Scott: Intel.
Victoria: Yep. So, many different things that can happen. So, there are actually a few different strategies that we could employ depending on how much liquidity he needs. But this is the direction we decided to go for him because he wanted the most amount of flexibility and liquidity. So, for the money that was originally in the ESPP, okay, that's in a taxable brokerage. We want to go ahead and minimize the risk of that right away without having to sell it. So, how do you do that? Well, one way to do it is you can color it. So, what that means is you are basically saying that, "I'm willing. I can participate in the gain of this stock up to, say, a 15% cap. And after that, I'm willing to sell the future annual gains beyond 15% to buy some downside protection." So, let's say my comfort level is...
Scott: So, essentially, you're going to buy some insurance on it, and the way to pay for it, you say, "If the stock just takes off like bananas, I'll forego some of that upside."
Victoria: Right. And we're not doing it with all of it, we're doing with 30% of it, right, just to take down some of the risk. So, you're basically pre-selling future growth in order to fund downside protection in this case.
Pat: But you could just fund downside protection and keep all future growth.
Victoria: You could if you want to, if you want to pay out of pocket for that downside protection. A lot of folks decide, "Hey, let's make this cash neutral event. Okay, so I don't want to have to pay out of pocket for the protection. Let's go ahead and sell some future gain. And then we can fund the downside protection." So...
Pat: And you start the downside protection at 10$ negative, 15% negative?
Victoria: Yeah, it depends on their comfort level. So, for them it was, we'll participate in the first 10% of loss. And then after that, we're going to be fine. And the more loss you're willing to take, then the higher that upside cap is, right? So, for them, they were able to participate in the first 15% of gain every year, so this is annually. And then if it went gangbusters and went up 30%, okay, well, on that piece, we protected, I guess we missed out on some upside. But for that, we're able to protect them.
Scott: You're able to be able to pay for the capital gain because you just had the big end upside.
Victoria: That's right. So, that's another perk, is that we don't then actually sell the stock if it gets called. And this is getting a little advanced. But then we just pay for another stock option to cover that call. It's a loss. Then we get to use that loss to sell some of the stock and right off the game. So, it's really a great strategy. Then in the meantime, we are able to sell enough of the stock that he was still in a zero percent capital gains bracket. So, there are lots of different income tax brackets. So, it's not just your income tax, there's also capital gains tax bracket. There's your IRMAA tax bracket. There's Social Security tax bracket. So, you want to make sure that all of these are working in tandem. So, especially in 2026, we can sell a lot of that stock in the 0% capital gains bracket. So, then we can take that money and kickstart what's called a direct indexing account. So, how that works is instead of going out and buying the S&P 500 ETF, instead, you put it in a direct indexing account where you're buying all 500 individual stocks.
Pat: It's beautiful.
Victoria: It's a beautiful strategy. And then...
Scott: Well, and then in this situation... Every situation is unique, but I know where this is going.
Victoria: But in this situation, it works. So, over the course of 2026, some of those stocks are going to do great, some of them are going to be stinkers. If you hold just an index fund, then you're just along for the ride. But owning 500 individual stocks of the S&P, well, then you can sell the stinkers to realize loss and offset the capital gain from selling some of that stock.
Scott: Yes, baby sister.
Pat: And Victoria, did you carve out any part of that direct index from the industry since he's already had a... Because you only you only did a color on one third of the portfolio in the ESEP?
Scott: Yeah, you can say I don't want to own that particular company or I don't want to own the whole industry.
Pat: Whole industry.
Victoria: Correct. Yes. So...
Pat: So, beyond a regular direct index, you actually excluded, let's just say that it was manufacturing, you excluded that sector of manufacturing of the index.
Victoria: Right. So, what we were able to do is say, okay, in the S&P, we obviously don't want to own more of this particular sector, so let's carve that out because we already are overweighted in that. And that, we have that flexibility to do that, so spot on. Yes, that's absolutely what we did. So, then we have this engine now that's producing these capital losses while you're still making the returns of the S&P 500 because you're invested in the entirety of the S&P 500. You're just manufacturing these capital losses so you can sell those overweighted stock.
Pat: How much more expensive is a portfolio like this versus regular ETF?
Scott: Yes, what's the direct investment cost nowadays?
Victoria: So, to add this strategy is a whopping point 0.4%. But the amount of tax alpha...
Scott: Just on the direct index.
Victoria: Yeah, just on the direct index. But you're owning individual stocks, so there's no cost to that.
Pat: Yes, correct. So, the alpha is incredible.
Victoria: Yeah, the alpha is amazing, especially in this particular situation, where if you sell all the stock outright, then you're paying 20% capital gains tax on most of it.
Pat: I'm trying to think of how many different techniques you used in this one client. And by the way, if you retired 10 or 15 years ago and you're like, my advisor never talked about this, or they don't talk about it today, this is really, really advanced. And what has brought the cost down significantly is the use of technology in the portfolios.
Victoria: You're spot on because 10, 15 years ago, you had to be an institutional investor or somebody with $10 million plus in net worth to even touch some of these strategies.
Pat: And it wouldn't have been this inexpensive. It'd be much, much more expensive.
Victoria: Much more expensive.
Pat: And this is all run by algorithms.
Victoria: Mm-hmm, yeah, that's right. Which is a lot more reliable than a human being, promise you.
Pat: And the cost will continue to fall.
Victoria: Yeah. Yeah, so these are strategies that are available to the everyday investor. But you need to have an advisor that knows how to put the pieces together to maximize that tax output.
Scott: And understand that those pieces even exist.
Victoria: Yeah, that too.
Pat: So, in our firm, we have different level of advisors, where they... You specialize in really complex things, right? So, they actually refer business up to you and you work in tandem with the advisor. How does it work?
Victoria: That's right. So, the advisor is still the head of the relationship. We're basically their team. So, they are the coach on that relationship. We are on the advisor's team. So, they can bring us in whenever they have the need to have a complex situation evaluated. Then we can do the planning. We can even present the plan to the client. But the advisor is always the head of that relationship.
Scott: Well, I always love hearing stuff like this. I mean, Pat, we built this company 37 years ago, and the stuff that we can do now for average investors.
Pat: It's crazy.
Scott: Like this is so great.
Pat: Crazy.
Scott: So, Vicki, thanks for taking some time to join us.
Victoria: Absolutely.
Scott: This all time we've got. We'll see you again next week. Scott Hanson and Pat McLean, Allworth Financial.
Automated Voice: 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 a state-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: You know, it's funny, Pat, we've been in the show a long time. And as I'm driving into the studio today, I'm thinking, "Oh man, I've been in this a long time." And I started thinking about all of the shows that eventually ended. And I thought... But now that I'm here, I'm having a great time.
Pat: Isn't that so much about life? Not just radio show, work in general, some relationships, Christmas with the family.
Scott: I remember talking to my daughter. She was debating how she was going to go to some event. It was a church youth group thing. "I don't know if I want to go tonight. Should I go down? Should I not go? I don't know if I want to go." And I said, "When was the last time that you we're going through this and you went and you were regretted going?" And she said, "I can't think of any." "So, well, then maybe you should go."
Pat: Perfect.
Scott: You'll see all your friends. It's a good, wholesome atmosphere, and all that kind of stuff.
Pat: It's kind of the same way I work, gym. What's the life?
Scott: What's the life?
Pat: So, Scott...
Scott: Anyway, we're financial advisors. That's what we're going to talk about. Not our daughters or our gym life.
Pat: Yes. So, well, I did want to talk about the markets. Just reflecting on the year, the effective tariff rates, tariff rates on import, highest they've been since the 1930s, right? That's the effective tariff. No one...
Scott: That's amazing, isn't it? It is starting to come. It is working its way through.
Pat: Oh, it will work its way through.
Scott: Yeah, for sure.
Pat: But it could change in minutes, truly in minutes.
Scott: No, Trump is so predictable. What do you mean?
Pat: It just, the biggest companies out there, their S&P 500, largest companies in the S&P 500, they feel like they're a little bit insulated from...
Scott: You look at the earnings growth, Pat. People are expecting Q2 to be about 5% for the broad stock market. We're coming in north of 10, like 12%.
Pat: This quarter, more than 40% of companies in the S&P 500 index raised their earnings estimate, 40%. In the first quarter this year, 17% raised. And so, what all that is, is a company actually giving guidance to the stock market.
Scott: They always sandbag a little.
Pat: Really?
Scott: Right?
Pat: Yes.
Scott: You think you're going to earn $100 million. Where you're like, "Let's say we think we're going to earn $92, and that way if we do better...?
Pat: We look great.
Scott: ...we get rewarded as opposed to being punished."
Pat: Yes. So, at the end of the first quarter, 17% of companies raised their expectation. The end of this last quarter, 40%. And it's hard to point to. The retailers and restaurants are really struggling with the tariff situation, but certain industries are, most certainly.
Scott: For sure.
Pat: But the implementation of AI is really, really actually taking place.
Scott: Well, it's what's fascinating, Pat. So, like NVIDIA and the companies, some of these companies that call themselves AI companies, you look at the market caps of these things, right? Then you look at these pay packages that...
Pat: They're paying you.
Scott: ...these hot shot engineers are getting paid to come work for Mark Zuckerberg or whomever, it's kind of crazy money. But it all going to have to trickle down into more productivity and more profits for the companies that are paying for the services, right?
Scott: That's right.
Pat: Because you're not going to pay for a technology unless it's going to give you a return. No matter how cool the technology is, if it can't give you a return, you're not going to bother spending the money as a business.
Scott: That's right. That's right.
Pat: It's all a business.
Scott: But it just it's...
Pat: The bet is that the pull through on this is going to be substantial. And then you think, well, is this the dot-com all over again?
Scott: Well, certainly. It doesn't feel...
Pat: There might be some companies priced that way, but where there...
Scott: But even the dot-com is transformational.
Pat: It was.
Scott: Look how we buy and sell. I mean, my oldest daughter, she's in Denver thinking about moving back to Truckee. We met with a real estate agent not too long ago in his office, and kind of curious about different neighborhoods. All on a screen there, different neighborhoods, all of course, in line.
Pat: Then you get in the car then go around.
Scott: No, no. And well, then it's on this part. Then here's the houses that are available. Here's the ones that had sold before. And in an hour, what we accomplished in an hour, sitting in the office, looking at a big screen, would have taken us a few days 25 years ago.
Pat: Yeah, at least, for the initial screen.
Scott: That's not even a AI induced, it's a...
Pat: It's interesting. I just I was just reflecting this morning on it. And I just thought, and then I just remind myself, this stuff happens all the time. I just forget about it. What's the...
Scott: Then the markets just like the beginning of COVID, how quickly the market fell, and how quickly it recovered.
Scott: Well, it's been an amazing time because our downturns have been so short lived, right?
Pat: And what do you think is it? What do you think, Scott? Is it by the dips that the investing public is just...?
Scott: Well, if you think of the last two major downturns, right, so the dot-com, what we had there is overhyped companies that there was no there, there. It was all hype. They had a web presence dot-com. They hardly had any employees. They had no revenue. They had no real business model.
Pat: And then it hyped up the rest of the market.
Scott: And there were mutual funds that was still big mutual fund day, where grandma in Kansas City would put money into mutual fund. Essentially, it was a wealth transfer from individual savers to some of these dot-com creators. When that blew over, that created a big downturn. Add 9/11 on top of that. Because that was about halfway through, then suddenly, we had 9/11. So, there were there were some real headwinds. And same thing with the financial crisis. That was real.
Pat: I mean, that wasn't an emotional reaction to something that was going on.
Scott: No, no, no. There were millions of homeowners that had mortgages that became worth more than their homes.
Pat: Oftentimes, from the day they purchased them.
Scott: But it created this downward spiral. But so, we've not had anything quite like that. We had COVID, but that was short lived. Government stimulus kind of helped bridge that gap. We knew we weren't going to all die from the virus. So, once that was clear, things rallied back up. And then, you know, this tariff thing, I think people realize pretty quickly that whether you like the tariffs or not, and the way it's being implemented, it's not going to blow up the economy. And you can always reverse them.
Pat: Yes, you can pull them back.
Scott: Things get slow, you can reverse them. It's not like the housing crisis that's in a free for all. So, I think that's a...
Pat: Until we have some structural issue, that the markets, there'll be buybacks.
Scott: My guess.
Pat: These were like emotional reactions to the marketplace..
Scott: But as soon as I start to believe I have some idea of what's going to happen in the future...
Pat: Yes. As I...
Scott: ...you'll become a terrible investor.
Pat: This real estate agent a couple of days ago...
Scott: He told you.
Pat: Well, no, we'll see interest rates next year. And he said...
Scott: He said that to you, where they were going to go?
Pat: And I stopped and I looked at him and I said, "You know where interest rates are headed?" What he said, he cannot back.
Scott: Because I almost said because if that's the case, if I knew where interest rates are going, show us the biggest house here.
Pat: Like, why are we stopping? Let's look at the $50 million houses.
Scott: Did he have the interest rates going down?
Pat: Of course, yeah. They were going to be. If you need a loan, you can be able to refinance a few months for less.
Scott: It's, no. By the way, when someone tells you the interest rates are going to go up or going to go down, it's no different than someone tell you where the stock market is going to be in 6 or 12 months.
Pat: This guy was pitching me a real estate portfolio. A friend of a friend was trying to tell me, "Okay, he's buying all these houses in Idaho." He said, "Yeah, we're going to refinance these homes in three years at 4%."
Scott: That's their business model.
Pat: Yeah. I said, "Yeah, yeah."
Scott: What if you what if the interest rates are 10% then?
Pat: Scott, it can't be. You realize interest rate, like mortgage interest rates, if you go back 50 years...
Scott: They're historically still low.
Pat: Yeah. But any time that they throw out these projections...
Scott: I remember my first home, we bought a home in 1992. I believe it was seven and 3.25%, if I'm not mistaken.
Pat: Mine was north of nine, my first home.
Scott: It was a couple of years before I even did. That's when the rates were coming in. But why are we talking about our homes?
Pat: Home mortgage is not...
Scott: But I think the thing to always remember about the markets, you cannot predict the future. And just because things feel great right now, nasty times are going to come.
Pat: That's right.
Scott: We don't know when.
Pat: Whether you're Democrat or Republican, whether you're guy is in office or not in office.
Scott: Something bad's going to happen. The markets are going to go down.
Pat: And then the U.S. economy is going to take a hit. And then everyone's thinks it's going to be...
Scott: And it's different this time.
Pat: ...a reset a little bit. And then smart people are going to figure out how to go back and make money.
Scott: And the market's going to recover.
Pat: Again, again.
Scott: And we'll hit new highs.
Pat: Again. The Dow Jones Industrial Average is what? Roughly $45,000. When I started in the industry, 1990, July of 1990, it was roughly twenty $2,600.
Scott: Yep. That's a lot. It's increased quite a bit.
Pat: It's increased, yeah.
Scott: Because if you joined the industry...
Pat: Phenomenal.
Scott: ...in what? 1920?
Pat: 1990, July of 1990.
Scott: There we go.
Pat: Good reminder.
Scott: Was it August?
Pat: July of 1990.
Scott: You crawled a wall of worry. Is what they call it, investing.
Pat: Yeah. Well, all right. Let's get the calls.
Scott: Why don't we go to...? Yeah. Let's take a... And if you want to join us, you can send us an email, questions@moneymatters.com. By the way, we like taking calls. And if you've got a decent question, we'll take your call. It's not like we vet out 100 calls for every one we take. If it's a good question, there's a high probability...
Pat: If we were vetting, you think we'd have much better calls?
Scott: Well, we might. Wait till you get this next one. We're talking with David. David, you're with Allworth's "Money Matters".
David: Hey, gentlemen, how are you doing today?
Scott: We're doing outstanding. How could we be of help.
David: I got a two parter for you, two parter. First one is how are we doing so far? And then the second one is where do we go from here?
Pat: All right. Give us a breakdown.
David: Yeah. So, I'm 36, married. We have four kids.
Scott: By the way. You're doing well. The fact that you're 36, listen to the financial program and call for advice, that tells me you're doing well. So, you're 36, married, and four kids.
David: Four kids, yeah. We got started young, yeah. So, I work full time in professional industry. My wife is a part time engineering consultant. Together, we bring in about $200,000. About $170,000 is me, $30,000 for my wife. Primary caregiver, of course, in the home. We've got a house.
Scott: Is she employed somewhere or she's self-employed. Is she a contractor of sorts?
David: Self-employed contractor. Yep. We have a house. We've got about $215,000 left on that. About 10 years on the mortgage left. And it's worth maybe $800,000. We have about P0,000.
Scott: The interest rate is what?
Pat: How old is your oldest kid?
David: Oldest kid is 12, and interest rate 2.25%.
Scott: Okay.
Pat: All right, thanks.
David: Yep. For savings, we've got $500,000, $30,000 in retirement. Most of that is 401(k). I have a little bit like $15,000 in a Roth IRA. And then we've got some cash and checkings and cash and emergency fund. And that's kind of snapshot so far.
Scott: How much life insurance do you have on yourself?
David: I've got a million. And it was a 20 year policy we did maybe five years ago. And I think we have about $500,000 on my wife.
Pat: I'd double it on both of you.
Scott: Yeah. I don't know if...
Pat: I'd double it on both.
Scott: Yeah, you would need people to drive your kids around everything else should something happen to your wife. And it's so inexpensive.
Pat: Yeah, double it. Yeah, double it. And how old is your youngest?
David: Five.
Pat: I would double it. And I'd probably buy...
David: Ten, fifteen?
Pat: Yeah, that's actually... I'd probably buy...
Scott: Yeah, have a look at it.
Pat: ...a 15-year level term.
Scott: That gets your five-year-old at 20.
Pat: Yeah, I'd buy a 15-year level term.
Scott: By the way, in 15... In your financial situations, look, you're phenomenally good shape here, right? You've been in the workforce... Did you graduate college in '22, '23, somewhere in there, right? So, 12, 13, 14 years you've been working here. You're married. You guys have four children. Your home is almost paid for relative to the value of the house. You've got half a million dollars in savings. You've got no debt. You've got emergency reserves.
Pat: I'd buy a disability policy as well. What do you have offered through your employer?
David: I'd have to check it out. I've never really considered it. I'm sure we have something.
Pat: You want to buy as much as they sell you through your employer, because it's cheap through the employer. It's very expensive in the in public markets. But you should buy as much...
Scott: My next door neighbor is a surgeon. Fully disabled. He's 40. I mean, he can't do his surgeon, he can't. He has had something in his neck. Quit being a surgeon.
Pat: He's still a doctor, though.
Scott: Yeah, he's got five kids.
Pat: Wow.
Scott: Had some good disability insurance. And he's trying to figure out, you know, his next chapter and all that stuff. But...
Pat: Yeah, because it...
Scott: It happened.
Pat: It happens. Yeah. So, you want to buy as much disability as they will sell you through your employer, and then I would... As long as it covers 75%, anything less than that, I would actually consider going to the market. You give me a look, Scott.
Scott: No, I'm thinking. I mean, I did at this age, when I was that age.
Pat: Oh, I had... Yeah, a lot.
Scott: Yeah, I did as well at that age.
David: Okay. That's great.
Pat: All right. And then double the term life insurance.
Scott: And if you end up with some disability, get something with a really long waiting period. You don't care about it at six month or a year. I mean, you don't. That's not financially devastating, a six month or a year disability. A lifetime disability is disastrous.
Pat: Yes. You want, at least, a year waiting period, and then lifetime coverage. Okay, and the...
Scott: How much are you saving?
David: Per month, I'm putting away about 8% of my salary. And it was a pretty fair matching program.
Pat: You were putting a lot more away at one point in time.
David: Well, so there's... I was putting 10% to 12%. We paused that a little bit for starting kids college funds and some other thing.
Pat: What do you have in the college fund?
David: About $60,000 between all the kids. And we're doing about 100 bucks a month for each of them. So, we're going into the 401(k) is, like, about $2,000 a month.
Pat: Can you afford to put a little bit more into the 401(k)?
David: I think so. And I guess, this kind of gets into my next question, the second part, the where do we go from here? In the big context behind that is actually contemplating a career move. I've been teaching part time. So, that's where a lot of the some of the extra cash comes from that we can put away for saving for kids college and other things. And this career move would actually take me full time into teaching at the university level. I've been doing that part time for about six years.
Scott: And what's that mean for your pay?
David: Pretty significant cut.
Scott: How big?
David: Well, for me, about half. But I need to pick up some part time work in industry, you know, through the summers and through the school year. And then my wife getting to a point where she can take on more work. So, it's, you know, mine cuts in half, but we're going to try to build up from there now that the kids are a little bit older in school.
Pat: What type of university would it be?
David: Be at Cal State, CSU.
Scott: Okay.
Pat: And would you get a pension?
Cal State: He would.
David: I would. Yeah, there'd be a defined benefit plan. So, you know, let's assume that I work for the next 26, 27 years there, I'd be 62 or so.
Scott: You've got a... You're in a good place right now, right? It's not like you're starting out with zero and four kids. You don't have a time safe retirement. You've got to... It's a decent amount for a 36 year old. Life's about the journey. Well, you would be able to take up contract work. Have you talked to your existing employer?
David: I could talk to them, and I also have quite a few industry contacts that I think would we be willing to introduce my part time job.
Scott: I got to tell you, look, I can't tell you how many people I've talked to, Pat, and you have as well.
Pat: Their early 50s, mid 50s, and they come in and they say..."Pat, I hate my job. How many more years do I have to do this before I can retire?" You heard that 100 of times.
Scott: If you were my son, this is what I would tell you, figure out how to make it work.
Pat: Yeah, I would too. First of all, that advice I gave you about the disability policy, the university has a great disability policy.
Scott: That's right. You don't need to worry about it.
Pat: They might have a great life insurance as well.
Scott: That's right.
Pat: My guess is that the health insurance is probably better than what you get in three years if you're still employed.
Scott: You'll make it work anyway. You'll make it work.
Pat: At least you've got the financial discipline.
David: Yeah, I think we're going to make it work. And we're going to figure out how much we need to make. So, the big question is, you know, obviously, we have to continue to contribute. So, is it just we max out our IRAs and...?
Pat: David, you're going to hire an advisor. They're going to tell you exactly, exactly what to do. And they're going to model this...
Scott: And you might say, for the next 18 months, the next two years, you got a 5-year-old, right? I don't think the kids in full time school, yet, is he, she?
David: Yeah, kindergarten.
Scott: Okay. Full time?
David: Yeah.
Scott: Okay. So, you just hit that point. You're talking about your wife being able to work more because you got kids in school full time. But if it means that you pause retirement saving for a year or so, so be it.
Pat: David, look, if you were my son, right, you're a little bit older than my oldest, I would hire a financial advisor for you and make you actually go to a Zoom meeting, make you, ask you nicely to go to a Zoom meeting to figure out how it works. Because what they'll be able to do is give you some clarity on how much income you need to make up so that you're not out there thinking, "Oh, I need to land every contract." And they'll give you clarity about what your retirement will look like when you're at 60 or 65.
Scott: Well, and if you're a professor, I mean, you might know these guys.
Pat: I have a friend I spent a couple of weeks with ago. I spent the weekend with him, a friend from high school. And I just remember... He's a college professor. And he always told us when he was in high school, he wanted to be a college professor because it was the only job he could think of where he didn't have to get up before 10 a.m.
Scott: He's still he's still teaching?
Pat: He loves it. Loves it. He's 62. Pay for advice. I'll tell you what, I'm going to have someone... I'm going to do this. I'm going to do this for free, Scott. Just listen, right?
Scott: We've got your contact.
Pat: We've got your contact. I might have someone call you and they'll walk you through a free financial plan.
David: Yeah, that'd be that'd be awesome, guys. Really appreciate that.
Pat: The anticipation is because, like, how do I take care of my family and make this to sleep, right? Which is really scary.
Scott: Of course. You've got four kids. They got to play sports and all that stuff. It's going to...
Pat: The better visibility that you have into what the future looks like, the better you'll do.
Scott: And not being so stressed like, "Oh, I better go find another little contract to make some more side money." And maybe you'll be an point saying, "I'm just going to see how I make myself more valuable at Cal State."
Pat: Who knows? You're 36. Are you an engineer?
Scott: I think it's cool.
Pat: What kind of a professor will you be? You'll be engineering?
David: Yeah, engineering construction. It's kind of a crossover.
Pat: There we go. Good for you.
Scott: Yeah, seriously.
David: Thanks, guys. I really appreciate it.
Pat: All right, David. Good for you. Keep it up.
Scott: You know, it's interesting, Pat, my favorite kind of...literally...
Pat: Oh, by the way, I'm sorry, Scott, let me give this disclaimer. Don't call the show looking for a free financial plan.
Scott: My favorite kind of planning is working with someone mid-career, whether they're this young or older, that is trying to say, how do I do something that I really love to do with less money and still have financial independence?
Scott: And he's teaching on the side, so he knows what it's like. Because, I mean, we're financial guys, right? Wealth managers, financial advisors, calls, whatever. But it's not it's not necessarily about the highest dollar amount. Obviously, that's not what life's not about for most people. Oh, I did read AM. I think it was last week, there was an opinion piece in "The Wall Street Journal" about this, and I agree with the headlines. It was pretty much, forget work life balance in your 20s.
Pat: Oh, yeah, I read that article.
Scott: And I kind of agree with that. You got to figure your career out. But then the more I read it, he, like, limited his relationships. How many people in his life? And he was hoping to be a billionaire. And then once he had the billion dollars, he was going to change and start saving the world or something.
Pat: I read the article. He seemed a little unhinged.
Scott: I didn't agree with it at all, but after I read the thing. But...
Pat: He hired he hired someone that would... Anything that was less valuable than his time to his employer, he had someone else do for him. Like, what's the humanity? What's it?
Scott: His goal was to accumulate a billion dollars. Maybe he will, maybe he won't. For most people, what's the point?
Pat: What do you think the chances of accumulating a billion dollars?
Scott: How many billionaires are in the world? A couple hundred. Not a lot. And don't forget hard work. And there is...
Pat: Luck.
Scott: There's luck. There's a lot of luck too, come on.
Pat: There's luck.
Scott: Of course, there's a lot of luck.
Pat: There's luck.
Scott: Yeah, for sure. Anyway. Pat, there are a lot of people in their 50s that hate their job, that don't have quite the financial independence to just call it quits. But there are times, instead of hating your job and quitting at age 60, go do something you love to do and work till 65 or 70. Anyway...
Pat: Let's hear...
Scott: ...let's continue on here. We're going to talk with Ed in Philadelphia. Ed, you with Allworth's "Money Matters".
Ed: Yes. Thanks for letting me call in.
Scott: Thank you.
Ed: I have a question for you, guys. I am retired. I got, I believe, more money than I need for retirement. And most of my income from retirement is in dividends. I have an IRA, a traditional IRA that's worth over $500,000. My question for you two is, I have a lot of money, I believe a lot of money sitting in my checking account at the end of the year. And for the last 30 years, I've been reinvesting most of that back into the dividend paying stocks. And my tax bill is getting pretty big.
Pat: How old are you, Ed?
Ed: I'm 63.
Scott: Are you married?
Ed: Yes.
Scott: And how much do you have in stock? What's your stock portfolio value that are paying these dividends?
Ed: Just under $9 million.
Pat: And you only have four or five hundred thousand dollars in your IRA?
Ed: Yes.
Pat: And why dividend stocks? Just out of curiosity.
Ed: I've been factuated with dividends ever since I was like a teenager.
Scott: It's worked for him.
Ed: Oh, they have, they have.
Scott: Yeah. I'm not going to try to get you changed on that one. It's clearly worked for you. And what's the problem?
Ed: My problem is, is at the end of the year, when I'm done paying all bills and the taxes and everything, I still have a lot of money, I believe too much money sitting in my checking account. And for the last 40 some years, I've been taking a lot of what's left over at the end of the year and putting it back into the dividends, to reinvest into the dividends. But my tax bill now is getting to be pretty big.
Pat: Well, if I gave you a solution, you're not going to like it. I'm going to tell you that you should quit buying dividend-paying stocks.
Ed: And do what? Just leave the money sitting...
Pat: How about buy some stocks that don't pay dividends.
Scott: Buy some growth stocks.
Pat: Some growth stocks. My guess is that your portfolio is highly tilted towards value companies. You could just buy an index. You're not managing this portfolio in a tax efficient manner.
Scott: No, not at all.
Pat: Not even... There's been no attention paid to the tax efficiency of your portfolio, none. Because I would make the argument that you should have 50% of your portfolio and non-dividend paying stocks. And the reason behind that is, obviously, for current taxations, also because at death, not appreciated assets under current law receive a full step up in basis.
Scott: So you can avoid the tax.
Pat: Completely. So, I appreciate the fact that this investment philosophy has worked for you. It would have worked for you if the portfolio been growth stocks as well. In fact, it would have worked better. How much you have in cash?
Ed: Excuse me, right now, I got about $90,000.
Pat: Oh, well, that's not bad.
Scott: No.
Pat: Have you started gifting...? You have children?
Ed: Yes.
Pat: Have you started gifting to them?
Ed: Yes.
Pat: And the maximum amount?
Scott: You gave them stocks?
Ed: I give them money right out of my checking account.
Pat: Are they in a lower tax bracket than you?
Ed: Yes.
Pat: Why not give them stocks?
Scott: I'd give them stocks.
Ed: Never thought about that. Okay.
Pat: Well, you did call.
Scott: Financial show.
Pat: One idea. You did call a financial show to get an idea of something that you're not doing, right? So, what happens, here's the reality, if you came into our office today, we would look at this portfolio. And the first thing we do is we'd look at the allocation. My guess, as Scott says, is mostly...
Scott: Highly allocated towards value stock. Then there was a thing...
Pat: And large cap value would be my guess.
Scott: Large cap.
Pat: So, we'd look at the portfolio. And the first thing we do is say, okay, where are the risk in the asset allocation itself?" Well, you know, if I had a square with nine different squares inside of it, yours would be mostly concentrated in the top left hand. We'd say, let's try to actually mimic more of what the market is, which is growth, mid cap, small cap. Then after we said, okay, this is really how it should look, how can we build this so it's as tax efficient as possible? So that...
Scott: And I'd use a direct index technology on this.
Pat: That's right.
Scott: You build a synthetic index that and it's managed for tax. You do some tax lost harvesting.
Pat: That's right. And so, what happens is that... And by the way, if some of these terms are new to the listeners or yourself, it's because they weren't around 10 years ago,
Scott: Three years ago.
Pat: And the reason they weren't around was, is the cost of friction, which is the cost of trading, was oftentimes more expensive.
Scott: Yeah. Now, it costs nothing.
Pat: It costs nothing. What we call friction was the cost of buying and selling. And the other thing is that we use technology today that didn't exist five years ago. Certainly didn't exist 10 years ago. We use that to actually manage portfolios. So, you know, technology in the investment advisory world has changed. It's the democratization of investments by the use of technology. It brings private office-type services to the middle class or the high net worth, which you would be. You wouldn't be ultra-high net worth, but you'd be considered a high net worth client. So, what you're doing, and you're probably doing all of this yourself, correct?
Ed: Correct.
Pat: And you probably don't want to turn this on to anyone else. My advice to you is, you're missing out on technologies.
Scott: Not only that. I mean, so we've mentioned one idea. You're gifting your children. That's an easy one. Just give stocks now, appreciated ones. They're in lower tax bracket. If they plan it right, they have no capital gains when they sell it. But you also might say, maybe we take some portion of this and use a charitable remainder trust. And get a nice big tax deduction from that.
Pat: Today
Scott: Today, with a guaranteed income tomorrow. And as we do that, the tax deduction, we can turn around, and sell some of the existing stocks that we have now, encourage the capital gain... I mean...
Pat: Encourage.
Scott: ...realize the capital gain, but have them wash out each other. And then we can invest in something that's much more tax efficient. You got a lot of options here in front of you.
Pat: But it would be moving a little bit away from large cap value.
Scott: A hundred percent value.
Pat: Yeah, large cap value, which what you're investing in.
Ed: Well, I do have a lot of growth stocks in the IRA.
Pat: Which, by the way, is exactly opposite. You've got to completely...
Scott: Opposite.
Pat: You've got to completely wrong. Like if I said, let's make this tax efficient, I'm like, "Let's call Ed." Or, "Let's lose tax efficiency in this portfolio. Let's call Ed." Because your growth stock should be in the IRA. And the dividend...
Scott: You mean, and your dividend should be in the IRA.
Pat: Excuse me. The dividend should be in the IRA, and the growth stock should be in the brokerage account.
Scott: And I think it got it. Look, Ed, you've done a great job.
Pat: You've got a great saver. Good saver. This has worked for you, right? But it's at a point now, now you've created a new problem for yourself. And it's the taxation of this, right, because you've got what? You probably got... Depending on what kind of dividend stocks, you might have $400,000 coming on, you have to pay taxes on each year, and dividends, right?
Ed: A little bit more than that, yeah.
Pat: It tells us, it's even worse than we suspected in terms of large cap value, right? And...
Ed: So, you suggest that I...
Scott: Here's what I would do. You're my brother, I'd say, "Hey, Ed, go interview two qualified financial advisors, certified financial planners. Go meet with two different ones and just hear what they have to say. Hear about their ideas. And if one resonates with you..." And I'd just say, "Look, once you do a financial plan, pay for them to do a financial plan that they can come up with all these strategies to show you the impact it could have on you financially."
Pat: The money you would actually save in taxation would more than pay for the cost of a professional asset management on this account. That's a promise.
Scott: Oh, yeah, for sure. I mean, you manage this account for what? Four tenths, five tenths of a percent, and cut your tax bill in half, promise, promise.
Ed: That's good. I'm glad I called.
Pat: Well, I'm glad you are, too. And by the way, you've done well so...
Scott: Listen, if you did nothing, you're still going to be fine. You're still going to be fine.
Pat: That's right.
Scott: You did not nothing...
Ed: I'm not worried about outliving my money. I'm worried about what you guys... What I called in about is my tax bill is huge.
Pat: Well, I get it. And...
Scott: You have to take a different approach than the approach that you're taking today. And truly, you could get this tax bill...
Pat: And you might choose to take some portion, some of your stocks each year, and put them in a donor advised fund.
Scott: Or you can do a lot of some charities in the future, if you like.
Pat: And you may actually choose to actually accelerate how you're actually giving the money to the children and use up part of your unified credit, right? I mean, no one says that you can't go in and give the kids a million dollars today because you can't. It's just less money that you could pass on at your death.
Scott: Well, hey, we're going to take a little time to... We've got a special guest in our studio, special to us anyway, Victoria Bogner, who is our head of wealth planning at Allworth. You're going to... We were chatting, and she has just some good planning with the client we thought it'd be interesting for her to talk about. So,
Pat: And they bring you in, head of financial planning, but...
Scott: Head of wealth planning.
Pat: Wealth planning. So, more complicated, like super complicated?
Victoria: So, complicated, yes. We see it all. Let me tell you.
Pat: Give us your educational background just for basis to start with.
Victoria: Sure. I've been in the business since 2005. Started as a temp worker, actually. But my background is in mathematics, originally in computer science. So, I stumbled into this career, and along the way, became a financial advisor.
Pat: You have a degree in mathematics?
Victoria: I do. That's my true passion spreadsheets. So, I got a degree in mathematics, computer science. Then I joined McDaniel Knutson Financial Partners in Lawrence, Kansas, became a temp for them, then became an advisor. Then I became the Chief Investment Officer because of my math background, and eventually, became the CEO of the company. And in that time, I got my certified financial planner designation, my chartered financial analyst designation, and an accredited investment fiduciary designation. All over the span of 20 years.
Pat: The CFA, though, is rough.
Scott: It a tough one.
Victoria: It is rough. We got marital counseling after that one. Three years being in the trenches.
Pat: That is a rough... Well, and then you joined us, what? Three years ago?
Victoria: Two years ago.
Scott: Two years?
Pat: It's only two years?
Victoria: It's only been two years.
Pat: Goodness gracious.
Victoria: I know. It feels like I've been here for 20 years.
Scott: It does.
Victoria: Just two years.
Scott: Feels like old.
Pat: Well, when you joined the firm, I remember saying to you, you're going to love it here.
Victoria: Oh, and I do. It's fantastic. I mean, I went from working for a small boutique firm to a large boutique firm. I mean, Allworth is large, but still has that very personal feel. And I love that. I found that that's pretty rare in our industry, too.
Pat: We're glad you joined us. And I don't see you very often. Just kind of...
Victoria: I know. I was looking into your eyes right now.
Pat: We're no longer the CEOs of the firm. We brought in someone more experienced than ourselves, which, by the way, if you're a business owner, it's hard to do. It's been the right thing for our clients and the right thing for our advisors. There's no question.
Scott: Yes, he does such a better job than we did.
Pat: Absolutely, he does.
Scott: In three years.
Victoria: He's pretty great, yeah.
Pat: You've got to give up that. Anyway, back to this client story, bring us through ages, count size, complications, solutions, the whole bit.
Victoria: You got it. Okay, so we got two clients, married couple, 62 and 60. They came to us with... You know, he worked for a company that I won't name, because then if he's listening to this podcast, he'll be like, "Oh, yeah, that was me." But ABC Company, basically, his whole career. I mean, he's one of those people that got a job at 22 and worked there for 40 years. But in that time, he participated in the Employee Stock Purchase Plan. And then he was also purchasing company stock inside his 401(k). So, they come to us. They now have a net worth of $7 million dollars, $3 million of it is an ABC stock.
Scott: Wow.
Pat: Wow. And in ESOP and a 401(k).
Victoria: Employees Stock Purchase Plan, so ESPP. So, that means that he was purchasing this stock at a 15% discount. It's in a tax...
Pat: And never sold it?
Victoria: Never sold it.
Pat: Because sometimes you can sell it every six months or whatever. People do that old strategy.
Victoria: Never sold it. No. So, he's got a lot of stock with a little bit of cost basis.
Scott: By the way, how has that stock done the last 10 years versus the broad market?
Victoria: Now, it's not Apple. Okay, I'll tell you that. But it's a good blue chip stock. So, it's done pretty well.
Scott: So, total has outperformed the market.
Victoria: It's performed pretty much in line with the market, but still...
Scott: So, the only reason I ask, it's an example of taking on more risk without being compensated for it.
Victoria: Correct. Absolutely. Because inside of his 401(k), he's got, you know, $1.5 million of it. And then in the Employee Stock Purchase Plan, he's got another $1.5 million.
Pat: Were they matching with the company stock, or was he purchasing it?
Victoria: Inside the 401(k), it was part of his contribution. So, they were matching his contribution into the 401(k). He was just choosing to allocate some of that to companies.
Pat: Got it. Got it. Got it. Got it. Okay. And so, $7 million.
Victoria: $7 million.
Pat: What kind of income did this family make?
Victoria: He made about $250,000 a year.
Pat: Wow. Easily going to be able to replace...
Victoria: Yes, easily.
Pat: Standard of living would go up significantly.
Victoria: Right So, they can absolutely retire. But of course, the number one question is, and this is very common, you know, "I have so much of my net worth three sevenths of it in this company stock, but it's a ticking tax time bomb. I can't just sell it, and then pay...
Scott: And what about the 401(k)? I mean, that's an easy one, right?
Victoria: Well, there's something special that you can do with the 401(k) if it makes sense. And in his case, it did. He had both preferred shares and common shares inside the 401(k). With the preferred shares, that's where the bulk of this was, he only had a cost basis. Meaning that he actually put money in the 401(k). His own money purchased $100,000 worth of the stock, and the preferred shares were worth about a million dollars.
Scott: All right. So, we had $900,000.
Victoria: Of...
Pat: Net Unrealized Appreciation.
Scott: And I assume we're going to get to what we call NUA here.
Victoria: Correct. So, what we recommended is for those preferred shares, the common shares, he had, you know, very high cost basis. So, this doesn't make sense for that. But it made sense for the preferred shares. What you do is you take that million dollars, you move it into a taxable brokerage account. You move the rest of the 401(k)...
Pat: In shares.
Victoria: In shares, yes.
Scott: And this only works if the company actual shares in the 401(k), not some sort of fund that mirrors the preferred.
Victoria: Correct.
Scott: Or units.
Victoria: It's got to be the actual...
Pat: Or units.
Victoria: Correct.
Scott: Because, listen, you might work for a company that you have money in the company's 401(k) and that your company stock, but it's you don't technically own the shares, you own some sort of...
Victoria: Right. So, this is if you own the shares. So, you move those shares in kind to a taxable brokerage. You move the rest to an IRA. You got to do it all in one year. You got to empty the 401(k) in one year. You can't stagger it. But so, you take that million dollars, you move it to a taxable brokerage in those shares in kind. Then what happens is you're only taxed on the $100,000 of basis, that's ordinary income. On day one, that $900,000 of gain is long-term capital gain. Then any growth beyond that million, that short term capital gain until you hit the 12 month mark. So, you've got three kind of tax buckets going on in that account at the same time.
Scott: And...
Pat: Why wouldn't you just... I'm sorry, Scott.
Scott: I knew this at one point in time, but do you still get a full step up basis upon death too with that? Is it forgiven?
Victoria: Yes, you do. Yes, you do.
Pat: And would you just hold for 12 months and then put collars around it? Use options in order to get some downside protection?
Victoria: Well, here's what we were able to do. So, to see the story through a little bit further...
Scott: Oh, we're getting ahead of ourselves.
Victoria: You're getting little ahead of yourselves.
Scott: A little excited about this. Well, Net Unrealized Appreciation, an example like that, he doesn't have to worry about requirement of distributions anymore.
Victoria: No, that's exactly right.
Scott: He's taking something that went from ordinary income when he withdrew to now he's got dividends tax at favorable event, capital gains tax at favorable event.
Victoria: Exactly. On day one, that 900,000 grand is a long-term capital gains, which the top bracket for that's 20%, ordinary income tax top bracket is 37% as of today. So, by doing that, and since he's retiring this year, that we'll factor in in a second, we moved the IRA or the 401(k) money, the bulk that was left into an IRA. And then he's also got this Employee Stock Purchase Plan with a bunch of this company stock in it with a very low basis. So, what we're able to do then is say, all right, we want to go ahead and minimize the amount of time you have to be glued to the earnings report of this company. Because if something happens to it, you're going to be sunk, right? So, how do we enroll...
Scott: Let's say if he retire from GE.
Pat: WorldCom or GE, Intel.
Scott: Intel.
Victoria: Yep. So, many different things that can happen. So, there are actually a few different strategies that we could employ depending on how much liquidity he needs. But this is the direction we decided to go for him because he wanted the most amount of flexibility and liquidity. So, for the money that was originally in the ESPP, okay, that's in a taxable brokerage. We want to go ahead and minimize the risk of that right away without having to sell it. So, how do you do that? Well, one way to do it is you can color it. So, what that means is you are basically saying that, "I'm willing. I can participate in the gain of this stock up to, say, a 15% cap. And after that, I'm willing to sell the future annual gains beyond 15% to buy some downside protection." So, let's say my comfort level is...
Scott: So, essentially, you're going to buy some insurance on it, and the way to pay for it, you say, "If the stock just takes off like bananas, I'll forego some of that upside."
Victoria: Right. And we're not doing it with all of it, we're doing with 30% of it, right, just to take down some of the risk. So, you're basically pre-selling future growth in order to fund downside protection in this case.
Pat: But you could just fund downside protection and keep all future growth.
Victoria: You could if you want to, if you want to pay out of pocket for that downside protection. A lot of folks decide, "Hey, let's make this cash neutral event. Okay, so I don't want to have to pay out of pocket for the protection. Let's go ahead and sell some future gain. And then we can fund the downside protection." So...
Pat: And you start the downside protection at 10$ negative, 15% negative?
Victoria: Yeah, it depends on their comfort level. So, for them it was, we'll participate in the first 10% of loss. And then after that, we're going to be fine. And the more loss you're willing to take, then the higher that upside cap is, right? So, for them, they were able to participate in the first 15% of gain every year, so this is annually. And then if it went gangbusters and went up 30%, okay, well, on that piece, we protected, I guess we missed out on some upside. But for that, we're able to protect them.
Scott: You're able to be able to pay for the capital gain because you just had the big end upside.
Victoria: That's right. So, that's another perk, is that we don't then actually sell the stock if it gets called. And this is getting a little advanced. But then we just pay for another stock option to cover that call. It's a loss. Then we get to use that loss to sell some of the stock and right off the game. So, it's really a great strategy. Then in the meantime, we are able to sell enough of the stock that he was still in a zero percent capital gains bracket. So, there are lots of different income tax brackets. So, it's not just your income tax, there's also capital gains tax bracket. There's your IRMAA tax bracket. There's Social Security tax bracket. So, you want to make sure that all of these are working in tandem. So, especially in 2026, we can sell a lot of that stock in the 0% capital gains bracket. So, then we can take that money and kickstart what's called a direct indexing account. So, how that works is instead of going out and buying the S&P 500 ETF, instead, you put it in a direct indexing account where you're buying all 500 individual stocks.
Pat: It's beautiful.
Victoria: It's a beautiful strategy. And then...
Scott: Well, and then in this situation... Every situation is unique, but I know where this is going.
Victoria: But in this situation, it works. So, over the course of 2026, some of those stocks are going to do great, some of them are going to be stinkers. If you hold just an index fund, then you're just along for the ride. But owning 500 individual stocks of the S&P, well, then you can sell the stinkers to realize loss and offset the capital gain from selling some of that stock.
Scott: Yes, baby sister.
Pat: And Victoria, did you carve out any part of that direct index from the industry since he's already had a... Because you only you only did a color on one third of the portfolio in the ESEP?
Scott: Yeah, you can say I don't want to own that particular company or I don't want to own the whole industry.
Pat: Whole industry.
Victoria: Correct. Yes. So...
Pat: So, beyond a regular direct index, you actually excluded, let's just say that it was manufacturing, you excluded that sector of manufacturing of the index.
Victoria: Right. So, what we were able to do is say, okay, in the S&P, we obviously don't want to own more of this particular sector, so let's carve that out because we already are overweighted in that. And that, we have that flexibility to do that, so spot on. Yes, that's absolutely what we did. So, then we have this engine now that's producing these capital losses while you're still making the returns of the S&P 500 because you're invested in the entirety of the S&P 500. You're just manufacturing these capital losses so you can sell those overweighted stock.
Pat: How much more expensive is a portfolio like this versus regular ETF?
Scott: Yes, what's the direct investment cost nowadays?
Victoria: So, to add this strategy is a whopping point 0.4%. But the amount of tax alpha...
Scott: Just on the direct index.
Victoria: Yeah, just on the direct index. But you're owning individual stocks, so there's no cost to that.
Pat: Yes, correct. So, the alpha is incredible.
Victoria: Yeah, the alpha is amazing, especially in this particular situation, where if you sell all the stock outright, then you're paying 20% capital gains tax on most of it.
Pat: I'm trying to think of how many different techniques you used in this one client. And by the way, if you retired 10 or 15 years ago and you're like, my advisor never talked about this, or they don't talk about it today, this is really, really advanced. And what has brought the cost down significantly is the use of technology in the portfolios.
Victoria: You're spot on because 10, 15 years ago, you had to be an institutional investor or somebody with $10 million plus in net worth to even touch some of these strategies.
Pat: And it wouldn't have been this inexpensive. It'd be much, much more expensive.
Victoria: Much more expensive.
Pat: And this is all run by algorithms.
Victoria: Mm-hmm, yeah, that's right. Which is a lot more reliable than a human being, promise you.
Pat: And the cost will continue to fall.
Victoria: Yeah. Yeah, so these are strategies that are available to the everyday investor. But you need to have an advisor that knows how to put the pieces together to maximize that tax output.
Scott: And understand that those pieces even exist.
Victoria: Yeah, that too.
Pat: So, in our firm, we have different level of advisors, where they... You specialize in really complex things, right? So, they actually refer business up to you and you work in tandem with the advisor. How does it work?
Victoria: That's right. So, the advisor is still the head of the relationship. We're basically their team. So, they are the coach on that relationship. We are on the advisor's team. So, they can bring us in whenever they have the need to have a complex situation evaluated. Then we can do the planning. We can even present the plan to the client. But the advisor is always the head of that relationship.
Scott: Well, I always love hearing stuff like this. I mean, Pat, we built this company 37 years ago, and the stuff that we can do now for average investors.
Pat: It's crazy.
Scott: Like this is so great.
Pat: Crazy.
Scott: So, Vicki, thanks for taking some time to join us.
Victoria: Absolutely.
Scott: This all time we've got. We'll see you again next week. Scott Hanson and Pat McLean, Allworth Financial.
Automated Voice: 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 a state-planning attorney to conduct your own due diligence.