The 10 Decisions That Can Make or Break Your Retirement
On this episode of Simply Money, Bob and Brian count down the 10 decisions that can make or break your retirement plan. Plus, they reveal why some “set it and forget it” investment strategies may deserve a second look, tackle your questions about tax-smart investing and helping the next generation, and explain why slowing down could save you from a costly financial mistake.
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Bob: Tonight, the 10 decisions that ultimately determine whether your entire retirement plan will actually work. You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James.
Well, there are thousands of financial decisions you'll likely make during your lifetime, but when it comes to retirement, we think there are maybe 10 big ones that ultimately determine whether the whole thing is going to work. And we're going to go through and rank them, which means we may disagree on the order of them, but we're going to count them down, basically, from 10 to 1. Brian, let's get started. A lot to get through in this segment.
Brian: Yeah, and I'll say, these are sort of in an order, but sort of not necessarily. As long as all 10 of these are on your radar, then you're going to be in good shape. There's a bit of an order though. So, anyway, number 10, estate planning. So, before somebody gets angry that we put estate planning last, in terms of number 10, we're not saying it's unimportant. We're basically saying that we're kind of ranking these decisions that determine whether your retirement works financially. This is where we're starting.
So, of course, some of these are basics, and everybody needs something, right? This is one thing that's pretty much ubiquitous to everybody. You need a will. You need appropriate powers of attorney. You need healthcare directives. Beneficiary designations need to be thoughtfully put together. You know, and depending on your situation, trust may make some sense. At the very least, again, everybody needs a will to cover those things that you can't clearly title and name beneficiaries on everything that you can. Most of the time we're talking about financial resources, and those are almost always very easy to name beneficiaries on retirement plans, you just about have to, and IRAs, things like that. Bank accounts, taxable accounts, a lot of times, they don't make it very obvious that it's really, really simple to do. But that's why we rank in number 10. It's not that hard to do, but everybody's got to do it.
Bob: All right, let's move to number nine, the one that we'll call, helping the family. In other words, you could have a beautiful retirement plan built around, say, spending $150,000 a year, and then suddenly, your 28, 30-year-old son needs some help for a down payment. A grandchild needs some college tuition help. Another child maybe goes through a divorce. Somebody wants to start a business in your family. And suddenly, mom and dad can feel like the family bank, and then all bets are off here, "We did a wonderful plan and then money's going hither and yon that we hadn't planned for." And what we're saying here, there's nothing wrong with helping your family. For a lot of people, that's one of the main reasons they work so hard to build and accumulate money, but it needs to be planned generosity, not just this open-ended generosity that can create some feelings of entitlement within the family, and obviously, drain your retirement funds. Brian, let's talk about number eight. Oh, I know you had something to say there.
Brian: No, no, no. You were talking about down payments. And, yes, so we're talking about, oftentimes, you know, the kids need help with, you know, answering their housing questions. Well, we ourselves have housing questions. So, what is your goal? Number eight is housing. Do you stay in the house where you've lived for 30 years? Or maybe you want to downsize, get rid of the steps, have a one floor situation, maybe move closer to the grandkids.
Finally buy that condo in Florida. Or maybe keep the Cincinnati house and buy the condo in Florida. Who knows? That last one can get expensive very, very quickly, because now you're paying two of everything, two insurance premiums, two electric bills, and on and on down the line. So, housing also can become a liquidity issue, because if you're worth $5 million, but $2 million of that is real estate, then that doesn't mean you have a $5 million worth of liquidity. You've actually got about $3 million that you can tap into to help pay the bills. Other than that, you're borrowing against that one or more of those houses that you've got in place, and that can be a slippery slope.
Bob: For sure. Net worth is certainly different from liquid net worth. And when you get into owning multiple properties, that cashflow could get altered quickly, and by sometimes, large dollar amounts. And when your liquidity gets impacted negatively, other things can pay the price here. And that which leads to number seven, healthcare. It's the big unknown out there that I think a lot of people worry about in retirement. Some might be surprised that we've got this right number seven, but let's get into it.
One thing that some people don't think about, especially folks that want to retire a little bit early, as we might say, let's say you're thinking about retiring at 62, you got to think about where your healthcare is going to come from prior to reaching Medicare age. What does that bridge look like? What's its cost? Can you stay on your employer's plan? Can you get some COBRA coverage for a period of time? Can you get on your spouse's plan? You better know that answer before you just pull the rip cord and retire. Because, Brian, these premium costs are not going down anytime soon. And some people get a little bit of sticker shock trying to bridge that gap from a healthcare standpoint. And that's before we get into potential, long-term care issues, dental care, hearing, vision costs, you know, it adds up. And we see people spend a lot of money on out of pocket healthcare costs, even those that have rock-solid health insurance plans in place.
Brian: Yeah, that's right. And a lot of people look at our number six as the bridge to cover those things, which is Social Security. So, if you've accumulated, you know, several million dollars in your investment accounts, your bank accounts, and so forth, maybe Social Security isn't the thing that's going to make or break retirement. It's probably not the pivot point. If Social Security is the pivot point of success or failure, then you might have a plan that's going to need a lot of attention along the way, and you're going to want to be super careful with that.
But if that's not the case, that doesn't mean you should go automatically claim at 62, just because you can. There are efficiencies to this in terms of when you should retire. And for married couples, perhaps one goes earlier, one goes later. There are efficient answers to this. Social Security isn't necessarily the first thing you want to turn on. And it really has to do with your tax situation. If you have an enormous amount of money in IRAs, then that's going to get taxed a certain way. And you want to draw on those to preserve Social Security. That's fine. You're going to pay more taxes earlier because all that income coming out of that pretax IRA is completely taxable as ordinary income versus Social Security, which is not 100% taxable anyway, no matter who you are. So, this is a decision that represents, perhaps, decades' worth of income.
And for a married couple, you know, you have to think about that whole household, not just two of you. What are the ages? You know, not just two individuals, combine it together. What are the ages involved? What's the health? What other income sources are there? Who earned more over time? All of these are data points that factor into the right Social Security decision to maximize that benefit that you worked hard for so long. Now, here's something that happens after we turn on all these income streams, and that would be number five, which is, Bob?
Bob: Taxes, yep. And, you know, let's face it, during our working years, most of our income simply comes from a paycheck. Pretty simple. You get a W-2, you have withholdings, you pay your taxes, you move on with life, and you go back to work tomorrow. Things change when you retire. You might have a traditional IRA, say a 401(k) account, a Roth IRA, a traditional taxable brokerage account, Social Security, as Brian just reviewed, maybe even a pension, maybe something like rental income. And the question is, it's simply, how do I pay the least amount of taxes this year? That's where a lot of people get tripped up. The goal should be to manage taxes over many, many years. And, Brian, as we like to say, both on this show and in meetings with clients, a lot of times, this comes down to not whether you can afford to retire, but how efficiently you retire and leave assets to the next generation.
Brian: And that leads us to something we've already touched on several times, our number four, which is your overall withdrawal strategy. All the things that we just touched on, or most of them all impact the withdrawal strategy. This is one of the biggest psychological adjustments that there is, right? Because people convince themselves that they are not allowed to touch that nest egg that they've spent decades upon decades building. For 35 or 40 years, somebody else gave you money. We like to talk about streams of income versus piles of money and so forth. We all get kind of convinced that, "The only way I can pay my bills is if someone hands me money from the outside, I can't touch that nest egg."
So, the withdrawal strategy has to do with, let's figure out the most efficient way to take advantage of what you've built for yourself. Maybe it takes some money out of that taxable account. Maybe you're intentionally taking IRA distributions during lower tax years. Either that's to just pay the bills and use the living expenses, could be Roth conversions. Maybe you're spending your dividends and interest off some of those taxable accounts. And maybe you're simply spending down cash that you have, and then once or twice a year, replenishing that when the market moves favorably. That's where taxes and investments can collide. All these things work, but again, as we've mentioned many times, it's all about efficiency. What's the most efficient way to construct my withdrawal strategy? And that leads us to number three, which is the overall portfolio. Pretty important, I'd say.
Bob: Yeah, and this is the thing most people want to talk about and hear about and think about and look at all day long, and it is important. This is probably the one thing that should be number one because people think it's number one because it's the thing they think they can control. In other words, "The S&P was down today. What's my retirement plan doing?" But the bigger question isn't whether the market was up or down today. It's whether your specific personal portfolio is built to support the life you're asking it to support. In other words, someone with $4 million wanting to retire on $120,000 a year is completely different than that same $4 million trying to support $250,000 of withdrawal per year. So, you've got to look at your risk tolerance, portfolio construction, tax efficiently, all of that, and create an income strategy to make this work. All right, Brian, two more to go and two minutes to cover them in. Number two, what's number two, Brian?
Brian: Number two is timing that retire decision. When am I going to hang it up? So, one year of working can affect just about everything else we've talked about. One more year of contributions, one less year of portfolio withdrawals, and frankly, one less year of life expectancy if you're doing the math that way. One more year closer to Medicare and Social Security, and potentially, one more year for that portfolio to grow. The opposite is also true. One more year of time with the grandkids, one more year of doing what I want to do instead of what I got to do. All of that has value too, but it is definitely something that has to be taken into account, not just the financial stuff in terms of nailing down that date when you're going to tell your boss that, "You know what? I'm not going to be in next month. This is it for me." And that leads us to the big one here. Number one, Bob, is?
Bob: It is spending. It's spending. And I've said many times on this show, I remain shocked at how many people come into our office, you know, wanting to retire. And we ask one simple question, how much money do you plan to spend each year on an after-tax basis in retirement covering all these things that you want to do? And you get a deer in the headlights look and an answer like, "Well, we really haven't thought about that or written it down or calculated it." That's the number one biggest variable that's going to dictate whether this is all going to work. Yeah, we want to talk about the markets and tax efficiency and all that, but the number one thing that moves the needle is, how much are you going to spend, and when are you going to spend it? Brian, unfortunately, too many people don't spend enough time thinking about that, because that's the number one thing we can control, right?
Brian: It really is. And most people come in not really knowing. And that's usually a sign of financial success. People who have enough money, generally, don't know exactly what they spend on all the various line items. But it's important and not to nitpick. It's important to know so that we have a target to shoot at. What are we trying to accomplish? And then off of that, we can build all the concerns around investments going up and down, inflation, or the unexpected things such as long-term care type stays, that kind of thing. But that all starts with knowing, what does it cost you to keep your ship afloat to begin with?
Bob: Here's the Allworth advice, a successful retirement is not determined by just one magic number, it's determined by getting your biggest decisions all working together. Are your investments aging faster than you are? For 7 and 10 people with 401(k) plans, that could be the case. We'll explain next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Well, if your portfolio has big, embedded gains, but few losses left to harvest, could direct indexing open up more tax saving opportunities for you? We'll explain when the strategy can and can't earn its keep in terms of management fees and all that straight ahead. Well, Americans are living longer, and that raises an important question, are some retirement investments becoming too conservative too soon, Brian?
Brian: Yeah, there's new data out there based off of the fact that there's about a little over $10 trillion in 401(k) plans, a lot of money flying around out there. This is coming from the Investment Company Institute. About 71% of those 401(k) participants have money invested in target date funds. So, if you have a 401(k), there's a pretty good chance you've, at least, seen it on the list if you don't own it outright. So, a quick reminder of how these things work.
You pick a fund roughly based on when you expect to retire. And usually, these target date funds will have some year in the name of the fund. So, it could be the 2045 fund, 2050, 2060, what have you. And the whole point of it is that that fund will adjust itself over time. So, when you're younger, it owns more stocks. You got decades before retirement. So, of course, theoretically, you can handle the ups and downs of the stock market. Everybody's different. We all react differently to different things. But financially speaking, it's a good idea to go ahead and take some risk at that point. As you get older, though, that fund automatically will slowly become more conservative. Stocks will gradually come down in terms of the percentage of the portfolio where the fixed income side gradually goes up. You don't have to make those changes yourself. But that doesn't mean these are a panacea. They're not a solution for everything. Are they, Bob?
Bob: No. And let's be clear, at least personally, I like target date funds because they keep things simple for folks that tend to overcomplicate things. I mean, you get a fund-to-fund approach. You get a nice, diversified, professionally-managed portfolio. It tends to work. But it's just this one-size-fits all strategy for all times might not work. And here's an example. Obviously, a target date knows your age. It doesn't know your life. Let's say you turn age 60, the fund sees that your approach to retirement, and it starts to dramatically reduce the exposure to stocks within that fund. But what if you end up living until 85, 90, 95? You still got potentially 30-plus years that your money needs to work for you. And if you get stuck in, say, a 30% allocation to stocks, you're going to underperform, perhaps, even inflation over time. And that's why you can't just leave these things alone forever. Walk us through a hypothetical on what we're talking about here, Brian.
Brian: Yeah. Well, let's take a couple of 65-year-olds. So, we'll call them Dave and Linda. Dave's got about $1.2 million saved, and of course, he's got Social Security in his back pocket. But he has decided he's going to rely pretty heavily on his portfolio to pay his bills. Linda, for her part, she's got about the same dollar amount, $1.2, but she has a pension that's going to cover most of her living expenses. She'll have Social Security on top of that, so she's got two streams of income. And she doesn't really expect to touch much of the $1.2 million. So, in fact, she actually would like to leave a substantial portion of it to her kids because she knows she doesn't need it. And it's tax advantaged inside of her IRAs and things like that, so she wants to milk that as much as she can.
So, you know, this is where we would say, the difference between Dave and Linda is really the sources of income. They've got the same pile of money. They've got the same age. However, they have different sources of income. One will need to tap into that nest egg sooner than the other. So, I think, you know, a quick kind of summary to how to think about this. Maybe if you're somebody who is attracted to target date funds because you really like that said it and forget it, and we are not here to say they are bad, that's not the case at all. But don't necessarily tie that year. The year that's in the title of the name of the fund, don't tie that to when you're going to retire. Tie it to when you think you might need to draw on those dollars.
If you know you're somebody who, "I'm going to retire, but I'm going to work part time. Maybe my current job allows me to back off and kind of comeback as a pensioner," for my general electric friends out there that do that all the time. Then that might mean you're not tapping into that 401(k) for another 10 years beyond retirement. So, choose the year based off of that. The retirement date is not your expiration date. We need to stop thinking of it that way. Think in terms of, when do I actually need these dollars? And the answer is in some of the examples we shared. Might be never. Linda, for her example, her goal is to let these assets go to her kids because she doesn't feel she'll need it. That's another 30 years' worth of growth. Dave is going to need it sooner rather than later. That means two different target date funds to solve those different issues.
Bob: No, you bring up a great point, and I've actually given this advice before to clients, Brian. I'd love to know what you think of it. I've had people that are in situations where they know they're still going to work and probably never touch this money that's maybe in a Roth account or 401(k) account at their employer. And after running the financial plan, you know, even if they retired in 2024, you know, we say, "Hey, let's look at the allocation of," let's say, "the 2042 target date fund." If you like being 70% invested in stocks, which is where we probably ought to be, giving you all of your personal goals, we can just go ahead and invest in that and take full advantage of all the benefits of those target date funds without being married to the target date per se. You like that idea?
Brian: I do. I think that's a great idea. Just make sure you're clear on your goals. And again, this all comes with the... Like we've said earlier and many times, it all starts with understanding what your situation is. What does it cost you to keep your ship afloat? And then you can figure out, "I've got this much money. And here's the minimum that it needs to return to compliment my Social Security and maybe my pension," that will tell you how to invest. And then you can choose a target date fund based off that. But always look under the hood. Don't get hung up on that date. Look under the hood and see what's in that portfolio.
Bob: Here's the Allworth advice, your retirement date isn't your portfolio's expiration date. Make sure your investment risk reflects how long your money actually needs to last, and also, what you plan to use the money for, not simply how old you are. Coming up next, the retirement decisions you cannot easily undo. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" live every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your favorite podcast. Well, one of the nice things about financial planning is that most mistakes can be fixed, unless you pile all of your money into a variable annuity with a 12-year surrender charge, Brian. That's kind of not easy to undo. But I digress here. If you invest a little too aggressively, you can always change the portfolio. You're keeping too much money in cash, let's say, you can invest some of it, and save some of it for later. Spending a little bit more than maybe you planned, well, we can always adjust that. But retirement comes with a handful of decisions where you might not get that do-over and flexibility.
Brian: That's right. And Social Security is one of the big ones. So, obviously, this is something that you, basically, get one shot at. There are ways to do do-overs if you really want to jump through hoops and pay back your Social Security payments that you received and jump through a whole lot of paperwork hoops, then, yes, you can undo it. But promise, you really don't want to have to go through that. So, let's get it right to begin with.
So, the first, Social Security, don't ask only when you can claim, right? So, everybody becomes eligible for retirement benefits at age 62. That's the earliest you can file for Social Security. And for some people, that becomes the target, "I've paid into this thing my entire working life. I'm ready. Give me my money. I've earned it." And that can be the right answer. Claiming at 62 isn't necessarily a bad thing. It is the lowest check you'll ever see, of course, if you turn it on as soon as possible, the lowest monthly amount you'll ever see. But don't confuse that eligibility with strategy.
So, the question shouldn't be simply, "Can I claim Social Security?" It's, "When should I claim Social Security, giving everything else going on in my financial life? I have this pension that's going to kick in over here. I've got this type of nest egg and it's taxed this certain way," right? There's three tax flavors out there. Roth, which is never taxed, free tax, which has yet to be taxed. And then what we call taxable, which is kind of somewhere in the middle, taxed a little bit every single year. That would be those joint accounts and trust, those kinds of things. But most people have different mixes of those types of investments in their situations. And that will affect you directly when you should file for Social Security, because it affects the order of things to make your taxation most efficient.
Bob: Yeah. And remember, when you make that Social Security claiming decision, you're not only making that decision for yourself, you're also making it potentially for your spouse as well, you know, in terms of a spousal benefit. So, you know, in situations where your spouse is somewhat younger than you are, that really can impact things over a longer period of time. So, there's a lot to factor into that Social Security decision. Very similarly to the next thing we want to talk about, the pension claiming decision for folks that have a pension. Because like Social Security, that impacts the lives of two people as well.
Brian: Yeah, Bob, and there are still pensions floating around out there. They're rare, but they do still exist. A lot of companies around here still have pensions for long-time employees. And so, when you retire, you get a form you got to fill out, you have a menu of choices you got to choose from. So, you know, maybe there's a larger monthly benefit based off of your own single one life, or you can take a smaller monthly benefit in exchange for providing continuing income to your spouse if you should pass first.
Now, what that means, that's where you see joint and survivor benefits. And sometimes it'll be 100%, meaning that check is going to continue exactly as is until the second death, or perhaps it's maybe a 75% to the survivor benefit, those kinds of things. There's also recapture types of benefits out there, sometimes where if somebody chooses a joint and survivor benefit, and the spouse dies unexpectedly, then it will automatically revert to that single life. Sometimes those choices are in there. There's also something called period certain, where you may need to choose that, "I want to be guaranteed that somebody is going to get my pension dollars for 10 years, 15 years," whatever that choice is. We recommend these, not often, but sometimes in cases where there's concerns of illness or something like that. If the pension would shut down at one death, then maybe that's where period certain kind of plays a role there.
Bob: Yeah, Brian, and what I find with these pension decisions, sometimes making the more conservative pension decision, you know, not necessarily the one that gives you the most money on the 30-year spreadsheet, it allows people to have the emotional balance, let's say, to let the rest of their investment portfolio be more growth-oriented, because they know they got that backstop in terms of that fixed income, you know, paycheck coming in every year. So, my point here is, there's an economic piece to this decision, and certainly, an emotional piece to this decision. And both of those should be factored in so people can live with that decision, you know, on how to take the pension, just like Social Security, over the over the long haul. All right, let's get into healthcare decisions, Brian.
Brian: Yeah, don't wait until retirement to start thinking about this, because it's time and energy consuming to understand the healthcare situation. So, you know, maybe you're 61 years old, you got $4 million or so invested and a paid-off house, and you're thinking you're done, you don't have to move money around anymore. So, financially, retirement looks fantastic. Therefore, "This Friday, I'm done. That's it." And Monday morning comes around and you go, "Okay, well, hmm, I got a toothache. What are we doing about healthcare?" That's the wrong order to think about things. You want to make sure you're doing this in an order where you've got you've got continuing coverage, of course.
So, if you're leaving your employer coverage before Medicare eligibility, make sure you understand where that coverage is coming from, what it's likely to cost, what those deductibles look like, whether your doctors are in network and all those kinds of things. Your HR department will help you with this. You probably will have access to something called COBRA, which basically allows you to continue your existing health insurance for up to 18 months. You just have to be responsible for both sides of the premium. While you're working, you're in something called a group policy, where because you're in it with all of your other coworkers, and the expenses a little bit less because the company is sharing in it, COBRA allows you to keep the same coverage, same policy, but you have to pay both sides of the premium. Those are definitely things to look at before you pull the trigger on retirement, not after.
Bob: Yeah, another one we come across quite a bit is what we'll call the appreciated stock decision. Let's say, you've accumulated a large position in one stock, maybe it's the company you worked for decades. Maybe it's something you bought 25 years ago. You put $100,000 into it, now it's worth seven or $800,000. And you decide, "Hey, I'm retiring. I want to just simplify, sell it all." Well, hold on, there are tax considerations, you know, to take into account here. So, before you just pull the rip cord and make a massive decision here, make sure you've thought through all the ramifications. Because once that sale happens, you can't get those taxes back. And that leads to Roth conversions, same kind of thing, Brian.
Brian: Yep, exactly. And again, these take planning. Roth conversions are powerful, but they're definitely not a free lunch. Conversions are very, very much sacrifice first, benefit later. So, if you're retired age 62, you're well below Required Minimum Distribution age, which for some people, it's 73, but if you're turning 62 now, then it's 75 for you. Maybe you haven't even turned on Social Security yet. Taxable income is down because the salaries are gone. And now, you're thinking, "This is my opportunity. Let's convert a huge chunk of my IRA to Roth." Well, that could be, but then the question is, how much?
Conversions generally mean recognizing taxable income now in exchange for moving those dollars into the Roth, tax-free environment. So, you want to model out those tax brackets. Pick something and try to stay underneath it. You'll also want to think about the Medicare related income thresholds commonly known as IRMAA, I-R-M-A-A, because Roth dollars you voluntarily choose to convert to Roth will impact your Medicare premiums. That doesn't mean don't do it. People jump up and down over wanting to keep their Medicare premiums under control. But my thought, again, is if we're talking about 20, 30 years of tax-free growth, I'm not overly necessarily concerned about Medicare premiums going up for a year or so. The way that works is Medicare is calculated based off of what your taxable income was two years prior. So, the Medicare premiums that people are paying now are based off whatever their situation was in 2024. Learn how those things work together.
Bob: Here's the Allworth advice, before making a major retirement decision, know whether you do or do not get a mulligan, per se, or a do-over, because the choices you only get to make once deserve the most attention and planning. Want to pay for the grandkids college without putting too much into a 529 plan? It's one of the questions we actually received from you. We've got answers next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening on the iHeart app. Simply record your question, and it will come straight to us. Bill in Hyde Park leads us off tonight, Brian. He says, "Our taxable portfolio is around $2.5 million, and has roughly $400,000 of embedded gains. Our advisor talks a lot about tax loss harvesting, but after several strong years, there aren't many losses left to harvest." That's a good thing, Brian. "Does that make direct indexing a more valuable strategy because individual stocks continually create harvesting opportunities, or do those benefits diminish after you've owned the portfolio for several years?" I love this question. Great question.
Brian: Yeah, I'm glad you're considering this. So, direct indexing, yeah, that can be more valuable for this exact environment, but it's not a permanent tax loss machine. And frankly, the biggest benefits are usually front-loaded, which is kind of what you're sensing there. Here's the basic distinction, with an S&P 500 or even a total market exchange-traded fund, the fund itself might own hundreds of stocks, but you own just the one security. If that ETF is up, there's no loss available to harvest. You only own the one thing. Even though plenty of individual companies inside that index may be down, it's all lumped together.
With direct indexing, of course, you own the individual stock. So, even in an overall positive market, your advisor might be able to sell those handful of laggards at a loss, replace them with some similar exposure, and then overall preserve the market's exposure without making changes to the overall portfolio. Meaning, you can kind of have your cake and eat it too. As the market goes up, you're benefiting from that. But as inevitably, companies inside of an index will have good days and bad days, you can take advantage of that as well. But your second one is really an important one. So, the benefit does generally diminish over time.
In the early years, a newly funded direct index portfolio has tons of positions with fresh cost bases, normal stock-by-stock volatility. Well, that'll create losses to harvest just literally on day one. But as that appreciates over several years, the rising tide kind of lifts all the boats. More of the holdings develop embedded gains, meaning even when it pulls back, it's still not necessarily sitting at a loss position. So, this doesn't mean the strategy stops working. It just means expectations got to be realistic. Direct indexing tends to be most valuable when you've got a meaningful taxable account in a high marginal rate. $2.4 million, you certainly probably qualify for both of those. But you also may have gains elsewhere to offset. So, look for that as well.
Let's move on to our next question here. So, Bob and Linda have a situation where their grandchildren, ranging from age 2 to 14, and they've got about $4 million to spread between them. They want to pay for college, but they're concerned about dramatically overfunding 529s because some of these kids are smarty pants and they might receive scholarships. Or maybe they don't go to college at all, they find another way, another path, you know, those kinds of things. So, how should they be thinking about the 529 funding, knowing that unused funds could be an issue in the future?
Bob: Well, my first advice is to move slow. You can always increase gifting down the road, which leads me to my first point. Understand what the gift limitations are before you get into any kind of gift tax situation. Every person on the planet could give $19,000 per year to any person, you know, anywhere. You could give it to your kid, your grandkid, your mailman, anybody. $19,000 a year, which means, for a married couple, that's $38,000 a year. So, Bob and Linda, that gives you a lot of planning leeway to take a look at modeling out what these actual college costs are going to be. And that's what good financial planning software is for.
The 529 plans offer something called super funding as well. They'll let you go ahead and front load 5 years' worth of that $19,000 per beneficiary, $38,000 per spousal couple, you know, into a 529 now if you really want to get a jump on this thing and overfund it, you know, at the beginning. So, those are the gift limits. Now, we get down the road, and let's say, you do overfund the 529 plan. Under the new SECURE 2.0 Act, this created a way to take unused 529 plans and roll them, basically, into a Roth IRA without taxes or penalty.
Now, there are some rules about that as well. $35,000 lifetime maximum per beneficiary. There's also something called a 15-year rule. The 529 account must have been opened and funded for, at least, 15 years before the rollover occurs. And there's a five year contribution rule, meaning contributions made to that 529 plan during the five-year period preceding the Roth rollover, so to speak, are not eligible for the rollover. And those funds must go to the beneficiaries Roth IRA. You can't put it into your own Roth IRA account.
So, a lot of things to think about here. Based on the way you phrased your questions and the age range and all that, I think you got a lot of leeway here to first understand what the need is likely going to be. And then start slow, get a funding plan underway, and you can always add to it down the road, you know, as needed. Don't put too much in too quickly because remember, you first got to make sure Bob and Linda are taken care of before you completely unwind your whole portfolio trying to fund grandkids college education costs. I hope that helps. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Well, earlier in the show, we talked about financial decisions that are very hard to undo. Unfortunately, a lot of bad money decisions have one thing in common, they come at you very fast, Brian, let's get into that.
Brian: Tell me you've just seen this happen. So, you see something you want, you hear about an investment, or the market has a terrible day, or maybe then the phone rings, your kid calls asking for money, all of a sudden, you're making a decision involving tens or even hundreds of thousands of dollars that you really hadn't even thought about a day earlier. And so, here's what's interesting, we're not necessarily talking about bad ideas, right? Just because something happens suddenly doesn't mean it make it a bad idea. Maybe buying that vacation home actually makes sense, and you finally stumbled across, unexpectedly, the dream house. Maybe helping that daughter with a down payment is something you've always wanted to do and now it's time to do it. Maybe you're really ready to retire and you've just had enough and you're done.
So, you know, the problem isn't always the decision. Sometimes it's when you're making it. You can be under pressure sometimes. So, that brings us to a rule, I think, that people should have for their money. So, if it's a major financial decision, give it 24 hours. There shouldn't be anything out there that absolutely requires you to provide those dollars right now, right now, right now. Don't make the decision at the emotional peak when you are first hearing about that situation. Excitement, well, that can be just as dangerous as fear.
Bob: Brian, the good, old 24 hour rule, I love this rule, and I think it applies to a lot of areas in life. When I coached baseball for 30 years, I used to tell the parents that before the season started. You got something to say, you got a question right after a game, give it 24 hours and really think about what you're going to say. Same thing applies maybe when we have a snide remark or comment for our spouse. Give it 24 hours, let it percolate. Things tend to calm down, emotions tend to die down. It's a good rule to live by in general.
But let's get back to the financial decisions. I know we talk about this, and I think you and I have both lived this. Let's give that Florida condo example out there. It's 75 degrees. You're sitting outside having dinner. You check your phone, and it's 17 degrees with a minus 3 wind chill back in Cincinnati, and suddenly, we're on Zillow looking at condos. It looks like the perfect decision to make at the perfect time. And lo and behold, you find one that looks wonderful that you can afford right in the place that you want to be. And now, you've made a large financial decision and you have not given it much time at all to think about it.
Brian: Yeah, so what's actually happening during these 24 hours? Well, three questions you want to address. Would I still want to do this if this opportunity hadn't appeared today? Second question is, what does this decision change? What am I not thinking of? And then the third question, what if I was an arm's length away? What would I tell someone else to do? If you can take yourself through those three questions, I think we have a much clearer view of the kind of decision you want to make here.
Bob: Here's the Allworth advice, when the financial stakes are high, at least put a little bit of distance between the emotion and the actual decision. Thanks for listening tonight. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
Well, there are thousands of financial decisions you'll likely make during your lifetime, but when it comes to retirement, we think there are maybe 10 big ones that ultimately determine whether the whole thing is going to work. And we're going to go through and rank them, which means we may disagree on the order of them, but we're going to count them down, basically, from 10 to 1. Brian, let's get started. A lot to get through in this segment.
Brian: Yeah, and I'll say, these are sort of in an order, but sort of not necessarily. As long as all 10 of these are on your radar, then you're going to be in good shape. There's a bit of an order though. So, anyway, number 10, estate planning. So, before somebody gets angry that we put estate planning last, in terms of number 10, we're not saying it's unimportant. We're basically saying that we're kind of ranking these decisions that determine whether your retirement works financially. This is where we're starting.
So, of course, some of these are basics, and everybody needs something, right? This is one thing that's pretty much ubiquitous to everybody. You need a will. You need appropriate powers of attorney. You need healthcare directives. Beneficiary designations need to be thoughtfully put together. You know, and depending on your situation, trust may make some sense. At the very least, again, everybody needs a will to cover those things that you can't clearly title and name beneficiaries on everything that you can. Most of the time we're talking about financial resources, and those are almost always very easy to name beneficiaries on retirement plans, you just about have to, and IRAs, things like that. Bank accounts, taxable accounts, a lot of times, they don't make it very obvious that it's really, really simple to do. But that's why we rank in number 10. It's not that hard to do, but everybody's got to do it.
Bob: All right, let's move to number nine, the one that we'll call, helping the family. In other words, you could have a beautiful retirement plan built around, say, spending $150,000 a year, and then suddenly, your 28, 30-year-old son needs some help for a down payment. A grandchild needs some college tuition help. Another child maybe goes through a divorce. Somebody wants to start a business in your family. And suddenly, mom and dad can feel like the family bank, and then all bets are off here, "We did a wonderful plan and then money's going hither and yon that we hadn't planned for." And what we're saying here, there's nothing wrong with helping your family. For a lot of people, that's one of the main reasons they work so hard to build and accumulate money, but it needs to be planned generosity, not just this open-ended generosity that can create some feelings of entitlement within the family, and obviously, drain your retirement funds. Brian, let's talk about number eight. Oh, I know you had something to say there.
Brian: No, no, no. You were talking about down payments. And, yes, so we're talking about, oftentimes, you know, the kids need help with, you know, answering their housing questions. Well, we ourselves have housing questions. So, what is your goal? Number eight is housing. Do you stay in the house where you've lived for 30 years? Or maybe you want to downsize, get rid of the steps, have a one floor situation, maybe move closer to the grandkids.
Finally buy that condo in Florida. Or maybe keep the Cincinnati house and buy the condo in Florida. Who knows? That last one can get expensive very, very quickly, because now you're paying two of everything, two insurance premiums, two electric bills, and on and on down the line. So, housing also can become a liquidity issue, because if you're worth $5 million, but $2 million of that is real estate, then that doesn't mean you have a $5 million worth of liquidity. You've actually got about $3 million that you can tap into to help pay the bills. Other than that, you're borrowing against that one or more of those houses that you've got in place, and that can be a slippery slope.
Bob: For sure. Net worth is certainly different from liquid net worth. And when you get into owning multiple properties, that cashflow could get altered quickly, and by sometimes, large dollar amounts. And when your liquidity gets impacted negatively, other things can pay the price here. And that which leads to number seven, healthcare. It's the big unknown out there that I think a lot of people worry about in retirement. Some might be surprised that we've got this right number seven, but let's get into it.
One thing that some people don't think about, especially folks that want to retire a little bit early, as we might say, let's say you're thinking about retiring at 62, you got to think about where your healthcare is going to come from prior to reaching Medicare age. What does that bridge look like? What's its cost? Can you stay on your employer's plan? Can you get some COBRA coverage for a period of time? Can you get on your spouse's plan? You better know that answer before you just pull the rip cord and retire. Because, Brian, these premium costs are not going down anytime soon. And some people get a little bit of sticker shock trying to bridge that gap from a healthcare standpoint. And that's before we get into potential, long-term care issues, dental care, hearing, vision costs, you know, it adds up. And we see people spend a lot of money on out of pocket healthcare costs, even those that have rock-solid health insurance plans in place.
Brian: Yeah, that's right. And a lot of people look at our number six as the bridge to cover those things, which is Social Security. So, if you've accumulated, you know, several million dollars in your investment accounts, your bank accounts, and so forth, maybe Social Security isn't the thing that's going to make or break retirement. It's probably not the pivot point. If Social Security is the pivot point of success or failure, then you might have a plan that's going to need a lot of attention along the way, and you're going to want to be super careful with that.
But if that's not the case, that doesn't mean you should go automatically claim at 62, just because you can. There are efficiencies to this in terms of when you should retire. And for married couples, perhaps one goes earlier, one goes later. There are efficient answers to this. Social Security isn't necessarily the first thing you want to turn on. And it really has to do with your tax situation. If you have an enormous amount of money in IRAs, then that's going to get taxed a certain way. And you want to draw on those to preserve Social Security. That's fine. You're going to pay more taxes earlier because all that income coming out of that pretax IRA is completely taxable as ordinary income versus Social Security, which is not 100% taxable anyway, no matter who you are. So, this is a decision that represents, perhaps, decades' worth of income.
And for a married couple, you know, you have to think about that whole household, not just two of you. What are the ages? You know, not just two individuals, combine it together. What are the ages involved? What's the health? What other income sources are there? Who earned more over time? All of these are data points that factor into the right Social Security decision to maximize that benefit that you worked hard for so long. Now, here's something that happens after we turn on all these income streams, and that would be number five, which is, Bob?
Bob: Taxes, yep. And, you know, let's face it, during our working years, most of our income simply comes from a paycheck. Pretty simple. You get a W-2, you have withholdings, you pay your taxes, you move on with life, and you go back to work tomorrow. Things change when you retire. You might have a traditional IRA, say a 401(k) account, a Roth IRA, a traditional taxable brokerage account, Social Security, as Brian just reviewed, maybe even a pension, maybe something like rental income. And the question is, it's simply, how do I pay the least amount of taxes this year? That's where a lot of people get tripped up. The goal should be to manage taxes over many, many years. And, Brian, as we like to say, both on this show and in meetings with clients, a lot of times, this comes down to not whether you can afford to retire, but how efficiently you retire and leave assets to the next generation.
Brian: And that leads us to something we've already touched on several times, our number four, which is your overall withdrawal strategy. All the things that we just touched on, or most of them all impact the withdrawal strategy. This is one of the biggest psychological adjustments that there is, right? Because people convince themselves that they are not allowed to touch that nest egg that they've spent decades upon decades building. For 35 or 40 years, somebody else gave you money. We like to talk about streams of income versus piles of money and so forth. We all get kind of convinced that, "The only way I can pay my bills is if someone hands me money from the outside, I can't touch that nest egg."
So, the withdrawal strategy has to do with, let's figure out the most efficient way to take advantage of what you've built for yourself. Maybe it takes some money out of that taxable account. Maybe you're intentionally taking IRA distributions during lower tax years. Either that's to just pay the bills and use the living expenses, could be Roth conversions. Maybe you're spending your dividends and interest off some of those taxable accounts. And maybe you're simply spending down cash that you have, and then once or twice a year, replenishing that when the market moves favorably. That's where taxes and investments can collide. All these things work, but again, as we've mentioned many times, it's all about efficiency. What's the most efficient way to construct my withdrawal strategy? And that leads us to number three, which is the overall portfolio. Pretty important, I'd say.
Bob: Yeah, and this is the thing most people want to talk about and hear about and think about and look at all day long, and it is important. This is probably the one thing that should be number one because people think it's number one because it's the thing they think they can control. In other words, "The S&P was down today. What's my retirement plan doing?" But the bigger question isn't whether the market was up or down today. It's whether your specific personal portfolio is built to support the life you're asking it to support. In other words, someone with $4 million wanting to retire on $120,000 a year is completely different than that same $4 million trying to support $250,000 of withdrawal per year. So, you've got to look at your risk tolerance, portfolio construction, tax efficiently, all of that, and create an income strategy to make this work. All right, Brian, two more to go and two minutes to cover them in. Number two, what's number two, Brian?
Brian: Number two is timing that retire decision. When am I going to hang it up? So, one year of working can affect just about everything else we've talked about. One more year of contributions, one less year of portfolio withdrawals, and frankly, one less year of life expectancy if you're doing the math that way. One more year closer to Medicare and Social Security, and potentially, one more year for that portfolio to grow. The opposite is also true. One more year of time with the grandkids, one more year of doing what I want to do instead of what I got to do. All of that has value too, but it is definitely something that has to be taken into account, not just the financial stuff in terms of nailing down that date when you're going to tell your boss that, "You know what? I'm not going to be in next month. This is it for me." And that leads us to the big one here. Number one, Bob, is?
Bob: It is spending. It's spending. And I've said many times on this show, I remain shocked at how many people come into our office, you know, wanting to retire. And we ask one simple question, how much money do you plan to spend each year on an after-tax basis in retirement covering all these things that you want to do? And you get a deer in the headlights look and an answer like, "Well, we really haven't thought about that or written it down or calculated it." That's the number one biggest variable that's going to dictate whether this is all going to work. Yeah, we want to talk about the markets and tax efficiency and all that, but the number one thing that moves the needle is, how much are you going to spend, and when are you going to spend it? Brian, unfortunately, too many people don't spend enough time thinking about that, because that's the number one thing we can control, right?
Brian: It really is. And most people come in not really knowing. And that's usually a sign of financial success. People who have enough money, generally, don't know exactly what they spend on all the various line items. But it's important and not to nitpick. It's important to know so that we have a target to shoot at. What are we trying to accomplish? And then off of that, we can build all the concerns around investments going up and down, inflation, or the unexpected things such as long-term care type stays, that kind of thing. But that all starts with knowing, what does it cost you to keep your ship afloat to begin with?
Bob: Here's the Allworth advice, a successful retirement is not determined by just one magic number, it's determined by getting your biggest decisions all working together. Are your investments aging faster than you are? For 7 and 10 people with 401(k) plans, that could be the case. We'll explain next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Well, if your portfolio has big, embedded gains, but few losses left to harvest, could direct indexing open up more tax saving opportunities for you? We'll explain when the strategy can and can't earn its keep in terms of management fees and all that straight ahead. Well, Americans are living longer, and that raises an important question, are some retirement investments becoming too conservative too soon, Brian?
Brian: Yeah, there's new data out there based off of the fact that there's about a little over $10 trillion in 401(k) plans, a lot of money flying around out there. This is coming from the Investment Company Institute. About 71% of those 401(k) participants have money invested in target date funds. So, if you have a 401(k), there's a pretty good chance you've, at least, seen it on the list if you don't own it outright. So, a quick reminder of how these things work.
You pick a fund roughly based on when you expect to retire. And usually, these target date funds will have some year in the name of the fund. So, it could be the 2045 fund, 2050, 2060, what have you. And the whole point of it is that that fund will adjust itself over time. So, when you're younger, it owns more stocks. You got decades before retirement. So, of course, theoretically, you can handle the ups and downs of the stock market. Everybody's different. We all react differently to different things. But financially speaking, it's a good idea to go ahead and take some risk at that point. As you get older, though, that fund automatically will slowly become more conservative. Stocks will gradually come down in terms of the percentage of the portfolio where the fixed income side gradually goes up. You don't have to make those changes yourself. But that doesn't mean these are a panacea. They're not a solution for everything. Are they, Bob?
Bob: No. And let's be clear, at least personally, I like target date funds because they keep things simple for folks that tend to overcomplicate things. I mean, you get a fund-to-fund approach. You get a nice, diversified, professionally-managed portfolio. It tends to work. But it's just this one-size-fits all strategy for all times might not work. And here's an example. Obviously, a target date knows your age. It doesn't know your life. Let's say you turn age 60, the fund sees that your approach to retirement, and it starts to dramatically reduce the exposure to stocks within that fund. But what if you end up living until 85, 90, 95? You still got potentially 30-plus years that your money needs to work for you. And if you get stuck in, say, a 30% allocation to stocks, you're going to underperform, perhaps, even inflation over time. And that's why you can't just leave these things alone forever. Walk us through a hypothetical on what we're talking about here, Brian.
Brian: Yeah. Well, let's take a couple of 65-year-olds. So, we'll call them Dave and Linda. Dave's got about $1.2 million saved, and of course, he's got Social Security in his back pocket. But he has decided he's going to rely pretty heavily on his portfolio to pay his bills. Linda, for her part, she's got about the same dollar amount, $1.2, but she has a pension that's going to cover most of her living expenses. She'll have Social Security on top of that, so she's got two streams of income. And she doesn't really expect to touch much of the $1.2 million. So, in fact, she actually would like to leave a substantial portion of it to her kids because she knows she doesn't need it. And it's tax advantaged inside of her IRAs and things like that, so she wants to milk that as much as she can.
So, you know, this is where we would say, the difference between Dave and Linda is really the sources of income. They've got the same pile of money. They've got the same age. However, they have different sources of income. One will need to tap into that nest egg sooner than the other. So, I think, you know, a quick kind of summary to how to think about this. Maybe if you're somebody who is attracted to target date funds because you really like that said it and forget it, and we are not here to say they are bad, that's not the case at all. But don't necessarily tie that year. The year that's in the title of the name of the fund, don't tie that to when you're going to retire. Tie it to when you think you might need to draw on those dollars.
If you know you're somebody who, "I'm going to retire, but I'm going to work part time. Maybe my current job allows me to back off and kind of comeback as a pensioner," for my general electric friends out there that do that all the time. Then that might mean you're not tapping into that 401(k) for another 10 years beyond retirement. So, choose the year based off of that. The retirement date is not your expiration date. We need to stop thinking of it that way. Think in terms of, when do I actually need these dollars? And the answer is in some of the examples we shared. Might be never. Linda, for her example, her goal is to let these assets go to her kids because she doesn't feel she'll need it. That's another 30 years' worth of growth. Dave is going to need it sooner rather than later. That means two different target date funds to solve those different issues.
Bob: No, you bring up a great point, and I've actually given this advice before to clients, Brian. I'd love to know what you think of it. I've had people that are in situations where they know they're still going to work and probably never touch this money that's maybe in a Roth account or 401(k) account at their employer. And after running the financial plan, you know, even if they retired in 2024, you know, we say, "Hey, let's look at the allocation of," let's say, "the 2042 target date fund." If you like being 70% invested in stocks, which is where we probably ought to be, giving you all of your personal goals, we can just go ahead and invest in that and take full advantage of all the benefits of those target date funds without being married to the target date per se. You like that idea?
Brian: I do. I think that's a great idea. Just make sure you're clear on your goals. And again, this all comes with the... Like we've said earlier and many times, it all starts with understanding what your situation is. What does it cost you to keep your ship afloat? And then you can figure out, "I've got this much money. And here's the minimum that it needs to return to compliment my Social Security and maybe my pension," that will tell you how to invest. And then you can choose a target date fund based off that. But always look under the hood. Don't get hung up on that date. Look under the hood and see what's in that portfolio.
Bob: Here's the Allworth advice, your retirement date isn't your portfolio's expiration date. Make sure your investment risk reflects how long your money actually needs to last, and also, what you plan to use the money for, not simply how old you are. Coming up next, the retirement decisions you cannot easily undo. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. If you can't listen to "Simply Money" live every night, subscribe and get our daily podcast. Just search "Simply Money" on the iHeart app or wherever you find your favorite podcast. Well, one of the nice things about financial planning is that most mistakes can be fixed, unless you pile all of your money into a variable annuity with a 12-year surrender charge, Brian. That's kind of not easy to undo. But I digress here. If you invest a little too aggressively, you can always change the portfolio. You're keeping too much money in cash, let's say, you can invest some of it, and save some of it for later. Spending a little bit more than maybe you planned, well, we can always adjust that. But retirement comes with a handful of decisions where you might not get that do-over and flexibility.
Brian: That's right. And Social Security is one of the big ones. So, obviously, this is something that you, basically, get one shot at. There are ways to do do-overs if you really want to jump through hoops and pay back your Social Security payments that you received and jump through a whole lot of paperwork hoops, then, yes, you can undo it. But promise, you really don't want to have to go through that. So, let's get it right to begin with.
So, the first, Social Security, don't ask only when you can claim, right? So, everybody becomes eligible for retirement benefits at age 62. That's the earliest you can file for Social Security. And for some people, that becomes the target, "I've paid into this thing my entire working life. I'm ready. Give me my money. I've earned it." And that can be the right answer. Claiming at 62 isn't necessarily a bad thing. It is the lowest check you'll ever see, of course, if you turn it on as soon as possible, the lowest monthly amount you'll ever see. But don't confuse that eligibility with strategy.
So, the question shouldn't be simply, "Can I claim Social Security?" It's, "When should I claim Social Security, giving everything else going on in my financial life? I have this pension that's going to kick in over here. I've got this type of nest egg and it's taxed this certain way," right? There's three tax flavors out there. Roth, which is never taxed, free tax, which has yet to be taxed. And then what we call taxable, which is kind of somewhere in the middle, taxed a little bit every single year. That would be those joint accounts and trust, those kinds of things. But most people have different mixes of those types of investments in their situations. And that will affect you directly when you should file for Social Security, because it affects the order of things to make your taxation most efficient.
Bob: Yeah. And remember, when you make that Social Security claiming decision, you're not only making that decision for yourself, you're also making it potentially for your spouse as well, you know, in terms of a spousal benefit. So, you know, in situations where your spouse is somewhat younger than you are, that really can impact things over a longer period of time. So, there's a lot to factor into that Social Security decision. Very similarly to the next thing we want to talk about, the pension claiming decision for folks that have a pension. Because like Social Security, that impacts the lives of two people as well.
Brian: Yeah, Bob, and there are still pensions floating around out there. They're rare, but they do still exist. A lot of companies around here still have pensions for long-time employees. And so, when you retire, you get a form you got to fill out, you have a menu of choices you got to choose from. So, you know, maybe there's a larger monthly benefit based off of your own single one life, or you can take a smaller monthly benefit in exchange for providing continuing income to your spouse if you should pass first.
Now, what that means, that's where you see joint and survivor benefits. And sometimes it'll be 100%, meaning that check is going to continue exactly as is until the second death, or perhaps it's maybe a 75% to the survivor benefit, those kinds of things. There's also recapture types of benefits out there, sometimes where if somebody chooses a joint and survivor benefit, and the spouse dies unexpectedly, then it will automatically revert to that single life. Sometimes those choices are in there. There's also something called period certain, where you may need to choose that, "I want to be guaranteed that somebody is going to get my pension dollars for 10 years, 15 years," whatever that choice is. We recommend these, not often, but sometimes in cases where there's concerns of illness or something like that. If the pension would shut down at one death, then maybe that's where period certain kind of plays a role there.
Bob: Yeah, Brian, and what I find with these pension decisions, sometimes making the more conservative pension decision, you know, not necessarily the one that gives you the most money on the 30-year spreadsheet, it allows people to have the emotional balance, let's say, to let the rest of their investment portfolio be more growth-oriented, because they know they got that backstop in terms of that fixed income, you know, paycheck coming in every year. So, my point here is, there's an economic piece to this decision, and certainly, an emotional piece to this decision. And both of those should be factored in so people can live with that decision, you know, on how to take the pension, just like Social Security, over the over the long haul. All right, let's get into healthcare decisions, Brian.
Brian: Yeah, don't wait until retirement to start thinking about this, because it's time and energy consuming to understand the healthcare situation. So, you know, maybe you're 61 years old, you got $4 million or so invested and a paid-off house, and you're thinking you're done, you don't have to move money around anymore. So, financially, retirement looks fantastic. Therefore, "This Friday, I'm done. That's it." And Monday morning comes around and you go, "Okay, well, hmm, I got a toothache. What are we doing about healthcare?" That's the wrong order to think about things. You want to make sure you're doing this in an order where you've got you've got continuing coverage, of course.
So, if you're leaving your employer coverage before Medicare eligibility, make sure you understand where that coverage is coming from, what it's likely to cost, what those deductibles look like, whether your doctors are in network and all those kinds of things. Your HR department will help you with this. You probably will have access to something called COBRA, which basically allows you to continue your existing health insurance for up to 18 months. You just have to be responsible for both sides of the premium. While you're working, you're in something called a group policy, where because you're in it with all of your other coworkers, and the expenses a little bit less because the company is sharing in it, COBRA allows you to keep the same coverage, same policy, but you have to pay both sides of the premium. Those are definitely things to look at before you pull the trigger on retirement, not after.
Bob: Yeah, another one we come across quite a bit is what we'll call the appreciated stock decision. Let's say, you've accumulated a large position in one stock, maybe it's the company you worked for decades. Maybe it's something you bought 25 years ago. You put $100,000 into it, now it's worth seven or $800,000. And you decide, "Hey, I'm retiring. I want to just simplify, sell it all." Well, hold on, there are tax considerations, you know, to take into account here. So, before you just pull the rip cord and make a massive decision here, make sure you've thought through all the ramifications. Because once that sale happens, you can't get those taxes back. And that leads to Roth conversions, same kind of thing, Brian.
Brian: Yep, exactly. And again, these take planning. Roth conversions are powerful, but they're definitely not a free lunch. Conversions are very, very much sacrifice first, benefit later. So, if you're retired age 62, you're well below Required Minimum Distribution age, which for some people, it's 73, but if you're turning 62 now, then it's 75 for you. Maybe you haven't even turned on Social Security yet. Taxable income is down because the salaries are gone. And now, you're thinking, "This is my opportunity. Let's convert a huge chunk of my IRA to Roth." Well, that could be, but then the question is, how much?
Conversions generally mean recognizing taxable income now in exchange for moving those dollars into the Roth, tax-free environment. So, you want to model out those tax brackets. Pick something and try to stay underneath it. You'll also want to think about the Medicare related income thresholds commonly known as IRMAA, I-R-M-A-A, because Roth dollars you voluntarily choose to convert to Roth will impact your Medicare premiums. That doesn't mean don't do it. People jump up and down over wanting to keep their Medicare premiums under control. But my thought, again, is if we're talking about 20, 30 years of tax-free growth, I'm not overly necessarily concerned about Medicare premiums going up for a year or so. The way that works is Medicare is calculated based off of what your taxable income was two years prior. So, the Medicare premiums that people are paying now are based off whatever their situation was in 2024. Learn how those things work together.
Bob: Here's the Allworth advice, before making a major retirement decision, know whether you do or do not get a mulligan, per se, or a do-over, because the choices you only get to make once deserve the most attention and planning. Want to pay for the grandkids college without putting too much into a 529 plan? It's one of the questions we actually received from you. We've got answers next. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Do you have a financial question you'd like for us to answer? There's a red button you can click while you're listening to the show if you're listening on the iHeart app. Simply record your question, and it will come straight to us. Bill in Hyde Park leads us off tonight, Brian. He says, "Our taxable portfolio is around $2.5 million, and has roughly $400,000 of embedded gains. Our advisor talks a lot about tax loss harvesting, but after several strong years, there aren't many losses left to harvest." That's a good thing, Brian. "Does that make direct indexing a more valuable strategy because individual stocks continually create harvesting opportunities, or do those benefits diminish after you've owned the portfolio for several years?" I love this question. Great question.
Brian: Yeah, I'm glad you're considering this. So, direct indexing, yeah, that can be more valuable for this exact environment, but it's not a permanent tax loss machine. And frankly, the biggest benefits are usually front-loaded, which is kind of what you're sensing there. Here's the basic distinction, with an S&P 500 or even a total market exchange-traded fund, the fund itself might own hundreds of stocks, but you own just the one security. If that ETF is up, there's no loss available to harvest. You only own the one thing. Even though plenty of individual companies inside that index may be down, it's all lumped together.
With direct indexing, of course, you own the individual stock. So, even in an overall positive market, your advisor might be able to sell those handful of laggards at a loss, replace them with some similar exposure, and then overall preserve the market's exposure without making changes to the overall portfolio. Meaning, you can kind of have your cake and eat it too. As the market goes up, you're benefiting from that. But as inevitably, companies inside of an index will have good days and bad days, you can take advantage of that as well. But your second one is really an important one. So, the benefit does generally diminish over time.
In the early years, a newly funded direct index portfolio has tons of positions with fresh cost bases, normal stock-by-stock volatility. Well, that'll create losses to harvest just literally on day one. But as that appreciates over several years, the rising tide kind of lifts all the boats. More of the holdings develop embedded gains, meaning even when it pulls back, it's still not necessarily sitting at a loss position. So, this doesn't mean the strategy stops working. It just means expectations got to be realistic. Direct indexing tends to be most valuable when you've got a meaningful taxable account in a high marginal rate. $2.4 million, you certainly probably qualify for both of those. But you also may have gains elsewhere to offset. So, look for that as well.
Let's move on to our next question here. So, Bob and Linda have a situation where their grandchildren, ranging from age 2 to 14, and they've got about $4 million to spread between them. They want to pay for college, but they're concerned about dramatically overfunding 529s because some of these kids are smarty pants and they might receive scholarships. Or maybe they don't go to college at all, they find another way, another path, you know, those kinds of things. So, how should they be thinking about the 529 funding, knowing that unused funds could be an issue in the future?
Bob: Well, my first advice is to move slow. You can always increase gifting down the road, which leads me to my first point. Understand what the gift limitations are before you get into any kind of gift tax situation. Every person on the planet could give $19,000 per year to any person, you know, anywhere. You could give it to your kid, your grandkid, your mailman, anybody. $19,000 a year, which means, for a married couple, that's $38,000 a year. So, Bob and Linda, that gives you a lot of planning leeway to take a look at modeling out what these actual college costs are going to be. And that's what good financial planning software is for.
The 529 plans offer something called super funding as well. They'll let you go ahead and front load 5 years' worth of that $19,000 per beneficiary, $38,000 per spousal couple, you know, into a 529 now if you really want to get a jump on this thing and overfund it, you know, at the beginning. So, those are the gift limits. Now, we get down the road, and let's say, you do overfund the 529 plan. Under the new SECURE 2.0 Act, this created a way to take unused 529 plans and roll them, basically, into a Roth IRA without taxes or penalty.
Now, there are some rules about that as well. $35,000 lifetime maximum per beneficiary. There's also something called a 15-year rule. The 529 account must have been opened and funded for, at least, 15 years before the rollover occurs. And there's a five year contribution rule, meaning contributions made to that 529 plan during the five-year period preceding the Roth rollover, so to speak, are not eligible for the rollover. And those funds must go to the beneficiaries Roth IRA. You can't put it into your own Roth IRA account.
So, a lot of things to think about here. Based on the way you phrased your questions and the age range and all that, I think you got a lot of leeway here to first understand what the need is likely going to be. And then start slow, get a funding plan underway, and you can always add to it down the road, you know, as needed. Don't put too much in too quickly because remember, you first got to make sure Bob and Linda are taken care of before you completely unwind your whole portfolio trying to fund grandkids college education costs. I hope that helps. You're listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
You're listening to "Simply Money", presented by Allworth Financial. I'm Bob Sponseller along with Brian James. Well, earlier in the show, we talked about financial decisions that are very hard to undo. Unfortunately, a lot of bad money decisions have one thing in common, they come at you very fast, Brian, let's get into that.
Brian: Tell me you've just seen this happen. So, you see something you want, you hear about an investment, or the market has a terrible day, or maybe then the phone rings, your kid calls asking for money, all of a sudden, you're making a decision involving tens or even hundreds of thousands of dollars that you really hadn't even thought about a day earlier. And so, here's what's interesting, we're not necessarily talking about bad ideas, right? Just because something happens suddenly doesn't mean it make it a bad idea. Maybe buying that vacation home actually makes sense, and you finally stumbled across, unexpectedly, the dream house. Maybe helping that daughter with a down payment is something you've always wanted to do and now it's time to do it. Maybe you're really ready to retire and you've just had enough and you're done.
So, you know, the problem isn't always the decision. Sometimes it's when you're making it. You can be under pressure sometimes. So, that brings us to a rule, I think, that people should have for their money. So, if it's a major financial decision, give it 24 hours. There shouldn't be anything out there that absolutely requires you to provide those dollars right now, right now, right now. Don't make the decision at the emotional peak when you are first hearing about that situation. Excitement, well, that can be just as dangerous as fear.
Bob: Brian, the good, old 24 hour rule, I love this rule, and I think it applies to a lot of areas in life. When I coached baseball for 30 years, I used to tell the parents that before the season started. You got something to say, you got a question right after a game, give it 24 hours and really think about what you're going to say. Same thing applies maybe when we have a snide remark or comment for our spouse. Give it 24 hours, let it percolate. Things tend to calm down, emotions tend to die down. It's a good rule to live by in general.
But let's get back to the financial decisions. I know we talk about this, and I think you and I have both lived this. Let's give that Florida condo example out there. It's 75 degrees. You're sitting outside having dinner. You check your phone, and it's 17 degrees with a minus 3 wind chill back in Cincinnati, and suddenly, we're on Zillow looking at condos. It looks like the perfect decision to make at the perfect time. And lo and behold, you find one that looks wonderful that you can afford right in the place that you want to be. And now, you've made a large financial decision and you have not given it much time at all to think about it.
Brian: Yeah, so what's actually happening during these 24 hours? Well, three questions you want to address. Would I still want to do this if this opportunity hadn't appeared today? Second question is, what does this decision change? What am I not thinking of? And then the third question, what if I was an arm's length away? What would I tell someone else to do? If you can take yourself through those three questions, I think we have a much clearer view of the kind of decision you want to make here.
Bob: Here's the Allworth advice, when the financial stakes are high, at least put a little bit of distance between the emotion and the actual decision. Thanks for listening tonight. You've been listening to "Simply Money", presented by Allworth Financial on 55KRC, THE Talk Station.
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