Financial Planning / Podcast

YFP 294: 10 Common Social Security Mistakes to Avoid (Part 1)

Posted on by Caitlin Boyle

Tim Ulbrich, PharmD, is joined by YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP®, to kick off a two-part series on ten common social security mistakes to avoid.

Episode Summary

This week, Tim Ulbrich, PharmD, is joined by YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP®, to kick off a two-part series on ten common social security mistakes to avoid. Highlights of the show include Tim Baker sharing about the Retirement Income Certified Professional designation and training and why it is a crucial aspect of the overall financial plan. Tim and Tim dig into tackling the complex and critical decision of when to start claiming social security benefits, why it is an integral part of the financial plan, and how the program is funded. They then get into the weeds on the first five of ten social security mistakes people make and how to avoid them. Major mistakes include not checking your social security earnings statement for accuracy, only considering your benefits or not knowing what benefits are available to you, and not understanding how social security benefits are calculated. Tim and Tim discuss the mistakes of taking social security too early, not working long enough, and not coordinating social security benefits with a spouse and how all impact the financial plan. Listeners will hear practical ways to get on the path to success and learn about resources available to prevent those common social security mistakes.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey, everybody. Tim Ulbrich here, and thank you for listening to the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

This week, I had the pleasure of welcoming YFP Co-founder and Director of Financial Planning, Tim Baker, to kick off a two-part series on 10 Common Social Security Mistakes to Avoid. In addition to talking through just how big a part of the financial plan Social Security can be, we talk about the first 5 of 10 common mistakes, including some big ones like taking Social Security too early, not understanding how the benefits are calculated, and not coordinating benefits with a spouse.

Now, before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 250 households in 40-plus states. YFP Planning offers fee-only high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call at yfpplanning.com. Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom.

Okay, let’s jump into part one of 10 Common Social Security Mistakes to Avoid.

[INTERVIEW]

[00:01:21] TU: Tim Baker, welcome back to the show.

[00:01:23] TB: Thanks, Tim. Happy to be here. I lost my voice over the weekend. So hopefully, this will be okay. But, yeah, I’m doing well. How about you?

[00:01:32] TU: Go Eagles, right?

[00:01:33] TB: Go birds. Yeah. I was at the NFC Championship in Philadelphia. Shout out to my cousin, Pete, for scoring some tickets, and it was crazy. One of the best sporting events I’ve ever been to. It was great. Yeah.

[00:01:46] TU: Love it. Love it. So, Tim, you recently completed the RICP training, which connects well with the topic that we’re going to talk about today, considering Social Security is such a big part of the retirement planning process for many folks. Before we jump into the topic today, tell us more about the RICP training and why it’s such an important really aspect to the overall financial plan.

[00:02:10] TB: Yeah. So RICP stands for Retirement Income Certified Professional. I think what it does is it kind of expands further on the deculumation or the withdrawal part of the retirement phase. So I think so much of what the CFP really focuses on is just accumulating assets to get to that destination. I think what the RICP – First, it says it’s not really a destination. It’s more of like a journey. It’s a process. I think a lot of retirees, they think they’re like, “All right, I’m 65. I’ve made it,” and it’s so far from that.

But then the idea really is to say, okay, we have all of these assets that we built up over the last 30 or 40 years. How do we then translate that into a recurring paycheck that lasts us for the rest of our life, which is a timeline that’s undetermined? So it’s looking at sources of income like Social Security, like retirement plans, like individual retirement plans, like home equity, how does long-term care, insurance, health insurance, Medicare fit into this, any type of executive benefits? If you’re a single business owner, what are the risks in retirement? What are your overall goals? What are we trying to accomplish?

Kind of really put that together as people are transitioning from the workforce, sometimes very abruptly, whether it’s their choice or not. Sometimes, it’s a phased retirement. But to do that in a way that, again, is sustainable for the course of the plan. So that’s really what it is. Obviously, Social Security is a huge part of this and probably one of the biggest things that a retired professional or a retired person has to answer is how does one access. How does one determine Social Security benefits? When should I do this? How?

Yeah. I think it’s often an overlooked part of the of the plan. There’s so much focus on climb the mountain. But if you ever watched any type of documentaries about Everest, probably the hardest part is getting down and the most dangerous. So that’s kind of the best analogy I can give.

[00:04:23] TU: Yeah. That’s why I’m excited not only to dig deeper into Social Security, which we’ll do on this episode of the next, but to dig deeper into more of that climb down the mountain, right? We’ve spent a lot of time in the first five and a half years of this podcast, talking about issues related to the climbing up the mountain. I think that whether someone’s approaching retirement, whether they’re in the middle of their career, or whether they’re on the front end of their career, beginning to think about this, and even if it’s, “Hey, I’m on the front of my career, but I’m planting some seeds.”

Obviously, for those that are listening that are a little bit closer, there’s some tangible takeaway items that they can implement, hopefully, sooner rather than later. But so much attention given to the front end, the accumulation side. We want to spend some more time here in ’23 and into next year as well, talking about the decumulation.

So today, we’re kicking off a two-part series on 10 Common Social Security Mistakes to Avoid. We’re going to tackle five this week. We’ll tackle five next week. Just about a year ago, we talked Social Security 101, including the history, how it works, why it matters to the financial plan. We’ll link to that episode, which was episode 242, in the show notes. Tim, we’re not going to rehash everything we covered in 242. But let’s get some of the fundamentals related to Social Security on the table so that we have a framework to consider, as we talk about these 10 common mistakes.

So first and foremost, I think that decision about when to claim Social Security benefits, arguably one of the most important decisions that clients will make, that individuals will make, is in your retirement. Why is that the case?

[00:05:54] TB: I think it’s the case because for a lot of Americans, it’s going to be the biggest source of income that they have, even more so than money that’s coming from a 401(k) or equity built in the house. So many people – There is this impression that Social Security is going to be the paycheck that dominates. Unfortunately, for a lot of people, that’s the case. Hopefully, for a lot of our listeners, that is not the case because of either good planning outside of Social Security or even good claiming strategies.

The thing that makes Social security so powerful, one, is backed by the full faith and credit of the US taxpayers backed by the government, which is probably some of the surest assets that are out there, no matter what you think about. Where the economy is going or if Social Security’s going to be there, it is, I think, one of those things, unfortunately or fortunately, that it’s just too big to fail. So people hear horror stories about it’s going to go bankrupt. It’ll be there when – If you’re 25, 35, 45, if you’re listening, it’ll be there. It might not be what it looks like for retirees right now. But nonetheless, it will be there.

I think one of the big thing I think that is often overlooked, and we’ll talk about that, is it is inflation-protected. So when we saw inflation run rampant in 2022, Social Security and a lot of these other government payments that go out went up, I think, by about 8.7%. One of the things we’ll talk about this is like you can’t buy an annuity that has a COLA, that has a cost-of-living adjustment out there. So one of the big strategies is that you want that Social Security payment to you and your spouse to be the largest it can be.

I think so many people, so many retirees, similar to like a student loan strategy, kind of just goes with the flow or talks to a colleague, and that becomes the basis for how they approach their security. But it really needs to be a lot more in depth than that. It’s going to be a big part of your retirement paycheck. We want to make sure that we have all the data, and we understand the system to be able to make the best claiming decision that we can.

When we talk about our first point here, I’ll give an example of just looking at my own statement what that looks like. Obviously, I’m a few years off. But when we talk about the student loans, the delta between scenario A versus scenario Z can be hundreds of thousands of dollars. So that’s important to understand.

[00:08:28] TU: Tim, just a general scope, I think you make a good point that whether it’s a good thing or a bad thing, depending how you look at it, maybe too big to fail. I think there’s many folks that are maybe earlier in their career, they hear pay Social Security, and they think, “Hey, that’s not going to be a thing.” But I think if we take a step back and really look at just how big Social Security is in terms of like who receives the benefits, how many people receive the benefits.

[00:08:52] TB: Yes. Some of the numbers?

[00:08:52] TU: Yeah. And how big this is for many folks in terms of their income in retirement.

[00:08:58] TB: Yeah. So the number is the majority of American retirees receive more than half of their retirement income from Social Security. So that is the most important retirement asset on the balance sheet, so to speak, even though it doesn’t show up as something on their balance sheet. There’s just a lot of dollars involved. A client who currently claims benefits at the age of 70 and who is eligible for maximum Social Security benefit will receive a benefit that’s like 50k a year.

So over 20 years, that really kind of relates about a million dollars in inflation adjusted spending power. So if you think about that in that context, where it’s like, “Oh, it’s 1,500 bucks a month or it’s 3,000 bucks,” maybe it doesn’t hit. But there’s a lot of dollars involved. Really, for a lot of people, not everyone but working longer and deferring, which we talk about with an investment, typically how you feel is what you should do. You should do the exact opposite in investment.

It’s almost like the same with Social Security. It’s like if you’re like, “Man, I need to get out of my job. I’m ready to retire,” working longer and differing are strategies that can have the most impact to help you kind of mitigate the longevity risk, is the risk of running out of money because, one, it’s another year where you’re not spending in retirement. But it’s also another year where you’re deferring, and you’re potentially earning credits, deferral credits, that makes that dollar amount larger.

We’ll talk about the whole, well, if I put money into, I want to make sure I get every dollar out. People look at this from a breakeven perspective, which I think is a little bit flawed, and we’ll talk about that in one of our things. But if we actually break down the numbers, there’s about 47 million retired workers who are receiving benefits that are around $73 billion per month. So it’s huge.

The second biggest pie are disabled workers. That’s another thing that we’re going to outline. About eight million disabled workers receive about $10.3 billion. Then there’s survivors’ benefits. So this is, typically, you have a worker that dies, and they have children or a spouse that might be receiving benefits, about six million or survivors that are receiving benefits at about 7.3 billion. So it’s very much a piece of the puzzle.

We’ll talk about kind of the averages when we – I think in part two, where we’re talking about like how much this is actually percentage-wise covered from a paycheck perspective. So it’s a big thing. Again, like I think just like we talked about other parts of the plan, you got to take the emotional inventory. You got to take what the actual statements or the balance sheet looks like, and then make the best claim decision for you. That’s, hopefully, some of the things that we’ll uncover.

[00:11:43] TU: So with that, let’s jump into 10 Common Social Security Mistakes to Avoid. Again, we’ll tackle five this week. We’ll tackle five next week. So tip number one Common Social Security Mistake to Avoid is not checking your earnings record for accuracy. Tim, whether someone is nearing retirement, listening in the middle of their career or listening on the front end of their career, tell us more about where they can go to find this information and making sure that they don’t make this mistake.

[00:12:09] TB: Yeah. I think in an effort to go more paperless, I think back in the day, once you reach a certain age, you get like a statement every month. Now, I think they’re moving to every quarter. They’re trying to kind of modernize. For maybe retirees, that can be a little bit of a hard sell. The best place to go is to ssa.gov. You can – It’s the my Social Security website. I signed on right before we hopped on here. It’s really easy to get on, and the website is actually pretty easy to navigate. We’ve talked about some other things related to student loans. The websites that the government built actually is pretty good, same thing with like the IRS tools. S

When I log on, Tim, just to kind of give you a description of what this looks like, I can download my Social Security statement. I can go and replace my Social Security card. I can view my benefit verification letter. The big thing that catches my eyes when I first log in, it’s called the eligibility and earnings section. It basically says that you have 40 work credits you need to receive benefits, and there’s four blocks. There’s a big checkmark, which basically means that I have earned enough credits to earn Social Security.

So Social Security credits, you can earn for a year. You earn a credit by – I think in 2023, dollars is a little bit more than $1,600 in that year. So 1,600 times four, if I earn that amount of money, then I get four credits. Essentially, I need 40 credits to collect Social Security. So it’s essentially 10 years of earnings. But the cool thing is that under that section, it says review your full earnings record now. So when I click on that, it takes me to the eligibility earnings, and it goes back, essentially, from when I first started making money back whenever that was.

When we talk about accuracy, one of the big things that you want to do is you want to make sure that when I filed my taxes in 2022, it shows the tax Social Security earnings dollars, and this is basically how they calculate that. There is a cap, but that’s basically how they calculate what your benefit is. So I can go back and see, okay, this is the amount of money I made in ’21, ’20 for me, all the way back to 1998, Tim, where I earned $353.

[00:14:25] TU: Love it.

[00:14:26] TB: So this is really important because they’re looking at the way that the – And we’ll get into this a little bit more, but they look at, essentially, the 35 highest years of earnings. If there aren’t 35 years, then they essentially use zero dollar year, which moves your average down. So you want to make sure that when you’re reviewing this, that your earnings record is correct. It’s not infallible, like you find errors here. So you want to make sure that when you go back and you’re looking at the top 35 years, that it’s accurate. You’re getting the best benefit you can.

It basically lists for me from 2022, all the way back to 1998. I’m just eyeballing. I’m like, okay, that makes sense because I left the workforce here, or I work part time or that type of thing, just to make sure it looks good. The other thing worth mentioning when we talk about deferral, for a lot of people, the last years before they’re retired is typically their highest income years. So that’s another feather in the cap of like defer work longer. We’re closer to that full retirement age and beyond that. For a lot of us, it’s going to be 65. But then the longer you defer to age 70 is when the benefit gets the highest. The earnings record is going to be the biggest thing in terms of accuracy and making sure in that.

But the other cool thing about this, Tim, is there’s actually like a section on here that shows me if I were to retire at age 67, it says your monthly benefit at full retirement age is going to be $2,599. So it shows me like this pretty cool graph that says, okay, at age 67, this is your full retirement age. Your benefit’s 2600 bucks, if I retire early, say five years early at 62, which is the earliest I can collect it, that drops to $1,774.

[00:16:21] TU: It’s almost 900 bucks, right, yours Tim?

[00:16:22] TB: Yeah. Yeah, exactly right. But then if I defer, so if I worked three years longer from age 67 to age 70, that goes up to the delayed retirement where I earn referral credits, 3,231. So that’s the thing is like when I’m when I’m talking about tens of thousands, if not hundreds of thousand, the earliest I want to get out, it’s 1,700, 1,800 bucks. The latest, age 70, eight years later, 3,231.

So that’s where – Again, and this is inflation-protected. So that’s a huge thing, where those dollars go up every year with what the index says. But then you can also look at disability benefits, I mean, if you have them. It talks about Medicare part A and B, and how you qualify for that. But it’s just a good – When we talk about when we work with clients, get organized, the big thing is looking at the balance sheet, looking at what’s coming in income-wise. Like this is going to be a huge part of that for the retiree or someone who’s transitioning into that. So checking it, making sure it’s accurate.

The earnings is going to be a huge thing that a lot of people don’t do. You want to make sure that you audit it as you go and make sure it’s accurate. So if it’s not, you can make the necessary adjustments.

[00:17:39] TU: Yeah. So takeaway number one, if you haven’t already done so or recently done so, ssa.gov. Log in to my Social Security. You can access your statements, look at the dashboard. Tim’s looking at and talking about, obviously, looking at whether or not you have the 40 work credits. Then looking at some of those simulations for when you may retire.

Tim, I also like – You can play with some of this, right? So you can change your future salary. You can include a spouse or not include a spouse. You can see how that changes the benefits amount as well. So similar to some of the credit I’ve been given to the Department of Ed lately on what they built, that is studentaid.gov, I think they’ve done a really good job with this, so credit where credit’s due.

[00:18:17] TB: I agree. Yep.

[00:18:19] TU: So that’s the number one mistake, not checking your earnings record, not being aware of your Social Security account. Number two, Tim, is only considering your own benefits and not knowing what other benefits are available. So I suspect that folks are most familiar with retirement benefits in Social Security but perhaps to a lesser degree or maybe not even all some of the survivor and disability benefits. Talk to us about really the breadth of benefits that fall under the Social Security benefit.

[00:18:48] TB: Yeah. So the retirement benefits are the big one, and one of the things that is often overlooked is kind of that, yeah, those spousal benefits that are available for non-working spouses as early as age 62. Typically, a lot of the benefits are like kind of hinged on the worker. So if the worker isn’t collecting, then the spouse can’t collect, unless there’s a divorce, and we’ll talk about divorce here later. If it’s a separate household, even though you’re divorced and maybe you had to be married at least 10 years, then you can collect, even if the working divorced spouse is not collecting.

To go back, a lot of the benefits hinges on the working spouse collecting the benefit, unless retired. But the worker must claim the worker benefit to trigger the spousal benefit at full retirement age, which is kind of that middle number, so 67 for me. If you’re a little bit older, it could be 65, 66 years old. But at full retirement age, the spousal benefit is 50% of the workers’ PIA, and we’ll talk about that a little bit. But basically, that’s the number that they use.

The spousal benefit is not affected by the age that the worker claims benefits. So it’s basically once the worker claims it, it’s 50% of that benefit, but it can be reduced if – The spousal benefit can be reduced if it’s claimed before that full retirement age, which again, for me, is 67. Then deferring that benefit does not increase. So there is no referral credits for a spousal benefit. So getting that beyond full retirement age doesn’t make any sense. The spousal and survivor benefits do not increase, like I said, past full retirement age.

The other interesting thing is that if a spouse is caring for a child that’s under 16, you can receive the full benefits, regardless of the caregiver’s spouse’s age. So there’s a lot of just little like nuance here that if you aren’t part of Social Security, you can, again, look these up and see if you would be eligible for a benefit. But this can also be paid for a dependent, an unmarried child under 18. So if I’m 65, and I’ve retired, and I’m collecting my benefit, and I have a 15-year-old daughter, they’re eligible for a benefit, as an example.

Then if there’s a disability, as long as the disability started before age 22, there’s another benefits there related to that. There can be, Tim, a fat family like maximum applied. So like if my family – If I have two dependents and a spouse and then myself and then we’re all drawing like four checks, essentially, there is a cap per family that has to be considered, and that changes over time.

It’s just interesting to know, again, a lot of people overlook this. Unless they’re looking at their mail, which there might be some notices here, or working with a planner sometimes, like this goes unpaid. So you want to make sure that, again, this is a system that you pay into as a worker. That you want to make sure that you and your dependents have the ability to collect the maximum amount.

[00:21:50] TU: Tim, one thing that stands out here real quick is it feels like this is a good example. I mean, there’s many that you just listed off there, where really getting in the weeds and planning could be helpful. But I’m thinking about – Selfishly, I think about my situation, Jess, and others that maybe have a nonworking spouse. Like when you talk about things about a spousal benefit and the percentages and that being hinged on the worker and that it doesn’t have the deferment credits, like there’s really some calculations to be done there of like does it make sense that there’s a strategy around spouse gaining employment, and what might that look like, and what’s the net benefit relative to the time.

Or if the plan is that there’s a nonworking spouse, and it’s going to remain that way for whatever reason, then kind of understanding some of those nuances, right? It’d be hinged on the individual that’s working. What are the risks and benefits of that? Then also, that there’s not things like that deferral credit, right? So there’s a lot to unpack there.

[00:22:49] TB: Yeah. Even taking a step further, if your full retirement age is 67, and you decide to take it at 67, the things that you would have going on there is, say, your benefit is $5,000 at 67. Jess, if she decided not to work, it would be 50% of that, so $2,500. Or do you wait to get that 8% every year, which is essentially going from 67 at age 70, it increases by 8% every year. So you say you claim at age 70, which she can’t claim until you’re claiming, and then she gets 50% of that, right?

If you were to pass away or she were to pass away, you basically get the larger of that benefit. So if you’re at 5,000 and she’s at 2,500, that’s 7500 hours for the household. But then if you were to pass away before her, she would get your benefit. So you would get 5,000, but the other 2500 we’re going to turn off. So the exercise then is what is the best strategy for you to claim to get the maximum out versus deferring. So there’s lots that goes into this.

Again, even me making blanket statements of like, “Hey, deferring usually makes the most sense,” for your case, maybe that’s not the case because you want to turn that benefit on as quickly as possible because deferring for her is not going to really matter.

[00:24:12] TU: Yeah. But that highlights the value of the planning here, right? Yeah. I mean, you talked about at the beginning building a retirement paycheck. Well, that paycheck is going to come from multiple sources. Here we’re only talking about one source and within that one source all the decisions and the nuances.

[00:24:28] TB: Exactly, right. Yep. The second population of people, Tim, so everybody we’ve talked about so far in terms of like benefits, that’s like the worker and like their dependents. So the next bucket is for when that worker dies, so you have like a survivor benefit. When a person who has worked and paid Social Security taxes dies, certain members of family may be eligible for survivor benefits. So a widow, widower would get full survivor benefits are available at full retirement age, but reduced benefits can begin as early as age 60.

This is a whole another ball of wax that we get tested on for the RICP. That can be very confusing to understand. If the widow or widower is disabled, the benefits can then begin as early as age 50, not 60. Then full retirement, full benefits are also available if the widow is caring for a deceased person’s child who is under age 16. You can also get survivor benefits if divorced spouses are under certain conditions. Or unmarried children younger than 18 can also get a benefit. Children under the age of 80 or 18 or older, if you’re disabled before 22, so this kind of falls very similar to the worker benefits. Then dependent parents aged 62 or older. So if I am –

[00:25:43] TU: Interesting.

[00:25:45] TB: Yeah. So say I’m taking care of my mom, and I’m receiving a work benefit, and then I die, my mom might not be receiving a check for Social Security. She might get her own. But if she’s not, then she has the ability to actually get a benefit based on my Social Security. Again, a lot of nuance when a worker passes away as well.

[00:26:07] TU: Tim, what about disability? I know this is an area when I’ve talked to folks before that are evaluating Social Security, asking questions, thinking about Social Security, it’s always focused on the retirement income side of it. But a big part of Social Security on the disability side as well, correct?

[00:26:23] TB: That is correct. I think what we had said in the beginning that it is the second most behind – Yeah, second most behind workers benefits is the disabled workers. About 8.1 disabled workers receiving about $10.3 billion per month. This one’s tough, though, because the Social Security definition for disability is pretty strict. So to receive disability benefits requires providing proof that the worker is incapable of engaging in any type of gainful employment, any type of a gainful employment.

You have to be in a pretty tough medical status to be able to get this, and they typically have an end date. So they’re paid until the earliest of death, the end of disability, or attainment of full retirement age. So then you would go – So if I were disabled at age 55, and I was still alive at age 67, then I would switch over to my worker benefits. It can be pretty strict to be able to get the disability benefit, but it is the second largest after workers benefits. It’s a pretty strict interpretation of work and gainful employment.

It is important to know, again, do I have a worker benefit? Do I have a survivor benefit available to me or my kids? Do I have a disability benefit? So kudos to the website. I would be on there. Obviously, there’s a lot of education, but then being able to log in and see, hey, I do have this benefit because I paid enough into it. There’s some assurance there, to know that.

[00:27:57] TU: Tim, when I see on the disability side that the worker is incapable of engaging in any type of gainful employment, my first thought is, well, this seems to be why, for so many pharmacists, we’re often looking at standalone long-term disability insurance policies that have some type of an own occupation component to it. Am I reading that correctly?

[00:28:16] TB: Correct. Yep. Yep.

[00:28:17] TU: Okay. Yeah.

[00:28:19] TB: Really, the reason for that is like what often happens, if it’s not an occupation, say I’m a pharmacist and say I’m in an awful car accident, and I cognitively can no longer do the work of a pharmacist, that doesn’t necessarily mean I can’t do the work of bagging groceries or doing something like that. So what the insurance company could say is like we’re going to deny the claim because you can still have gainful employment. It’s just not for the employment that you were trained for. So that’s just – Yeah, it’s important to know that.

[00:28:51] TU: Good stuff. Number three on our list of 10 Common Social Security Mistakes is not understanding how benefits are calculated. Tim, admittedly, this is something I know very little about. You’ve already thrown around a term. I’m sure you’ll define PIA. Tell us more about the formulas that are used to determine one’s benefit?

[00:29:09] TB: Yeah. So the two big terms here is the PIA, the primary insurance amount, and the AIM, the average indexed monthly earnings, which I alluded to a little bit. So the worker’s benefit is tied to the primary insurance amount, PIA, which is a benefit formula applied to the worker’s average indexed monthly earnings or AIMs. That’s a mouthful. So the way you get to aim is you add together all of the index wages for the highest 35 years, and you divide that by 420 months or 35 years, and that’s the AIM.

So if you look at this on a timeline, the timeline zero is kind of the PIA. Then anything before that, so if you retire early, say at 62, that’s kind of a reduction, and I’ll take you through the math on that, then anything to age 70, which is the opposite on the spectrum, is a credit. So the worker’s benefit is reduced by – Of course, we don’t want to make this simple, Tim, but it’s five-ninths of 1% of the PIA for each month before retirement age up to 36 months. So essentially, you’re getting a haircut five-ninths of 1% of PIA for every month before your full retirement age.

If it’s greater than 36 months, it’s further reduced by five-twelfths of 1% per month. So in my exam, I’m basically calculating this. I’m like, okay, the full retirement age is 65. They – Yeah, no doubt. So here’s an example. If we’re claiming 44 years early, that’s 48 months. So the first 36 months, it’s five-ninths of 1%. Then the last 12 months to get to the 48 is five-twelfths of 1%. So if I do the math there, that’s a 25% reduction. So five-ninths times 36, plus five-twelfths times 12, the 12 months is 25%.

[00:31:06] TU: Four years early.

[00:31:08] TB: Correct. So that tells me that my paycheck is reduced by 25%. So if my primary insurance amount was 1,500, then my benefit would be reduced by 25% or 1,125. The scary thing or not the scary thing, but the problem is, Tim, is like once you do that, there are some like you can unwind it. If you claim early, you have 12 months to kind of give the money back. Or you can give them money back and say, “I’m just kidding. I want to actually defer.”

But once you take that haircut, you take that haircut. Again, you still might get the cost of living so that 1,125, if you’ve got that in 2022, you still get the 8.7% increase. But I would rather have the 8.7% increase on that 1,500. So if you defer the worker’s benefit, it increases by two-thirds of 1% for each month, until age 70 or 8% per year. So if that 1,500, basically, I go all the way out to age 70, for every year, essentially, it’s about 8% per year, which is why when I was looking at my benefit, I’m like, all right, 2,600 bucks at age 67, if I wait to age 70, 3,231. That’s kind of the idea.

[00:32:27] TU: What was your spread, Tim, your low to your high, 62 to 70? What was your –

[00:32:31] TB: 62, I’m getting $1,774. To age 70, I’m thinking 3,231s. What is that? 70, 80% difference between the two or something like that?

[00:32:43] TU: Quick $1,500 about. Yep.

[00:32:45] TB: Yeah. It’s significant. We’re talking about this a little bit, Tim, but what people are saying is like, “Well, if I retire at age 62, I’m probably going to live to age 65.” Like people have kind of very little sense of their own mortality, and they typically live longer than what they think. Now, that’s not always the case. There are some people that it does make sense to claim, and we’ll talk about a little bit more of the mindset. But a lot of advisors and people, it’s like, well, it’s kind of a breakeven. It’s like, well, if you are collecting at 62, that’s eight years of collecting it at that versus waiting at 70. There’s a breakeven analysis that you can do. But I think that’s flawed in a sense, in terms of it looking at it from an investment decision versus like an insurance decision. We’ll talk about that in the next episode.

[00:33:34] TU: Tim, a question I have, when you talked about the benefit going up 8% per year by deferring, is that 8% plus the COLA then, just like it was on the downside? You know what I’m saying?

[00:33:48] TB: Correct.

[00:33:49] TU: Okay.

[00:33:49] TB: Yeah.

[00:33:50] TU: Yeah. I mean, that’s wild, right? I was just kind of taking those numbers like, so instead of 1,500 going to 1,125, getting reduced by 25%. Essentially taking that up 8% per year and, obviously, it’s 8% on the 8%. But then adding to that the COLA piece, like that’s where the numbers start to really deviate.

[00:34:08] TB: Yeah. Again, this was a crazy year, so –

[00:34:13] TU: Yeah, that’s right. That’s right.

[00:34:14] TB: I’d have to look at in terms of like what the – But I feel like it’s gone up, even in years of very little inflation. The CPIW, which is the Consumer Price Index for Urban Wage Earners and Clerical Workers, is essentially what they use to adjust it, even if it’s a 1%, 2%. Yeah. That’s completely separate from the deferral credit of 8% that you receive away from inflation. Again, that can be huge.

[00:34:41] TU: Yeah. Yeah, absolutely. Again, I think this is a good reminder, like we’re talking in generalities. I think you mentioned, Tim, the importance of, hey, we can run the math. You can run a breakeven. But it doesn’t stop there, right. As we highlighted earlier in our conversation, there are so many layers to this and considering spousal benefits and quality of life and overall health condition, what you’re doing.

I mean, there are so many things that consider that, yeah, I mean, there are cases where someone may claim early, as we look at generally. Certainly, the math here would advocate that deferring makes sense, but that may not always be the decision. I think that’s where the planning really comes into play.

All right, number 4 on our list of 10 Common Social Security Mistakes is taking Social Security too early, not working long enough. Tim, we talked about this a little bit already, and perhaps it’s due to the age of my parents and in-laws, where this topic is one that comes up a lot. But this feels like a topic that is often discussed, often debated. So talk us through some of the major implications here.

[00:35:42] TB: Yeah. Just like any other parts of the plan, Tim, like what we’re really trying to strive for here is optionality. I can speak to my own parent, at least my dad. When he retired, it was kind of out of his hands because his company was bought by another company, and he was kind of duplicitous. So his options there were, okay, find a new job at 65 or whatever it was or start retiring.

Again, like if I’m him, in that moment, I’m probably trying to use other sources of income. So I can then defer Social Security, get the biggest benefit. Sometimes, your plan is out of your hands because of external things like that. You want to prepare yourself as best you can to kind of cushion the blow, again, if you are, if you do kind of get phased out of the workforce. A lot of it, it’s related to scale backs and things like that. But sometimes, a lot of it is health.

Sometimes, you’re like, “Oh, I’m definitely going to work to age 65, or I’m definitely going to work to age 70.” I think it’s something like 40% of the time, that’s not the case. So 40%, that’s a coin flip, a coin flip, Tim. Sometimes – Now, just because you’re not working doesn’t necessarily mean you have to claim Social Security. But for a lot of us, especially for a huge portion of that, you have to, right? But the argument that I would make is that if you can build a plan to have enough retirement assets or being able to tap home equity or taxable brokerage assets to kind of bridge that gap, it allows for further sustainability later because just more of your dollars are coming from Social Security, versus taking a 30% haircut or whatever it is. Yeah. Not working long enough is huge.

The other factor is that, again, typically, towards the end of your careers, when most of us are working or earning the most money, which, basically, we’re looking at the highest 35 years, so it could be I’m making $200,000. If I decide to work another year, $200,000, maybe that’s taken zero or that $358 a year that I had in 1998 off the table. Then my benefit is going up even higher.

But then the other side of it is like it is another year, where you’re not essentially senior. You’re not in senior unemployment, i.e. retirement, where you’re not basically generating your retirement paycheck yourself, which, again, is the whole purpose of retirement. So there’s a lot of people that are now really trying to either phase into retirement, or they have lifestyle, jobs, or businesses, or things that they do that maybe bring some dollars in that they’re not full stop.

Because, again, from an emotional standpoint, we talk about this from an identity perspective, a lot of us like my identity is very much wrapped up in the job that I have, which can be unhealthy. But we’re seeing high levels of depression and drug use, alcoholism in retirees that we haven’t seen before. I think it’s because a lot more people are talking about it. But that’s another benefit of like easing in from a work perspective.

But as we talked about it, again, it’s a 30% reduction if you claim at age 62, versus full retirement age. If you work past it to get the full credits, 8% per year. The difference, it can be like 70 to 80 percent between age 62 to age 70 in terms of the benefit, if you defer. One of the things that is if you’re listening to this, and you’re like, “Ah, I just retired summer of last year, and I took the benefit right away,” there isn’t the ability. It’s called a withdrawal of application, which can be made by a worker within 12 months of claiming the benefits.

It’s basically like a take back seats, like do over. You’re like, “Oh, I just kind of did what everyone else is doing, and my situation maybe requires some more TLC and attention to see. Like maybe I can get by or not claim this. I can work part time. I can consult or do whatever to kind of grow that benefit to –” Where you’re getting that 8% raise to age 70. I think that’s important. Really important to look at.

[00:39:57] TU: Tim, one of the things that just hit me as we were talking, to reiterate something we lead with, is the need for time, attention, love, planning, whatever you want to call it for Social Security. We spend so much time – When I think about numbers like $5,000 a month, right, just throwing a round numbers here, as we’re looking at some of our examples, $5,000 a month, and the attention and time we give to building and putting together a nest egg that would generate $5,000 a month, while we, I think, largely often kind of wander, walk into perhaps on some level and inform the decisions around Social Security, the implication around Social Security, a very similar level here we’re talking about, and it’s substantial, significant level, several thousand dollars per month.

I think it just highlights, as we’re digging into some of these numbers and how to optimize it, how much time and attention Social Security does really need and deserve as a part of the financial plan and one that admittedly – We look back over the first five years and said, hey, we haven’t really talked about Social Security. It’s a huge part of the financial plan, and that’s in part why we’re talking more about it right now.

[00:41:02] TB: Yeah. Again, just like anything, the financial plan is not necessarily built in a day. I think a path towards financial freedom, how you just decide that, is months. It’s years. It’s decades of being very intentional, of working towards stated goals. Social Security is a part of that. Again, we often think of it as just I’m earning money, 35 years of earnings in the background. But a tweak here or a tweak there, someone listening, and they’re like, “Hey, I can definitely earn $1,600 times four a year to turn that benefit on for me.”

Even if it’s a small benefit, I mean, that might be a car payment. It might be a chunk of rent. It might be groceries. So I think every little bit counts. At the end of the day, what really – Again, it goes back to the being intentional but then optionality when you get to that moment. Again, like one of the things that we do – Again, if we use the term, if we use 5,000, 60 grand a year for that, we might need another 60 grand to live.

So let’s say it’s 120,000. Essentially, what we’re doing then is we’re looking at those alternate sources, which could be pretax dollars from a traditional 401(k), after tax dollars from, say, a Roth IRA, a taxable account. We’re kind of trying to bring all those in, and it could be money from home equity. It could be money from an annuity that we take a chunk of the portfolio, and we say, “Hey. For us to get to a minimum, maybe it’s not – Maybe we need 80,000.” So maybe we buy a $20,000 annuity for that year or for like a term or whatever to get to that level. Then you know that based on Social Security and based on what that annuity is going to pay you that I’ll food, I’ll have a roof over my head, all those basic necessities. So everything else that’s coming from the portfolio, which is kind of cream.

Essentially, what I’m describing is like the flooring strategy. But, yeah, it’s huge. It’s huge. Again, I think what we’re advocating for is just intentionality. So it leads to optionality in the future.

[00:43:23] TU: Yeah. It’s separate conversation for a separate day. But just things that are coming into my mind as we walk through some of this if you have a solid flooring strategy in place, if that’s the route and pathway you’d go, like does that change your risk tolerance or risk capacity around investing or other opportunities? Again, all this feeds into to one another.

All right, let’s wrap up this two-part series on 10 Common Social Security Mistakes. We’ll finish up with number five here, and we’ll pick up next week with 6 through 10. Number five is making sure that we’re not looking at this in a vacuum and specifically not coordinating benefits with a spouse. Tell us more about this one, Tim.

[00:44:01] TB: Yeah. Kind of I’m thinking about this. We do have a lot of people that come through the door that’s like, “I’m looking for a financial plan just for myself,” but they’re married. I’m like it is hard to do because up and down, whether it’s a shared benefit like a home or even something like Social Security, like you got to be on the same page.

As we said, the spousal benefit does not increase if the worker defers benefits. But a survivor benefit may. You can get credit based on that because it’s based on the PIA of the worker. One of the things that like we often hear is like, “Well, I’m in poor health, or like my dad and my uncle, they all died in their early or late 60s, early 70s.” But it might make sense. So even if the spouse, who is in poor health, it might make sense to defer the benefit because the longer you defer –

Again, if we give an example of spouse A has a benefit of 1,700, and spouse B has a benefit of 3,000, that’s a $4,700 per benefit. But if I can defer spouse B to get the 3,500 or to get the 3,800, I still can either pick mine, which is 1,700, or my spouse’s at 3,000, when they do pass away.

Again, it can’t be looked at a vacuum. You really have to look at everything. But a lot of people at default, they’re like, “Hey, I just got to get the money as quickly as possible.” Because I put all this money into, I want to get out. That kind of goes back to like the whole investment. So it really is important for you and your spouse to go back to the first one, where it’s like look at your earnings. Look at everything. Make sure it’s accurate. Then really coordinate the benefit that maximizes the dollar for the household, when both spouses are alive but then also when one spouse predeceases the other.

So not in a vacuum, just like so many other pieces of the financial plan, you need to really make sure that there’s a coordination strategy there to, again, maximize the benefit and not leave money on the table.

[00:46:00] TU: Tim, one of the themes I’m hearing from you, especially for folks that are listening that have still a decent runway to save, is what can we be doing to take off that pressure of early claiming, if that’s not the move that we would desire to make, for the reasons we’ve talked about looking at the dollars and cents here?

Can we build those other sources that we can pull from, when it comes to that retirement paycheck? You mentioned the traditional retirement accounts, Roth IRAs, brokerage accounts, etc. Can we build those up in a way that relieves that pressure? Then if the decision really should be different for some and, again, that may not be a blanket for all, but we take that out of the equation, pressure out of the equation.

[00:46:42] TB: Yeah. I think this all goes back to like goals, like what is your goals around retirement? It’s funny. Like it goes back to all the other pieces that we talked about what the financial plan. It’s like what’s the balance sheet say? What are the sources of income, and where are we trying to go? What are the goals? It’s the same, whether you’re starting out, or it’s the same, whether you’re starting to wind down your career, so to speak.

Having a good eye on like where you’re at and where you want to go is just as important at age 60, 65, 70, as it is at 25, 30. To me, it’s really, really important to have these conversations out loud. I always – I laugh at myself, where I’m like, “Man, I love what I do. I love the work that we’re doing at YFP. I can see myself working at least till age 70 to get ready for retirement age.” But I also know that like we can be fickle creatures, right? Something could happen outside of our control that just makes the work that we’re doing a lot harder. There can be a lot of things.

So I think even checking in with yourself, checking in with your spouse in terms of like what you want is important. But then if you do have to kind of pivot because of maybe some of the things that we did 20, 10 years ago, we have the option to say, okay, we can still not be hasty with our retirement claim or Social Security claiming strategy because we have the ability to pull through other sources to still max them out, max out like what we get from the system.

Again, like I would almost say that this decision is going to be one of the bedrock decisions, if not the bedrock decisions, because we’re looking for sure things. Although, again, like there might be differences in the benefit in the future, it’s still going to be there, and it’s still going to be inflation-protected and all those things that is really positive about the Social Security benefits. So, yeah, I think, hopefully, this is a good first five and looking forward to getting to the next five. But I can’t stress the importance of this decision on the retirement income plan.

[00:48:43] TU: Great stuff as always, Tim Baker. We’re going to pick up next week, as we continue with 10 Common Social Security Mistakes to Avoid. Again, I’d reference you back to episode 242, where we relate some of the foundation around Social Security. We look forward to talking more about this topic throughout the year.

For folks that are listening, especially, Tim, I’m talking about folks that are maybe in that later part of their career, nearing retirement, a lot of these questions are really coming to life around Social Security. It’s moving from the education to the decision making, if you will. We’d love to have a chance to talk with you to determine whether or not the financial planning services that we offer at YFP Planning are a good fit for you. So you can do that by booking a free discovery call at yfpplanning.com. Again, that’s yfpplanning.com.

Tim, thanks so much, and we’ll be back next week.

[END OF INTERVIEW]

[00:49:29] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog posts, and podcasts is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analyses expressed herein are solely those of Your Financial Pharmacist, unless otherwise noted, and constitute judgments as of the dates published. Such information may contain forward-looking statements that are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 290: Getting Ready for Tax Season

Posted on by Caitlin Boyle

Sean Richards, CPA, EA returns to the podcast to discuss difference between tax planning and tax preparation, how effective tax planning can prevent costly mistakes, tax changes for 2023, and the basics of YFP’s Comprehensive Tax Planning.

About Today’s Guest

Sean Richards, CPA, EA, received his undergraduate degree in Corporate Finance and Accounting, as well as his Master of Accountancy, from Bentley University in Waltham, MA. Sean has been a Certified Public Accountant (CPA) since 2015 and received his Enrolled Agent certification earlier this year. Prior to joining the YFP team, Sean was the Senior Treasury Manager at PRA Group, a global debt buyer based in Norfolk, VA. He began his career at American Tower Corporation where, over 10 years, he held several positions in audit, treasury, and accounting. As the Director of YFP Tax, Sean focuses on broadening the company’s existing tax planning and preparation operations, as well as developing and launching new accounting offerings, including bookkeeping, payroll, and fractional CFO services.

Episode Summary

This week on the YFP Podcast, YFP Co-Founder & CEO, Tim Ulbrich, PharmD, welcomes Sean Richards, CPA, EA, back to the podcast to discuss getting ready for tax season. In their conversation, Tim and Sean discuss the difference between tax planning and tax preparation, how effective tax planning can prevent costly mistakes, tax changes for 2023, and the basics of YFP Comprehensive Tax Planning. Listeners will hear ways to prevent costly mistakes during tax filing season, including building a strategy around PSLF, nuances of real estate investing, and the impact of a side hustle or additional business income. Sean explains that the best way to avoid these mistakes would be through proactive tax planning throughout the year, but in particular, before tax season. Tim leads the conversation to the differences between tax planning and tax preparation, plus various tax changes for the 2023 tax filing season and into the future. Sean shares resources and information on changes to charitable contributions, energy credits, and clean energy credits. Sean closes out the conversation with an introduction to YFP Tax, the new YFP Tax website, and the various services available to clients including YFP’s Comprehensive Tax Planning (CTP), what it is, and the type of client the service would be a good fit for.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey, everybody. Tim Ulbrich here, and welcome to this week’s episode of the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

Now, aside from being pharmacists with a passion for personal finance, there’s something else that you and I have in common, and that’s that we have to file our taxes each year. Now, I know what you might be thinking. Tim, it’s only January, and the tax filing deadline is still a few months away. 95 days to be exact, in case you’re counting. Do I need to start thinking about taxes right now?

I get it. But the truth is that now is an important time to shift gears and start thinking about the strategies that you can use to optimize your tax situation, and that’s why I’m excited to welcome back onto the show YFP Director of Tax, Sean Richards, to talk through getting ready for tax season. We discuss on this episode the difference between tax planning and tax preparation and how effective tax planning can prevent costly mistakes. To learn more about the services offered by YFP Tax, you can visit yfptax.com.

Now, whether you’re looking for help with your individual taxes, business taxes, or both, YFP’s comprehensive tax planning combines traditional filing with our proactive year-round planning process. All right, let’s jump into my interview with YFP Director of Tax, Sean Richards.

[INTERVIEW]

[00:01:22] TU: Sean, welcome back to the show.

[00:01:24] SR: Thanks for having me, and I’m excited to be here before we get into tax season, while I actually still have a chance to get on the pod and talk to you.

[00:01:31] TU: Absolutely.

[00:01:32] SR: Catch me in a couple of weeks, and I’m probably going to ignore all of your calls and everything. So get me while you have me.

[00:01:37] TU: Tis the season indeed. We had you on episode 283 not too long ago. We talked about how to optimize your tax situation as a pharmacy professional. We’ll link to that in the show notes for folks that want to go back to that. But as you mentioned, here we are in the midst of tax season, this episode going live right around the middle of January. Sean, this is about the time where we start to see those tax forms coming in the mail. I don’t know. Folks maybe are like me, where I start to pile those up on my desk. Maybe clutter the –

[00:02:06] SR: [inaudible 00:02:06] or whatever.

[00:02:09] TU: Clutter the countertop a little bit. It’s that visual reminder that we’re going to be filing our taxes. One of the things we’re going to talk about here today, not only what are some things that folks can do to, hopefully, have a smooth tax filing season, but also how can we be strategizing and planning, hopefully, year round and not necessarily just house on fire when we go to file our taxes each April.

So we’re going to talk in really a few different parts. Number one, what are some of the ways that folks can prevent some of the costly mistakes during filing this season? What are some most common mistakes that you see? We’ll then talk about some of the differences between tax preparation and tax planning. Then we’ll talk about some of the changes that folks need to be aware of for both this tax filing season, some of those coming from the Inflation Reduction Act, and then also some of the things that folks can be looking out for into the future. So I’m ready if you’re ready. Should we do this?

[00:03:07] SR: I’m always ready. Like I said, this is the most ready I’ll be for a while. So here we go.

[00:03:12] TU: So let’s jump into some of the costly mistakes that folks may find themselves making during the filing season. Obviously, we want to avoid this if we can. You recently wrote a blog post on this topic. We’ll link to that in the show notes. But give us some of the examples, as you’ve been talking with many pharmacists that are interacting with YFP Tax, many pharmacy clients. What are some of these examples of mistakes that are being made that if we had some more proactive planning, perhaps we could prevent it?

[00:03:43] SR: Yeah, and thanks for bringing up that blog post because that really gets into the nature of how a lot of these kind of arise and can be prevented. Not to give everything away about that, but the idea of the whole thing is really just sort of being able to go back in time, if you could, right? In a lot of circumstances in life, it would be nice to be able to get a redo and be able to go back and kind of get a mulligan, if you will. But with a lot of things in life, you can’t do that, and taxes are one of those things.

So I would say the biggest examples where I see pharmacists or anybody really making mistakes when it comes to taxes is not planning ahead and kind of looking back and saying, “Oh boy. I wish I had done that.” So that time that you had a great year, and you made a ton of money, and maybe you’ve had a side gig going, and you had so much cash that you didn’t know what to do with it. But then you come to the end of the year and you didn’t have that cash anymore when your actual tax bill comes due. So, “Oh, I wish I could have put some of that money aside, done a projection, see what I’m going to owe at the end of the year.” Maybe make estimated tax payments if you apply for something like that.

Or something like, “Hey, real estate’s hot right now.” You bought up a place. You fixed it up. You finally sold it. You hit that peak before interest rates went up, and now you’re sitting there going, “Oh, my goodness. I have to pay taxes on all those capital gains.” What are some things you could have done to maybe make different improvements to the house or take advantage of those improvements against your bases when you’re calculating the taxes? Or, “Hey, maybe I could have invested in some solar property or something.” Take advantage of some of those credits that we’ll talk about with the Inflation Reduction Act. So things of that nature.

A big one with pharmacists is loan forgiveness, right? PSLF. If you’re looking at this, and you’re saying you did your taxes, and you’re going to apply for forgiveness in the future and say, “Oh, maybe I could have filed separate for my spouse last year. If I had done this a little bit differently, then maybe I could have had some more of my loans forgiven.” So it tends to always be an – I’m not going to say always, but there tends to be a common recurring theme of if I just planned ahead, and I could go back in time and change these things, maybe that problem wouldn’t be there.

But actually, now that I think about it, I had a personal situation. I like to bring this one up because it’s near and dear to me and if I can ever prevent folks from having the same thing. I know, early in my career, I was lucky enough to have RSUs given, granted to me, and I was a young budding accountant and went to do my taxes and paid the capital gains and said, “Okay, that’s fine. I understand. I cashed them in. I have my capital gains.”

It wasn’t until I was looking at it a little bit down the line and talking to some of my colleagues that I realized I didn’t actually account for that properly. I had already paid taxes on some of that, and then I went and basically double-counted and paid again. So RSUs are one of those things. I know a lot of pharmacists get them. They get excited about them. If you don’t really pay attention or you don’t talk to somebody who knows what they’re doing with these things, you can end up double paying, and the IRS certainly won’t reach out and let you know that you did that. You have to find that on your own.

[00:06:44] TU: Yeah. Sean, to that point, we’ve worked with a lot of the pharmaceutical industry fellowship programs, and as a result, have a handful of those that are in pharmaceutical industry as clients, whether it’s on the planning side or on the tax side. So this is something that we see come up a lot about trying to understand what are RSUs, and what are some of those tax implications. Certainly, student loans, you mentioned PSLF strategy. It’s a big one in our community, real estate. We’ve got a whole separate podcast dedicated to that topic. So of course, that can be something that’s top of mind.

Then the first one you mentioned is something, Sean, I know I’m seeing and hearing more and more of. We featured many pharmacists on the show that are beginning to monetize their clinical expertise in a variety of different ways, whether that’s a business, whether that’s a side hustle, or perhaps a side hustle that turned into a business. As you mentioned, often there’s that new income that’s coming in. By the time we get around to filing, we’re maybe putting that income back into use in the business or other expenses that come up. Then there’s that surprise tax bill. So, yes, we’re doing good. We’re growing the business. We’re achieving that goal of monetizing whatever we’d been working on. But are we proactively planning for, obviously, the tax bill that’s going to be due? How can we plan for that throughout the year? So great examples I know that will touch many people that are listening.

The next question then is what is the antidote to these mistakes? You mentioned a couple times you were sharing that really that more proactive tax planning, not just necessarily looking at that point of filing, where we’re looking backwards, but really thinking strategically throughout the year can help us not only prevent these mistakes, but also optimize our overall tax strategy. So define for us the difference of tax planning versus tax preparation, and why it’s so important that we understand how these two are so different.

[00:08:36] SR: Sure. So tax preparation is the traditional what you think of with taxes. It’s, hey, you go to your account at the end of the year. You hand them a big box of receipts and say, “Here’s all the stuff.” All the things that you were just talking about you get in the mail, you put a little pile on the table, you bring it to your accountant and say, “These are what I have. This is what I did last year. Get my taxes done for me.”

That also is the traditional area where people kind of are fearful about taxes or have that stress like, “Oh, my goodness. Am I going to owe something?” Or even getting a big refund can be a good thing. But at the same time, you just gave the government an interest free loan for however long, right? I mean, getting a big refund, there’s probably a pretty good chance you could have done something better with that cash. So that’s typically the surprise or the idea I was talking about like, “Oh, goodness. I wish I had done that in the middle of the year in July,” something like that.

That’s tax preparation, and it’s not inherently a bad thing. It needs to get done. Again, it’s what most people are familiar with, whether it’s going to an accountant or going on to TurboTax yourself and getting it done. But that also, again, is where a lot of these stresses tend to come from. On the flip side of that is this idea of tax planning. So that is not just thinking about taxes at the end of the year, but making sure that you’re keeping them top of mind throughout the course of the year, and you’re synergizing your tax strategy with your overall financial strategy.

One thing I want to be clear about is I don’t want people sitting there all day long thinking about tax because, I mean, maybe I want to do that. But a lot of people don’t, and that’s not what we’re getting at with tax planning. It’s not where you’re sitting there all day long and how is this going to impact my taxes? It’s just making sure that when you’re making decisions, that it’s not something that you’re thinking about in April or next filing season. But it’s something that is in your mind. So, hey, I’m thinking about buying a property at the end of the year. What will those implications be from a tax standpoint? Or I’ve been working this side gig. Should I be putting cash aside and trying to plan ahead and everything?

One analogy, if you’ve ever heard me on the pod, I think I talked about this before. If you’ve ever talked to me in person, you’re probably sick of hearing this one. But I often compare it to tax preparation at the end of the year. It’s like a film editor versus tax planning. It’s like a film director who can kind of change things over the course of the year. A new analogy I’ll kind of introduce this time around, I’m really into cooking. So what I found it to be is tax planning is sort of like reading the recipe, prepping your ingredients, getting everything kind of ready to go. Like you watch these tasty videos. They all have everything measured out, and they’re just pouring it in at the time, and it’s all kind of ready.

Versus tax preparation is the last step of getting everything plated and putting it all together. Would you want to do all that piece, without having done any of the prep work to begin with? Are you going to try to throw everything together when you haven’t even cut the potatoes or anything yet? No. I mean, ideally, if you’re preparing a meal, you want to also plan, cut the things, read the recipe, and just have a good idea throughout the course of the thing. So that’ll be my new analogy going forward maybe until I get sick of cooking, and then I can come up with something else.

[00:11:35] TU: I’m smiling because I can totally see you this past weekend cooking and thinking, “Oh, I’ve got another analogy for how I’m going to explain tax planning versus tax preparation.”

[00:11:45] SR: Exactly. I was probably panicking and realize I didn’t cut something ahead of time that I needed to put in and was saying, “Oh, my goodness. If I had just done that ahead of time and made the connection there.” Most likely, this would happen.

[00:11:55] TU: Yeah. I think you’ve given some really good examples, Sean. I was thinking about this this morning. Even when I was working a W-2 job, a pretty simple tax return, pre-kids, there still was this kind of underlying feeling of like, “Am I really optimizing everything?” What I don’t know, I don’t know. Number one, yeah, I could do the TurboTax. I could do the H&R Block. I could figure that out. But how is this really interfacing with the rest of the financial plan? Then, obviously, over time, as things become more complicated, more than one income perhaps or rental properties or children enter the equation, changes of income throughout the year, all these different scenarios where there’s some real time adjustments that you want to make, as well as how can we look at all these things across the plan to make sure we’re optimizing this in the best way we can.

Sean, you know this because you’re my phone a friend on the tax side. But probably once a week, once every other week, it’s a, “Hey, I’ve got this notice. I’ve got this question. What about this? What’s it looking as we’re thinking about the estimated payment, whether it’s on the business income or question related to the real estate piece?” So there’s just so many things going on, and I feel like I have a high level understanding. But there’s a whole another layer of depth that, obviously, you and others with this expertise have and can really advise people to be thinking across the entirety of what’s going on with the taxes and the financial plan. But also looking at how can we be more proactive than just simply doing the filing each year.

[00:13:24] SR: Yep, I agree. The thing is, is that taxes often become a stressor for folks because they don’t plan ahead. That’s the biggest thing is that you go to your mailbox, and you see a letter, and it says the IRS on the top, and you immediately get this fear in your head. It’s because you think, “Oh, what did I do wrong? Or what should I have done otherwise,” or something like that.

I mean, it really just comes down to if you are thinking about these things proactively, if you have sort of that phone a friend that you can reach out to throughout the course of the year, you’re not going to be worried when the time comes because you’ll say, “I already talked to him about that. I already know what this is going to be. Oh, this letter from the IRS is just the refund check that I’m expecting to come back from them.” It’s not going to be that fear anymore.

[00:14:02] TU: So let’s shift gears and talk about some of the tax changes that individuals should be aware of. I think one of the main advantages in working with a professional is that you as the individual don’t have to sift through all the changes that are happening and understand the implications to your own plan. You can get the CliffsNotes version of that or someone that’s looking out for you and, obviously, has an understanding of your individual situation.

Sean, my understanding is there are some changes that folks should be aware of that impact this filing season. Then there’s also some other changes on the horizon that will impact things in the future. Tell us more.

[00:14:36] SR: Yeah. I mean, at this stage of the game, I don’t want to say it’s too late. It’s almost never too late to do really anything. But given that we’re getting into January of 2023 now, not a whole lot to talk about for 2022, but just a couple things to keep top of mind for folks, especially because it’s questions that people may have when they’re talking to their accountant about, “Hey, this looks a little different than last year.”

So one big thing that will probably be glaring to a lot of folks is there was a $300 above the line, we call it, credit for charitable deductions that has happened for the past couple of years. So that basically, even if you’re not itemizing your deductions, if you’ve made charitable contributions, you were able to take $300 of that as a credit, that is sort of a no more going forward. So in order to take those charitable contributions, you’re going to have to itemize your deductions.

Again, I just want to point that one out because I know a lot of people, it was right there on the front of the – On the form. So a lot of people will probably think, “Hey, what happened to that?” But that also brings up a good point that you always want to – Another reason why working with a tax professional stay on top of these things is really helpful because different states, different jurisdictions all have different rules when it comes to these things. I know I was just talking about charitable contributions, for example. In the state of Arizona, that’s actually something where you’re able to make donations up until the filing date. Sort of like you can traditionally with IRA accounts when you think of on the federal side of things.

That’s another reason why I say even though it might seem like it’s too late, it’s not always too late, and you really want to keep in mind that different states and different jurisdictions have different kind of rules with that.

[00:16:05] TU: Which is why, Sean, you love the Ohio jurisdiction and the [inaudible 00:16:09], right? Isn’t that your favorite?

[00:16:11] SR: Yeah. Love would be one word that I could use to describe it. I would definitely say that that’s one of them. It keeps me on top of my game. I could say that too. I’m running out of nice things to say. But, yep, sure, we’ll go with that.

Sticking on the subject of sort of top of mind 2022, things to keep in mind, one of them – This is not so much of a, hey, it’s something that you can still do now, just something that you’re going to want to really be careful of, especially when you’re talking to your accountant and probably trying to argue. Hey, how come I’m not getting the credit for this or something? You alluded to the Inflation Reduction Act. So that was the act that President Biden signed back in August. So a lot of changes to a lot of things, specifically, energy credits, things of that nature. A good number of changes to keep an eye on there.

A big one is the Residential Clean Energy Credit. So that is traditionally – Forgive me, I can’t think of the old name. They keep changing the names of these things. But keep in mind solar, geothermal, that type of thing, really the renewable energy sources. So that was supposed to drop down to a 26% credit in 2022. That bumped back up to 30% in 2022, and that’s going to go all the way out through 2032. So that’s a good one to keep in mind.

Electric cars, that’s another one, very important. So as of – The date on this one is August 16th. So if you bought a car before August 16th of last year, electric car, sort of the old rules, I won’t get into those. You’re probably familiar with them. If you bought a car beginning August 16th and through the end of last year, an electric car, there’s a final assembly requirement where your vehicle must have been assembled in North America. Those rules apply as of August 16th of last year, so something definitely to keep in mind there.

Then going forward into 2023, if you purchase a car in this year going forward, there’s not only final assembly rules, but there’s mineral sourcing rules. There’s sort of battery component rules. So a lot stricter requirements there. We can link to – The Department of Energy has a good list where you can kind of put in your VIN and see if your vehicle qualifies and what it is. But the long story short there is it’s $7,500 credit going forward. But again, you want to keep those dates in mind whenever you purchase the vehicle. So it’s kind of one of those things to keep in mind now.

That’s a good segue into 2023. So again, closing the door in 2022, a lot of good things heading into 2023, specifically around those energy credits. We talked about new – Or electric vehicles. We talked about new electric vehicles. But starting this year might bring a lot of people into the used market here, so used electric vehicles. That will be a new credit, 30% up to 4k of those. So that’s something definitely to look forward to.

Energy credits, again, not so much on the solar geothermal side, but more on the, hey, I got new doors, new windows, the typical sort of regular household improvements. You’re probably familiar with those being a $500 lifetime credit. That starting this year going forward is actually going to be a $1,200 annual credit, so that is quite the jump there. Definitely some new restrictions and everything to keep an eye on. Obviously, you want to talk to an accountant about all that kind of stuff. But that’s a very big jump from $500 a lifetime to $1,200 a year. So definitely want to take advantage of that going forward.

[00:19:34] TU: Is that one that if I invest, I don’t know, $10,000 in new windows, that you can disperse that credit over several years? Or is it within the year of purchase for 1,200, right? Because a lot of those examples you gave, windows, doors, roofs, etc. are, obviously, going to be fairly significant expenses.

[00:19:54] SR: Yeah. It’s in the year that you actually dole out the cash that you get the credit back. In a lot of cases, these credits are nonrefundable. So what that means is that if you, at the end of the day, don’t owe anything or don’t have any taxes to offset, you don’t get that credit back for you. So refundable credit basically means, hey, if I actually offset all of my taxes and still then get some, you’ll actually get that back as a refund.

A lot of these energy credits, you just want to take a look at all of them. I won’t get into which of which. But some of those are nonrefundable, meaning they’ll offset your taxes that year but not going forward.

[00:20:30] TU: Which is another great example of planning, right?

[00:20:31] SR: Of planning. Exactly, exactly right. You beat me to it, where if you’re making a big capital purchase, you say, “All right, I’m putting in these new windows or I’m getting this solar. I’m finally getting it done,” you want to make sure you have the taxes to offset. Maybe you sell some of those investments that you’ve had for a while. Take on some of those capital gains. Use the credits to offset it or – That’s where that tax planning definitely comes into play. Absolutely. You’re taking my job, man.

[00:20:56] TU: Sorry. It was a good example. I was just thinking about all – Obviously, a large percent of our community may be doing home improvement projects, other things. This is a common one, I think, will be coming up.

[00:21:05] SR: Absolutely. Yep. But, yeah, I mean, sticking to this year, I don’t want to say it was a boring year. Every year from a tax standpoint is exciting in my mind. But the biggest thing I would say outside of the energy stuff, the name of the game has been inflation. So obviously, inflation is top of mind for a lot of folks. So a lot of inflation-related changes going into next year, and what does that mean? Mostly means limits are going up for a lot of things.

So 401(k), deferral limits. That was up $2,000. That’ll be 2,500 this year. Catch up deposits also up 1,000, so that’ll be $7,500 this year. IRA contributions went up $500, so that’s $6,500 this year. The catch up stayed the same on that, but similarly, inflation. So starting next year, 2024, that will be indexed to inflation. That’s another one there. Tax brackets, so all the tax brackets were bumped up a bit due to inflation. I’m not going to get into the specifics of which one. Each of those, each of the limits are there. The overall story is that you basically can make more money before you bump into that next bracket.

But the one thing I really want to hone in on there is a lot of people don’t really – I don’t want to say don’t understand the concept of tax brackets. But a lot of people think, “Oh, I don’t want to make another $1,000 because that’s going to bump me into the next bracket. Or how’s that affect me? Is that going to put me the next tax bracket? Or how’s that look with everything?” I just want to make sure a lot of folks on here understand the idea of incremental dollars being taxed at that next bracket. So what does that mean?

If you’re right on the edge, and you make an extra $100 that bumps you into that next tax bracket, that $100 will be at the new tax rate. The rest of your cash is all getting taxed at the rates that you were before. So I don’t want anybody here who’s got two job offers on the table and saying, “I don’t want to take this higher one because it’s going to put me in the next tax bracket.” That’s not how it works. It’s only going to be a couple extra dollars. I know that’s a big scary one. So that’s where you hear about effective rates and everything. There’s a lot we can get into there, but I just don’t want to scare folks any more than they already are.

[00:23:07] TU: Sean, it reminded me as you’re talking. I’m sure many folks listening are familiar with the Schitt’s Creek episode, where David is talking about the tax-write offs and the things that he’s buying because they’re tax-write off, right? This –

[00:23:20] SR: Write-off, yeah.

[00:23:20] TU: It’s like we need an episode on the incremental approach. I mean, you hear that all the time of like, “Oh, I don’t want to go in the next tax bracket. Or if I earn additional money, I’m going to go into that.” I think a lot of that may come from the misunderstanding of how that works in terms of the incremental approach.

[00:23:37] SR: Exactly, right. You’d never want to turn down more cash. I think we had talked about before. But even though it might not seem like the best thing, a bigger tax bill at the end of the day generally means that you actually did better that year.

[00:23:49] TU: Yeah. Well, this is great stuff, Sean, and I want to transition. One of things we’re really excited about as we head into this tax filing season is that for new clients of YFP Tax, we’re really putting a stake in the ground that we’re not doing filing only. One of the reasons we got to that decision point was everything that we’re talking about right here, which is that we really feel like tax when done well is really proactive. It’s strategic, and we’re thinking about this year round so that we can optimize that situation. Yes, filing is a part of that, of course, but we really need to be thinking more strategically.

So that’s one of the reasons that we are really excited, Sean, to be introducing YFP’s what we’re calling CTP, comprehensive tax planning. Tell us more about what it is, who is it for, and potentially who is it not for as well.

[00:24:39] SR: Yeah. So comprehensive tax planning is – It’s a lot of what we had talked about before, right? So the idea of really synergizing your tax strategy with the rest of your financial strategy. It’s something where you’re touching base with us throughout the course of the year, and it really depends on what your individual needs are. It’s not something where we’re saying, “Hey. Every Friday at five o’clock, we’re all getting on the call. It’s the YFP Tax happy hour. We’re all going to talk about taxes and everything.” That’s not what this is all about. It’s really for everybody to look at their own situation and say, “Hey, I’m looking for more guidance on my withholdings.” Maybe it’s something where we’re meeting a couple times a year to talk about, “Hey, I have this new side job. I think I have to make estimated payments now. Can we talk about what that looks like?”

Or maybe it’s something where I have a real estate property that I’m thinking about purchasing at the end of the year, but I don’t even want to begin to go down that path until I can talk about what are the implications here. What if I rent it out a couple days a year? What if I rent it out 100 days a year? How’s that look? Can I live there? What are the tax implications? So it’s really for folks who want to not wait until the end of the year, like I said, and say, “Hey, here’s my box of receipts. I’ll see you next April. Get my stuff done,” and who really want to be able to sleep at night when it comes to taxes and don’t want to open up their mailbox and say, “Oh, no. It’s the IRS. What could this possibly be?”

[00:26:01] TU: Sean, if I’m interested in learning more about the comprehensive tax planning or perhaps even ready to get started, where’s the best place that I should go?

[00:26:09] SR: So the best place to go would be yfptax.com. So that’s our new and improved website we launched recently. It has a lot of different resources on there. It has the blog that you mentioned before, a lot of videos that we posted throughout the course of the year with some of these updates and some of these new tax laws that we’re talking about. It really has a breakdown of all the different services that we have.

So whether it’s the comprehensive tax planning, CTP, that we’re talking about here, or maybe you have a side gig and you’re interested in doing some bookkeeping for that. We offer bookkeeping services, all the way from, “Hey, I just have a couple of contractors I need to do payroll for,” all the way up through what we call our fractional CFO service, which is more of the, “Hey, let’s sit down. Let’s talk strategy about my business. Let’s put some forecasts and budgeting together and everything.” That website will have a great starting point to get you started.

But from there, you can get in touch with me. I’ll answer any questions you have. We can get on the phone. If you want to look at my face, we can get a Zoom call together. Or I’m happy to talk via email, answer any questions. So you can reach me personally at [email protected]. Again, you can also go to www.ypftax.com. You’ll get links to me. You’ll get links to all the things that we’re talking about here. That’s the best place to start.

What I would say is, definitely, if you’re interested, don’t wait. We’re getting into tax season. I know that I’m biased to say that, but I think you’re going to lose a lot of us in a couple of weeks. So might be not a bad time to hop on there and take a look.

[00:27:34] TU: Don’t wait indeed. This is really the – Now, I’m not going to say quiet. You guys got a lot of stuff going on, but really the lull before the storm that is the tax season and then, obviously, some hibernation of rest and recovery thereafter. So make sure to head on over to yfptax.com. Lots more information there. As Sean mentioned, you can reach out to him directly to set up a call, get some more information. If you’re ready to get going, you can also click on a complete a quick form. You can get started. But all the information is there on the website.

Sean, thanks so much, and we look forward to hearing from you after tax season.

[00:28:06] SR: Thank you. Yeah. It’s definitely the calm before the storm. But like I said, it’s sort of like if you watch the weather channel before a hurricane. Even though it’s the calm, everybody’s still prepping and getting ready and everything. Then once it’s all said and done, yeah, it’ll be nice to touch base in May once everything’s kind of a little bit calmer.

[00:28:23] TU: Great stuff. Thanks, Sean.

[00:28:24] SR: Thank you.

[END OF INTERVIEW]

[00:28:25] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 288: An Interview with Suze Orman (YFP Classic)

Posted on by Caitlin Boyle

This week we replay a YFP Podcast Classic. Suze Orman, #1 New York Times bestselling author on personal finance with over 25 million books in circulation, joins Tim Ulbrich on today’s episode. They talk about her most recent book Women & Money: Be Strong, Be Smart, Be Secure and the advice Suze has for pharmacy professionals feeling overwhelmed with their student loan debt and managing their financial plan.

About Today’s Guest

Suze Orman has been called “a force in the world of personal finance” and a “one-woman financial advice power house” by USA today. A #1 New York Times bestselling author, magazine and online columnist, writer/producer, and one of the top motivational speakers in the world today, Orman is undeniably America’s most recognized expert on personal finance.

Orman was the contributing editor to “O” The Oprah Magazine for 16 years, the Costco Connection Magazine for over 18 years, and hosted the award winning Suze Orman Show, which aired every Saturday night on CNBC for 13 years. Over her television career Suze has accomplished that which no other television personality ever has before. Not only is she the single most successful fundraiser in the history of Public Television, but she has also garnered an unprecedented eight Gracie awards, more than anyone in the entire history of this prestigious award. The Gracies recognize the nation’s best radio, television, and cable programming for, by, and about women.

In March 2013, Forbes magazine awarded Suze a spot in the top 10 on a list of the most influential celebrities of 2013. In January 2013, The Television Academy Foundation’s Archive of American Television has honored Suze’s broadcast career accomplishments with her recent inclusion in its historic Emmy TV Legends interview collection.

In 2010, Orman was also honored with the Touchstone Award from Women in Cable Telecommunications, was named one of “The World’s 100 Most Powerful Women” by Forbes and was presented with an Honorary Doctor of Commercial Science degree from Bentley University. In that same month, Orman received the Gracie Allen Tribute Award from the American Women in Radio and Television (AWRT); the Gracie Allen Tribute Award is bestowed upon an individual who truly plays a key role in laying the foundation for future generations of women in the media.

In October 2009, Orman was the recipient of a Visionary Award from the Council for Economic Education for being a champion on economic empowerment. In July 2009, Forbes named Orman 18th on their list of The Most Influential Women In Media. In May 2009, Orman was presented with an honorary degree Doctor of Humane Letters from the University of Illinois. In May 2009 and May 2008, Time Magazine named Orman as one of the TIME 100, The World’s Most Influential People. In October 2008, Orman was the recipient of the National Equality Award from the Human Rights Campaign.

In April 2008, Orman was presented with the Amelia Earhart Award for her message of financial empowerment for women. Saturday Night Live has spoofed Suze six times during 2008-2011. In 2007, Business Week named Orman one of the top ten motivational speakers in the world-she was the ONLY woman on that list, thereby making her 2007’s top female motivational speaker in the world.

Orman who grew up on the South Side of Chicago earned a bachelor’s degree in social work at the University of Illinois and at the age of 30 was still a waitress making $400 a month.

Episode Summary

Happy Holidays! This week, we bring back a YFP Podcast classic! YFP Co-Founder & CEO, Tim Ulbrich, PharmD, is joined by the one and only, Suze Orman. Suze, #1 New York Times bestselling personal finance author with over 25 million books in circulation, talks about her book, Women & Money: Be Strong, Be Smart, Be Secure, and shares advice for pharmacy professionals feeling overwhelmed with their student loan debt and managing their financial plan.

Suze shares her journey of being a waitress until she was 30 years old and going through a loss of $50,000 from an investment through Merryl Lynch in a three month time period. This is where her passion for personal finance began. Suze landed a job at Merryl Lynch, quickly began rising in rankings and eventually started her own firm. Suze became an advocate to ensure other people’s investments make more money than she’s earning.

Suze says it’s important to have a healthy relationship with money and that there is no shame big enough to keep you from who you are meant to be. She shares that fear, shame and anger are the three internal obstacles to wealth.

In regards to student loans, particularly for those with the biggest debt loads, Suze says that first and foremost you have to understand the ramifications that unpaid student loan debt will have on your life. She suggests following the standard repayment plan to minimize the additional interest and amount added on the end of loan (if following an income driven plan), and the taxes to be paid if the loan is forgiven. After paying off your student loan debt, Suze says that you can start dreaming. If an employer offers a 401(k) or 403(b) with an employer match, Suze suggests to contribute to the retirement account only up until the amount of the match.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey, everybody. Happy holidays. Tim Ulbrich here, and thank you for listening to the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

This week, our team at YFP is taking off an annual tradition for us, as we reflect on the year behind us, plan the year ahead, and most importantly, spend time with family and friends. Since our team is on a break this week, I’m bringing back one of our most listened to episodes of all time. That’s an episode from July 2019, where I had the pleasure of interviewing the one and only Suze Orman, a number one New York Times bestselling author on personal finance with over 25 million books in circulation.

On the show, we talked about one of her books, Women & Money: Be Strong, Be Smart, Be Secure, and the advice she has for pharmacists, as it relates to managing their finances. Now, Suze has been called a force in the world of personal finance and a one-woman financial advice powerhouse by USA Today. She’s a number one New York Times bestselling author, magazine and online columnist, writer, producer, and one of the top motivational speakers in the world. Orman was a contributing editor to the O, The Oprah Magazine, for 16 years, the Costco Connection magazine for over 18 years, and hosted the award-winning Suze Orman Show, which aired every Saturday night on CNBC for 13 years.

With that said, it’s without question and honor to welcome Suze Orman to the YPF Podcast.

[INTERVIEW]

[00:01:28] TU: Suze, before we jump in to discuss how pharmacists can be more intentional with their financial plan, I want to give a shout-out to one of our avid listeners, Amanda Copolinski, who is a super fan of yours that said, “Tim, you need to interview Suze on the podcast. Her message will resonate so well with your listeners in the financial issues that pharmacists are facing.” So while you have impacted millions of people, Amanda is one of those. Because of your work, your message will now impact thousands more in our community. So thank you so much for coming on the show.

[00:02:00] SO: You’re welcome. But, Tim, I just have to say one thing about Amanda, seriously. Amanda asked, and because she had a voice, because it is so important, particularly, that women have a voice, and they ask for what they want, and because she asked for what she wanted, even though it was for the good of all, it obviously was also good for Amanda. She got what she wanted. So if we can just learn to ask for what we want, I mean, what’s the worst thing that could happen? I say no. So then it wouldn’t have mattered if even – Do you see what I mean? So, Amanda, you go girl, you go girl, you go girl. All right, we can go now.

[00:02:41] TU: So before we jump in and talk more about your book, Women & Money: Be Strong, Be Smart, Be Secure, I’m curious and want our listeners to know as well a little bit more about your background into this world of personal finance that has led you to transform millions of people on their own financial journey. Were there a series of events or an aha moment for you that set you on this path, on this journey to teach and empower others about personal finance?

[00:03:07] SO: Yeah. It was a very simple story, actually, where I was a waitress till I was 30 years of age in Berkeley, California. Having been a waitress for seven years, making $400 a month, to make a very long story short, I had this idea that I could open up my own restaurant because I made these people a fortune with all my ideas. My parents had absolutely no money. My mother was a secretary. My father was sick most of his life, blah, blah, blah, blah. And the customers I had been waiting on lent me $50,000 to open up my own restaurant.

So I’m, again, making a long story short. They had me put that money in Merrill Lynch, which was a brokerage firm. I had a crooked broker. Within three months, all $50,000 was lost. Now, I didn’t know what to do, and I thought I know I can be a broker. They just make you broker. Because during those three months, I really loved starting to learn about a world that was so foreign to me. I didn’t even know what a money market was or Merrill Lynch was.

Anyway, I went and applied for a job at Merrill Lynch because I knew I wanted to pay these people back that lent me $50,000, and I wasn’t going to do that at $400 a month, which was my salary as a waitress. They hired me to fill their women’s quota. While I was working for them, I realized what my broker did was illegal, and I also had been told that women belonged barefoot and pregnant. They had to hire me, but they would fire me in six months. So while I was working for them, I sued them with the help of somebody who worked for Merrill Lynch who told me what had happened to me was illegal. Because I sued them, they couldn’t fire me.

During the two years until it came to court, and they then settled outside of court because I was their number six producing broker at the time, but what happened was during that time, those two years, I realized, oh, my God, how many people out there don’t have the money to lose? Like all right, I was young. I could have somehow come back. But what if it were my parents? What if it were your parents? What if it was somebody who that was every penny they had to their name?

Even though I was a financial advisor, in terms of serving people at that time, I became an advocate to make sure that every single person that invested money, that their money meant more than the money I was going to earn off of them. I put them before me. People first, then money, then things. It was those people that mattered because I was one of those people. Before you knew it, I just rose and rose in the ranks, started my own firm, and here we are today.

[00:06:20] TU: Indeed. I think that’s a good segue into talking about your million-copy,

number one New York Times bestselling book, Women & Money: Be Strong, Be Smart, Be Secure. As you may or may not already know, the profession of pharmacy is made up of a majority of women, approximately 60-40 split, two-thirds, one-third of graduates today, roughly speaking. So I think this message in your book is certainly going to resonate with our audience.

You start the book with a chapter titled Imagine What’s Possible, and there’s a passage in there that I want to briefly read that really stood out to me. You said, “Women can invest, save, and handle debt just as well and skillfully as any man. I still believe that. Why would anyone think differently? So imagine my surprise when I learned that some of the people closest to me in my life were in the dark about their own finances. Clueless or, in some cases, willfully resisting, doing what they knew needed to be done. I’m talking about smart, competent, accomplished women who present a face to the world that is pure confidence and capability.”

So why, Suze, is this topic of personal finance, even for well, smart, accomplished women, such as the pharmacists listening, and heck, regardless of gender, I would say this is true. Really smart people that often can’t effectively manage their money. What are the root causes for them?

[00:07:42] SO: Yeah. You just used the word can’t. Oh, they can. Women have more talent in their little fingers, I’m so sorry to say, more capability than most men have in both hands, really. I don’t say that as a put-down to men. It’s just that women hold up the entire sky here in the United States. They take care of their parents, their children, their spouse, their brothers, their sisters, their employees, their clients, their patients, everybody, their pets, their plants. When it’s all said and done, when they’re 50 or 60 years of age, that’s when, for the very first time, they start to think about themselves.

You have got to remember that women have the ability to give birth, in most cases. They have the ability to feed that which they have given birth to, in most cases. So a woman’s nature is to nurture, is to take care of everybody else before she takes care of herself. So it’s not that she can’t. It’s she doesn’t want to. She doesn’t want to. She wants to make sure that her kids, in particular – A woman will do anything to make sure that her children are fine. That is not true with men. That is not true with men.

I used to think that it was until 2008 came along and when people were laid off of their jobs. They lost their home. They lost their retirement. They lost everything. Women would go back to work, working three or four jobs, a waitress, a cocktail waitress, anything, just to put food on the table. A man, if they had a $200,000 job, would not go back to work if all they were offered was $60,000. They weren’t going to do it.

Again, it’s not putting men down. Please, men, don’t think that because I don’t put you down. It’s the socialization effect of the difference between a man and a woman. So a woman just will do it all, but she won’t take care of herself. She chooses not to. In any aspect, she’ll only take care of her household expenses. You know why? Because her house holds everybody that she loves. That’s the only difference. That’s the only difference, boyfriend. That’s the only difference.

[00:10:06] TU: Which is a good segue to talk about healthy relationships with money because in the book, you mention that in order to build a healthy relationship with money, there are attitudes that women need to get rid of, with the first of these being these weights or burdens that you referenced that are commonly carried around, one being the burden of shame and the second being the tendency of blame. Can you tell us more about this concept of blame?

[00:10:29] SO: Yep. You know, in the book, I talk about truthfully that there is no blame big enough or shame big enough to keep you who you are meant from being. There just isn’t. Sometimes, we’re ashamed that we don’t know about money. Sometimes, we’re ashamed that we don’t have the money that we need to be able to give our children what they want.

Now, what I just said was very heavy, believe it or not, because it’s really difficult. I mean, I just experienced it. I had my niece here. In fact, I had all my nieces here, but one in particular that has a five-year-old child who loves Pluto more than life itself. He literally thinks Pluto is alive. He said to me, “Aunt Suze, how do I get a real Pluto?” I mean, “You mean a dog?” He said, “No, really. I want this Pluto to be alive.” You could just see, you want to give this kid anything this kid wants because he’s so fabulous. Not that – All your kids are fabulous, to you, anyway.

So a mother feels, especially if she’s a single mother, that she has to make up for the loss of a father figure or another mother figure or parent figure, and she does it usually by purchasing things for her kids because when they go to school, oh, but this kid has this cute backpack, and this kid has this, and look at these watches, and look at this iPhone. So it becomes very interesting that a lot of times, you’re ashamed of what you yourself don’t have. You’re not proud that you have anything. You’re ashamed of what you don’t have, and you blame it, usually, on somebody else. Or you blame it on yourself.

It’s – Fear, shame, and anger are the three internal obstacles to wealth. They just are. I have people – I know you’re talking about the book right now, but my true love at this moment in time is the Women & Money podcast because it’s on the Women & Money podcast that you can hear. You can hear via the emails that are sent in the shame and the blame that women feel, the anger that they have at themselves for staying in a relationship that they don’t want to be in, but they don’t have the money to leave, the confusion that’s out there. A lot of these women are so powerless because they’re not powerful over their own money.

[00:13:10] TU: In the book, you go through a detailed financial empowerment plan, which I think is incredibly helpful for our listeners to hear more about since we know many pharmacists are struggling with spinning their wheels financially, graduating now with more than six figures of student loan debt, the average about $166,000, having many competing financial priorities with home buying, starting up a family, building up reserves, saving up for retirement. The list goes on and on. So the question is where does one start when they are looking at so many competing financial priorities, and it can feel so overwhelming?

[00:13:42] SO: You start by, number one, really understanding the ramifications that student loan debt that goes unpaid will have on your life forever. So your number one, bar none, is your student loan debt, and you have got to understand the difference between paying back student loan debt on the standard repayment method and the income-based repayment methods. You have to understand that in your head, if you think, “Oh, I have all this debt. I’m just going to pay back a little bit because I don’t have that much of an income, and they’re going to forgive it in 20 or 25 years. I’ll be OK,” no, you won’t.

You won’t because if under the standard repayment method, your monthly payment should be $1,500 a month, and under income-based repayment, you’re only $750 a month, that $750 difference gets added onto the back end of your loan, plus interest. When they forgive it, when a debt is forgiven, you need to pay taxes on that, as if it were ordinary income. It is possible that if you do that over 20 years, you’re going to end up owing more than you even started with that they’re going to forgive.

So you have to be realistic here. If you’re going to go in this industry, if you’re going to become a vet, if you’re going to become anything with massive student loan debt, then you have to put your priorities in place. Your first priority is your student loan. After your student loan, hopefully, on the standard repayment method, it is paid off, then start dreaming. Ten years isn’t that big of a deal. It will come, and it will go. But don’t try to do it all at once.

[00:15:45] TU: Yeah. That’s really timely. I know for many pharmacists that are listening to this, they’re looking at, as I mentioned, six figures of student loan debt, $160,000, $170,000, $200,000 of loan, unsubsidized many of those, interest rates that are at six to eight percent. So obviously, those interest rates and the growing interest and the baby interest can have an incredible negative impact on their financial plan.

That being a good segue, I think, into the conversation about loan forgiveness, which has gotten a lot of attention with the upcoming presidential elections, and we’ve had some discussion with Bernie Sanders, Elizabeth Warren, have forgiveness plans that are out there. Not even getting into specific candidates or politics or the individual policies, I think it brings up an interesting discussion around loan forgiveness and the positives and benefits of that, relative to what people learn through the process of paying off student loans.

I know, for me, individually, going through the process of paying off more than $200,000 of student loan debt, there was a lot I learned and that my wife and I learned through that lesson in terms of budgeting, working together, setting goals. But I also understand that for many, and certainly would have been the case for us as well, not having that debt would have been fantastic. So how do we reconcile forgiveness relative to being able to learn through that process?

[00:16:58] SO: First of all, let’s talk about student loan debt to begin with and the viability of it. Is everybody crazy that we should have to pay, our children should have to pay $200,000 for a college education?

[00:17:13] TU: Amen.

[00:17:14] SO: Like is that, just to begin with, the sickest thing you have ever heard in your life? So while everybody’s dealing with the debt that we have, what we also should be dealing with is why are we paying that kind of money? Listen, if that’s what these financial institutions need to keep the buildings and the teachers and everything going, maybe we need to go to online universities that are fully credited that everything is done online because the burden that these kids are leaving school with is so heavy. It is the number one question that I am asked. What is so sad, it is the number one question that I do not really have an answer for because they will not let you discharge it in bankruptcy. They do not –

I mean, it is crazy that you pay the same amount of money to get a master’s in social work as you do an MBA. Really? So tuitions, number one, should be based on the area that you are specializing in. Hey, if you’re going to graduate and you’re going to make $200,000, $400,000, $500,000 a year, fine. Then you start spending money that then subsidizes those that are going to make $30,000 a year because they want to be a teacher. Or whatever it may be. But I do think what’s going to start to happen is that people are going to have to start going to community colleges for the first two years or so, and then probably switch over. But then, you have to be crazy if you go to a school that’s $50,000 a year.

Now, with that said, I get when you want to be a vet, when you want to be a pharmacist, when you want to be a doctor. That’s what they charge. So if you know, if you know beforehand that that’s what it’s going to cost you, and you have an unsubsidized loan, which means that it is growing while you are in school, can you at least pay the interest on that loan while you’re in school?

I know everybody’s going to say, “But, Suze, I’m working full-time at school. I can’t.” Oh, yes, you can. I had to put myself through school. I worked until 2:00 AM every morning. I started at 7:00. I worked seven days a week for four years straight. Don’t you dare tell Suze Orman you can’t do it. You most certainly can. You just don’t want to. When you have debt that you can’t pay back, this is not a choice if you can or you can’t, if you want to or you don’t want to. You have to, and it’s – I don’t mean to sound harsh to you, but you’ll thank me years from now that at least you haven’t accumulated an interest rate on top of everything else.

[00:20:02] TU: Suze, one of the most common questions that I get and I’m sure you get all the time as well is how do I balance paying off my student loan debt relative to investing and saving for the future? As we think about pharmacy professionals specifically, many of them have gone through lots of education to get where they are. They may have four years of undergrad. They have four years – Likely, some people more in terms of getting their doctorate degree. They may go on and do residency training.

So here they are, and they look at the clock and say, “Yes, I’m young. But I also know I need to aggressively save, and I keep hearing the message of I need to be putting away money for the future. But I’ve got $160,000, $180,000, $200,000 of student loan debt, unsubsidized loans, six to eight percent. So how do I balance the two of these?” What advice do you give people to help them think through that?

[00:20:48] SO: I would not not pay a student loan under the standard repayment method in order to then save in a retirement account. Obviously, if you work for a corporation that gives you a 401(k) or a 403(b) or whatever it may be, and it matches your contribution, then you have absolutely no choice whatsoever but to absolutely at least invest up to the point of the match. After that, your very first bill that has to be paid before you can decide anything is your student loan repayment.

After you know what it’s going to cost you to pay on your student loan, then you have to make a decision. Oh, do I have to move in with six or seven kids and all live together in order just to do whatever? What do I have to do after that payment? Is there any money left over? If there is, what will it allow me to do? It may only allow you, I know you’re going to really think I’ve lost it, to move back in with your parents for a number of years.

[00:21:53] TU: You’ve got to do what you’ve got to do.

[00:21:54] SO: You’ve got to do what you’ve got to do. For all of us to make it in today’s society, we have to either really enhance the nuclear unit and nuclear family, and really help each other. Or if we can’t do what we’re born into, then create our own nuclear family, whereas five or six of you get together and you go, “Okay, we have this problem.” It’s not like communal living, but it’s how do we solve this problem? So rather than you each have your own individual apartment, you each have your own car, you each have all of this stuff, what can you do as a group of people? Uber and Lyft and Zipcars, all of that came, especially Zipcars, about people who couldn’t afford to have their own car.

Again, I don’t mean to be Suze Smackdown here. But I do want you just to be realistic about your life and the independence dream, living on your own, having all of these things. Nothing will give you more pleasure than having money versus things.

[00:23:08] TU: Yeah. My wife and I talk often, as we think about our own financial situations, that we felt some of that pressure in our mid-20s of wanting to live up to the lifestyle that our parents have gotten to after 30 or 40 years. So I think really reshifting expectations and thinking about specifically today’s pharmacy graduates just really has to be intentional with their financial plan and change some of those expectations to set them up to be successful in the long run.

Shifting gears a little bit, I want to talk about planning for the future, and we recently had on the show Cameron Huddleston, author of the book, Mom and Dad: How to Have Essential Conversations with Your Parents About Their Finances, an excellent book that has me thinking more and more about the significance and importance of healthy and open financial conversations with family about money and ensuring that the estate planning process is well thought out and is in place.

I noticed that you offer a protection portfolio that is meant to help people take the worry out of protecting themselves, their assets, and their family. So tell us a little bit more about why this process of having a protection portfolio in place is so important and what information is compiled in a portfolio like this.

[00:24:19] SO: What’s really important is for everybody to understand that we have no control over the things that happen to us. Are we going to be in an accident? I mean, really, just the other day, Tim, you know I live on a private island, and I’m driving down this road. I mean, there are no cars on this private island. There are only golf carts. There were only like – There’s 80 homes. There’s nobody here most of the time. I’m driving back to my house, and I come up on a golf cart that overturned on these four 20-year-olds, and they were seriously hurt, all right? I mean, five minutes before then, they were on this private island, having a fabulous time. Now, I’m like, “Oh, my God.”

So anything can happen at any time, and every one of you needs to be protected against the what ifs of life. May you always hope for the best, but may you plan for the worst, whether it’s an accident, an illness, an early death, whatever it may be. The number of emails I get from 40-year-old women, 50-year-old women, 30-year-old women saying, “Suze, my spouse died. I have three kids. I never expected to be in this situation.” They go on and on and on about it.

This is also, what I’m about to tell you, very important if you have parents. Because if you have parents, the question becomes like – My mom lived till she was 97. If something happens to your parents, they lose their mind, so to speak, they have dementia, they have Alzheimer’s, and they can’t write their checks anymore or pay their bills, who’s going to take care of them? You can’t do anything for them, unless you have what I call the must-have documents. Not only a will, a living revocable trust, an advanced directive, and a durable power of attorney for healthcare. You must have those.

But most of the time, lawyers tell you, “All you need is a will.” Oh, give me a break. The less money you have, the more you need a living revocable trust because wills make it so that in most cases, if you own a piece of real estate or whatever it may be, your estate has to go through probate. Guess who gets the probate fees? The lawyer that told you all you need is a will. So a living revocable trust not only passes your assets from one person to another within a two-week period of time, no fees, nothing. But in case of an incapacity, it will say you can sign for so-and-so. So-and-so can sign for you. It sets up your estate every way you want it, and it also helps you because minors cannot inherit money.

So if you have young children, and both you and your spouse are killed in a car crash, something happens, the money can’t go to your minors. If you left your money to them via your will, good luck. It’s going to end up in a blocked account until they’re 18. So with that said, most trusts, if you go to see a trust lawyer, first of all, you have to know there are good trust lawyers. Most of them are not, are at least $2,500. Every time you make a change, $500, $1,000, you’re just sitting here talking to me about you don’t have even have enough money to pay your student loan debt. Where are you going to get $2,500 to do a will, a trust, an advanced directive, a durable power of attorney for healthcare? Every time you need to make a change, where are you going to get the money to do that?

So years ago, with my own trust lawyer, I created what’s called the must-have documents. These documents are my documents. If you were to look at my trust, my will, everything, you would see these. But I wanted to do it at a price that every single person could afford. So we created over $2,500 worth of state-of-the-art documents for approximately $69. What’s great about these documents, not only are they fabulous. Every time the law changes, they automatically get updated, but you can change it as many times as you want.

So if you go from one kid to two kids, you go back to your computer, you change them. So you never have to pay for it again. If you’re interested, really, in that offer, you can just go to suzeorman.com/offer. Through there, it’s $69. Otherwise, you’ll see it sold for $100, $90. They’re sold for all over the place. But these documents have changed the lives of millions and millions and millions of people over the years.

[00:29:28] TU: Yeah. I think it’s also important for our listeners just to consider the peace of mind of having all of this together. When you think about all of the things that are found in estate planning documents, and my wife and I went through this process we’ve talked about on the podcast before, where you put together insurance policy information and where your accounts are at and birth certificates and all of the papers that would need to be readily accessible, in addition to all of your estate planning documents. To get there and the conversations you have and the peace of mind it provides is incredible. Again, suzeorman.com/offer will get you there.

Suze, I want to wrap up our time together by talking about legacy, and I’m fascinated with learning more about what drives very successful, highly influential individuals such as yourself to take on the life’s mission and work that they do. So for you, as you look back on a career that is undeniably wildly successful and that has positively transformed the lives of millions of people, what is the legacy that you’re leaving?

[00:30:31] SO: I hope the legacy that I leave is that women in particular, but men as well, but women in particular really know that they are more capable than they have any idea, that they will never be powerful in life until they’re powerful over their own money, how they think about it, how they feel about it, and how they invest it, and that every one of them, one of them, has what it takes to be more and to have more. They just have to want to.

I don’t really know. I don’t know how to answer that because I never think about what I’m going to leave. I only really think about what I’m doing. I can tell you right now, like one of my friends said to me, “You just can’t help yourself, can you, Suze Orman?” So with the Women & Money podcast, people write in their emails. I keep saying, “I’m not going to answer them. I can’t answer all these emails.” Now, I’ve answered almost every one, except four. I’ve got four left, and then they’ll mount up again, and blah, blah, blah, blah.

But I have such a desire for every single woman and the men smart enough to listen, but really for every single woman to get the right advice, the best advice, to start to educate them so that they become smart enough, strong enough, secure enough. So they can start educating their daughters and their sisters and their aunts and their moms and their grandmas and everybody. So that we start really teaching one another because I’m just so afraid of where this world – Truthfully, the hatred in this world that we are experiencing right now, I am very afraid of where it’s going to take us next year. So I hope I leave a legacy of love and power. That’s what I really hope I leave.

[00:32:45] TU: Yeah. What really stands out to me, Suze, the work that you’re doing, and you alluded to this, is the generational impact that it’s having, and that will forever go on. I mean, that’s an amazing thing, when you think about transforming somebody’s personal financial life. Let’s say they’re a mother, and they pass it on to their kids and their friends and their cousins and their network, and that gets passed on to another generation. That is incredible transformational work that will forever have impact. So I thank you for that work, and I know it’s had an impact here on me in even having the opportunity to talk with you today.

To our listeners, as Suze mentioned, she responds to her requests as it relates to the podcast that she has each and every week, the Suze Orman’s Women & Money podcast. So if you have a question for Suze that we did not touch on during today’s show, make sure to reach out at [email protected].

Again, as a reminder, make sure to head on over to suzeorman.com, S-U-Z-E-O-R-M-A-N.com, where you can learn more about Suze, including her blog, the podcast, comprehensive resources, live events that she hosts, and books and products that are designed to help empower you in your own financial plan.

Suze, again, thank you so much for coming on the show, and I’m grateful for what you were able to share and the impact that it will have on our community. Thank you very much.

[00:34:04] SO: Anytime, boyfriend. Anytime.

[END OF INTERVIEW]

[00:34:07] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 286: YFP Planning Case Study #5: Modeling Retirement Scenarios and How to Handle a Large Cash Position

Posted on by Caitlin Boyle

YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP® is joined by Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®, and Christina Slavonik, CFP® to discuss retirement scenarios and how to handle a large cash position in this YFP Planning Case Study.

About Today’s Guests

Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®

Kelly Reddy-Heffner, CFP®, CSLP®, CDFA® is a Lead Planner at YFP Planning. She enjoys time with her husband and two sons, riding her bike, running, and keeping after her pup ‘Fred Rogers.’ Kelly loves to cheer on her favorite team, plan travel, and ironically loves great food but does not enjoy cooking at all. She volunteers in her community as part of the Chambersburg Rotary. Kelly believes that there are no quick fixes to financial confidence, and no guarantees on investment returns, but there is value in seeking trusted advice to get where you want to go. Kelly’s mission is to help clients go confidently toward their happy place.

Christina Slavonik, CFP®

Christina is a Certified Financial Planner™ located in Texas and has over 15 years of financial planning and industry experience. She received her Certificate in Financial Planning from Southern Methodist University.

Christina is passionate about helping clients live their best lives now while not losing sight of the future. She enjoys the collaborative approach of creating a custom financial plan with her team at YFP.

Episode Summary

YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP®, is joined by Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®, and Christina Slavonik, CFP® to discuss various retirement scenarios and how to handle a large cash position in this YFP Planning Case Study. Tim Baker introduces the fifth case study, examining the fictitious couple, Jane Smith and Tyra Lee, from Westchester, Pennsylvania. Jane, age 59, is a Certified Registered Nurse Anesthetist, and Tyra, age 60, is a pharmacist working part-time. Jane and Tyra also have two teenage boys, Thomas and Robert. During the discussion on this case study, listeners will learn about the couple’s plans to retire in three to five years, earlier than previously expected. Tim, Kelly, and Christina discuss options for care and long-term care insurance concerning Jane’s elderly mother, college plans, and a recent car purchase for their children. The discussion leads to considerations for how the couple might handle their massive cash position and whether or not to pay off debts with their reserves. Tim, Kelly, and Christina talk through the couple’s housing situation as they transition to retirement, their plans for purchasing a cabin or potential forever home, and how that may impact the financial plan.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TB: You’re listening to the Your Financial Pharmacist Podcast, a show all about inspiring you, the pharmacy professional on your path towards achieving financial freedom.

Hi, I’m Tim Baker and today I chat with two important team members at YFP planning Kelly Reddy-Heffner and Christina Slavonik, both CFPs.

In this episode, we discuss our fifth case study of a fictitious couple Jane Smith and Tyra Lee, and their teenage kids Thomas and Robert. Jane is 59 and is a certified registered nurse anesthetist while Tyra, age 60, is a pharmacist working part time. We cover a bevy of topics that include in retirement in three to five years, where we model out different scenarios using our financial planning software. We chat about long-term care insurance, how to handle their massive cash position, and whether they should pay off some debt, their housing situation as they transition into retirement, college planning for the boys, and potentially how to handle care for Jane’s elder mother.

[INTERVIEW]

[00:00:58] TB: What’s up everybody? Welcome to YFP planning case study number five. So, I am joined today by Christina Slavonik and Kelly Reddy-Heffner, two of our CFPs on the YFP planning team. So, Kelly and Christina, welcome.

[00:01:14] CS: Thank you, Tim.

[00:01:15] KRH: Thanks, Tim.

[00:01:17] TB: So, we are recording this right before Thanksgiving. So, excited to get this recorded in the books and then enjoy some time off with family. I just would like to say that we are very thankful for all the listeners out there, thankful for the community that we’ve built, thankful for the two of you, Christina and Kelly being part of the team. And yeah, just really excited for the upcoming holiday season. Let’s jump into it.

So today, we are exploring a couple in Westchester, Pennsylvania, Jane Smith, and Tyra Lee. So, Christina, you’re going to take us through the first part of the fact pattern, Kelly is going to get into goals. And then, I’m going to talk about the wealth building, wealth protection tax and some of the miscellaneous stuff. And then we are going to dissect this client case study and see what are some planning opportunities? What are the things that should be discussed with the client, that we should really get in front of to make sure that they are on track with their financial plan? So, Christina, if you please kick us off on Jane Smith and Tyra Lee.

[00:02:18] CS: Sure. So, the clients we’re looking at today are Jane Smith, who is a CRNA, aged 59, makes about 194,000 a year and Tyra Lee, who’s a part time pharmacist, age 60, salary is 65,000. They are married filing jointly. They have two sons. I have Thomas, who is age 17, and is currently a student, and Robert, who was 14 and currently a student as well. They reside in Westchester, Pennsylvania, annual gross income is 259,000, which breaks down into monthly around 22,000, and then net after taxes and whatnot, 15,000.

Expenses for these people are fixed at about $5,977 a month. Variable expenses are the 4,500 a month, and the savings of about 4,400 or so. Their current living situation is they’re in a five-bedroom, single-family home outside of Philadelphia. They apparently have a great first floor master. And if Jane’s mom had to move in, they could accommodate her as she is ill and cash resources are currently limited.

[00:03:37] KRH: Complicated, right? This seems like a scenario that we’re seeing a little bit more of with some of our like pre-retiree clients, just that intersection between nearly adult children, but not quite adult and parents kind of having some needs as well. They both would like to retire over the next couple years. But they are thinking through making sure the children are taken care of, parent needs are also taken care of. They have a fairly large cash position and are not sure if they should leave it in cash or pay off some things. They have that home in Philadelphia that they like, it’s functional, but they’re not sure that this is the forever home where they want to stay indefinitely.

With the kid’s college tuitions, one tuition has is about to start, I think based on the age. One is a little bit further in the future, but they kind of want to see what the 529s are going to cover, and what they can maybe do out of pocket and what they simply can’t do. They’ve asked about long-term care insurance, kind of understanding the premiums and how those could change in the future. They might want to buy a lake cabin, maybe that could be the forever home or the primary residents. If they wanted to retire earlier, they had started at age 65. Could they do it like 62, 63? They’ve got a little bit of debt. They have a car note for their own vehicle, 1.9% interest rate. There’s three years left on that note. They also bought a car for the teenage children, so there is a payment of 545 per month, interest rates 2.25, three years also left on that. Obviously, they made those purchases prior to our current interest rates, or it would be much higher. They also have a reasonable interest rate on their mortgage at 2.75. But it is a pretty recent purchase. So, the amount left on the mortgage is pretty high and that monthly payment is 2,858. So, early in that, and that’s one of their questions.

[00:05:58] TB: So, picking up on the asset side of the of the ledger, Kelly had mentioned that they do have a good amount of savings tucked away. So, 143,000 in a joint savings account, 3,000 in check in, and then another 9,000 in an HAS that’s Jane’s. From a 401(k) perspective, looks like Jane is putting in 11%, which is the max for 2022, 20,500 into her fidelity 401(k) through her employer that’s invested in a target date fund for 2030. Tyra also has a 401(k). She’s putting in 31.5%, which is also max amount of 20,500.

Now, for the two of them, one of the things we’ll talk about that you have a catch up available if they want to do that, but she’s also her Vanguard, she’s in a Vanguard target date 2030. Jane has a Roth IRA. This is from a previous employer. It’s invested in a Vanguard 2030 fund. She’s not contributing anything to that presently. Tyra has a SEP IRA from her previous consulting work as a pharmacist. It’s 100% in the S&P 500. So obviously, there’s some little bit differences there in their allocation. And then they also have a taxable account that they’re putting in about two grand a year, $167 a month into a Vanguard target date 2060 fund.

So, it looks like this is going to be maybe a retirement fund, maybe for the boys. We have to kind of get some clarity on that. They do have a primary home that’s valued at 920,000 versus the 683,000 and change that’s left. And then, looking to potentially, maybe buyout another property that they could transition to. We’ll talk about that in a bit.

Overall, you’re looking at total assets, about 1.9 million, total liabilities of just over 725,000. So, net worth is about $1.25 million. We look at the wealth protection stuff. Jane has an individual policy, 1.5 million that expires at age 65. She also has a group policy through employer which is one-time income 194,000. Tyra has a $750,000 policy that also expires at age 65. And then she also has a onetime group policy through employer which is 65,000. They both have short term and long-term disability through their employer that pays out a 60% benefit for short term and long-term disability. They both have their own professional liability policies. And the estate planning documents are up to date.

But one of the things that they’re not sure of is if Jane’s mother has anything, which obviously can affect their financial plan. From a tax perspective, they use YFP Tax. So, thank you very much for that. They’re concerned about their pretax retirement investments and when Roth conversions might be helpful, so obviously there could be time where they’re maybe sunset into retirement, so they might be in a lower tax bracket. So, it might be beneficial to convert some funds over to the Roth. And then Tyra is willing to work more over the next several years if both can retire early. They’re wondering if they should pay off their debt based on the interest rates, and they also want to make sure that they are maximizing the FASFA for their sons.

So, a lot of stuff to talk about. What are the big things, I guess for you, Kelly, that jump out, that you would want to tackle first with regard to Jane and Tyra?

[00:09:07] KRH: Probably the first two is just like the taxable account, the cash position, like having a good understanding of what they have those in place for. Is it a future expense that’s very short term? Is it something more intermediate where we could do a little bit more with those resources? I do think for the wealth building, probably three of the investments are okay-ish, like the target date funds of 2030. I would want to just double check what’s in those funds, make sure they’re close to the right asset allocation, but the SEP IRA for retirement is a little bit more aggressive than it should be for their age, and I suspect the Vanguard target date 2060 potentially could be as well. That seems to make it seem like it’s for retirement, if it’s in the target date fund, but something that I would agree should be confirmed, for sure. But also, what Jane’s mother’s need is, I think, if some of the cash has been earmarked towards helping with some of her care, that would make a difference in kind of the recommendations for how to best put it to work, short term, midterm or long term.

[00:10:27] TB: My thoughts on the on the estate plan documents. I definitely would run out would want to run those to ground. We had some content about a book about how your parent’s estate planning or lack thereof can really affect your own financial plan. “Mom and Dad, we need to talk.” We can link that into the show notes. But I think that’s a vulnerability, and we want to make sure that that’s lined up. So, we’re not having to sue for conservative ship or do things that, if those documents are in place, are really going to put us in a bind later on.

From an asset allocation perspective, Christina, how would you broach this subject? Because obviously, there’s, Kelly’s point, digging in to fidelity 2030 target date fund, Vanguard target, not all target date funds are created equal. We have one that 2030 is probably a little bit – we’re going to be a little bit more conservative than the S&P 500, or the 2060. So, what would be your process to kind of get them in the right model right now, three to five years from retirement, they’re probably going to want to be the most conservative that they ever want to be. Because if the market dips now, it’s very hard to uncover, and that’s where we have to start having conversations of potentially pushing retirement age back, which is not a fun conversation to have. So, from an asset allocation perspective, how would you tackle that with Jane and Tyra?

[00:11:46] CS: Sure. So, first thing I’d want to look at is taking a deeper dive, like what exactly is built into these target date funds? How are they allocated? Mostly looking at the ratio of equities to bonds. So, someone who’s about three to five years out, they can be a little risky, but we want to see more of the bond exposure. Things starting to dial back, their savings years, so maybe looking more at a 60% equity, 60% to 70%, equity 30% to 40% bond allocation for them. And yeah, and then revisiting the S&P 500, for sure, since that is definitely a lot more aggressive than we would want them to be invested at the moment.

Also, another thing to consider too, Tim is we got to get people thinking too, what does my cash needs? What are those going to look like, as I’m getting closer to retirement? So, yeah, we might have some money earmarked that we could be investing, but we still need to have money set aside for emergency fund. Maybe, as you get closer to the retirement date, like have at least a year or so of cash saved up, that is one thing that we’re considering keeping it in a money market, or high yield savings type of environment as well.

[00:13:06] TB: Yeah, for sure. I mean, I think really looking at our processes to really look at the investments by approaching the client with a risk tolerance and seeing what comes out there. And then kind of comparing that to what we think their risk capacity is. So, risk capacity being like, what is the risk that they should be taking? The risk tolerances, what is the risk that they want to take? And they should be taken to your point, Christine, a lot less risk, because we want to really protect that principle. We don’t want to lose anything, and potentially have to push back the retirement or do something different because of where the markets are going.

So, I think foundationally, making sure that that’s there is going to be really important. And to Kelly, your point, 143,000 in cash money savings is a good chunk of change. Christina, you mentioned like, you didn’t say the bad word, but the bad word would be like, what is the budget had been through retirement, which is going to shape the emergency fund. It’s going to shape a lot of things, what’s the retirement paycheck going to look like? The clarifying questions I would want to have is like, what is that 143,000? Is that to pay Thomas’s tuition next year? Do we run that money through the 529? I don’t see a 529 on the balance sheet. But the benefit that PA residents get from a state tax deduction is pretty generous. I think it’s 16,000 per beneficiary, 30,000, 32,000 per filing jointly.

So, if you can shelter some of that, that would be great. But what is the savings account for? What’s the taxable account for? Is the taxable account, is that earmarked for retirement? They’re in a position right now where I’m assuming Jane, if she’s not beyond 59 and a half, she will be sued. So, all of these 401(k)s, Roth IRAs, SEPs, like they can be accessed and used for whatever purpose so we can use some of that money for things that are other than retirement, but I would just want to clarify, what’s the savings account for, what’s the taxable account for, et cetera, before we kind of get into how to deploy these accounts, and again, making sure that, we need an emergency fund, let’s not invest it in a risky way. But we want to get that yield. I think, high yield savings accounts are now at 3%. You can get CEs at 4%. Even the eye bond is still attractive. I think it’s 6.8% plus a fixed rate at point 4%. So, there’s some liquidity issues there. But that might be a good place to park some dollars. You can put up to $10,000 a year there.

So, Kelly, if they’re asking, are we on track for retirement? How do we best answer that question? I’m a visual learner. So, are there things that we can show the client to kind of model that out a bit? What’s that look like on your end?

[00:15:50] KRH: I think these are very, very good questions that we do get from clients. And we ask clients to work on uploading and linking documents to eMoney. So, it’s a software tool that we use, that can be very helpful and looking at where things are at. Even to answer the question about the 529, they’re not listed on their spreadsheet. But they do have –

[00:16:17] TB: Oh, they do have. Okay, good.

[00:16:19] KRH: – do have them. And actually, they don’t pull across on a balance sheet either. So even when we’re working with eMoney, because they’re technically assets for the beneficiary. So, there are the two 529s in place. And you’re right, that Pennsylvania is quite 529 friendly with the rules. But when we get that question, like, good, not good, like we do a nest egg calculation, but then we can also go in the eMoney and look at goals, just to see overall. I’m going to pick one of the scenarios that they were kind of asking about the retire early. The baseline facts is like, based on now how things look towards retirement, and they originally had an age 65.

So, we’ve got the 65 in here, this 95% would suggest like, looks pretty good for being able to retire at that age. We have a couple expenses embedded in. We’ve got college costs, but we can add in college, I mean, we could probably spend the whole rest of the day and Thanksgiving, turkey dinner, talking about things we can do in eMoney. But just to give a high-level overview, we can enter education as like only the 529s cover that expense or do they want to pay out a cash flow a certain amount to help with that goal. We can enter specific school, so they wanted to see public school, public state school, and they wanted to see a private school just to have a comparable.

So, we’ve added in both of those. From here, I like to look at some cash flow reports, so this gives you a like, this looks reasonable and doable. Even the retire early like looks pretty reasonable, but then it is good to see the layers just to make sure things are input pretty well to reflect what the client wants to accomplish. Do the expenses. Tim, you’re right, spot on, are the expenses accurate for what the client is looking to do? So, we entered in living expenses, their liabilities, going to be the mortgage. They have some other expenses added in so they have car purchases every couple years. This is the 529 expense coming across.

So yeah, we do like to take the information that the client provides. Our data is only as good as what accounts are linked. But then we can go back in and run some of those scenarios too. Can they buy the lake cabin? Now, it’s entered as an additional property, not instead of their primary residence. This is less successful. We do like to see above 80%. I guess, I probably on the conservative side like to see 85 to 90. I think when Christina and I look at scenarios, because there’s things that can happen in between that really do impact. Like this really does not include Jane’s mom. Does a certain amount need to be embedded to help Jane’s mom and what is that amount per year? But we can add that? Is it an extra $1,000 a month for her care? Is it 500? Is it something different? But those are important combo situations like what do Jane and Tyra collaboratively think they can do? The conversation is really important with both of them. They have to be on the same page about what they’re willing and able to do and maybe make tradeoffs about to help in that scenario.

[00:20:19] TB: Yeah. So, for those of you that are listening to this, maybe in the car, don’t necessarily see the visual, if you’re not watching us on YouTube, on our channel, what Kelly is really presenting here is an illustration of what ifs. If we buy a lake house to retire early, what is the probability of success, if we have to use these monies for different goals that we have? Are we still going to have money at the end of our plan?

So, what the tool does is that it uses simulation, it uses 1,000 randomly generated market returns and volatility, called trial rounds to say, okay, 95% or 950 times out of 1,000, there’s going to be money leftover of the plan, and anything above the threshold of 80% or 82%, is good. And typically, if it’s lower, we’re going to adjust the plan as we go to make sure that there is money left over. So, the idea is to keep, there is money, between now and then when you when you pass away.

So, the nice part about this is it allows us to kind of toggle on and off different scenarios, to see how it affects the overall nest egg, so to speak, and provide some math behind it. So, the nice part about this is that, you can kind of talk to the client, and you can talk to Jane, you can talk to Tyra and you say, of all these different things that we’ve extracted from your goals, whether it’s a cabin, or being able to take care of your mom, or retire at this age versus this age, what’s the most important? And then basically turn those on and off to see, okay, once we get to this threshold, then the plan might be in jeopardy and we can adjust from there.

But I think this is great, and a visual perspective, and this is the way I learned. I think, like from a client impact, I think, this is huge. Yeah, this is great modeling Kelly. Christina, when you look at this particular client, at least from some of the models that we’re seeing, are there things that you would want some additional information, whether it is Jane’s mom, or maybe more additional information on what is the goal for the education planning? Is it the put the boys through four years of school? Is there a certain percentage? Are we using some of that? Are we counting on scholarships? Are we counting on debt? What are some of the approaches that you would take with the client to kind of refine this out a bit?

[00:22:39] CS: Yeah. So again, just digging more into the weeds. And to your point with the education. Yes, are they going to be relying strictly on loans? Or are there scholarships involved? Or is it a combination of all three? Are they going to be funding, maybe a third of it, from their cash flow? Some from the 529, others from scholarships?

So, we’d like to see some diversity, so to speak, when it comes to funding college needs, especially if 529 is not going to carry the weight. And then looking at savings and withdrawals for the education expenses, as is it does look like there is going to be a shortfall. So, having more of those conversations, again, what is the 143,000 saved for? Is part of that going to help Thomas and Robert. But then again, looking back at what they had given us with the 529, how is it invested? Kelly, when you had shown us that it looked like it was probably just in the money market at the moment, and I would be more curious to see, well, A, is it linking properly. But B, is it indeed invested? You have to have a good solid allocation in there, if you want that money to work for you, over the period of time they have left.

[00:23:53] TB: And probably a good chunk of that money for Thomas, who’s the 17-year-old should be for a money market. It’s almost like you were saying like you want, maybe, like a year’s worth of cash for retirement. That might be true for the first year or so for tuition. But then the balance of that should be invested. I think Thomas had 45,000. So, a good chunk of that should be either in a balanced fund or something like that. For Robert, who is 14, and he saw us four years until the first year, we probably can be a little bit more aggressive. And then, as we get closer, same thing with retirement, we’re having more of a bond allocation, less of an equity allocation. The money mark is going to do well today just because of inflation, but you’re also being killed by that purchasing power that’s kind of being eroded every year.

So, what Kelly is showing right now on the screen is kind of the shortfall, the projected shortfall for the education expenses and it basically showing us what percent is underfunded, which is not necessarily a bad thing. We kind of talked about the rule of 33% and where we want, if we’re saving for a kid, a kid’s college, and we don’t really know what our goal is, it might be okay, we’re going to try to get x amount into a 529, pay x amount from , in that year, that’s the salary in that year for college. And then maybe the last third comes from scholarships, student loans, et cetera.

So, this is kind of showing us what has been underfunded so we can kind of plan for that and know what to do, so great stuff. Kelly, can you shift back to the case study real quick, I want to have a discussion that we really haven’t had much discussion on. We talked about Social Security in the past, I think, again, pulling their statements is going to be really important to see where they’re at. But I really want to talk a little bit more about the long-term care, and then Medicare decisions. So, walk me through, how would we approach those? Obviously, these are two things that, I think, there’s a lot of kind of negative press around long-term care insurance. It shouldn’t be something that we sell fund. What is long term care insurance? Why do I need it? So, I guess, let’s start there, how would we approach this particular risk that Jane and Tyra have to their financial plan?

[00:26:12] KRH: I will admit, it is a little bit newer territory for us, like typically, with our client base, we’re not having a ton of conversations about an immediate need. So, we have done some work recently, just to be better educated and to kind of get up to speed on some of the products. So recently, talking through kind of two products. One is a pretty traditional, like, pay a premium, get a policy, and it covers a certain amount of care per day, calculated out on an annual basis. And one of the biggest issues with those policies is like premium goes up. We had some education that I found to be very concerning, and enlightening, just so we know the premiums can go up. But with state regulations, there’s not a ton of regulation on how much the premiums can go up. So, that’s one of the challenges is like, if you buy a policy, you have it for like 10 years, your age 75, and the premium goes up and it becomes unaffordable. Pay 10 years into it, but you have to stop, that’s a concern.

So then, there’s a hybrid product that has some insight into that premium piece, but also provides a death benefit. Because the other concern is you never need the long-term care. You’ve paid for this premium, you have, unfortunately, a death event, without any care happening, and all that money has not been allocated anywhere else. So, there are some things out there. I think that’s kind of one of the things we’ve been working through, is understanding those policies, and then write the comparable, like many insurance products, is like if you paid for it out of pocket and funded it yourself. So, kind of running some scenarios like, that’s one of the things we started to build out, and that eMoney scenario was, if you take the premium and put it away, like how much could that grow? Because it seems like the premium, happy medium timeframe is like age 60 to 65 to start a premium then.

But again, a lot of things that we are learning about too, because there’s been a lot of movement. I think there used to be the person that was talking with us about it, like thousands of long-term care providers, like insurance providers, and it’s down to a very small quantity now, so a lot has changed.

[00:28:46] TB: Yeah, when I was first getting into the industry, it was that and it was tons of providers, premiums going up. I think the industry didn’t have enough information, because this is kind of a newer product, and some of these policies were priced, not correctly. They were – I think it was like low interest rate environment, which makes it makes it tough for them. People are living longer, or they’re alive longer with conditions that pay out a policy, because our medicine is better. I think though that, we’ve kind of gone through the burst of the bubble. I think a lot more of these policies have stabilized. I think you can still see increases I think the hybrid model is good in a sense that there are – it’s guaranteed, so your premium is fixed. Whereas, that’s not necessary for long term.

To back up, for those that are thinking like what are we talking about, long-term care, really what it is, it’s a broad range of skilled custodial and other types of care that’s provided over an extended period of time, due to things like chronic illness, physical disability or some cognitive of impairment. And the scary number of this is like roughly 60% of Americans are going to need some type of like long-term care in their life, and I think that number is continuing to go up. So, this is where, I think, a lot of people think of like nursing home, and that’s not we’re really talking about. I think the idea behind aging in place and keeping you in the home, as long as possible.

So, if you are getting older, and you’re starting to have problems bathing or dressing or with personal hygiene or eating, you would have someone come in and help and aide. For a lot of people, it’s a family member, or it’s a spouse, which can take a toll on their own mental, physical and financial health. I think, my perspective on this is evolving, but I think that studies have shown that couples, when they look at this type of care, are willing to spend, on average, in the range of $2,500 to $3,000 per year to get some type of policy, and you can get pretty decent coverage by doing that. I think it’s establishing a baseline at least to cover like home care. So, to have somebody come into the house and 80% of care that is provided through these policies, is homecare.

I think conversation, is what really what we need with Jane and Tyra. I think it’s to kind of demystify it a little bit, maybe not make it as scary as I’ve been led to believe or has seen. Because this is a major risk, like if you can – this can be a major drain on the financial plan if you don’t have that large reserve of cash or investments, or a policy in place. So, I think it’s important to kind of get in front of it, and just have a have a good conversation and at least have a baseline policy for homecare, I think would be a good starting point. And then see like, what are the social like, is Thomas, is Robert, are they going to be a safety net? Or my dad always says, “Just put me on the ice float and give me the Eskimo retirement.” That’s kind of what he’s looking for.

But I think, some of the social networks that you have, in terms of talking through this is going to be important as well.

Christina, how about Medicare? What’s your take on this? Obviously, they’re a couple years away from enrolling in Medicare. But how do you approach this with Jane and Tyra in terms of how that works?

[00:32:21] CS: Yeah, so I think it’s just giving them a high-level approach to what to expect like a year in advance. So, when you reach age 65, the window opens up three months before their 65th birthday, and they have until three months after their 65th birthday. So, in essence, is a seven-month period. You can go in, enroll your Part A, Part B, if necessary. Most of times, it will be, because if you’re retiring, you’re going to be off of your employer’s medical plan, and you may not have to worry about correlating benefits at that point. So, it’s really not that scary. And then, on an annual basis, once they are involved with Medicare, there’s ways you can change up your plan or your drug plan as you need to, and there are resources and people to help you with that.

[00:33:12] TB: Yeah, the enrollment period is going to be super important, right? It’s typically three months before you’re 65, and then three months after you turn 65, so it’s like a seven-month enrollment period for initial. You want to do that so you’re not penalized later, that can happen, so you don’t want to blow through that enrollment period. I think that you get a ton of mailers for that to remind you.

But I think the big decision from there is like do I do Original Medicare A and B? Or do I do a Medicare Advantage plan which is a kind of more like private insurance HMO that Medicare reimburses for on a per participant basis? There’s I think, hundreds of plan Ds, which is the prescription. Do you get a Medigap policy with Original Medicare? There are so many things that go into this. And that’s going to go into like, what’s your view on, do you want convenience? Most providers will accept Medicare insurance, but it’s not necessarily as simple as maybe like a Medicare Advantage. If you’re going to be a snowbird, like if they decide, “Hey, we’re going to buy this cabin, but we also want to buy a place in Florida.” Having care coordinated between those two, if you’re in a Medicare Advantage is more like an HMO. So, if you’re out of network, that can be problematic.

There’s lots of different things that go into this. At the end of the day, this is probably one of the bigger concerns, I think, that people have is like, what does this look like? If there is a gap, if they decide to retire before age 65, what do they do? Is that something like Cobra? Does the employer offer anything that’s becoming more and more of a dinosaur feature of late? The other thing that we didn’t mention that, Christina, we were talking about off mic was like, even long-term care insurance, I think we’re seeing that show up on an employer benefit. So, really taking a look at that and what’s provided there. The big things with long-term care, just to circle back to that is like, when we’re looking at this, what is the monthly benefit that we’re targeting? If we are trying to cover home care, you can – Christina was telling me about this awesome calculator that you can find at your state, this is what it costs. So, it’s 5,000, it’s 6,000, like, we’re going to target that. What’s your deductible period? So, that’s the elimination period or the time you have to wait before you have benefits. So, a lot. It’s just like disability insurance, a lot of them are built as 90 days. How long is the benefit going to pay out? And then like, do you want an inflation rider?

So, to circle back on those things, those are the conversations we’re going to having concert of like, what do we do with Medicare? If there is a gap in Medicare, what do we do, et cetera? But I think Kelly, the only other thing that we probably should discuss briefly, that the client brought up, I think this is the one thing that I have outstanding here is the debt. So, one, is should they be concerned about the amount of mortgage debt? Should they use some of that cash set savings for the car note and pay it off? Obviously, interest rates have moved a lot, over the last year or two. So, what would be your answer to that question? Obviously, we probably need some more context with what’s going on in different parts of the plan. But how would you approach that with them?

[00:36:07] CS: Right, so it is interesting, like, I think just baseline, high level, the mortgage, usually, it’s more desirable to not have a mortgage in retirement to have the cash flow be less. But I am intrigued by like, this is not the forever home. It’d be nice to know, well, like how long? When would the transition take place to either a smaller home or to that cabin? We see a lot of people talk about being expats too, which is kind of interesting, depending on what happens with Jane’s mom and the kids in college, is that on the radar as well?

So, like the mortgage, I feel like normally would be a priority to not have on the table. But in this case, I don’t have as much of a concern about it, if there is a potential for a transition that we can talk through, to see what is affordable. Is the 2858, is that affordable in retirement with the rest of the expenses? The cars, I would say that interest rates are lower, which is good. I wonder if maybe the kiddos would like to contribute and pay off if they’re going to eventually take ownership of the car. I feel like having the kids have some type of responsibility, some piece of the puzzle that they have to take care of, whether it’s paying part of their car insurance, definitely upkeep, maintenance gas. I personally think it’s an important piece for them to feel some type of responsibility. So, I guess I’d be curious as to their student jobs and the college, and can they help take care of the one vehicle. I guess, I’d be inclined to maybe pay off the other depending on what the other goals with the cash flow is.

[00:38:03] TB: Yeah, mathematically, I wouldn’t be in a rush to pay off the notes if you can get 3% in a high yield and both these notes are 1.92, 2.25, doesn’t necessarily make sense. But some of that is just kind of peace of mind to clear the balance sheet on the liability side. But the mortgage is I think the bigger one, the bigger shoe that we’d have to figure out, like how it’s going to drop because there’s some equity in the primary home, what it’s valued at, versus the mortgage. My big thing is if they buy the cabin, they would have essentially two mortgages, that if they sold the primary house, they could pay off the original mortgage and maybe apply some of that back to the cabin. It’s just a matter of like, what’s their comfort level in terms of carrying a mortgage debt into their 70s, 80s, et cetera.

So, there’s nothing concerning about, I think they’re on a fixed rate for the mortgage, so it’s not like it’s a variable rate or an arm or anything they have to worry about, but it’s just kind of the comfort level and then how is that, to your point, that 2858 go into play on a fixed income when we’re talking about generating a paycheck from Social Security, from the retirement assets and maybe any part time work or whatever they’re doing, so that would be the main concern.

What did I miss guys? I feel like we covered a lot of ground here. This was great. This is a great case study. Did we did we miss any question?

[00:39:30] CS: FAFSA, Tim, which is –

[00:39:31] TB: Oh, yeah.

[00:39:33] CS: I mean, it’s mostly income in the formula and probably like that cash might be a little bit of – if you’re planning to use it for college expenses, like running it through the 529. Yeah, I guess if they retired, there’s the two-year look back period. So, at least Thomas would be pretty well through school. I think by the time, if they retired, but they might have an impact on Robert’s last year or last two years. But we get questions about maximizing the FAFSA and again, with the income being the biggest component, we don’t know what the kids’ assets are, those aren’t entered in the eMoney, usually don’t ask about those. But I guess I’d inquire about those too, make sure if they have an UGMA and UTMA that they spend those down first before the 529s, since they count different in the formula.

[00:40:34] TB: I think one of the things that I would say is I think some sometimes people are, because of the formula, they detract it from putting money into the 529. But I think, having that pot of money there that’s grown tax free, if it’s used for education expenses, is more valuable than I think not doing it because you think that the FAFSA equation is going to change.

So, just like, what we talked about, sometimes people do weird things that are out of character because they’re trying to like save on taxes. If going to college is a big part of the plan for your kiddos, the 529 is going to be one of the best – it’s depending on your state, but it’s going to be one of the better vehicles to do that and I wouldn’t let the FAFSA formula detract anybody from doing that. But I think, yeah, probably looking at some of those assets. I know you can also put assets in. I think grandparents’ name, and I think that doesn’t necessarily capture in the equation. So, definitely something that we want to look at as we’re tackling the other parts of the financial plan, so good stuff guys. I appreciate the chat here. I think very, very productive. And yeah, just look forward to doing more of these in the future and thanks for lending your opinion and how this client is shaping out. So, enjoy the holiday.

[00:41:55] KRH: Thank you.

[00:41:56] CS: You too. Thanks.

[00:41:57] TB: All right, take care.

[OUTRO]

[00:41:58] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog post and podcast is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analysis expressed herein are solely those of Your Financial Pharmacist unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward looking statements, which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you again for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 283: How to Optimize Your Tax Situation with Sean Richards, CPA

Posted on by Caitlin Boyle

YFP Director of Tax, Sean Richards, CPA, EA, talks about how to optimize your tax situation as a pharmacist. He discusses tax basics that every pharmacist should know, the critical distinction between tax planning and tax preparation, and how to prepare for the year-end to put yourself in the position to have a headache-free tax season.

About Today’s Guest

Episode Summary

This week on the YFP Podcast, YFP Co-Founder & CEO, Tim Ulbrich, PharmD, welcomes YFP’s Director of Tax, Sean Richards, CPA, to the show to discuss optimizing your tax situation as a pharmacist. During the show, they cover areas for optimization, including tax basics that every pharmacist should know regardless of their income or stage of career. The discussion covers basic tax terminology, the federal income tax formula, and why we don’t have a better understanding of tax fundamentals in general. Sean explains AGI (Adjusted Gross Income), how to calculate AGI, an overview of deductions and credits, and how they differ in their impact on your tax picture. Sean takes a moment to explain the difference between marginal and effective tax rates, how bunching charitable donations can impact tax optimization and the triple tax benefits that exist with HSA Accounts. Sean details the distinction between tax planning and tax preparation with a comparison that listeners will enjoy. The discussion leads to common tax strategies that many pharmacists currently employ to optimize their financial situation and things to look out for to avoid common mishaps and mistakes with tax. Sean answers a question on the Inflation Reduction act, providing examples of tax benefits that listeners might take advantage of, and closes out the episode with ways to prepare for the year’s end and put yourself in a position to have a headache-free tax season.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRO]

This week, I had the pleasure of welcoming YFP Director of Tax, Sean Richards, onto the show to talk about how to optimize your tax situation as a pharmacist. During the show, we discuss tax basics that every pharmacist should know, regardless of income or stage of career, the important distinction between tax planning and tax preparation, some common tax strategies that pharmacists are employing to optimize their financial situation, things to be on the lookout for where there’s common mishaps and mistakes, and finally how to prepare for the year end to put yourself in the position to have a headache-free tax season.

Now, at YFP, we know that filing your taxes and figuring out how to optimize your tax situation can be stressful and overwhelming, and that’s why YFP Tax is opening up its tax planning services to more pharmacist households this year. Unlike other firms, YFP Tax isn’t focused on just completing your return. Rather they provide value care and attention to you and your taxes. Because they work specifically with pharmacists, they are familiar with aspects of your financial plan that have an impact on your taxes like student loans, benefit packages, side hustles, and more. You can visit yourfinancialpharmacist.com/tax to learn more and to join the waitlist for the 2022 filing season. Again, that’s yourfinancialpharmacist.com/tax.

[INTERVIEW]

[00:01:29] TU: Sean, welcome to the show.

[00:01:30] SR: Thanks for having me. I’m glad to be here.

[00:01:33] TU: Excited to have you officially part of the YFP team, leading our tax team and efforts. I know some folks listening may not be aware of who is Sean and what is he doing, as it relates to the YFP team. So give us a brief intro to, Sean, some your background and the work that you’re doing with YFP Tax.

[00:01:52] SR: Sure, yeah. So I mean, I wouldn’t be surprised that people haven’t seen my face yet. But it’s crazy because I’ve only been here for about three months, and I feel like I’ve met so many people and done so many things. It’s been awesome. But, yeah, I’m Sean Richards. So I’m the Director of Tax at YFP Tax, CPA, EA, my most recent certification there. So for those who don’t know, EA is an enrolled agent. It’s the IRS certification. It kind of gives you a leg up with talking to the IRS.

Like I said, I’ve only been with the YFP team for a few months now. I worked at a large corporate for a while. They’re doing audit, accounting, treasury, a couple of different functions there. I briefly had another job before this. But, yeah, now I’m leading the YFP Tax team. So we have some tax offerings that we focus on, sort of more direct to consumer, where we’re doing prep tax planning, some of the things we’ll be talking about during this call.

Then we also have a completely different sort of bookkeeping, payroll, all the way up to fractional CFO services, if you’re doing more of the side business or small business type thing. So, yeah, I’m really excited to be here and be part of the team.

[00:02:55] TU: Yeah. We also are excited, grateful to have you on board. It’s been fun to see the momentum of the work that you’ve been doing in just a couple months. It feels longer than that and that’s –

[00:03:05] SR: I said the same thing but in a good way, not a bad way. It feels longer but because it’s been a lot of good fulfilling work, not in a bad way.

[00:03:12] TU: You’re going to be hearing a lot more from Sean on the podcast and webinars, probably on the blog as well. As we’ve talked about on the show many times, tax is such an important part of the financial plan, one of the reasons that we’ve brought these services in house, so we can make sure that the financial plan is humming with the tax plan. Because of that, we’re going to be focusing on even more content than we have done in the past, as it relates to tax strategy and tax planning.

The theme of this show today is really how to optimize as a pharmacist your tax situation. Our hope is whether you’re just getting started as a new practitioner, whether you’re mid-career, whether you’re further along in your career, maybe retirements on the rise in that. Regardless, you’ll be able to take one or two things away that you can apply to your situation, right? Whether we like it or not, taxes ain’t going away, right? It’s not like student loans where we pay them off and they’re gone. This is something we need to be thinking about throughout our career and how we can optimize. As Tim Baker says, we want to pay our fair share but no more. So we’re going to talk about how we can best optimize our tax situation.

The first thing, Sean, is really understanding the tax basics. We’re going to talk about some specific formulas and terms that we need to make sure we understand, so we can appropriately prioritize that as a part of the plan. But first off, why are most of us, myself included, deficient in our basic tax understanding, right? We should all, I feel like, have a more foundational understanding, especially since we’ve got to pay these every year. Why don’t we have that?

[00:04:45] SR: Well, we could probably have a completely separate hour-long conversation about lobbying and all sorts of things from that standpoint. But, I mean, I think it really comes down to, I mean, I’m a product of the public school system, and I didn’t learn about taxes in school. I feel like it’s something where it’s just some schools might offer basic finance classes and how to open up a credit card or something.

But taxes is something that doesn’t really come up. It’s one of those things that you just sort of join the workforce, and all of a sudden it’s expected that you’ll know what to do. Or you’ll have a guy or your dad or somebody will have a guy who can do it for you. But, I mean, I went to a business school, and it wasn’t even until my third year or so that I even took a tax class, where you kind of get into some of this stuff.

So it really is something that isn’t fundamental as part of the education system here. As unfortunate as that may be, that’s why I’m hoping that I can kind of give some background to folks, so they’re not completely lost when it comes to the end of the year.

[00:05:35] TU: Yeah. I don’t think it’s a super exciting topic. Even in Econ 101, like we did some fun investing games and other things. I don’t remember learning about tax. Or maybe we did, and I just zoned out. But it certainly isn’t ever present in our educational system. I’m trying to teach my boys a little bit about taxes right now, and I’m having very little success. Hopefully, Sean, maybe they’ll hear your voice and listen a little bit closer.

Let’s start with the federal income tax formula. How do we ultimately get to the final number of what we either owe or we receive back as a refund? Why is it so important that we understand this formula?

[00:06:12] SR: One of the reasons why it’s so important is that a lot of these terms get thrown around interchangeably, or they’re used as buzzwords. You’ll be hearing car commercials, and you hear kind of REITs and all these different things thrown out there. Everything’s sort of used interchangeably. So if you don’t really understand how the basic formula works, you might misinterpret something, or you might think that somebody’s talking about something that they’re not talking about.

The basic formula is you have your income. You take out anything that’s tax-free, so things like municipal bond interest, something like that. Then you have your gross income, so not adjusted gross income, your gross income. Then we have what we call above the line deduction. So some of those would be like IRA contributions, things like that. Those are the what we call above the line because the magic line is what gets you to that AGI.

Once you take out those above the line deductions, you get to what I just referred to, the magic number of AGI, which is an important one, and we’ll get to it in a little bit. But, I mean, that’s something where a lot of different phase outs and things kind of come into play. So that’s a really important number to have in the back of your mind.

[00:07:13] TU: Yeah. I think if folks, Sean, can really look at their tax returns, again not super exciting, right? But if you look at the 1040, if you start to understand some of these terms, and you can visualize like these above the line types of things, all of a sudden, the strategy pieces start falling into play, correct?

[00:07:30] SR: Yeah, exactly. A lot of people just have their tax return. They hand a box to their accountant. At the end of the year, he says you owe this much, or you’re getting this much in a refund. You say awesome, shake their hand, and you’re done. But all the things I’m talking about right now, I mean, your return could be 100 pages long. But if you look at that front page, you’ll be able to see these numbers that I’m talking about to at least give you a better understanding of how some of these things work.

Once you have your AGI, then we get into deductions. I want to be careful here because this is one of those ones that gets very often thrown around interchangeably. So deductions, which can either be itemized or the standard deduction, depending on which one’s larger in your individual circumstance, are, what, take your AGI and get you down to the taxable income. That’s what actually ends up getting multiplied by your tax rate at the end of the day. So those are things to get you to your taxable income amount.

Then you multiply by whatever your tax rate is. So there’s marginal rates and stuff, which I’m sure we’ll talk about in a little bit. But you take your taxable income, multiply it by your tax rate, and that gets you to what you theoretically will owe or what you’ll get back. Then we get into what we call credits. Those are, again, kind of used interchangeably or often confused with deductions.

Credits dollar for dollar reduce what you owe at the end of the day. Whereas a deduction reduces your taxable income, you’re really only saving 30%, whatever your tax rate is on that deduction amount. So if someone says, “Oh, I’ll write it off,” you’re only really saving the times your tax rate portion of that. A credit is dollar for dollar. So if you’re able to take advantage of credits, you can really have a big impact on reducing what you owe at the end of the day.

[00:09:07] TU: Awesome. So you defined well deduction versus credit. Again, as folks are listening, pull up your tax return. Again, I think as you visualize this, it starts to come to life a little bit more. Let’s break down further AGI, and then I want to come back to marginal and effective tax rates, two terms that you threw around that are important that folks have a good understanding of.

AGI, adjusted gross income, tell us more about that in detail. This comes up all the time, right? You saw this recently with some of the debt cancellation news. What’s your AGI? We talk about it as relates to different strategies with how we invest or how we save. What is AGI and why is it so important?

[00:09:43] SR: So AGI, again, is your gross income. So that would be your income less any of the non-taxable stuff like municipal bond, just like I mentioned. Less those above the line deductions. So that would be things like student loan interest deductions, contributions to the HSAs, traditional IRAs, things like that. That’s what gets you to that AGI. Why AGI is so important is because, like you just mentioned, a lot of different policies or different credits or things like that are based on that number. So they’ll say, “Hey, you’re eligible for this credit if you’re in this AGI range. Or if you exceed this AGI, you’re no longer eligible for this credit.”

PSLF student loan relief is a big one. So they’ll say, “Hey, you’re eligible for this if your AGI is within this range or under this amount.” So that’s why it’s really important to have that number. Of all the numbers, that’s probably the most important one to have, just sort of handy when you’re looking at these different things.

[00:10:36] TU: How about your marginal versus effective tax rates? What’s the difference and, again, why is this important to understand?

[00:10:42] SR: So marginal is – When people say tax bracket, that’s usually what they mean. They mean marginal when they’re talking about that. So that’s where you’re sitting there, and you’re saying, “Oh, I’m in the 25% tax bracket. If I make another dollar, I’m going to be in the next tax bracket. I can’t make any more money. I’m going to owe more taxes.” So it doesn’t really work out that way because for each of these different brackets, you’re being taxed at the marginal rate for that particular bracket. If you average that out, that’s your effective rate at the end of the day. If you take what you actually owe in taxes versus what your income is and do a simple mathematical equation, you get your effective rates of what you truly are paying.

Again, when you’re looking at your marginal rate in your bracket, that’s important for things like deduction. So if you say, “Hey, if I’m going to take this deduction,” if you want to do a quick calculation of what that would be for a dollar value for you, you multiply that by your marginal rate. But if you’re really thinking about it saying, “Oh, I don’t want to make any more money. It’s going to put me into the next bracket,” you got to really think about your effective rate when it comes to something like that.

[00:11:43] TU: Yeah. Usually, we want to be careful about not making more money because of taxes, right? So if we’re making more money and we’re paying taxes, that’s not necessarily a bad thing, right? We want to –

[00:11:52] SR: It’s a good thing.

[00:11:53] TU: It’s a good thing.

[00:11:54] SR: Some would argue that the more money you pay in taxes, the better that you’re actually doing at the end of the day, despite what anybody would say about trying to cheat the system or anything. You tax bill shows how healthy your finances are.

[00:12:06] TU: Yeah. [inaudible 00:12:07] and I wrote a book recently that he makes an argument that your number one KPI, key performance indicator, is the amount of taxes you pay to the IRS each year. I think the point is a good one, right? Obviously, you want to optimize and be as tax-efficient as possible. But if we’re able to earn more money, we’re paying more taxes. Again, that’s not a bad thing. That’s the first bucket here, understanding the tax basics.

The second thing, Sean, is tax planning versus tax preparation. It’s something we have talked about on the show before but I think, honestly, something we can’t talk enough about because we confuse sometimes the filing versus the actual strategic look, as it relates to the tax planning and how we can optimize that as part of the plan. I’ve heard you presented this talk before and give a really cool example of a film director and a film editor, and how that helps highlight the difference between the two, tax planning and tax preparation. Tell us more.

[00:13:01] SR: Yeah. So it’s actually kind of what you were just saying, where you want to pay your fair share. The more you pay in tax at the end of the day, whatever your tax bill is, it kind of shows that you’re doing better, right? But at the same time, you don’t want to pay more than your fair share. You don’t want to pay more than you need, just because you’re not paying attention or for whatever reason.

The way I like to think of it is tax planning is like a film director. So film director is watching the actors. They can affect change as they go. They have kind of an idea of what they want at the end of the day. If something goes wrong, they can say, “Ah, let’s take that back. Let’s change that.” Or, “I don’t like the way that that worked. I have this other vision in my head. Let’s do that.” Whereas a film editor, equally as important in the film production process, but they’re basically getting film that’s already been recorded. They’re saying, “All right, now work your magic and make this look good.” Of course, they can do a lot. They’re professionals. They can tweak it. They can make it look beautiful. But they can’t go back and change what’s already happened in the past, right?

Even though it’s an important piece, that tax preparation piece is really only a historical look back. It’s not something where like the tax planning, the director side, you can actually make changes throughout the course of the year and have those kind of play into the final product. So that’s the way I like to look at it.

[00:14:13] TU: Yeah, especially if you think about the timeline of filing your taxes mid-April. We’re already a quarter-plus into the New Year. So even when we file – Even if at that point, we’re starting to think ahead and more strategically, we’re already beginning to put a dent in that year. So, yes, we’ve got to file, right? Or else the IRS can come knocking on our doors. But better yet, we’re doing some of the strategy, the look ahead, the planning as the year is going on, and we’re being more proactive than just the filing alone. Then we’re not only optimizing but, hopefully, also minimizing any surprises.

[00:14:47] SR: Exactly, yeah. You don’t want surprises. You want to be able to take a look at things in the middle of the year and say, “Hey, where am I going to be come filing time? Or where am I even going to be a couple years from now down the line?”

[00:14:56] TU: I’ve seen you present on this before, where you give an example. Obviously, there’s many ways that tax planning can help optimize, but one example being around how one might bunch their charitable giving to help optimize how efficient that tax is in that given year. So talk to us a little bit further about that example. It’s just one of many examples of how someone might optimize your tax strategy.

[00:15:21] SR: That’s a perfect example to give right now because, like you just said, we’re getting towards the end of the year. So someone might say, “Well, if tax planning at this point isn’t really going to make much of a difference, maybe I’ll start next year or something.” But with something like bunching, that’s something that can be affected at the end of the year, up till the last day. So that’s something where if you’re looking at things and you’re saying, “Well, all right. I’m taking the center deduction this year, but I’m really close to being able to itemize my deductions.” So some people might just do what they’re normally going to do and just take whatever they get, whether it’s a standard deduction or itemized.

But if you’re going to be donating to charity for an example, and you know that you want to give, say, $10,000 over the course of the next couple years, you could break that into 5,000 this year and 5,000 next year, whatever. But if you look at it and you say, “Hey. Well, what if I bring some of these charitable contributions into this year and maybe be able to take advantage of itemizing my deductions? And then in a future year maybe not give that money and take the standard deduction?”

That’s something where you could make that donation on December 31st, and it’s effectively like given 5,000 on December 31st and given 5,000 on January 1st. But from a tax standpoint, it can make a really big impact. So that’s something where that tax planning, that directorial thing really comes into play, where if you look at those things and think about the impacts that will have down the line, even where you don’t change any of the facts and how much money you’re actually going to give, it can make a big difference.

[00:16:43] TU: That’s one tax strategy to employ a good example of where the tax planning can really be helpful the more strategic look ahead versus just the filing alone. Let’s shift into the third area here, which is common tax strategies to employ. Certainly not an exhaustive list, right? There’s many, many, many different strategies. It’s, of course, customized and individualized to one’s personal situation. But let’s talk about a few common ones that we see. Let’s start with the HAS, Sean. What is it? If folks are kind of new to that term, what are some of the tax benefits? Who qualifies, contribution limits? Give us the lowdown on the HSA.

[00:17:18] SR: HSA is great. That’s one where if I had a time machine, I’d go back and tell myself to get involved in those more. It’s something where I just didn’t really hear much about it. Or even if I did, it was something where I’d say, “Well, I’m young. I don’t have a lot of health expenses or anything. I’m not going to really worry about that.” But HSAs are great because they’re one of the few vehicles that have a triple tax benefit. So any of your contributions are going to be tax-free. The growth of those contributions will be tax free. Then when you actually go and make your distributions on it, those are tax-free.

Basically, what it is, it’s sort of like an IRA, where you put money in, and you can take distributions on it. Until you get to retirement age, you can only use those distributions for medical expenses. But it’s something where, again, it’s just a different type of investment vehicle for you. So if you have medical expenses that you can use now, great. If not, well, maybe not great, but it’s a good way to use it. If not, then you let it grow. When you reach retirement age, you take it out.

Anybody can contribute, as long as they’re enrolled in a high-deductible health plan. The limits are pretty similar to IRAs. I think in 2022, it’s 3,650 for individuals, and then double for married folks. There’s no limit based on how much you make. Well, there’s the limits that I just mentioned, but there’s no phase outs or anything like that. So if you make too much money, you don’t disqualify yourself, so definitely a great vehicle to take advantage of.

[00:18:41] TU: Yeah. Sean, we see this a lot with our community, I think, for good reasons. One being you just mentioned, right? So higher income professionals, especially if they have a joint household income, where they may be phased out of other opportunities, this is not one of them. Then depending on what they’re thinking of this, either use of short-term known healthcare expenses so that they can optimize and save a little bit on taxes or using it more in that long-term savings vehicle to also optimize the tax benefits.

We’ve talked about this on the podcast before, but we’re going to keep talking about it because we still see a lot of pharmacists that aren’t taking advantage of this. Given that there’s more and more high-deductible health plans that are being offered that people are opting into because of the rising costs of health care expenses, I think we’re going to see this even more popular in the future than it is today.

So Episode 165, we talked about the power of an HSA. We’ll link to that in the show notes. We also have a blog post, why I’m not using my HSA to pay for medical expenses. That talks more about the strategy side of using the HSA as a long-term investing vehicle. We’ll link to that blog post as well in the show notes.

Next up, Sean, for common tax strategies is the IRA. Talk to us a little bit. We’ve covered this in detail on the show, but just traditional versus Roth and some of the strategy around the IRA side of things.

[00:19:57] SR: Yep. I won’t go too much into this because I’ve listened to the podcast before. I know it comes up often. But basically, the two differences here are your traditional IRA, your Roth IRA. So the traditional is something where your contributions you’re making now, you’re taking a tax deduction on it now. Then in the future, when you take it out, you’ll have to pay taxes on it. Roth is the opposite. So you do not get the deduction now. But then when you go to take the money out in the future, when you reach retirement age, it will be tax-free.

With that, that one’s really one where you want to sit down with your financial planner or whoever is kind of coming up with the financial strategy and really determine where am I going to be in the future? What’s my tax bracket going to look like there versus what’s my tax bracket going to look like now? It gets into that whole planning versus preparation thing I was talking about before. So there’s a lot to unpack there.

Like I said, similar as the HAS, so there’s a $6,000 limit. I think it goes up to 7,000 if you’re over 50. So you get a little bit of a catch up there if you’re older. But, yeah, no, just another one to take advantage of definitely. You should be making sure that with all of these, that you’re looking at what you’re – If your employer has any benefits and stuff and really try to take advantage of all these.

[00:21:01] TU: Yeah. Both of these HAS, IRA are great examples, where if the financial plan is humming with the tax plan, we can really start to think about this strategically, rather than we’re filing taxes here, and then we’re looking at the financial plan over there.

[00:21:14] SR: Yeah. It’s something that definitely should be married together.

[00:21:16] TU: Third area, I want to talk about the common tax strategies and the Inflation Reduction Act. You and I are not here to debate whether or not the Inflation Reduction Act is actually going to reduce inflation. But rather, we’re here to talk about what are some of the opportunities and the credits that folks might be able to take advantage as a part of the Inflation Reduction Act.

So hit us with the highlights of some of the things around the energy-efficient homes or Residential Clean Energy Credit and the Clean Vehicles Credit that folks may or may not already be aware of.

[00:21:44] SR: Yep. So I will try not to use too many of the different names for these because I know that they keep changing. So if I say it now, I’m sure by the time this airs, they’ll have some new fancy name for it. But basically, there’s three areas to highlight. So there’s sort of the more traditional home improvement type energy credit stuff. That’s things like installing new doors and windows on your house that are more energy-efficient, which is almost anything nowadays that’s coming out. But that’s something.

So people might be familiar with the $500 lifetime credit. That’s where that used to kind of sit. Going forward, that’s going to be a $1,200 annual credit on your taxes. Remember, credits dollar for dollar reduce your taxes. So if you’re thinking – And this goes into effect next year, so something just to kind of keep in mind with planning ahead and everything. But if you’re thinking about getting some energy-efficient renovations done on your place, that’s definitely a big one to keep in mind.

Even more on top of that, so if you’re not only thinking about, hey, let me get some new windows or something, but why don’t I throw some solar onto that or get some geothermal heating systems or anything, something like that going, so the Residential Clean Energy Credit, that recently bumped up to 30% of whatever your expenses are in that regard. Again, say you’re putting new solar panels outside. You can get a 30% tax credit on the cost to install that equipment, which is huge.

Especially, again, if you’re planning ahead, you can maybe knock down some of your withholding. So if you know you’re going to have kind of a bigger tax bill at the end of the year, but you have this large project to offset, it’s something really to keep in mind there. Then the clean vehicles one, so there’s a lot to unpack there. I won’t get into too many of the details. But basically, they’ve expanded the credits available for buying electric vehicles or energy-efficient vehicles.

The biggest one that I’d like to highlight there is going forward they’re actually going to start allowing a credit on previously-owned vehicles. So that’s something where in the past, you had to buy a new car, and I’m sure a lot of people want to buy a nice brand new Tesla but might not have been able to jump into that or afford it right away. So opening up that secondary market to be able to take advantage of the tax credits is going to be huge.

There are some restrictions on that. If you’re buying a new car, definitely make sure there’s some restrictions around the car being assembled in North America and avoiding some of the mineral countries and stuff. So definitely go out and take a look. We can link to that in the show notes as well. The IRS has specific guidance on that, but those three are definitely some big areas to look forward to going forward.

[00:24:12] TU: Great stuff. I think there’s been a lot of news and potentially some confusion around that. So awesome, brief summary on what folks may be looking out for and how they can take advantage of those credits. The fourth area, as we continue this discussion on how to optimize your tax situation, is some things to be on the lookout for, perhaps some common mishaps or stumbling blocks along the way.

The first one, Sean, may not apply to a huge percentage of our community listening, but we do have a handful of folks that work in the biopharmaceutical industry or in situations, where restricted stock units or employee stock purchase programs may be a thing, and so it’s worth talking a little bit further about. But what are some of the things that folks should be thinking about if RSUs or if ESPP does apply?

[00:25:00] SR: Yeah. So you’d be surprised. I mean, I’ve done some webinars and some speaking events. Even though it might only apply to a small percentage of people, the people who does apply to it really does kind of nail home because there’s a lot of, I don’t want to say, hidden tax confusion there. But it’s something where you’re excited you’re getting a bonus, you’re getting these restricted stock units, and you want to get in the market. People are all excited about Robinhood and everything. But you have to be careful because there might be some things that you might not be considering.

With RSUs, you definitely want to make sure that when you’re selling your shares at the end of the day, when your shares vest, oftentimes you will actually recognize income when those shares vest. So taking a very, very quick step back, restricted stock units is usually something where a company will say, “Hey, we’re going to give you 40 shares, but it vests over a four-year period of 25% a year.” So when they vest, normally, you’ll recognize income on that. So what you want to make sure is that you’re not double counting that. When you’re going to sell those shares, make sure that that piece has been picked up already, and you’re not kind of picking it up again.

Similarly, with employee stock purchase programs, ESPPs, another great thing to take advantage of if it exists for you, usually, what that is is a company, if you work for a publicly traded company, allowing you to buy into the company at a discount. What you want to keep in mind there is that oftentimes, when you buy it at that discount, that discounted price, say, it’s 15% of the market value, that will often come on your W2 as income as well.

Again, it’s something else that you want to keep in mind. Make sure when you’re paying capital gains on that at the end of the day that you’re backing that piece out. They’ll often be what they call a supplemental form that comes with your 1099. So make sure that you look at that and adjust your basis or work with your accountant. I know I’m probably going over a lot of people’s heads, but make sure you find that piece of paper and give it to your accountant. So they know, hey, I need to adjust this basis and not pay additional on that income that you already were taxed for, right? You don’t want to pay twice in the same money.

[00:26:55] TU: Yeah. This is something, Sean, we see, as you mentioned, a lot of interest and attention, especially from folks that may be doing fellowship programs or others, looking at job offers, trying to understand what do these terms mean, and then how do they strategize around them, of course, the tax considerations that you mentioned.

The other area to talk about, as we continue discussing things to be on lookout for, cryptocurrency transactions. I know this was something that our tax team spent a lot of time on during the previous filing season. We saw rapid growth in folks that were investing in cryptocurrency, making transactions. Maybe that slowed up a little bit, just because of what’s been going on in the market. Maybe it hasn’t. But nonetheless, this is reaching more and more people out there that may be dabbling into cryptocurrency.

So we’re not going to talk about the strategy around cryptocurrency but here specifically about some of the tax considerations. Tell us more.

[00:27:47] SR: Yeah. So the thing to keep in mind with crypto is that – And I just talked about ESPP and RSUs, and that might, to some people, sound complicated. You get into capital gains and all that stuff. Cryptocurrency, the IRS considers that to be property, just like stocks. So if you’re going to the store and you’re buying a coffee with cryptocurrency, you’re effectively, at least to the IRS, going and selling like a share, right? Then buying your coffee. So every time you do that, there’s capital gains or losses associated with it, every single transaction.

It’s something to keep in mind. I mean, I’m not discouraging anybody or giving anybody advice on whether to use it to buy a coffee or not. But something to keep in mind at the end of the year, you’re going to have to report on each one of those transactions. Some of the crypto software out there doesn’t readily print out that stuff for you, so you might have to use a third party to do it.

The other thing to keep in mind is that NFTs are another kind of hot topic. I know that IRS has recently – I actually think that the 1040 this year, right on the front page, is going to have a little checkbox like they did last year with crypto saying, “Hey, did you buy or dispose of any digital assets?” So something else to keep in mind, NFTs are a hot topic, but it’s something that you actually have to record all those transactions. If you had a gain, you have to pay taxes on them.

[00:29:00] TU: Yeah. I wonder if anyone at the IRS 5 years ago, 10 years ago would have predicted having questions front and center on the 1040 about cryptocurrency and NFTs. But here we are, right? So obviously, there’s a lot more attention for good reasons that’s been given to those transactions, and I would say our tax team learned a lot through the tax season last year on this, just working with clients and kind of working through some of these issues. So if cryptocurrency transactions were something that was a part of your planning, something that we may be able to assist with.

[00:29:30] SR: Yeah, absolutely.

[00:29:31] TU: Sean, the last thing I want to talk about here on things to be on the lookout for is something we commonly see, which is paying the right amount of tax throughout the year. Especially important for those that maybe have significant changes in income, changes in dependents, maybe for those that are earning additional income, side hustle, business. Really, what we’re talking about here is whether or not we need to adjust withholdings or set aside some money for tax throughout the year, if that’s not being taken out of our paychecks. So what are some of those considerations around estimating and being able to estimate our taxes due throughout the year, so we’re not surprised come the filing season?

[00:30:08] SR: Yeah. So this goes back to what I was saying before, where you really want to keep the whole tax planning throughout the course of the year in mind. You don’t want to commit to at the end of the year and have a large bill or have even a large refund at the end of the day. I mean, it’s always nice getting cash back. But at the end of the day, it’s an interest-free loan that you’ve given to the government. So you want to avoid that.

One of the things you want to do, like I said, is sort of project it out and see what you’re going to owe at the end of the day and decide whether you need to withhold any additional interchanger withholdings or make estimated payments. So one thing you can do, it’s called the safe harbor. So if you look at last year’s return and look at what you actually owed at the end of the day – Sorry, not actually owed at the end of the day in taxes but what your tax bill was. Your tax liability, I should say.

So whether you had a refund or not, what your tax liability actually was, if you multiply that by 1.1, so 110% of that, and you make sure that whether you’re making payments to the IRS or just having regular withholdings from your W – For your regular paycheck. If you get that money into the IRS by the end of the year, you will avoid having to pay any additional penalties. Now, you might actually owe tax at the end of the day, but you won’t have any penalties. We call that the safe harbor amount saying, “Hey, that’s what I owed last year. 110% of that, we’re good to go.”

One thing – So if you have a side gig and you’re not having money taken out of your paycheck is you might have to actually make estimated taxes. So there’s a schedule on that. It’s a quarterly schedule. But it’s something – Again, you want to take a look at your calculation and say, “Hey, if money is not being taken out my paycheck, I need to put this money aside and actually send it into the IRS on a regular basis.”

So the way I like to look at it is think of your friend who’s the most financially irresponsible. If they didn’t have money taken out of their paycheck at the end of the day, would they be able to cover it at the end of the year? Probably not. So something you want to keep in mind.

[00:31:59] TU: Yeah. This is another reason. I think when you’re working with someone effectively throughout the year and planning and being more strategic, someone can help you with estimating what these payments will be. Obviously, especially for those that are earning additional income, side hustle, business, whatever, we want to make sure we’re doing that, and we’re looking at the overall financials of the business and accounting for the taxes that we’re going to owe.

Sean, as we wrap up here with our fifth and final point, preparing for the year end, great timing as we’re getting ready to turn the calendar into December. Hopefully, it’s the time of year we’re starting to think about our taxes more intentionally. Hopefully, if we’ve done our job here, people are going to be thinking about this all the way throughout the year. So what are some of the year-end things that folks should be thinking about to ensure that they can minimize the stress and headaches that may otherwise come during the tax filing season?

[00:32:49] SR: Yeah. So it’s a lot of the things that I talked about before, right? Especially what I even just ended at, you want to look at your income, your taxes, your withholdings. Kind of project that out and say, “All right, here’s what I think I’m going to owe at the end of the day. Here’s what I’ve withheld. Here are the estimated payments that I made, and am I going to be in a good spot?” Maybe I am. I mean, at this point, there’s not a whole lot you can do from withholding standpoint. But you can change that going forward. You can make estimated payments now. So you want to do that. You want to make sure you maximize your HSA contributions, IRA, any of those types of things. So make sure you’re taking advantage of anything, any benefits that your employers are giving in that regard.

If you’ve over contributed, so those limits I mentioned before, if you’ve gone over that, make sure to correct those. Take that cash back out or re-characterize them for next year because, otherwise, you’ll end up getting penalties on those. If you are able to contribute to charity, make sure you have a conscious strategy regarding that. You can use donor-advised funds, which we didn’t get into. But it’s kind of like mutual funds for charitable contributions. Think about your capital gains, so things I just mentioned. If you’re sitting there going, “Oh, my goodness. I’ve been buying coffee every day with crypto,” you got to kind of think about that, and maybe go back, and take a look, and see what your gains were or your losses might have been on those, and think about how to apply those going forward.

Then just make sure you have all of your documentation ready to go and saved down and everything. Then just decide what you’re going to do, or you’re going to do it yourself. Do you want to reach out and hire somebody to prepare your taxes for you? Or better yet, reach out to somebody who can actually be a partner throughout the course of the year and give you more of that guidance and really align your tax strategy with the rest of your financial strategy like it should be.

[00:34:27] TU: Great stuff, Sean. For those that have listened to this episode or have followed us for some time and this concept of year round planning from a tax standpoint, if that really resonates with you and really aligning your taxes in a more strategic, proactive, look ahead way, yes, of course, we’ll do the filing. But we really want to be a partner with you throughout the year so that we can optimize that situation and employ much of what we talked about here. Really, we just, I think, scratched the surface on some of this as well.

If you’re interested in working with Sean and his team over at YFP Tax, you can visit yourfinancialpharmacist.com/tax. There, you can learn more about the services. You can sign up to join the waitlist for the 2022 filing season. As well, you can also reach out to Sean directly if you have a question, [email protected].

Sean, thanks so much for coming on the show and looking forward to having you involved in future episodes as well.

[00:35:21] SR: Yeah. Thanks for having me. I’m looking forward to it as well and looking forward to getting into tax season, hearing from some of the listeners. So have a good one.

[00:35:28] TU: Awesome. Thank you.

[END OF INTERVIEW]

[00:35:30] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 278: YFP Planning Case Study #4: Selling a Pharmacy and Leaving a Legacy Before Transitioning Into Retirement

Posted on by Caitlin Boyle

YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP® is joined by YFP Planning Lead Planners, Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®, and Robert Lopez, CFP®, to discuss selling a pharmacy and leaving a legacy before transitioning into retirement.

About Today’s Guests

Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®

Robert Lopez, CFP®

Robert Lopez, CFP®, is a Lead Planner at YFP Planning. Along with his team members, he helps YFP Planning clients on their financial journey to live their best lives. To go along with his CFP® designation, Robert has a B.S. in Finance and an M.S. in Family Financial Planning. Prior to his career in financial planning, Robert worked as an Explosive Ordnance Disposal Technician in the United States Air Force. Although no longer on active duty, he still participates as a member of the Air Force Reserves. When not working, Robert enjoys being outdoors, playing co-ed volleyball and kickball, catching a game of ultimate frisbee, or hiking with his wife Shirley, young son Spencer, and their dogs, Meeko and Willow.

Episode Summary

In this week’s episode, YFP Co-Founder & Director of Financial Planning, Tim Baker, CFP®, RLP® is joined by YFP Planning Lead Planners, Kelly Reddy-Heffner, CFP®, CSLP®, CDFA®, and Robert Lopez, CFP®, to discuss YFP Planning Case Study #4. In this case study, Tim, Kelly, and Robert delve into the financial details of a fictitious family, the Patels. Aman Patel is a 59-year-old independent pharmacy owner looking to sell his pharmacy to his daughter, Jessie. Jessie currently works on staff at the pharmacy. Amin’s wife, Hannah, is a teacher with questions about her retirement pension and social security claiming strategies. Amin and Hannah also own a rental property they are looking to sell and want to know how best to use the proceeds of that sale as they are approaching retirement. Together, Tim, Kelly, and Robert cover the details of the Patels’ retirement timeline. They dive deep into how the Patel family will need to coordinate with a CPA and an attorney to best structure the succession plan for the pharmacy with considerations for both Jessie, who has student debt, and themselves as pre-retirees. Lastly, they explain planning options for the Patel family’s investments and insurance policies as they approach their transition to retirement.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRO]

[00:00:00] TB: You’re listening to the Your Financial Pharmacist podcast, a show all about inspiring you, the pharmacy professional, on your path towards achieving financial freedom. Hi, I’m Tim Baker, and today I chat with YFP Planning’s lead planners, Kelly Reddy-Heffner and Robert Lopez, to walk through our fourth case study of a fictitious family, the Patels.

Aman Patel is 59 and is an independent pharmacy owner, who was looking to sell his pharmacy to his daughter, Jesse, who currently works on staff at the pharmacy. We discuss the Patels’ retirement timeline and how they’ll need to coordinate with an attorney and CPA to best structure the succession plan to Jessie. Aman’s wife, Hannah, is 55 and works as a teacher. At retirement, she’ll receive a pension and has questions of how to claim it, along with how to claim Social Security.

We also discuss questions about what they should do with their rental property and how they should handle the proceeds, whether they should pay down debt or invest. Finally, we discuss their investments and insurance policies, as they approach this very important transition.

[EPISODE]

[00:00:57] TB: What’s up, everyone? Welcome to our fourth case study in our series. Glad to be back with you. We’re going to today go through the Patels. The Patels are going to be a little bit of a different case. So in the past, we’ve through a couple in their 30s, a couple in their 40s, a couple in their 60s. Now, we’re actually going to talk about Aman Patel and Hannah Patel, who are a couple in their 50s, who were actually a pharmacy owner. So I’m glad to welcome back Kelly and Robert to go through this case study. Guys, what’s going on?

[00:01:25] KRH: Doing well.

[00:01:25] RL: Just staying cool out here in Phoenix.

[00:01:29] TB: Awesome. So let’s jump into our guy. So like I said, we’re going to be talking about the Patels and what they’re looking at as they approach retirement. So, Robert, why don’t you set us up, like we’ve done in previous cases, and kind of go through their overall demographic, what they’re looking at, where they live? Kelly, you’re going to get into goals and debt. Then I’ll kind of take us home with the rest of the balance sheet.

[00:01:50] RL: Yeah. So let’s jump right in. So we have Aman and Hannah Patel. So Aman is a pharmacy owner. He’s 59 years old. The salary he’s pulling out of the business is $150,000 a year. Obviously, as a pharmacy owner, he has no other income. That’s kind of his main source. His wife is a teacher. She’s 55. She makes $75,000 a year. Then she has some tutoring and support on the side, where she makes an additional $10,000 a year. They file their taxes jointly, and they are joining the pharmacy by their daughter, Jesse, who is a 29-year-old single pharmacist, who works through the pharmacy as well.

They are residents of St. Paul, Minnesota. Their income numbers break down to a gross of $235,000, which breaks down to 19,005 monthly and roughly $9,500 net, beating after taxes, contributions, and insurance. So those expenses break down to roughly like a 40-20-40 fixed expenses, variable expenses, and savings. They’re living in a three-bedroom single-family home that they purchased back in 2005, when the prices were good, and it was a 30-year-mortgage at 5.75%. They were able to refinance in 2012, down to 3.5%, and they have about $155,000 left on that mortgage.

[00:03:04] KRH: All right. In terms of goals, they both want to retire in the next several years. Aman would like to sell the pharmacy to daughter, Jesse, and help her with that transition. Hannah will receive a teacher’s pension. So that is about $2,500 per month. But she doesn’t quite know how to claim that, how it works. Then also, knowing what their Social Security benefit might be as well is important.

They are interested in no longer having a rental income property and would like to sell that, along with the pharmacy. But they are interested in staying in the St. Paul area. They have questions about paying off their debt, as they’re looking for that financial independence and retirement. Aman wants to golf more regularly and take those trips abroad, and Hannah wants to be more involved with charitable endeavors. They both want to help Jessie as much as possible, both as a new pharmacy owner, and she has some student loan debt as well.

So the debt in question that we’ll be looking at is that there is still the home equity line of credit that looks like a balance of about 10,000. They’re paying aggressively on that, and it does have the interest rate of the 5%, as Robert mentioned. There is a car note of about 15,000. That has an interest rate of 4%. They’re paying 250 per month on that. Then they do have that mortgage payment for their primary residence, just under $1,400 for that and about 10 years remaining.

[00:04:41] TB: From a wealth-building perspective and, again, kind of bouncing back and forth between the net worth statement, they have about $50,000 in cash in the checking account and then another $75,000 in a high-yield savings account. They have a variety of investment accounts, Roth IRAs for both of them, 403(b) for Hannah, the SEP IRA that Aman has through the pharmacy, and then a taxable account that they’ve been contributing to.

For the 403(b), Hannah has that, in addition to her pension. She puts about 10% in, which is about $15,000. She’s invested in balanced funds. Aman’s SEP IRA that he puts money into, he tries to target about $1,000 a month or $12,000 a year. He’s more conservative with his allocation. The Roth IRAs they’ve had in recent years contributed to, but they’ve stopped because they’re over the threshold for married filing jointly. Right now, they’re directing all those funds to their joint taxable accounts. So it’s about $1,400 a month or nearly $70,000 a year. Again, in terms of the allocation for the Roth IRAs, bounce more for Hannah, conservative more for Aman. Basically, the taxable account is going to be used to supplement their retirement.

On the real estate perspective, they do have their primary home that they’ve purchased, and it’s worth about 395,000, with about 155,000 left on the mortgage. They have a rental property, which was their first home that they didn’t sell. Once they purchased the most recent one, that’s worth about 275,000 with no mortgage. Then Aman had did a recent evaluation on the pharmacy, and he thinks that the pharmacy is worth about 750,000. So that’s basically the balance sheet.

From a wealth protection perspective, Aman has a $1.5 million term policy, life insurance policy that will expire at age 70. Hannah has one quarter of a million dollars that will expire at age 66. Aman has no short-term or long-term disability. Hannah has what she has through an employer, which basically covers 60% short term, 60% long term. Professional liability, Aman has his own policy. Then there’s the documents that definitely need to be dusted off, need to be updated and reviewed, especially with kind of the sale of the business upcoming. So they’re going to have to engage in attorneys for the sale and as the attorney to kind of get that rolling.

From a tax perspective, Aman has an account he’s used for the last 10 years. Then they’re just concerned about how the taxes are going to be treated related to sell on the business. So they have to kind of navigate that. So miscellaneous things kind of makes additional income, as Kelly said, with school activities, and she might continue to do that post retirement. Cash flow and staffing issues are top issues during the transition. So I’m just making sure that the [inaudible 00:07:25] have the adequate staffing to make sure that Jesse is not killing herself initially.

They have questions about, when do they – What’s the timing on the rental property? What do they do with the proceeds? Do they invest that? They’re kind of leaning towards more paying off the debt. Then Jesse wants to expand services at the pharmacy to increase lines of revenue. But Aman is less sure. So you kind of have that change management that they’re going to have to negotiate in terms of like who is the boss and when and what that looks like.

So a lot of stuff going here, guys. Kelly, I’ll start with you. What would be some of the things that jump off the page for you in terms of what we need to tackle with regard to the financial plan?

[00:08:08] KRH: I mean, I guess the top priority would be the sale of the pharmacy, since it relates to funds they’d have available for retirement, also helping to take care of Jesse in the process as well. This certainly would speak to needing an attorney to be involved in some tax planning as well. But I guess one of the things to think through would be like how much – Jesse has student loans. Her resources might not be robust to do an outright sale, if the value of the pharmacy is $750,000. So sometimes, those family sales can be structured over time, deciding if there’s an interest rate or as part of it a gift. It would all be things that would be important to think about.

It may be that smaller increments would be helpful for the family, in terms of planning as well, just to keep that tax liability for Aman and Hannah a little bit more manageable from year to year. So I guess that’s where I would start is getting some professional input to see what their options are, what an interest rate might look like, and how Jesse might be able to facilitate payment. That might also touch on the question of who’s making decisions. If it’s a partial buyout, if – I think those are always important things. Like the non-dollar and cents is just some of those logistics about how decisions will be made, who is going to be the board of directors, how to transition out. If you still have kind of a foot in the door, what does that mean in terms of your input and say?

[00:09:47] TB: Yeah. This is definitely one of those instances where as the CFP, I think you’re trying to quarterback in bringing different professionals because, obviously, from a legal perspective, from a tax perspective, an attorney, a CPA are going to have insight in terms of how to best structure this, and then kind of herd the cats along with a financial plan to see, okay, how does this all fit together?

But, yeah, timing of like the sale. Is it a complete sale? Is it something that invests over time? How does the tax work in terms of capital gains on the sale of that? How do you structure a promissory note? Is there money down? Is Jesse taking less of a salary and doing more sweat equity? Or is she kind of being paid as an independent pharmacist would at a market rate? So those are all things I think that like those would be questions that bringing in other professionals to help kind of navigate that.

Rob, I don’t know your take, but I think like three to five years, I think the time is now to start those conversations because I think it’s going to – Especially with an asset like this, it’s going to take longer than they think. So outside of kind of bringing in some of the professionals to start asking and answering some of these questions, what else would you want to know more about, whether it’s goals or what that looks like, with regard to their planning in kind of this transition that’s coming up?

[00:11:10] RL: Yeah. How much does he really want to work after that, right? So he’s 59 right now. Is he saying, “We’re going to stop working at 62 or 65.”? Is this a, “I want to have this transition started in three to five years.”? If he’s going to continue to work, especially helping her out, right? If she’s taking on the purchase of the business, she’s going to have to decrease expenses, and she may do that. Decrease that sweat equity, right? But she’s going to need help from a staffing perspective.

So if he’s going to be working there into the future, then, yeah, the time is now to get that transition started. So that way, she can slowly take over, while he’s still accruing an income and then working on transitioning that business. I think a real perspective on not only when they want to sell the pharmacy but when he wants to fully retire will set that timeline from a payout perspective is what we are working with the lawyers and the accountants to decide what the timetable or the time horizon is for that buyout. That’ll factor in pretty strongly.

[00:12:07] TB: Yeah. I think like it could be one of those things, where if you’re doing some part-time staffing at a pharmacy that your daughter’s drawn in that you kind of built that, that might be a little bit more enjoyable in the later years of your career, where you’re not having to worry about payroll, or you’re not having to worry about management and things like that. Obviously, you’re mentoring your daughter. But maybe it just kind of takes a lot of the stress off of you, and it can extend your career.

The thing that I would have bouncing around in my head is, okay, how can we structure this if it’s a seller finance and note that we can get paid enough to kind of get to that age 70, where Social Security – The strategy might be to delay that. Take money from the retirement accounts, delay Social Security, and then use that structured note as a way to kind of bridge that period. So I think those are the discussions in terms of like how long is that note going to be? What’s the interest rate to, Kelly, your point? If it’s not a market interest rate that that has to be considered a gift that we have to kind of track and make sure that we’re accounted for.

So these are all things. I think it goes back to the goals, right? So like when do you see yourself getting out? Is that something where it’s a clean break? There’s a note in here about Jesse kind of wants to – She wants to expand services. Is Aman going to be on board with that, if he’s still majority owner, if it’s like a 50-50 thing? Or is it at this day, in January 1, 2028 or whatever it is, that they’re going to you, basically, hand the keys to Jesse, and then it’s going to be here’s the run. Those are all things I think to get on the table and flesh out to make sure it works for everyone.

Kelly, what’s your take in terms of like – It sounds like they kind of want to simplify life. Obviously, passing on the ownership of the pharmacy to Jesse, they talked about selling the rental property and kind of getting out of the landlord game. What’s your take in terms of timing of that, what to do with the proceeds, etc.?

[00:14:15] KRH: I guess the timing of the sale of the rental property is a pretty well time to have this conversation with the way the housing market is at present. So I guess that’s always a factor, like depending on the urgency, like understanding the market factors in like is it now. Is it maybe wait a bit? We have at present such an interesting situation. We’re coming off like really high rates for purchases, low interest rates earlier in the summer now with the rates rising. So I guess that would be a component is kind of getting some professional advice about the market and whether now is the time.

In terms of what to do with it, like I think it would be interesting to build out. I’ve heard you in the podcast, Tim, talk about the retirement paycheck. So kind of what do they need to have? That pension for Hannah adds a really nice resource, understanding at what year she gets what amount. If there are any other benefits from that pension would be good to know. Like are there any health care benefits, any disability, survivor benefits? So details there but then kind of looking at what’s coming in from the pension, getting their Social Security statements poured.

Then you can took take a look at expenses and see like, okay, well, then I feel like then you’re looking at the debts and seeing like, well, what really does need to be paid off to make that paycheck work with the resources. The rate of the 5% is on the high side. So I like that they’re aggressively paying that off. That probably would be the top thing I would target. The car and the mortgage a little bit less. So but, again, depending on resource, if they really don’t want to have any payments, that does come back to personal preference. We can run some numbers. It’s probably a combination of the two. Like does the paycheck work? Do the financial numbers work? Just how they feel about having some debt going into retirement.

[00:16:18] TB: Yeah. What’s not represented here is probably like what is the rental income that they’re getting from that. So obviously, giving that up for the potential of liquidating the 275,000, which was what we think it’s worth and then, again, how to apply that to the debt. To your point, I’m less concerned about that. I think maybe getting rid of the HELOC. Maybe the car note and then keeping the mortgage rolling could be kind of a balance.

But right now, where the market is, is like if you have cash to potentially put in the market, now’s the best time to do it because of how depressed prices are. Again, not an advocate of timing the market, but it could be that we’ve lined up the sale along with – To Robert’s point, when we exit the pharmacy and kind of do it in one fell swoop. Or just kind of let the market drive it in terms of maybe you list it for sale or you try to rent it simultaneously and see what comes out. So I think there’s a little bit of give there. We don’t – There’s not an overwhelming need for cash, I think, as we as we sit here but definitely something to kind of, again, flesh out with regard to the plan.

Robert, from an insurance perspective, is there anything that kind of jumps out here? Obviously, Kelly mentioned the pension. One of the things I did look up in Minnesota, if you’re a state employee, you do get Social Security as well. So she’ll have that. A lot of state employees don’t pay in Social Securities. They don’t have that benefit. So that’ll – She’ll kind of be able to get both. But in terms of like looking at the pension, looking at health care, Medicare, she has some life disability. Do you have any big concerns from an insurance perspective, as you’re kind of approaching this plan?

[00:18:01] RL: It’s hard to say kind of what that overall perspective looks like. I think their life insurance policies are in a good place right now. Aman’s going to go out till 70. She’s going to go till 66. She’s got the short-term long-term disability and Social Security disability benefits from them. He doesn’t have any disability benefits. But as a pharmacy owner with a daughter working there, you could probably finagle some work that you could still accomplish for an income.

The professional liability is there. I’d be interested in starting to look at maybe some long-term care, depending on what the parents look like. What does mom and dad look like from then? Are they still around? Is this something that they’re going to have to care for? Then what that longevity looks like for Hannah and Aman. Are they going to be expecting to do some long-term care? Because as we approach that age 60, it starts to become more of a conversation of is this a policy we need to be looking into? But yeah.

[00:18:51] TB: Yeah. I think the other thing – So if we look at – You kind of mentioned not having anything through the pharmacy. I think one of the things that is glaring is the lack of a 401(k) offering, which a lot of small businesses, independent pharmacies don’t offer. I think it’s because of like the expense related to 401(k)s. I think there are options out there. So that would be something that I would be talking too about them, once the dust settles or some of these initial things, is to kind of open up that bucket. So they can defer. Jesse could defer for herself. Even if Aman is planning to do that, it’s to kind of set up that bucket. So it’s another place to basically get retirement funds set aside. So I would definitely encourage that.

In terms of the investments, obviously, they’re pretty conservative to balance between the two of them, which is not necessarily a bad thing to be three to five years from retirement. That’s probably fine. But when we get post retirement and kind of outside of the eye of the storm with [inaudible 00:19:53] risk, we’re going to have to adjust that once we get kind of everything rolling.

But, yeah, I think the big thing here is really to start the conversations, if they haven’t already, and with the CPA, with the attorney, just to make sure everything is tracking to what they’re trying to do. I think the big thing that I would be talking to the two of them about is you got to make sure you’re taking – Anytime you have kids, it’s making sure you’re taking care of yourself and your retirement and not being, I don’t want to say, overly generous with the deal. But you want to make sure that it’s structured in a way that benefits both.

I know you’re concerned about Jesse’s loans as well. But at the end of the day, we need to make sure that the retirement nest egg has longevity and that Aman and Hannah don’t have to go back into the workforce to kind of sustain their livelihoods. So a lot going on here. Anything else that you guys would call out with regard to the plan?

[00:20:49] RL: A good taxable investment that they’re doing, I think there might be a better use for that. Basically, it sounds like they took some of that mortgage money that they weren’t paying before, minus the property taxes, and they started putting it into a taxable account, which is a strong idea. Let’s have that money grow for us in the future. But I think if we’re putting that in 1,400 hours a month, that money – We could max out her 403(b). So let’s get that 403(b) maxed out. That brings down the adjusted gross income, which might even get us below or close to that threshold, where we could start making some sort of Roth contributions again.

They’re over 50, so they get a little bit of plus up, so using a little bit of gap there. So if we can get under that threshold, that would be a nice place to just get more money going towards the retirement, instead of in a taxable account.

[00:21:27] TB: That’s great point. So the catch up for the Roth IRAs, they could put up to 7,000. So 6,000 plus $1,000 catch up. Then for the 403(b), I think they have a special provision, where it’s 20,500. I think it’s an extra 6,500 for catch up. 403(b)s have kind of some special rules with regard to the catch up, but that would be another place to put dollars. I definitely want to see a balance of Roth, taxable, and pre-tax, which I think they have a good – But to your point, they probably could plus up more into Hannah’s, potentially open up the Roth IRA. I think they have a sizable enough taxable portion that if they needed to draw from that, in addition to IRAs, as they’re waiting to claim Social Security, there’s probably enough there to do that. Again, we’d have to model that out and see. But potentially, take advantage of the 403(b) while it’s there. So that’s a great point, Robert. Anything else that you guys would fall out here? I think we covered a lot of ground.

[00:22:29] KRH: I mean, I would agree with the investment assessment. I mean, even exploring backdoor Roths if they’re over the limit. At some point, you’ll model Roth conversions, potentially as well with other resources when the time is right. I guess the other thing with insurance too, if he does sell it, if Aman sells the pharmacy to his daughter, and there’s a buy-sell agreement, like often that involves insurance as well, if they’re partners and kind of just keeping an eye on that.

[00:22:59] TB: Liability, cross purchase, key person, all of those things probably just need to be relooked at and potentially even bringing in an insurance professional to make sure that that’s all looking good. Yeah. So I think those are good points as well.

Well, guys, I really appreciate the thoughts on this. I think a lot of work to do. I think a lot of coordination, obviously, with the sale of an asset, transitioning into retirement, working with family. There’s I think good constructive conversation to be had. So I appreciate your guys’ thoughts on this case study today, and I’m looking forward to doing the next one.

[00:23:32] KRH: Okay.

[00:23:32] RL: Sounds good.

[00:23:33] KRH: Thank you.

[OUTRO]

[00:23:34] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 275: How to Build a Retirement Paycheck (Retirement Planning)

Posted on by yfpadmin

How to Build a Retirement Paycheck (Retirement Planning)

In the fourth episode of the four-part series on retirement planning, Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, discuss how to build a retirement paycheck.

Episode Summary

In this week’s episode, Your Financial Pharmacist Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, wrap up our four-part retirement planning series by discussing how to build a retirement paycheck. Highlights from the show include a discussion on retirement income planning and how social security claiming strategies fit into retirement income planning. Three critical issues addressed include how to replace your paycheck with your retirement income that meets your retirement expense needs, how to plan for large one-time expenditures in retirement, and how to mitigate the risks one faces in retirement. Tim Baker shares three approaches to building a retirement paycheck, The Flooring Strategy, The Bucket Strategy, and The Systematic Withdrawal Strategy. Tim dives into the theory behind each and how to put them to use in your retirement planning. When it comes to retirement, the value of a financial planner throughout the timeline of your life is tremendous, not just in the accumulation phase of your retirement planning. It is valuable to take stock of where you are now regarding the social security statement, cash flow, budget, and net worth, in addition to plans for retirement. Tim Baker explains how life planning plays an integral role in retirement planning, often ahead of financial planning to build the retirement lifestyle you envision with a paycheck to match.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRO]

On this week’s episode, Tim Baker and I wrap up our four-part retirement planning series by discussing how to build a retirement paycheck. Highlights from the show include discussing what retirement income planning is, three key issues when determining a retirement income plan, how Social Security fits into retirement income planning, and three different approaches to use or consider using when building a retirement paycheck.

Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 250 households in 40-plus states. YFP Planning offers fee-only high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call by visiting yfpplanning.com. Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom.

Okay, let’s jump into my conversation with certified financial planner, Tim Baker.

[INTERVIEW]

[00:01:17] TU: Hey, everyone. Welcome to this week’s episode of the YFP Podcast. We are on our fourth and final part of our series on retirement planning. On episode 272, we talked about determining how much is enough, building that nest egg. Episode 273, we discussed the alphabet soup of retirement accounts. What are the different options or at least the tax favored accounts that we’ll focus on potentially? Then last week on episode 274, we talked about risk tolerance versus risk capacity and determining or beginning to determine our asset allocation plan.

So this week, we’re going to talk about how to build a retirement paycheck. Ultimately, we’re at the point where we’ve accrued that nest egg we established at the very beginning, and the question is now what, right? How are we going to distribute those funds and ultimately replace what was our W2 income and be able to replace that with the various investments and buckets of savings that we’ve accrued over the years?

So Tim, this feels like an overlooked topic and one that is not often discussed. You recently shared with me that, really, up until more recently, it has not even been foundational in the Certified Financial Planner training. So why is that the case with what appears to be such an important topic?

[00:02:28] TB: I think it’s kind of rooted in for a long time, the predominant advisor that was out there was – I’m not going to say an advisor was a broker. So when you work with a financial advisor back in the day, it was kind of more to transact investment trades. So it was you calling your broker and saying like, “Hey, I like this stock,” or, “I like this mutual fund,” or whatever. Like, “What do you think?” Then that would be the exchange. Really, it was more about placing the orders than kind of looking at something more comprehensively.

The problem, though, is that even like in the CFP’s like curriculum, I feel like most of it is really geared around the accumulation stage of like gathering assets, and this is how to understand modern portfolio theory in investment, all that kind of stuff. But it’s kind of like when you get to the end, it’s like, “Okay, now what?” Like, “What do you –” We have these buckets of money that are separated between a Roth IRA a 401(k). You might have money in a pension.

What we’re really trying to figure out is like, okay, how do we convert these pools of money into a steady, sustainable retirement paycheck that’s going to last the rest of your life? It’s really hard to do. It’s really hard to do. Again, like, I’ve worked with firms where the conversation is, “Hey, Tim. You’re the client. We’re going into 2023. What do you need next year?” I think that like if you’re in that relationship of like you’re kind of just advising on stocks or investments, maybe that holds up.

But I think like what we’re seeing, like if I’m the client, the first question I would ask to that question was like, “Well, what can I take?” Like, “What can I take, so I don’t run out of money,” advice. Or like –

[00:04:19] TU: Shift of conversations. Yup.

[00:04:20] TB: Yeah. Tell me that like. It’s nice that – That’s kind of like what we talked about in previous episode is like investments are really important. But I think if you’re working with someone comprehensively, it shifts more to like, okay, what are the investments and less about the tactical and more about the strategic approach of like, “Okay, now that we’ve accumulated all these assets, like how can we do this with the mountain risks that we face?”

Because one of the really hard parts about this, Tim, is like you could live to your 72 or you can live to your 102. We have no idea.

[00:04:54] TU: That’s right. Yeah.

[00:04:55] TB: Without that major variable of like the duration of the plan, which is connected to your life, super hard, right? So I think the industry is changing, where it’s trying to equip advisors with more tools and more education around this shift from the accumulation phase to withdrawal phase and really have meaningful conversations with clients because this is only going to get more important, right? The data says that roughly 10,000, baby boomers turn age 65 every day, and half of them have never really calculated where they’re at with what they need to maintain their lifestyle.

So it is kind of a little bit of like flying by the seat of your pants. Like I said, it’s just a complex thing. If you’re looking at how do we convert assets to income streams while keeping the tax man in mind, and those income streams could be Social Security. It could be working part-time in retirement. How does that affect your Social Security paycheck? It could be distributed money from a 401(k) or a taxable account or a Roth IRA. There’s very strict ways you should do that to maximize your taxes or minimize your taxes, I should say.

It could be a pension or like you convert part of that bucket of money into an annuity, along with – We’ll talk about that more with the flooring strategy. How does your home play a part in this? A lot of people kind of discount the home, even when that’s going to be the biggest expense of any retiree is your home. That’s typically at any phase of retirement, except for maybe like old old, where it might be more of a health – Those people that are kind of 90s plus is more medical expensive.

So it is a complex thing to basically tackle, and you wouldn’t think it would be that hard because a lot of people are like, “Oh, $1,000,000. Four percent, $40,000. We’re good.” Kind of wipe your hands of it, and you’re good to go. But it’s a lot more complicated than that.

[00:06:59] TU: Yeah. I think it’s a good reminder, and I’m glad we’re digging into this topic, really, for the first time in detail. I think we’ve certainly spent a lot of time on the show talking about the accumulation phase. But to your point, we very much tend to oversimplify this, right? You need 3.2 in a nest egg. Or you need – Based on the four percent rule, you can draw so much per year.

Well, what about all the various asset pools that are out there, right? What about your home, whether you’re going to work at all during retirement? How does that impact how and when you withdraw? What about all the tax strategies? What about taxable accounts versus tax-deferred accounts? I mean, just so many different layers to consider here. Then, obviously, Social Security is another one to put on top of that as well.

So important that we’re thinking not only about the accumulation but also what’s the strategy and the optimization. I think this is another great example where like, in my opinion, obviously, bias, like the value of a financial planner is a lifelong journey. So early on, we’re working on accumulation, getting started, really understanding our options and our vehicles, doing it at a tax-efficient way.

Here, we’re talking about a whole another host of things that when you look at advisor fees and other things that are involved, like if done well, the return on investment there is very strong, not only numerically in terms of tax saving optimization, but also in terms of having that third party, having somebody affirming and making sure that you’re feeling comfortable and confident in the distribution of all the hard work you’ve done to accumulate along the way.

[00:08:30] TB: Yeah. I think the big thing that I would say along those lines is that I think the difference between advisors today and then advisors of your, like it’s more of a collaborative process. Before, it might be like, “Hey, what do you need?” Or this is like what you get type of thing. Whereas more it’s coming from like a place of like what’s going on and like what are the things that are going on in your life and then basically constructing that from that approach.

I think it is more of a collaborative approach versus like us saying this is what it is or waving our finger or whatever. So like I think that’s a big distinction to make too.

[00:09:12] TU: Tim, what are some of the key issues? So here we’re talking about retirement income planning. Ultimately, we’re discussing how to build this retirement paycheck. What are some of the key issues that folks need to be thinking about when it comes to building this retirement income and planning for this?

[00:09:29] TB: Yeah. So the three big things that are out there are how do you replace a paycheck with kind of a stable source of income to meet your basic retirement expenses, which, again, can be a tough thing to figure out because you snap your fingers, Tim, and like you’re not going to work. So like how are you spending your day?

For some people, it might be you’re just sitting in a room because your spouse is still working. For other people, it’s like your guys are both retired. So it’s like, “Hey, school’s out.” You’re kind of throwing your books in the air. You’re traveling. You’re dining out. You’re doing all those things that you didn’t do. So like maybe your expenses go up.

So I think sitting down and looking at like what does retirement look like for you and trying to sketch out. We talked about budgets with clients, younger clients, and like they don’t go away like because like a big part of this equation is like how much you’re going to spend. So how do we give you a paycheck that’s going to meet your basic retirement expenses, number one?

The second thing is how do you plan for those one time, large, large expenditures that are planned? So that might be like a car purchase, like big vacations. It could be –

[00:10:42] TU: Second properties, right?

[00:10:43] TB: Second property. It could be paying for a son or a daughter’s wedding. Like those types of things are big. Then the last part is like how do we start to not inoculate but mitigate the risks that you face in retirement. The risks are many. There’s lots of potential potholes that are out there that can trip you up. One is like life expectancy. We don’t know how long you’re going to live. So a lot of people, they base their Social Security decision making on, “Well, my uncle died at this age, and my dad died at this age, and I’m just going to take it,” which is typically not –

Sometimes, it’s advisable. But sometimes, it’s not because the other thing that we have to remember is that in Social Security, your spouse gets the larger of the benefit that you’re collecting. So if I claim early because my life expectancy in my mind is lower, my benefit is going to be reduced. But it still might be better for me to wait and defer, so that benefit grows. So then like maybe I collected for four or five years, but then Shea would get that when I kick the bucket.

So those are things that people just don’t think about. So life expectancy, big risk. Inflation. So sources of retirement income need to increase at the same rate as the cost of goods and services, which right now is tough, right? Because we were seeing a spike in inflation. So how do we combat that, the inflation, and how do we how do we make sure that the – So that’s another reason that Social Security is great because it gets cost of living adjustments every year, most years, that keeps pace with inflation. Most products out there do not. Even if you buy an annuity on the street, Social Security is going to beat that every single time.

The other one is a death of a spouse. So income needs don’t necessarily go in half when your spouse dies. So how do we – Is that looking at things like insurance or second to die policies? The things like that to make sure that you are okay that you had two Social Security income streams, and now you only have one. It’s the greater one. But like how do we plan for that?

Health care. So we know that’s increasing exponentially. How do we plan for that long-term care? So this is the possibility of needing care for those everyday activities like eating and bathing and using the bathroom, those types of things. I think the majority of people, they use family members. But do you buy a policy to help with that?

Investment returns. We talked about, Tim, the stock market is volatile. Fixed income portfolios, which are often retirement portfolios because we want more of that safety in principle, like those things changes over time. So right now, it’s probably good to look at things that have something with inflation tied into that.

Then probably the last one, which I think is the most dangerous one, is the sequence of returns risk. So this is the risk of receiving a lower or negative returns early in your retirement when withdrawals are made. That’s what I talked about last episode. If your portfolio goes from a $1 million to $600,000, and then you’re taking 40,000 or 50,000 dollars a year out of that, it’s almost impossible to overcome both of those.

So that’s where it goes back to like is your asset allocation right when you get into that eye of the storm before retirement. If it isn’t, maybe the hardest conversation that we have to have is like we have to wait for the market to recover because, ultimately, you might have to go back to work anyway if you go out and then you have to go back because we just don’t have enough money to sustain you for the rest of your life.

So those are probably not all of the risks that are out there, Tim, but a good amount of the risk that you’re facing as you’re kind of saying, “Okay, how do I take this pot of money that I have and make it last for the next 30 years or so?”

[00:14:40] TU: Yeah. The example of that last one, Tim, the sequence of returns, I think about folks that have retired in the last, what, 12 to 24 months, right? If there wasn’t kind of a change of asset allocation in the eye of the storm, as you talk about. Some folks might be feeling that in the moment, right? I saw the portfolio drop significantly, and maybe that did or did not change. If they had more than enough saved, maybe that didn’t matter as much. But maybe that means going back to work for a little bit of time or elongating the timeline to retirement.

Again, so important that we’re really planning this from beginning, all the way through the actual withdrawal phases.

[00:15:15] TB: Yeah. One thing to note is that sometimes this is out of your control, like when you’re going to retire. Sometimes, it’s like –

[00:15:22] TU: That’s right.

[00:15:23] TB: When there is a downturn in the market, it’s also because the economy is bad. So companies could be looking to either get you out the door or force retirement, and that can be really, really bad for your – I talk to my dad a lot. Like his company was bought by another company, and he was kind of winding down. But he was not ready to retire yet. But he was kind of duplicitous. They’re like, “Hey, you’re kind of on the chopping block here.”

So that is the other thing is like sometimes we assume. Just like what I was talking about, some people assume they’re going to die early, so they take – Most of the time, they like outlive what they think. But the other part of that is we assume that like when I asked you the question, “Hey, Tim, like when do you want to retire,” and you say, “Hey, I will retire at full retirement age.” For us, it’s 67. That that’s actually going to be an option.

[00:16:12] TU: In our decision, right? Yup.

[00:16:14] TB: Yeah. Sometimes, it’s either because of job, or it’s because of the health of yourself or a family member that causes you to retire earlier than you expected. Something like 40% of people kind of fall into that bucket.

[00:16:29] TU: That’s a good point and a good reminder. Before we get too deep into talking a little bit more about Social Security and then specifically three different approaches and strategies to build your retirement paycheck, I want to reference folks to a resource that they can use to download, follow along with some of the discussion, as well as provide some other information. That resource is What Should I Consider Before I Retire. It talks about some of the considerations around cash flow, assets and debt, health care and insurance, tax planning, long-term planning, and other topics as well. You can download that at yourfinancialpharmacist.com/retire. Again, yourfinancialpharmacist.com/retire.

Tim, we can’t go too far into this topic without talking about Social Security. You’ve dabbled in it a little bit already. We talked about it in episode 242, which was Social Security 101, history, how it works, why it matters. One of the most common questions for good reasons is when. When should I begin to withdraw or begin to have access to Social Security? We all know. We’ve heard it before that the difference is significant between if we take it early at 62 or we wait until the age of 70.

So give us some more information here on why this is such an important topic, what the differences can be in those numbers, and obviously the role that Social Security can play and will play likely in building retirement paycheck.

[00:17:47] TB: Yeah. I would even back up before we even talk about that, Tim, because I think it’s going to play into this. I think it’s kind of like people want to talk about like, “Oh, what do you think about this like stock or this investment or whatever?” I’m like, “I don’t know. Where are you at? Where are you going?”

So I think the first thing, even before we talk about Social Security, is to take stock of those two things. Where are we at, and where are we going? So like, to me, I think the two biggest things to look at, and Social Security is part of this, is look at your Social Security statement. I’ve done this recently. You can go on to socialsecurity.gov and put in your Social Security number and create an account. It’ll basically pull up your benefits estimate. So like it’ll say – Like for me, if I retire early, like this is the benefit that I get, 2,200 bucks. If I retire at full retirement age, for me, it’s 67, my benefit’s 3,300 bucks. Then if I wait till 70, which you get deferral credits, 4,220.

[00:18:54] TU: Wow, big difference.

[00:18:55] TB: Yeah. Socialsecurity.gov is actually pretty – They have some good calculators and like – So it’s pretty decent. So I would say like take stock of where you’re at, which means looking at the Social Security statement, looking at your cash flow statement, i.e. budget, like what’s that look like? Then the big one is the net worth statement. So what are the assets? What are the liabilities?

From there, I think we have a conversation of like where are we going. I think that’s like when do you want to retire. Some people might be like, “I want to work forever.” Some people are – They’re like, “Now. I want to retire now. I’m 45. I want to retire now.” So I think going through some of those exercises, like I’m a huge proponent of life planning. It’s like changed my life. But actually sitting down – I think so much of the emphasis on retirement is kind of this oasis of like, “I’ve made it. I have some type of financial independence. My calendar is back, and it’s like this destination.” But it’s really more of an ongoing journey of, okay, so you wake up. The retirement party’s over. You just got back from your Hawaii trip to celebrate your retirement. What are you doing? Are you by yourself? Is your spouse still working? Like how are you spending your day?

So actually write down like what is an ideal schedule. What are the things that are still on your – Things that if you were to die today or tomorrow that you have left undone. What are the things that you’re passionate about? So sometimes, unfortunately, our passions might not necessarily align with like our ability to earn and make money. So sometimes, those things are left for retirement to say, “Hey, I always want to volunteer to do this,” or, “I always wanted to help kids here,” or whatever.

So I think really having a plan for that. Because to be honest, like the finances are almost – They’re not almost. They are. The finances are secondary. The financial plan in retirement is secondary to like the life plan in retirement because so much of our identity is tied up in our job as director of pharmacy here or pharmacy manager or whatever it is. That it’s hard for us to like wake up one day and be like, “Okay, I’m not that person anymore.” Well, you are that person. You’re just not working in that job anymore.

But it’s even hard for spouses too because so much of your time is at work, right? So kind of to relearn and do – That’s a real thing. A lot of retirees struggle with addiction, with depression, with kind of like a loss of sense of self and things like that, that I think needs to be addressed. More and more people are talking about this, which is good. So I think like once you get an idea of like, “Hey, where are we at numbers wise and like where are we going life planning-wise,” then I think it’s really important to start getting to things like Social Security and claiming strategies and things like that.

So to answer your question, Tim, I think that it is one of the most important, if not the most important, decision that you make in building out your retirement plan. Actually, Morningstar did a study that said that – So I think it was based on working with an advisor. It helps you with better decision making can increase your retirement income by 37%. Nine percent of that, which is the highest one, was the Social Security claiming strategy. Of the 37%, 9% of that was that alone.

You could see, when I rattled off my numbers, 2,200, 3,300, 4,200, that’s a huge difference. For so many people, for a long time, they’ve looked at it as like a breakeven. So they say like, “Okay. If I take 2,200 versus the 3,300, then I have to live to this age to breakeven on what I would be given up.” The problem with that is that the biggest risk that Social Security combats is longevity, meaning that your money doesn’t run out. So if a good chunk of your income is coming from Social Security, which gets cost of living adjustments and never runs out because it’s backed by the full faith and credit of the US government, like that’s huge.

It really doesn’t matter if you leave some money on the table. But even in most cases, that calculation is typically early 80s for a lot of people. So unless you are thinking that you’re going to live less than that, and you don’t have a spouse because we talked about the spouse gets the higher benefit, then maybe you look at that. But it really needs to be looked at from I think more of an insurance. Like a safety perspective is when you’re looking at that.

As we said, 78% is basically the amount of your Social Security benefit increases each year from age 62 to 70. So what that means is that every year you defer, you get a 7% increase, a raise in your retirement paycheck. So if you think about that as a working person, if I can lock in seven or eight percent as a raise for eight years, like that’s huge. But for whatever reason, we look at this as like, “If I don’t take this as soon as possible, I’m going to lose out. I’m not going to get the money back.” I think it’s a framing of the decision that we have to relook at.

So I think the big thing here is like it’s kind of getting away from the water cooler. I think a lot of people claim benefits as soon as possible. I think it’s sometimes greatly influenced by family members, coworkers. It’s the same thing we say with like student loans, where people are like, “Oh, my classmates are doing this.” I’m like, “You’re not your classmates. You have your own financial plan. You do you type of thing.”

Sources of income in your retirement paycheck do not have an inflation protection as Social Security does. So that’s also hugely important, especially in the times that we’re living in right now. So I think the steps to optimize your claiming strategies, one is to educate yourself. Determine what your benefit is and the implications of claiming at different ages, which means pulling your statement.

I think that before you even get there, Tim, this is kind of in the get organized of like where are we at. One of the things that you’ll see on your statement is like all of your years. So it looks at 30 years, 35 years, I should know this, of earnings. You can actually say like, “Okay, this is right or this is wrong.” So if you have a beef with what they’re reporting, then you can basically say, “Hey, let me pull my 2008 return.” I can say I actually didn’t make 100,000. I made 150,000, and that will change your benefit. So that’s also a big thing.

Then take the steps to figure out what is the best solution for you in terms of claiming, and that’s going to be so huge with kind of a jumping off point of how you’re going to build your retirement paycheck.

[00:25:34] TU: Tim, can you read your numbers again? I think those were really powerful. So you gave the early full retirement. I’m looking at mine as well, but they’re skewed a little bit because I worked at universities for a while, where I wasn’t contributing to Social Security, so much lower. But you gave your early number, your full 60 to 67. Then you’re delayed. What were those numbers?

[00:25:52] TB: So my early at 62 is $2,211. If I were to wait until my full retirement age, which for me is 67. Anybody that’s born after 1960, I think, the benefit goes to $3,325.

[00:26:15] TU: So almost a little over 1,000 more. Okay. Then what about 70?

[00:26:18] TB: Then at age 70, the benefit goes to $4,220, and there’s no benefit to defer past that. That’s the range, so again – It’s getting better. People are most – You can see like people are delaying claiming now, which I think it means more people are educated about this. But I think for a majority of the people that are out there – Even if I don’t work, my plan is to not to claim Social Security until and unless barring some unforeseen things, is I’m going to be claiming that 70, and I’m going to collect – Again, this will change between now and then because my earnings will change.

[00:26:58] TU: Numbers will change. Yup.

[00:27:00] TB: But you can see the impact is huge. Again, the other thing to remind ourselves is that this is inflation-protected. So at the end of this year, retirees are going to get a major bump in their retirement paychecks because of how inflation has been this year. Whereas if you buy a commercial annuity on the street, so you say, “Hey, I’m going to take $200,000, and it’s going to be paying me a paycheck,” you might get some type of like 2% or 3%, which you’re going to pay a lot of money for.

[00:27:30] TU: I get 9%, though, when inflation’s up.

[00:27:32] TB: No, new. So that is off. That’s another thing. Again, it doesn’t really hit home for a lot of pre-retirees or even before that because like the world is your oyster, right? Like when you’re accumulating, you can always earn more money. But like for retirees, especially if they can’t work, which it’s a fixed income, so if you can make a greater percentage of your retirement check Social Security that is inflation-protected, it’s just going to greatly improve your longevity. To mitigate longevity risks in the money running out.

[00:28:12] TU: So in your example, there’s round numbers, about $2,000 difference between your early and your delayed, 62 and 70. So just some rough math. So $2,000 a year, I’m looking at eight years difference between 62 and 70. So basically, if you were to take it at 62, by the time you got to 70, there’d be a little over 16,000, 17,000 dollars that you wouldn’t have otherwise had if you delayed, right?

Now, if you wait and delay till 70 and it’s 2,000 extra per month, you can kind of see the math there of how many years it’ll take to essentially breakeven, right? Now, what we’re not including there is, obviously, the inflation component. Someone could argue, “Hey. Well, there’s an opportunity cost. If you pull money earlier, you could do other things with those.” But again, it goes to really show the difference and how if we’re planning early on, as we’re working on our nest egg kind of coming full circle where you started the series, if we’re planning for a delayed withdrawal from Social Security, well, then we’re going to be able to mitigate that feeling or need at 62 of, “Hey, I’ve got –” Or whatever the age would be for individuals that I got to have this money at this point in time.

[00:29:21] TB: Wade Pfau, who is the professor of retirement income at the American College of Financial Services, one of the things he stated, because I’m going through a certification for retirement income certified professional, his quote is, “Deferring Social Security is the cheapest annuity money can buy.” So he’s done that study, where from 62 to 70, and then if you take that money and you were buying annuity, like it’s not even close. So you could do it like, hey, if you were to invest this for eight years, but it’s not even close like to basically do a one for one if you were to buy like an annuity on the street.

That’s the big thing here because, again, if you put the money in the market, if you’re putting into an S&P 500, you’re risking that money, and it goes back to the sequence of returns. If you’re eight years and you needed that money, it’s going to be very, very conservative. You’re not going to be able to get the return. So you’re talking about a seven to eight percent raise for yourself year over year, and that is also inflation-protected, which is huge.

Again, like one of the things that we should address is that if you’re a 30-year-old or even a 40-year-old, a 20-year-old, and you’re saying, “Social Security, I get it,” it’s going to be there. Social Security, I think, is one of those things, and I hate to say this, but it’s too big to – It’s not going to fail because so many people rely on that as their every day. So there’s a lot of things that says like the trust will be depleted. But you’ll still be able to sustain payouts at a reduced benefit.

I think that’s what’s going to happen. I think people – I think the Congress is going to be forced to raise like payroll taxes to fund the trust. But I think that we’re also going to either see a step back in benefits in some way or

[00:31:00] TU: Yeah, combination. Yeah.

[00:31:02] TB: But at the end of the day, even a reduced version of Social Security is still going to be your best. I’m still going to encourage to – If your retirement paycheck is 1,000 bucks theoretically, I still wanted that to be – If we can get that to be $400, $500, $600, the most of that paycheck needs to come from Social Security because of its safety and the inflation protection.

[00:31:27] TU: Yeah. Again, when you’re working with someone who kind of is helping you build the next egg, you can run it with it. You can run it without it. You can run it in a middle ground, to your point. So maybe it’s not the full benefit or numbers we’re seeing there, but we think it’s a reduced amount and kind of see how you feel with what shakes out in terms of whether you’re on track or not and what you need to do.

[00:31:47] TB: Well, one last point to make about Social Security is really looking at this as an insurance decision versus like an investment decision. So typically, like wealthier people or people that don’t necessarily look at or need Social Security, they look at it more as like, “Okay, how do I get the most out of my money?” Most of the times, they’re going to defer. But for a lot of people that are really relying on this to make sure that their retirement paycheck is sustained for at least 30 years or their lifetime, it needs to be looked at as an insurance decision.

If you look at the different risks like longevity risk, which is the risk of your money running out, the larger – This is a larger stream of lifetime inflation-protected risk. Like that’s important. Long-term care risk, so you have like more resources later than life. So if you’re getting a bigger paycheck, so if I’m getting 4,200 at 70, versus if I would have taken the 2,200 at 62, that means I have to deplete my portfolio more later. Inflation. We talked about the larger percentage that’s protected by inflation.

The other big thing is reality risk. Like as you get older, if a majority of your paycheck is just coming straight from the government, it simplifies decision making. You’re also less at risk for like elder financial risk, which is you want to have a greater stream of income. It’s more about income streams versus assets. You have less opportunity for people to defraud you. Unfortunately, like financial advisors are top. They’re not top of the list. Actually, family members are at the top of the list for that.

But the big thing is like excess withdrawals. So like if your greater paycheck is coming from Social Security, you don’t necessarily are going to deplete your assets faster. Eliminate some market risk because, again, you’re not relying on your assets as much. Then that whole risk of like early loss of spouse, deferring that larger benefit that then your survivor would get.

So in the case of like, Shea, let’s say Shea has a benefit that’s $2,800, and I claim it 2,200 because I feel like I’m going to, I’m going to pass away early, that’s a big mistake because she is stuck with her $2,800 because my 2,200 is less, whereas if I were to defer and say, “At 70, I’m collecting 4,200.” Then even if I die at 78, she gets the 4,200, and then 2,800 goes away. Those are some of the things that we’re talking about in practice. It just makes sense to really look at this closely before kind of just doing whatever your coworker is doing.

[00:34:14] TU: Great stuff, Tim. We’re going to come back to this topic more. We’ve touched on it here. We talked about it previously in episode 242. But, man, there’s so many layers of Social Security to consider, and I think regardless of where someone is at in their career journey, an important topic and part of the financial planning that probably doesn’t get enough attention. Or it maybe just prematurely gets kind of ruled out, especially for folks that are early on in their journey.

Let’s wrap up this series and this episode by talking about at a high level the three approaches to building your retirement paycheck. I love when you talk on this topic because I think we’re starting to get a little bit more granular on how are we actually going to build this retirement paycheck. How are we going to produce this income? We all are familiar with the W2 income, the paycheck we get it once or twice a month. Now, we’ve got to find a way to build that same type of paycheck in retirement.

So Tim, walk us through three approaches, certainly not the only ones that are out there, but three approaches to building the retirement paycheck.

[00:35:11] TB: Yeah. So the three are going to be the flooring strategy, the bucket strategy, and the systemic withdrawal strategy. So to start with the flooring strategy, so it’s probably going to be the most conservative approach of the three. Critics of this approach will say like, “I don’t want to survive. I want to thrive.” But what the flooring strategy does is it builds an income floor to meet essential expenses with things like Social Security or like an annuity. So the essential expenses might be housing, food, gas, utilities, medical expenses, insurance, maybe debt.

So that is basically – If we determine that those expenses are, say, $5,500 a month, and we know that Social Security is going to pay us, say, 3,500, then we need to buy, essentially, like an annuity. So think of an annuity as like a private Social Security. So you give an insurance company a sum of money, and then they’re going to pay that back. Usually, it can be for a term certain, but it’s usually for the rest of your life. So you would buy a stream of income to make up the rest of that floor. So that if something were to happen, you always have the essentials met.

Then the discretionary expenses, there are things like travel and gifts and dining out and entertainment and hobbies, are then basically funded by the portfolio. So you have $2,000 a month of discretionary. Then that money would basically come from the portfolio or could come from like part-time work or something like that. So the flooring strategy is for those that are very conservative, and they want to ensure that for as long as they are alive, they have money to basically keep the lights on and feed themselves. What that typically takes, which is hard for a lot of people, is parting with potentially a good chunk of your income.

If we use this example, and I don’t know what it would take to get $2,000 worth of income, but say you have a million-dollar portfolio, and you get $2,000 worth of income based on your age, your gender, maybe to part ways with $300,000 or let’s say $300,000 that all of a sudden, you wake up one day, and you have the income stream. But your million-dollar portfolio is now $700,000 that you’re now drawn on for those discretionary expenses. Now –

[00:37:28] TU: You’re trading some of that nest egg for an income stream. Yeah.

[00:37:32] TB: Exactly. Now, psychologically, they say that that’s tough to get over that hump. But it’s a lot better to do that, versus someone who is in a systematic withdrawal strategy. We will talk about it. That’s drawn down every year. Their portfolio is going down and down and down most years. So just to have that paycheck coming in is from a mental perspective good.

Now, the bucket strategy is essentially where you set up separate pools of investments with the lowest risk investments in the near term time horizon or segment. Then you have like a middle bucket and then a longer term horizon bucket. The idea is that you would say, okay, bucket one is going to be funded with X amount of dollars, and it will say it’s like five years of spending. So it might have $250,000 in there that is going to be super conservative, and that’s going to be with cash, things like tips, which are inflation-protected bonds, a bond ladder, whichever year creates some type of income for you.

Then the medium term bucket is going to be more moderate. So that might be for like a 6 to 15-year time horizon, and that could be in like income stocks or like utility stocks and maybe some bonds. Then you have a 15-plus year bucket. That might be the balance of your portfolio that’s more aggressive. So that’s going to be more growth stocks and things like that. The idea is that once the first segment is depleted, so that zero to five-year bucket, that $250 is spent over five years, then the bucket two kind of replenishes bucket one, and then bucket three kind of replenishes bucket two. There’s lots of different rules that you can put into place of how you do that.

From a conceptual perspective, one of the advantages of this is that clients are like, “Okay, I get this,” and like, “All I’m really worried about is like do I have enough money in bucket one,” and knowing that, although like the market can be crazy, and bucket three is not good right now, I’m not going to touch that for another 15 years. So it’s a way to kind of bucket or segment different money for different purposes. This is one that a lot of advisors use.

Probably the predominant one is the last one, is systemic withdrawal strategy. So this is based on essentially the work of William Bengen, who researched the all 30-year time periods, and he gets the 4% rule. So the idea here is that you look at your portfolio balance. You look at like what the market – How the portfolio performed and then inflation. Then you essentially – Like if you start the first year and you say, “Okay, it’s a million dollars,” and you get $40,000. Then that year, the market returns 6%, and inflation was 2.9%. Based on those inputs, you then adjust the paycheck, the $40,000 for the next year.

So you might say when the market is up and inflation is moderate, then you basically give yourself a raise with maybe some caps. If the market is down and inflation is such, maybe you freeze it. Or maybe you actually reduce spending. So it’s a very rule-based way to kind of use the 4% rule as a guide. But to work dynamically year to year with the portfolio and with the market factors that are inflation and those types of things, to make sure that year to year, you’re given the client a paycheck that is sustainable for the longevity of the retirement period.

Again, there’s a million different ways to kind of skin this as well. But the idea is that you’re working more dynamically with market forces, and it’s based loosely on the 4%. Now, a lot of researchers have said that like the 4% rule won’t necessarily hold up in the future because of when that was done, you have low inflation and really high equity valuations. So that’s important to take note of. Although he did his research, it’s not necessarily indicative of what’s going to happen in the future.

So you have the flooring strategy, you have the bucket strategy, and then you have the systemic withdrawal strategy, are kind of different approaches on how to build out their retirement paycheck on a year-to-year basis.

[00:41:35] TU: Tim, great stuff. I’m just reflecting on the journey we’ve come over the last four episodes, and we’re going to dive into all of these topics in further detail on future shows. We’re going to be doing webinars. We’re going to have blog posts. Make sure to check out information at yourfinancialpharmacist.com.

We understand the needs that are out there around retirement planning, wherever someone is at on their financial journey, a new practitioner midcareer, pre-retiree, or those that are even in retirement. So whether you have yet to work with a planner, and this is an opportunity to do so or perhaps you’re working with a planter but are wondering what might else be out there and interested in a second opinion, we’d love to have an opportunity to talk with you in terms of learning more about the one-on-one comprehensive financial planning services that are offered by the team at YFP Planning.

We’ve got five certified financial planners and in-house tax team. That includes a CPA and an IRS enrolled agent, soon to be two IRS enrolled agents. So we’d love an opportunity to learn more about your financial goals, learn more about your situation, and determine whether or not those planning services are a good fit for you.

You can learn more and book a free discovery call at yfpplanning.com. Again, that’s yfpplanning.com. Thanks so much for listening to this series, and we hope you have a great rest of your day.

[END OF INTERVIEW]

[00:42:47] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 274: Risk Tolerance vs Risk Capacity (Retirement Planning)

Posted on by yfpadmin

Risk Tolerance vs Risk Capacity (Retirement Planning)

In part three of the four-part series on retirement planning, Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, explain why it’s critical to evaluate how much risk you are able to stomach versus how much risk you should take to achieve your long-term savings goal and considerations for setting asset allocation in alignment with your risk capacity.

Episode Summary

YFP Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, explain the difference between risk tolerance and risk capacity in this episode, the third part of the four-part series on retirement planning. Tim and Tim explain why it’s critical to evaluate how much risk you can stomach versus how much risk you should take to achieve your long-term savings goal, and considerations for setting asset allocation in alignment with your risk capacity. Tim and Tim break down some strategies to employ when your risk tolerance and capacity are not in alignment. They connect the topic of the retirement nest egg to asset allocation. What we determine we need for the nest egg, combined with risk tolerance or risk capacity, will guide asset allocation. Tim Baker shares the value of a financial planner as an objective third-party in making retirement planning decisions, explains how preconceived notions about money impact the financial plan, and mentions early and ongoing financial literacy to increase risk tolerance. The five to ten years leading up to retirement can be a period of uncertainty, and Tim and Tim explain the sequence of returns risk during that time frame. They close with a reminder to revisit asset allocation percentages over time to maintain the amount of risk initially planned.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey everybody, Tim Ulbrich here and thank you for listening to The YFP Podcast, where each week, we strive to inspire and encourage you on your path towards achieving financial freedom.

On this week’s episode, Tim Baker and I continue our four-part retirement planning series by discussing the difference between risk tolerance and risk capacity, and how this impacts your asset allocation plan. Highlights from the show include why it’s critical to evaluate how much risk you’re able to stomach, versus how much risk you should take to achieve your long-term goals. discussing strategies to employ when your risk tolerance and your risk capacity don’t jive and some considerations when setting your asset allocation plan to be in alignment with your risk capacity.

Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one on one with more than 270 households in 40 plus states. YFP planning offers fee only, high-touch financial planning that is customized to the pharmacy professional.

If you’re interested in learning more about how working one on one with a certified financial planner, may help you achieve your financial goals, you can book a free discovery call by visiting yfpplanning.com. Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission on how pharmacists achieve financial freedom.

Okay, let’s jump into my conversation with certified financial planner, Tim Baker.

[INTEVIEW]

[00:01:25] TU: Welcome everyone to this week’s episode of the YFP, podcast excited to have Tim Baker alongside me again as we continue our four-part series on retirement planning. On Episode 272, just two weeks ago, we talked about determining how much is enough when you’re saving for retirement. Last week, episode 273, we talked about the alphabet soup of retirement accounts with a focus on those tax advantaged accounts. In this episode, we’re going to focus and dive into further on how to differentiate risk tolerance versus risk capacity, which ultimately leads to how the funds are going to be allocated within your various accounts as you’re putting together your savings strategy, also known as asset allocation.

So, Tim Baker, let’s start with why this topic matters and the connection to the nest egg ultimately, that folks may need to take just about the risks they think two or perhaps even more or less.

[00:02:18] TB: Yeah, I think this is one of the probably the most important concepts to understand. Because I think once you understand it, it’s kind of the easiest thing to adapt to better improve your financial situation, especially for like long term investment for the sake of retirement. So, I think a lot of people leave a lot of meat on the bone with regard to opportunity to improve their financial planning, because they either lack the experience or they don’t understand it, or it’s scary. But I think understanding this concept between what your risk tolerance is and what your risk capacity is, and then adapting that to your portfolio is huge. Again, we’ll kind of talk about conservative Jane versus aggressive Jane and really, all of the factors that are involved in that. One of the easiest ones to kind of change your dial up has to do with risk and ultimately, your asset allocation, which we’ll get into today.

[00:03:08] TU: Yeah, and I think this is a topic, Tim, where like, just being honest with yourself and having some self-awareness on how do I feel about the risk that I’m taking. Obviously, we’re going to talk about the importance of putting that alongside of your goals, do those jive, do they not jive. And I think this is really where the value of a third party can come in as well, when you’re looking at whether it’s one individuals, two individuals doing the financial plan, but often we might need to be both pushed and or held accountable. Obviously, an objective third party can play a really valuable role there.

So, I think we’ve all been told before, at some point or another that, hey, we’ve got to take some risk, if we’re willing to achieve, those big lofty, long term goals that we have. We talked about in episode 272, we need this big number 2, 3, 4 or $5 million, that seems way off into the distance, or perhaps for folks that are a little bit closer to that, not so far off in the distance. But regardless, it can feel overwhelming. And so, we’ve got to take some risk to get to that goal. But I don’t think we often differentiate this concept of risk tolerance versus risk capacity. So, Tim, let’s start there, break these two down in terms of definition of tolerance versus capacity.

[00:04:16] TB: Yeah, the tolerance is what we’ll start with, and this is typically the one that most people understand and know about. When I think of risk tolerance, I think of like the questionnaire. So, probably a buyer’s perspective, one of the things that we need to do to make sure that we’re doing our due diligence with a client is to ask them some questions about their experience, their outlook on the market, their understanding of how stocks and bonds work. If x loss, how they would feel about x loss or x gain and what their actions would be.

So, it’s really based on a questionnaire. From the advisor perspective, it’s really based on what we think the client can handle in a down-market. So, we’re trying to build out the best, and again, what we’re trying to do here, ultimately, is to get the best possible return for the least amount of risk, and that’s what asset allocation is. So, from the investor’s perspective, or in our case, the advisor or the client’s perspective, it’s the amount of risk that you want to take. It’s more of an emotional thing.

To me, that is basically the starting point for the conversation at least. And there are a lot of ways to get about, like what your risk tolerance are. So, one of them is kind of the rule of thumb, and I think I misspoke on a couple episodes back when we talked about this, because I think they’ve actually adapted it, the general rule of thumb. So, the general rule of thumb is that, to get your risk tolerance, you take 110, and then you subtract out your age, and then that gives you the amount of stocks or equities that should be in your portfolio.

So, if you’re 30 years old, 110 minus 30, you should have an 80% of your portfolio in stocks, or equities, and then the remaining 20% in fixed income or bonds. I think that that is a terrible rule of thumb myself. I think that’s a rule of thumb that doesn’t like necessarily hold up. But it’s what a lot of people use to kind of get started. The other way is to kind of go actually go through like a risk questionnaire, and I know Vanguard is one that – you can do that for free, go to their website and basically answer a few questions and it says, “Voila, you are 60/40, or you’re 70/30”, whatever that is. And I would actually start there before using any rule of thumb.

So again, the risk tolerance team is basically what we think you can handle on a down-market, or what you think as a client, you want to take. It’s more of an emotional thing.

If we shift over to risk capacity, this, from an advisor perspective is based on what you can actually handle on a down-market. So, this is actually using some numbers and looking at time horizon, and things like that. So, from your perspective or the investor’s perspective, it’s how much risk you should take. It’s more objective, and factors, and savings rate, goals, time horizons, think things like that. Again, it goes back to that amount of the risk that you can handle.

To give you an example of a risk capacity, versus risk tolerance, say we’re both 40-year-old pharmacists, and me close closer to you, and I’m not a pharmacist. Say, we’re just –

[00:07:23] TU: Coming up. It’s coming up.

[00:07:24] TB: So, if we both take a questionnaire, you could take that questionnaire and be a very savvy investor, have read up on the topic, and you can come back with a very, say, aggressive allocation for where you need to be. And I could do the same thing and come back very, very conservative. So, I could be a 50/50, you could be a 90/10. That’s risk tolerance, is basically based on our inputs in a questionnaire. For risk capacity, it does have to do with the individual itself, but it’s really about, I think, kind of where you’re at in life as well. So, in the same breath, if we’re both 40 years old, and we have 25 years left in the workforce, and we both kind of have the similar amount saved or earning potential, our risk capacity is so much higher than, say, my risk tolerance because I’m scared of the market, because I just have a longer time horizon.

So, where risk capacity is typically the lowest is right at the point of retirement. Because that is typically your longest time horizon, where you have a fixed dollar amount, i.e. your nest egg to work with. So, you just don’t have a lot of room capacity to take a lot of risk. You have to be somewhat conservative. Whereas if you have a longer time horizon, you have good earnings, a good savings, your capacity is a lot, a lot more. Maybe a convoluted way to say it, but to recap, tolerance is kind of like what you feel or like what you want to take. Risk capacity is what you can or what you should take. One of the things that often happens in this, is that those two things are not often equal. So, what we do as a third party is kind of have a conversation about this, and educate a client and sometimes that is over years, because sometimes they’ll say like, “Hey, Tim, I understand what you’re saying, but I just want to be safer.” I’ll say, “Okay, I’m going to bug you about this again.” The next time it’s like, “All right, well, my head didn’t fall off when the market went down 20%. It’s doing what it’s doing. Maybe I’ll be a little bit more aggressive.” And I think that is all the difference when it comes to long-term investing, is making sure that you are – again, you keep expenses low. We’ve talked about that numerous times with regard to your investment portfolio, but your asset allocation, which is based on your risk tolerance, and your risk capacity is set where it needs to be and then the big proponent of that.

[00:10:00] TU: Yeah, this is Tim, where I think the rubber meets the road of what we started this series on, with the nest egg calculation and looking at how much is enough, right? Because you and I could punch numbers in a calculator, or like, “Great, we need 4.2 million 3.7”, whatever the number is, but then we start to get a layer deeper. We talked about the tax advantaged accounts of how we might get there. But the next layer of which we’re getting into today is really that how are we going to invest within these types of accounts, which is the asset allocation. Which, as you just mentioned, comes down to, ultimately our risk capacity and the potential friction that may or may not be there with the risk tolerance.

So, I think that my question here, let’s lean into that situation where there’s a disconnect, where there’s a rub, where I understand what you’re saying, risk tolerance is what I’m able to stomach, risk capacity is maybe what I need to be able to do to get to that nest egg number. So, let’s say I punch in my numbers in the nest egg, they come out at $4.2 million, but then I realized, like, based on the rate of return and the level of aggressiveness that, those numbers are determined upon. I’m not comfortable with that. So, play that out. Is that a scenario where, as you just mentioned, we’re kind of working towards this and getting more comfortable in the long run? Is it adjusting down that nest egg goal? How do you begin to work through this with a client?

[00:11:20] TB: Yeah. The nest egg is a multivariate problem. So, the two defaults that I would always go to is like, if you’re not comfortable with taking more risk, and again, I would say, investing is definitely risky. Of course, it is. But what I would say over a 20 plus year time horizon is actually fairly predictable. We have enough data points that says that the US market, and again, there’s not necessarily any – it’s not past performances are indicative of future performance. But I think we’re not gambling here, we’re not speculating.

So, we’re not taking a bet all on like one stock. But I think if you’re uncomfortable with that, I think, the second thing I would say, is you have to save more though, you have to invest more. When we talked about conservative Jane versus aggressive Jane, and we kind of said, “Hey, conservative Jane, she makes $120,000. She gets 3% cost of Living raises, she saves 10%. She has a 30-year career. And then this is her nest egg.” What’s your income? What’s your cost to live? What do you actually save? And then the time horizon, 30 years. So, the other thing that you could say is like, “Okay, well, maybe we’re not retiring at 65 in 30 years. Maybe we’re retiring at 70.” So, it’s a 35-year career. And that’s the thing is like, you can always work longer.

One of these things have to give, and that’s why I say like, the easiest thing for me, is to say like, “Look, if you’re 30, 35, 40, even 45, and you have 20 years, left until retirement, who gives a crap if the market goes down in 2022?” But, we as humans, we feel that loss, we’re like, “Man, my portfolio was $200,000 or $20,000, and now it’s $140,000 or $14,000.” You feel those losses. But again, this goes back to like what I was saying, it’s hard for us to conceptualize time, and when the market went down during the pandemic, I don’t even think about that and a lot of people freak out about that. But we know that the market is going to do this, and this is like on a podcast, I’m just waving my hand up and down like a roller coaster. But typically, it’s going in a positive trajectory. You’re just going to have some of those ups and downs.

What I would say is that, if you can stomach those ups and downs and lean more towards equities, you’re going to be better off. I think what people do is they put more bonds or fixed income in their portfolio, to smooth out those rides, even those rides are still the same. But what they do is they make themselves feel better in the near term, at the behest of like long-term performance.

So, on the other side of this, Tim, is like, if we’re talking to the pre-retiree, the person that’s going to retire in the next five years, sometimes you look at that portfolio, and it’s looking at him like, “Whoa, we’re taking way too much risk.” Because if the market does go down 40%, then we don’t have enough time to recover from that. So, it’s really indicative to like, say, “Hey, I’m glad you took risks throughout your working career. But now we got to start protecting the principal.” And this is where you probably want to be the most conservative with your portfolios is kind of that right in the eye of the storm, which is 5 to 10 years plus or minus, your retirement date. And people get that wrong, too. That’s where you almost – you’re at risk for like sequence of return risk, which means that if the market is down, say 20%, 30%, 40%, and then you’re taking 40 or 50 grand out of your portfolio to live on, the failure rate, meaning you’re going to run out of money is so much higher than anything that you could be doing leading up to that.

So, it’s really, really important to know where you are in space and time, and ensure that your portfolio is positioned in a way that’s going to, one, get the best returns, but also protect you. For a lot of us, it’s kind of not knowing. And I would say it’s one of the major missteps that I see, looking at people’s portfolios is a misalignment of that.

[00:15:31] TU: Yeah. Tim, one of the things I’m sensing, at least anecdotally, and talking with pharmacists, about this in various settings, is that the mid-career pharmacist, so I’m thinking about the group that is maybe 10 to 25 years into their career, they’re not yet feeling the retirement date right around the corner, but they’re certainly past kind of the early part of their career. I think there’s a real risk here, as you highlighted. Some of the limitations of the rule of thumb, to get too conservative too early. And I think, in this moment, we’re in a period of volatility right now in the markets. And depending on when people graduated and started investing, this might be the real first significant downturn that they’re feeling in the market, right? You look at even some of the start of the pandemic. That was very short lived. It was significant, to drop. But it was pretty abrupt and recovered quickly.

So, I think this is really – I graduated in 2008. I’ve talked about this on the show before. This is the real first test for me in my portfolio to say, “All right, am I really adhering to my asset allocation plan and what I need to be doing, and the rub potentially the tolerance capacity.” And I think it’s different than a new practitioner, because you have worked hard for 10 or 15 years, you have built up several $100,000 or more of savings, and you’re looking at this saying, “Man, this hurts in the moment.” But if we’re looking 20, 30 years into the future, as you said, over and over again on the show, the worst thing we can do is buy high and sell low. So, the third party here, I think, it’d be really helpful making sure we have a plan to kind of weather the storms. But I specifically am thinking about that mid-career group right now, in this period we’re in of volatility, and they’ve done hard work, they’ve built up some savings, and this might be the first test, of that happening.

[00:17:12] TB: Yeah, I mean, and when those numbers get bigger, you feel that even more, right? I’m human. When I do catch a glance at my portfolio, I’m like, “Oh, is this really?” But I had to step back and look at the long term. I almost have to like detach myself emotionally from it. Because what happens, and I say this all the time is like, when the market just does this, and it’s just a downward plunge, your first reaction is you want to take your investment ball and go home. You don’t want to play anymore. Oftentimes I say, is like, you want to do the exact opposite of how you feel. So, that’s when I reassure myself and I say, “Hey, Tim, you know what, you are putting in x amount of dollars into your 401(k) at every pay period. And now, what you’re buying with those dollars is going. It sets the dollar cost averaging.” So, when it’s up, I’m not buying as many shares, but I’m still like, patting myself on the back, because I’m like, “Yeah, my portfolio is up.” But when it’s down, I have to basically say, “Look, if I’m putting money into my portfolio systematically, on a recurrent basis, which is typically what people do in their 401(k), your dollars are just going farther.” So, then when it does rebound, you’re going to see that impact even more.

So, it is one of those things where it’s, again, it’s not getting caught up in the moment, and it is really looking at the long term. But when you hear the news, or you hear other people talking and there are things that – it gives you pause, and you start to doubt yourself. But I think at the end of the day, what I always say to myself is like I trust the market. I trust what the data has showed. Again, maybe it’s not always going to be 10% when you just sit down for inflation, it’s 6.87%. But always not be that. And sometimes people go to the catastrophic thing. I’m like, “Then we have other problems to worry about, if that’s the case.”

I really believe that, if you look at all this all the things, whether it’s you can make more money, and then potentially save more or you can work longer. To me, the easiest thing to do is to kind of like surrender yourself to the market and say, “Look” – to your point, Tim, like the rule of thumb, it’s this gradual, and I have – I’ll share the camera here, which I’ll be on the video, but this is like a really terrible sketch. Because I was trying to like sketch this out conceptually, because I’ve never showed this. I’m a visual learner. In the rule of thumb, it has you go in and say like, “Okay, if you’re 30, then how do you start in 80% equities?” And then when you go to 40, you’re at 70%. In my mind, I’m like, “No.” Hell to the no. Because it’s just so much lost opportunity.

Whereas mine is more like, my belief and this is more of a capacity thing, is more of a cliff. So, you should be very much mostly equities, and there’s a lot of criticism against an equity portfolio. And again, this is not investment advice. This is not investment advice. But it should be typically closer to the equity or equity portfolio. And then when you get close to that eye of the storm, that’s when you start to basically divest out of equities, and go more to the fixed income, the bonds, and then you go through that eye of the storm where you’re here, and then you start to gradually, as you get to 75, 80, and you’re really looking for combating its longevity risk, which is the fear of the money running out. You need that to last into your 90s, 100, that type of thing. So, you’re going to take more risks on the back end, but typically, you have a more of a handle on spending, and things like that, post eye of the storm time.

So yeah, I mean, no matter where you’re at in life, this is an important conversation to have. And there is no right answer. But I would say that there are wrong answers in my estimation. But I also think it’s important to say that, at the end of the day, we say this about student loans, but at the end of the day, if you’re like waking up and you’re like sweating bullets, because you’re worried about how your investments are faring, especially in a volatile market, then we talk about this with the emergency fund, it’s just not worth that.

[00:21:20] TU: But, something’s got to give.

[00:21:21] TB: Something’s got to give. That means you either have to save more or work longer, and there’s a lot of –

[00:21:27] TU: Spend less.

[00:21:28] TB: Spend less, yeah, which, which is really hard. That’s the one I didn’t mention, because that’s really, really hard to do, for most people. And I think I said on a previous episode, some people look at a 60% to 80% of their income, and that’s basically what they need is. Some advisors just look at what the tax return says, and if you’ve earned $180,000, leading up to retirement, that’s what they plan for, because that’s basically the money that’s flowing through. So, there’s lots of different ways to kind of look at that as well.

[00:21:59] TU: Tim, I think one of the interesting things here is for folks, again, I mentioned the self-awareness thing. I think they really dig deeper about like, where might these beliefs come from. Wherever you are, on kind of the risk tolerance, what you’re able to stomach scale. You mentioned earlier in the show, some folks might be like, “Hey, I’m scared of market. I’ve heard that multiple times. I have no interest kind of investing in the market. Don’t trust it. Not comfortable with the risk, whatever the case may be.” And then there’s obviously the other end of the spectrum, which is like, I’m all in on whatever investment strategy could be equities, could be cryptocurrency, could be real estate, could be a combination of things. I don’t even feel the risk. It’s like, “Man, you could have two people at the same point in their journey, and are just dichotomously in very, very different directions.”

I’m just curious from your life experiences working with clients, is that coming from some of the money scripts and things that were growing up in? Is that coming from experiences like, “Hey, I lived through the 2008 recession. I saw my parents lose a significant amount of their nest egg or grandparent”, whatever be the case. Obviously, the pandemic could have an impact. Where does that come from?

[00:23:13] TB: I think it’s a combination of all those things. I mean, you even look at it, the Great Depression, that generation didn’t put money in banks, because they just didn’t trust banks, and then that can kind of filter through later generations. I think it’s a combination of, kind of your – I think your upbringing, like I would – I talked to my parents, and they’re older now, but even when younger, I think, my mom opened up a Roth IRA for me when I was really, really young, but I think it was like, mainly in cash, or like, very, very conservative bonds, or something like that, that we actually invested in which , again, doesn’t really make any sense if it’s going to be used for 14-year-old in retirement, 50 years later or 60 years later.

So, I think it is a lack of understanding and kind of, I think, a lack of education, or financial literacy around investments is part of it. That’s not anyone’s fault. I just think it should be more part of the curriculum and the things that we talk about as students in grade school, in high school. And again, we kind of talked about you can take out hundreds of thousands of loans, but not really not understand like the financial implications of that. So, I think we need to do a better job of that. I think, again, to go back to my own experience, Tim, we didn’t talk about money growing up. It was very much a taboo thing. So, it was kind of just something that was hands off, which I think kind of does lead to stunted growth in that regard. I think that a more openness to kind of talk through some of these things, and some of like the head trash, I think, a lot of it goes – it does come from your experience. I think there is a curiosity for a lot of people and we see it, where we kind of talked about maybe some missed prioritization of like, you’re invested in penny stocks or individual stocks, but you’re not necessarily taking your match for 401(k) or you have zero emergency fund.

I don’t hate on that too much, because I think it’s someone’s willingness to kind of learn and understand, like how markets work, right? I’ve been in that boat. But I think over time is like, the market is very, very humbling, where you – it’s almost like going to the casino. No one ever says, like, “Oh, man, I lost all this money.” It was like, “I had a great” – those things get lost in the fold. I think that over time, I think people’s experience with the market is, even professional. I just read a headline somewhere that Warren Buffett says, like a monkey could pick stocks better than most financial advisors, which I would agree with. Because there is a lot of randomness with that. So, it’s, again, buy the market, don’t try to beat the market.

I think it’s a little bit of that. It’s experience, it’s education. So, people that are nerds about this, that read up, I think kind of understand what to do. But I think a lot of it is the fingerprints of what our families put on us, and sometimes those things are overcomeable, and we are aware of those things, and sometimes they’re not. Sometimes it takes someone to say, “Maybe we need to look at this a different way.” Because if you want to get to where you need to go, and for a lot of pharmacists, especially if they’re a lot of pharmacists out there, they might be the first person in their family to have graduated from college. They might be the first person that make a six-figure income.

So, with that, comes, I think, a different set of issues and things to think about as you’re – because, again, typically, the higher you are on the income scale, we look at like Social Security, less of your retirement paycheck is coming for security. The lower you are on the income, the majority of your paycheck is going to come from security. So, you just have a different set of issues and things to think about, as you make more money and have that paycheck. So, I think it’s all of those things that can shape your money script, the things that you’re saying to yourself, but I think it also is even deeper than that. It’s kind of the caveman, cavewoman approaches like you don’t want losses, right? So, you want to protect yourself in any way that you can to shield yourself from those losses. So, we do sometimes irrational things just to protect that pain. I think that’s just in our DNA. We’re here today because our ancestors have survived, some didn’t. But as the evolution of sorts is that you are programmed to do things that maybe don’t necessarily make sense in here now.

[00:27:45] TU: Tim, that’s so true. I think it’s human behaviors, you mentioned. But as you’re talking, I can and always will, I think vividly remember the significant losses in my portfolio. You feel more in the moment, but I don’t remember the significant gains in my portfolio. The long-term trend is up in a positive direction, and the significant ups have been bigger than or equal to some of the significant downs. But I don’t remember those. Like I do the losses.

Let’s wrap up this third part of our retirement planning series by connecting all of this to the asset allocation plan. So, what we determined we need is the nest egg. We talked about that in the first episode. What our risk tolerance or capacity is, those two things combined is going to then help us inform what our asset allocation plan is. So, how we actually are going to distribute these dollars within the accounts, the various alphabet soup of accounts we talked about in the last episode. So, what is asset allocation, Tim? Just to find that a little bit further, and then what are the main variables. We’ve obviously talked about one in terms of the risk, but other variables that can impact our asset allocation plan?

[00:28:51] TB: Yeah, so the asset allocation is basically the art, or you can say, even the science of construction of portfolio with a mix of stocks and bonds to achieve the most amount of return for the least amount of risk. That’s what you’re really trying to do. So, at a very strategic level, there’s basically two buckets or two asset classes. There are stocks, which are basically where you own an equity share and a company, and you’re afforded things like dividends and capital appreciation. These are the things that we need to outpace things like the inflation monster, the tax man, et cetera. And then the second part of the portfolio are bonds or fixed incomes, and these are typically IOUs or notes that say, “Hey, government, I’m going to lend you the money.” Or, “Hey, corporation, I’m going to lend you my money. Give it back to me sometime in the future, but give me an interest payment as we go.”

Between the two, typically, bonds are more like a linear growth. Stocks are more exponential growth, but there’s typically more risk with stocks and less versus with bonds. That’s asset allocation in a nutshell. And then what you could do is, you can kind of go more granular in terms of like, “Okay, well, if I have this” – if 80% of my portfolio is going to equities or stocks, you can divide that up between things like large cap, mid cap, small cap, international, emerging market, real estate, that type of thing. And then same thing with bonds, if 20% of your portfolio is going to bonds, you can divide that up between junk bonds or international bonds or short duration bonds, long duration bonds, government bonds, that type of thing.

So, it is more granular. But at a very high level, to tie risk to asset allocation is, either using the rule of thumb, or using some type of risk tolerance, gauge or questionnaire, you can say, “Okay, I’m going to answer these questions. It’s going to say I’m an 80/20 portfolio, maybe a more balanced 60/40 portfolio.” And with that, if you have kind of an unexamined, approach, meaning like, most of the time, I think a lot of people will take that, and that’s how they invest. And I think, what we, as an advisor would do is say, let’s say, “I’m you’re 35, I know what saying you’re at an 80/20. But here are some numbers to show you that you should probably should be more aggressive.” We’re not going to spend this portfolio for another 30 years. Who cares what it does for the next 20, for the next 10, whatever that is. But let’s take a little bit more aggressive.

So, that’s where you kind of get that talk about risk capacity. And then what you do is say you say, “Okay, we’ll compromise. We’re going to like a 90/10.” Then essentially, if you have $100,000, we’ll just say you’re a government employee with a TSP, if you have 100,000, know that 90,000 is going to go into some type of equity portfolio. So, the big one in TSP would be the C fund, which mimics the S&P 500. And then 10%, would go into the bond fund. That’s basically it. That’s where you connect the risk of where you’re at which again, is partly derived from the things that we just talked about, your upbringing, the head trash that you have, your experience. If you’ve experienced any pain, et cetera. And then, it should be then examined from where you’re at in terms of your time horizon, what you have saved. You’re working with an advisor, obviously. If you don’t have experience, you have a little bit more cred there to come up with, you know, what your final number is for your asset allocation. And then you put that into practice.

And then the idea is that over the course of a year, five years, 10 years, that portfolio is going to drift. So, say you are at 90/10, it could drift to a 95/5. It could drift down to an 80/20 or an 85/15, and you really want to make sure that you rebalance that over time. Because if you don’t, then if you’re an 80/20 portfolio, and you drift to something like a 90/10, if the market was then to go into a spiral, you’re taking more risk than what you signed up initially. So, sometimes when I say to rebalance, it just means to basically lock your percentages back to what you originally had agreed upon with your advisor or with yourself. That’s the big thing. So, you are kind of just resetting the percentages.

[00:33:12] TU: Again, this is a really important connection, as we bring this all together and talk about the value of a third party and the value of a planner that can really help your –it’s not – the value is not coming from picking stocks or picking investments that are going to beat the market. We’ve established that, what you’re describing is more passive investing strategy and here, we’re just talking about investing, which again, is just one part of the financial plan. The value really comes from okay, what is the game plan? What is the life plan? What is a wealthy life look like now? What is retirement life look like? What’s the number for us to get there? What does that mean today? How much do we need to be saving today to get there? We talked about that, in the first part of the series. What accounts are we going to leverage? How do we optimize this tax strategy? And within there, how do we begin to pick the investments, rebalance those portfolios over time.

Again, just such an important reminder, there are a lot of nuances in there alone, but investing is one part of the financial plan. So, we need to take that step back out of this silo that we’re in retirement planning and say, “Okay, what else is going on? What are all the other aspects of the financial plan that are happening? And does that impact or does that change potentially how we’re going to approach our investing plan?” I think, sometimes, we can hear this and hear the passive investing strategy. We can hear the nest egg calculators and think like, I can do that, I’ll just rebalance every once in a while. And you certainly can do it yourself. But let’s not lose sight of what can happen when you bring a third party into the equation, and we also have some value in zooming out and making sure this is fitting in correctly with the rest of the financial plan and the other puzzle pieces that are involved.

[00:34:56] TB: Yeah, the act of investment is a necessary, I don’t want to say evil, but it’s a necessary thing that we need to do to, again, get in front of things like inflation and taxes. A lot of advisors make that the central part of their practice and it is important. I don’t want to say it’s not important. But it typically takes a backseat to a lot of the other things that are going on in life, whether that is, “Hey, I need to pull money out of this investment, because we have to put an additional on our house, because I’m taking care of an aging parent.” Or, “Hey, we have a kid that’s going to college. So, we need to, again, change some things around.” Or, “Hey, I lost my job, so I’m not going to be able to invest like I was.”

The thing with a financial plan is that, the value is more in planning, not the plan. And the investment piece is very important, and it can be as complicated as you want to make it. But even in the simplest version, it can be complicated, because again, if we’re talking about an asset allocation, the example that I gave is in a TSP, but if you’re trying to do that across a brokerage account, an IRA, a Roth IRA, some of the task, it can very quickly, when you add layers, get more and more complicated. But I think that the – yeah, the value, I think, with working and this is at any part of the financial plan, not just the investments. It’s almost like an am I crazy type of – am I crazy to be doing this? Should I give myself permission to do this? And sometimes, because of the environment or the way that we live today with social media, like there’s so much gaslighting. You can almost start to doubt your own judgment. So, it’s sometimes good to have a rock or a steady influence, and this is at, really, any part of your life, but I think finance is what we’re talking about here to just say like, “Hey, am I crazy? Or what do we do here? Or this is a variable or this is a bump in the road? Or this is an opportunity, like what’s the best way to proceed?” Again, super biased. But I think that’s really the value. It’s not necessarily saying like, “Hey, we’re going to beat the market and all that nonsense. It’s like, life has happening, and are we living a wealthy life or not?

[00:37:20] TU: Yeah. And so, to that point, whether you are a new practitioner listening, early on in this journey of saving for the future, mid-career pharmacists wondering, “Hey, am I on track? Are there other things I should be thinking about? How does this fit in with other goals that I’m working towards? Or, pre-retiree, retiree thinking about more the distribution stage and building that retirement paycheck, which we’re going to talk about on our fourth and final part of the series. Regardless of where you’re at in the financial journey, our fee only financial planning team of five certified financial planners, in-house tax team that includes a CPA and an IRS enrolled agent. They’re ready to work with you to build your retirement plan, among work with you on your other financial goals.

So, you can book a free discovery call, learn more about our one on one financial planning services that is customized for the pharmacy professional. You can book that call at yfpplanning.com. Again, that’s yfpplanning.com. Thanks for listening and have a great rest of the week.

[OUTRO]

[00:38:09] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog post and podcast is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analysis expressed herein are solely those of your financial pharmacist unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward looking statements, which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you again for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 273: Alphabet Soup of Retirement Accounts (Retirement Planning)

Posted on by yfpadmin

Alphabet Soup of Retirement Accounts (Retirement Planning)

On this episode, sponsored by Insuring Income, Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, for the second part of the four-part series on retirement planning. Together they discuss the alphabet soup of retirement accounts including commonly used vehicles for accruing a nest egg.

Episode Summary

YFP Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, discuss the alphabet soup of retirement accounts in this episode, the second part of the four-part series on retirement planning. Tim and Tim know that planning for retirement and building a nest egg can be overwhelming with so much to consider. In this episode, they break down common vehicles for building a nest egg into two main buckets. Tim Baker differentiates between tax-advantaged accounts administered by the employer and those administered by the individual. Tim and Tim spend time discussing how each tax-advantaged account works, including the contribution limits, catch-up provisions, and phase-outs where applicable. They get specific on how not all “buckets” are equal in terms of what you, as the investor or retiree, will receive. Due to the nature of retirement accounts and their relationship to the financial and tax plans, Tim and Tim share the importance of marrying the retirement plan to tax planning for the most benefit to the investor. Lastly, Tim and Tim explain that there are many factors to consider when determining the priority of saving among different tax-advantaged accounts, reference resources for listeners on prioritizing investments, and mention the services provided by YFP Planning and the YFP Tax team for pharmacists.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey everybody, Tim Ulbrich here. Thank you for listening to the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

On this week’s episode, Tim Baker and I continue with the second of our four-part series on retirement planning. Last week on Episode 272, we discuss, determining how much is enough for retirement. This week, we take a step forward by talking about the alphabet soup of retirement accounts including commonly used vehicles when occurring a nest egg. Highlights from the show include differentiating tax advantaged accounts into those that are administered by the employer, and those that are administered by you the individual, how each tax advantaged account works, including contribution limits and ketchup provisions, and why not all buckets are created equal, and factors to consider when determining the priority of saving among different tax advantaged retirement accounts.

Now before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 270 households in 40 plus states. YFP Planning offers fi only, high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call at yfplanning.com. Whether or not YFP Planning, financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom.

Okay, let’s hear from today’s sponsor, and then a jump into my conversation with certified financial planner, Tim Baker.

[SPONSOR MESSAGE]

[00:01:39] TU: This week’s podcast episode is brought to you by Insuring Income. Insuring Income is your source for all things term, life insurance and own occupation, disability Insurance. Insuring Income has a relationship with America’s top rated term Life Insurance and Disability Insurance Company, so pharmacists like you, can easily find the best solutions for your personal situation. To better serve you, Insuring Income reviews all applicable carriers in the marketplace for your desired coverage. Supports clients in all 50 states and make sure all of your questions get answered.

To get quotes and apply for term life or disability insurance, see sample contracts from disability carriers or learn more about these topics. Visit insuringincome.com/yourfinancialpharmacist. Again that’s insuringincome.com/yourfinancialpharmacist.

[INTERVIEW]

[00:02:31] TU: Tim Baker, welcome back.

[00:02:33] TB: Yeah, good to be back, Tim. Looking forward to part two of this series.

[00:02:37] TU: Yes, this is our second part of the four part series we’re doing on retirement planning. Last week, we talked about, How to Determine How Much is Enough? We ran through some mistakes scenarios and calculations to determine that number. This week, we’re going to start to get into more of the X’s and O’s on how to get there. As I mentioned, as we wrapped up last week’s episode, often when we begin to wrap our mind around, okay, this 3 million, this 4 million, this 5 million number and we begin to accept what that is and what we need to be saving each month to get there.

The next natural question is, all right, where do I actually invest the money? What are the vehicles and options that are available? That’s what we’re going to talk about this week, some of the variety of investment vehicles and we’re primarily going to focus on tax advantaged retirement accounts, but certainly acknowledge that there are a variety of ways to build a nest egg outside of just the accounts that we’re going to talk about. So that could be real estate, that could be digital currency and assets, business ownership collectibles, and knowing many individuals are building a base that comes from, maybe not exclusively includes, but comes from traditional retirement accounts. We’re going to focus our time there.

Another important distinction I want to make is that for our small business owners that are listening, we know there are several you out there. We will cover not in detail on this episode, but certainly there are other options from a business standpoint, SEP IRA, simple IRA, solo 401K. We’re not going to focus on those in this episode, but certainly, those are a valuable option to get us to our goal, as well.

Tim, we throw these terms around all the time in pharmacy as notorious for throwing around acronyms. We put together pharmacy and financial planning. I feel like it gets worse. So we throw around term 401K, 457, TSPs, traditional IRAs, Roth IRAs, HSAs. This is often when we’re speaking with a group of pharmacists where we start to see the eyes gloss over. Okay, I understand there’s options I need to take advantage of, especially from a tax standpoint, but there’s a lot to consider, this can be overwhelming. We’re going to break this down into two buckets to give ourselves a framework.

Those tax advantage accounts that are administered by the employer. Then the second bucket is those tax advantage accounts that are administered by you as the individual. So this distinction I think will help us begin to organize and have a framework for how we can think about different options that we have to save. Tim, let’s start with the accounts that are administered by the employer. Give us a rundown of the accounts that are available here and some of the distinctions between them.

[00:05:10] TB: The ones that are typically administered by the employer are going to be the 401K, the 403B, the TSP, those are the three primary ones. Then sometimes you run into things like the 457 plan, which is typically a bonus plan. Sometimes you see 401As, which are like 401Ks, except the participants aren’t making contributions to them. The one that we’ll talk about, synonymous with all the other ones is a 401K. The 401K, is the most popular profit sharing plan. Essentially, how it works is when you are hired by an employer. They’re going to say, “Hey, welcome to the team. As part of a benefit to working on our team, we have this 401K that we’ve set up through fidelity or whatever, whoever the custodian is. These basically are funded through salary deferrals from your paycheck.”

Back in the day, you had to basically make that election yourself, but the Obama administration, I think, smartly made it, so you have to opt out. A lot of these plans, now you’re auto enrolled at a certain percentage into the plan, I think, based on your age into a target date fund. The backdrop of this, Tim is back in the day, when our dads were starting the career, the most prevalent retirement plan was a defined benefit plan, a pension. What happened over really started in the 80s and 90s, employers were starting to see how big of a burden that was on their own balance sheets, because they were basically carrying the lion’s share of saving for the employees retirement. The 401k was introduced, which is a defined contribution plan and that means that that risk of having enough save for retirement has shifted from the employer to the employee.

Now it is up to the employee to figure out how much they need to be different from their paycheck, where to invest it, and then how to distribute it tax efficiently in retirement. The problem is that we just aren’t necessarily good at that. The 401K has really taken off and now defined contributions will outpace pensions, as many of us know that do not have pensions. Participants make elective salary deferrals and for anything that doesn’t have Roth in front of it, contributions are not tax until they’re withdrawn. What this means is that, I’m a pharmacist, and I’m making $120,000 a year, and I put 20,000, just for round numbers, the maximum you can put in is 20,500, but let’s say, I put $20,000 into my 401K. The IRS taxes me as if I made $100,000. It goes in pre-tax.

Now the money is actually, it’s only going to be taxed either going in or going out. That traditional 401K, that $100,000 is going to grow and grow and grow. Then when we pour it out in retirement, that’s when it’s going to be taxed. If we think about this, say I’m going to 25% tax bracket at age, we’ll say 40, it’s not taxed at 25%. It goes in tax free. Now let’s say I’m at age 65, I’m retiring. I’m at a 25% tax bracket. If that $100,000, let’s say, it grows, but that’s going to be taxed at 25%. Your benefit, there’s really no benefit either way. The benefit comes if your tax bracket is actually lower. If you’re at a 20% tax bracket, that’s when you see some of the statements. That’s for the traditional. Now if you are age 50 and older, Tim you can make a $6,500 catch up.

Now all of these things are the same for a 403B, which is typically 401K you typically see for profit 403B, you typically see for a non-profit or hospital that type of thing. The 403B has an additional catch up and it says typically if you are a certain age and you have a certain years of service, you can put in as typically 15 years you can put an additional $3,000. So you get your 20,500 Plus the 6,500 regular catch up plus another 3000. So that’s just a funky thing with 403Bs. TSPs are very similar to all of them they have the catch-up, not like a 403B, but a regular catch-up. Their matches the same across, so TSPs is the Thrift Savings Plan, typically for military government workers, their match is 5%. The big benefit for the TSP is that they’re in basically five funds that are super low costs, which is not necessarily the case with the 401K or the 403B.

The appropriate use for these, Tim are typically when If the employer wants to provide a quality retirement benefit, without being required to make ongoing employee contributions. So you can have, you can have an employer that offers a 401K, but doesn’t put any match or anything into it, that’s up to the employer to do that. A lot of employers are doing this to incentivize their employees to save, but also as a retention, because you can have vesting schedules attached to it, which means if you leave after a certain amount of time, you don’t get that match. It’s a great vehicle if you have a young workforce, because you can accumulate savings over a long period of time. But the basically the risk is on the employee to do what they need to do to get to have an adequate retirement.

A lot of 401Ks allow for insert with withdrawals for hardships, you can take loans against it. Most 401K’s these days, same thing with the TSP and the and the 403B have a Roth component. The big disadvantage here, Tim, is that oftentimes a 401K can be expensive. So typically, the rule of thumb is, the smaller the employer, the more expensive the 401K is to that individual participant. I’ve seen it, where all in cost on a 401K is almost 2%. So think of that, I have $100,000 in a 401K, $2,000 per years coming out either to pay an advisor expense ratio or things like that. Whereas something a TSP, it’s like, three basis points, which is $30, compared to 2000.

Then the other disadvantage is that, it’s not going to guarantee an adequate retirement benefit as a pension would. Oftentimes, again, smaller 401K is the investment selection won’t be great. That’s the main one. Again, all of those, the TSP, the 403B are going to be very, very similar to that without with some minor nuance. The 457 plan, which some people will see is a non-qualified tax advantage, deferred compensation retirement plan. This is typically for people who work in state government, local government, even some nonprofits. This is often another bucket that you can put up to $20,500 into. It’s the same thing they’re typically not taxed until it was withdrawn, but often those are available to the creditors of that. If you work for a local government that goes bankrupt, then you could potentially lose that money, which is problematic. That’s a big thing that some people will see as a 457. So typically, work on the 401K, the 403B first and look at a 457 after you’re maxing that out already.

[00:12:37] TU: Tim, correct me if I’m wrong. When I was at one university, we had the 457 available with a 403B and a 401A, but the 457 amounts was on top of in addition to –

[00:12:49] TB: Correct. Completely separate bucket, yeah. Sometimes we get that – we’re going to talk about those administered at individual levels, some people say, “Well, if I put 20,500 into my 401K, can I also put money into an IRA?” So they’re separate buckets, just like the 457 is a separate bucket that’s available to you.

[00:13:07] TU: Great synopsis. That was covering our first bucket, which is those that are administered by the employer, as Tim articulated, really looking at those interchangeable 401K, 403B, TSP, typically for profit, not for profit, those that work for a federal government agency organization. He talked about the contribution limits per years, some of the catch-up provisions after the age of 50. Then the additional one for the 403B. Then making sure we’re not confusing, a Roth 401K, Roth 403B with a Roth IRA, which we’ll talk about here in a moment. I think as we see the Roth employer sponsored accounts grow in popularity, there’s some confusion among okay, I’m contributing to a Roth 401K, can I also contribute to a Roth IRA?

The answer to that is yes, there are some considerations there, but totally separate. One administer by the employer when administered by the individual. Let’s shift gears, Tim to that second bucket. Those administered by the individual. Two, subcategories here that I want to talk about would be the IRA accounts, both the traditional and the Roth IRA. Then the second would be an individual that wants to invest in a brokerage accounts. Let’s start with the IRAs differentiate the traditional IRA, the Roth IRA, some of the income limits and considerations for pharmacists that would contribute here.

[00:14:22] TB: Yeah. So same thing, when you see traditional or no precursor at all just IRA, you’re going to think pre-tax, when you see something Roth, you’re going to think after tax. The traditional IRA is a retirement account. It’s the traditional individual retirement account. It is an account that you either set up yourself so you go to something like Fidelity, a Vanguard, TD Ameritrade, a Betterment and you basically open it up or you can work with an advisor and they’ll basically open one up to advise for your benefit.

The traditional IRA is funded with pre-taxed dollars. Again, this is a separate bucket away from the 401KL, the TSP, etc. you can contribute up to $6,000 per year, plus $1,000 per year catch up if you’re age 50 or older. Now, anybody essentially with earned income can contribute to a traditional IRA. It’s subject to phase out deductions. So what does that mean? If you are a single individual, and you make anywhere from 68,000, to $78,000 like AGI Adjusted Gross Income, then once you get to $78,001, you can no longer take a deduction for your IRA. I’ll give you example on the other side, so if you make less than $68,000, so $67,999, you can deduct 100% of your say $6,000 deduction or contribution. It phases out, which means that once you get to that midpoint, so 68,000, to 78,000 the midpoint is 73,000.

If you put $6,000 in you can deduct 3000, but then you can’t, which is half of it and you can’t deduct the other 3000. This is really good for people that are listening to the podcasts that might be fellows or residents or maybe they’re in school, and they’re working and they’re trying to save some for retirement, typically, pharmacists are not going to be allowed to make a deductible contribution. So just to give you an example, if I’m out there, and I make $60,000, which is below that, and I’m single, and I make below that threshold, and I put $6,000 into my traditional IRA. The government, the IRS looks at me as if I made 54,000. So similar example, as I used before.

Now, the difference between the IRA and the 401K is the 401K is coming out of your paycheck. It’s not basically hitting your bank account. This is typically funded where it hits your bank account and you’re technically contributed into that with after tax dollars, but you’re just deducting it on your 1040 when you go to file. That’s a little bit of the nuance. The phase out, if you’re married filing jointly is 109 to 129, which again, typically for a lot of pharmacists if they’re dual income, they’re going to be above that that threshold. The same thing as, so that $6,000 goes in pre-tax, it gets invested, it grows tax free. Then when we pour that out in retirement, when we withdraw it in retirement, that’s when it’s taxed. Again, it’s either tax going in or going out.

The Roth is the one that’s tax going in. The Roth IRA is an account that’s fun it with after tax dollars and it stays after taxes. You’re not going to take a deduction. So basically, it’s the same thing, you can contribute up to $6,000 plus $1,000 after age 50. Now, and this is an aggregate, if you were to contribute $4,000 a year to your traditional you can only contribute $2,000 to your your Roth IRA. This is subjected to phase outs to actually contribute. So what that means is that once you make as a single person, once you make the phase out is 129 to 144,000. Tim, once you make $144,001 the door slams shut, and you can no longer make a contribution to the Roth IRA. For married filing jointly that ranges 204,000 to 214,000. So if you’re a couple and you make more than 214,000, you can’t directly put money into the Roth IRA, which then gets into that, you fund a traditional IRA, you got to go through all those rules that we talked about and then you can do a backdoor Roth IRA, again easier to explain, harder in actual concept.

To just reiterate, if I make, we’ll use the same example. Let’s say I make $60,000. I put $6,000 into a Roth IRA. Now, the government looks at me as if I made $60,000 that $6,000 that goes in, it grows tax free. Then when I pour it out in retirement, because it’s already been taxed, that $6,000 is all mine, or whatever it grows to. That’s the big thing that we often talk about is like, if you have a million dollars in your traditional IRA at the end of the rainbow, when you’re going to retire, you don’t have a million dollars. If you’re in a 25% tax bracket, you actually have $750,000 and the government has 250,000. If there’s a million dollars in a Roth IRA or Roth TSP or a Roth 401K, that money is yours. That’s super important to remember. I think I hit everything with Roth.

[00:19:34] TU: Yeah. Then again, Tim, just to zoom out for a moment so in the first segment, we talked about the big security number, what do we need at the end of the rainbow at the nest like three, $4 million. We back that into, okay, what do we need to be saving per month based on a set of assumptions, asset allocation, risk tolerance, all those things? Maybe that number is 800 1200, 1500, whatever it is per month. Now we’re talking about where does that go, right? So we started with employer counts. Is that a 401K, for profit 403, not for profit TSP federal government? Or and or are there individual options, traditional, perhaps maybe not a deductible option there for many pharmacists based on income or a direct Roth or backdoor Roth, depending on income limits for pharmacists.

If you put these two together, and where we see many pharmacists beginning to build their foundation, again, not the only place that we’re going to be investing 20,500, certainly more than that, for those that are listening, that are in that catch up age, older than 50. Then on the individual side $6,000 per year, so 26,500 per year between the two of those and that 20,500, Tim is not including any employer match as well, right? That’s employee –

[00:20:46] TB: Yeah. If you include the employer match, and anything else they give you, I think the number can go all the way up to 61,000. As long as the employee and the employer match doesn’t exceed, 61,000 you’re good to go, which that’d be nice if you got that much in a match.

[00:21:02] TU: We put the two of these together. Again, not investment advice, but we put the two of these together, and we’re now north of $2,000 per month towards our savings goal. Is this the only way we can invest? Absolutely not, but these two tax advantage accounts, and there’s a lot of strategy and consideration here. Tim, you mentioned it a few moments ago, tax bracket today, tax brackets in the future, what else is going on in terms of the tax situation, another great example where we need to marry the tax plan with the financial plan, but a really good place to begin to think about the foundation for our investing.

[00:21:33] TB: Yeah. That’s a common question that we have, is like, should we put in Roth, we put it in traditional, should we be putting it in taxable, which we haven’t talked about, the brokerage account, which we can talk about here in a sec. The answer is yes, all of them. Because what we do when we try to build a retirement paycheck, we’re trying to get that money out of those tax advantaged accounts at the lowest tax rate possible. The other thing at the sprinkle in is oftentimes what use the brokerage account for, so often you use a brokerage account for an early retirement or to delay claiming Social Security as long as possible. So you increase that percentage of a known income stream from the government that’s inflation protected, and that is a bigger part of your percentage of income, that’s huge and a lot of people will not do that correctly.

Before we get to the Brokerage account, the last thing I’ll say about all these accounts that we talked about, so far, the 401K, TSP 403B, Roth traditional IRA, the other one that’s often synonymous with a traditional IRA is a rollover IRA, that’s typically, when you’ll see that’s also pre-tax. Worth mentioning for all of these accounts is that if you take non-qualified withdrawals, which that’s typically when you take money out before you’re 59 and a half years old, you’re subject to a 10% penalty along with paying the tax. That’s basically discouraging you to rob that account for a car, or a home downpayment or things like that. There’s exceptions to that rule, but that 10% penalty it’s a good way for you to keep that money in there.

Again, we talked about gratification, sometimes it’s really hard for us to lock that money away and not use it until the future. So the brokerage account, Tim, is the last account that we can talk about, and the brokerage account is, it’s a taxable account. It’s an account that you can set up through any of those custodians that I mentioned. It’s funded using after tax dollars. This can either be set up as an individual account, so in your name, just like all your retirement accounts or a joint account with a spouse or a partner. The contributions to this are unlimited. With all these other accounts, we’re saying, “Oh, you can only put $20,000, 500 or $6,000.” Here’s have at it, if you if you get an inheritance, or you’re maxing everything out, and you can put five grand a month or whatever into an account, you can do that.

You typically use this when you’ve exhausted your retirement contributions previously mentioned. The other one that we of course, always mentioned is the HSA, it’s another bucket, that’s good. You typically use this account when you’ve exhausted those things or if you’re doing something else like, we often use this account for a tax bomb for a non-PSLF strategy. It could be for something that –

[00:24:23] TU: Early retirement.

[00:24:24] TB: Yeah. It could be something that’s an early retirement. So if I’m going to retire at age 55 and I’m not going to be, I can’t collect on my other accounts until I’m age 59 and a half, you would use it for that or if you’re saying okay, I’m going to retire it 62 or 65. I’m going to delay to claim Social Security to age 70. I’ll use that account from that as well. Those are typically or the last one, which is not necessarily retirement related. You might say, “Hey, Tim, I want to basically buy a piece of real estate investment in 10 years.” I’m like, “Well, that’s probably long enough time horizon where we probably should do something other than a CD or high yield savings account.” So let’s build a balanced portfolio or something along those lines that we can get a little bit more return for a little bit more risk.

The advantage to the brokerage account is the greatest flexibility, there’s no penalty to withdraw, as I mentioned from the other accounts do, you can recognize losses to offset gains, that’s called tax loss harvesting. That’s one of the big disadvantages that when you put in will use the $6,000. Tim, I put $6,000 into my Roth account or my traditional. When we say it grows tax free, what that means is when you buy mutual fund ABC at $100 per share, when you sell it and withdraw the account and say it’s $300 per share in the future, there is a gain of $200 for that investment.

Inside of a Roth inside of a Roth IRA, a 401K, a traditional IRA, you don’t have to pay tax on that $200 per share gain, in a taxable or a brokerage account you do so what that means is that you’ve contributed after tax dollars, you made the investment, you have a 200 per share gain, you have to pay either long term capital gains on that, which is typically 0%, 15%, or 20%, most pharmacists are probably going to be in the 15% bracket, or short term capital gains tax, which means you’ve held it for a year or less, that’s typically ordinary income, which is 24% tax bracket plus whatever, in your state. So that’s the big disadvantage that you’re taxed multiple times on that investment, but it allows you flexibility to do what you need, move money in and out. The investment selection is yours and there’s typically less fees, because you don’t have that big administrator typically hanging over it like you do in a 401k or even an IRA.

We often see these, Tim with employee stock purchase programs, so if you’re in an ESPP with your employee, employer, they’ll put those dollars in a taxable account, typically RSUs are granted and they’ll put those dollars or shares and investment accounts, ISOs, that type of thing, as well. There are specific scenarios where you’ll use this, but the brokerage account, again, is often one that we don’t talk about enough for retirement purposes. Sometimes I don’t like to use it especially the further away you are for retirement, because you could say, “Hey, Tim, this is for retirement.” But it’s like, just kidding. Five years later we’re going to use it for something else.

Now that $50,000 that I accounted for in your nest egg calculation is gone, right? That can be problematic. That 10% penalty, although it stinks, it can be a good firewall for you not to take that money out, but this is another important account to utilize as we’re growing our assets to then disperse in retirement, and we want to make sure that we pick efficiently from a tax perspective from each of these buckets year over year.

[00:28:00] TU: Tim, when you teach this topic, and I think you teach it so effectively, you mentioned earlier that not all buckets are created equal, right? If you have a million dollars in a Roth, a million dollars in a traditional, a million dollars in an HAS, a million in a 401K, a million in a brokerage account, you don’t really have $5 million. I mean, I guess you do on paper, but there’s going to be tax implications that are different. The visual you give for the brokerage is it’s got holes in the bucket, right, because we’re putting money in after tax, and then we’re going to incur either short or long term capital gains doesn’t mean it doesn’t have value, you gave several examples where it could in terms of bridging to delay Social Security, it could be a short or mid-term type of purchase five, 10 years if you want to get some growth momentum for the market, don’t want that sitting in our checking account. So there’s value there, but we also want to make sure we’re looking at the right priority of how we’re investing.

I think one of the common mistakes that we are seeing, I think in part, just because of the availability in marketing around brokerage accounts is, are we putting money in a brokerage account and perhaps not taking advantage of some of the tax favored accounts we talked about. Is that intentionally the choice we’re making or are we not considering the tax implications by doing that?

[00:29:09] TB: Yeah. That’s one thing we talked about, it’s a prioritization. We see pharmacists that come in, they have 1000s of dollars in a brokerage account, but they’re not really taking full advantage of match or, and I get it, Tim. I’m not a hater. I get it, because a lot of times we’re marketed to by said company that says “Hey, buy this and invest and you’ll get free bitcoin or ETFs or stock.” I understand the want to scratch the itch and get in and try to make money and invest, but if you think about it, and again, it’s not a bad thing, because you can offset losses, but if I’m being taxed already on if I’m in a 24% tax bracket for that money goes in, and then I’m taxed another 10 or 15% when it from capital gains, but then you can defer that tax or in a pre-tax account or pay it after it comes out. I think that there’s a lot of meat on the bone with regard to efficiency, right? That’s one of the things we preach is just being efficient.

[00:30:14] TU: Yeah.

[00:30:14] TB: All of these have a place, particularly when talking about the in this retirement series, and there should be attention paid in a strategy and an allocation for each, just asking these questions if you’re listening to this, look at your balance sheet. Always comes back to the balance sheet and the goals. Look at the balance sheet, how much do you have in an after tax? How much do you have in taxable? How much you haven’t pre-tax? And take stock of where you’re at.

Once you know where you’re at, then you can outline where you want to go. Yeah, I think, it’s really important to look at the priority. Again, I don’t hate on anyone in that, who is doing that. It’s just a matter of focusing and say, “Okay, what is important, what’s not important? Sometimes if we want to do some stock picking and things like that in a brokerage account, let’s just keep it minimum 5% of the overall portfolio, and then we can go from there. I’m a big believer in keep it simple and keep fees low and set the right asset allocation, and then go from there.

[00:31:11] TU: While we’re talking about priority, we’re not going to dig in depth on this episode, because we’ve done it on many others, ruling to 165 is one example, but we can’t omit the HSA when we’re talking about priority of investing. Back to my visual of your brokerage account with the holes in it, the HSA is the bulletproof account, right? Depending on how we’re using that account, we have an opportunity to avoid taxes throughout. Obviously, if we have healthcare expenses that we need to fund, we can, of course, use it for that and have some tax advantages.

Got to be working for an employer, we have a high deductible health plan that dollars aren’t as big in terms of contributions that we’re going to see in a 401K or 403B, so 3650 for an individual 7300 for family in 2022. Some catch up provisions are again, but another tax optimization strategy that want to be considering. I hope we’re hitting that point home, intentionally is that I think one of the things our planning team does so well and a shout out to the integration between the planning and the tax team is, are those two things in sync? Are we are we planning with a tax mindset? Are we also thinking about the tax implications, but also building the financial plan around that as well?

Tim, I probably should have mentioned this earlier, but we’ve thrown around a ton of numbers in terms of contribution amounts, we’ve talked about phase outs and AGI limits, and maybe some folks are trying to scratch those down. Hopefully they weren’t doing that when they’re driving, but we have all these numbers available for use, you don’t need to memorize any of those. We’ve got a sheet that has 2022 important numbers, even beyond just what we’re talking about here and investing savings, you can go to yourfinancialpharmacist.com/2022numbers, again, yourfinancialpharmacist.com/2022numbers and get that information.

Again, this is our second part in a four part series on retirement planning. Next week, we’re going to come back to risk tolerance versus risk capacity, a very important distinction between those and how we begin to determine within these accounts we talked about in this episode, where we actually start to invest the money. Then finally, we’ll wrap up in our fourth part about how to build the retirement paycheck. The team at YFP Planning is ready, whether you’re new practitioner, mid-career pharmacist, someone who is approaching retirement, our fee only financial planning team of five certified financial planners and an in-house tax team, including a CPA and an IRS Enrolled Agent, ready to work with you to help build your retirement plan among your other financial goals as well.

If you want to learn more about the one-on-one fee only comprehensive financial planning services that are offered by YFP Planning, you can visit yfpplanning.com to book a free discovery call. Thanks for listening. We’ll see you next week as we continue the series on retirement planning.

[SPONSOR MESSAGE]

[00:33:50] TU: Before we wrap up today’s show, let’s hear an important message from our sponsor Insuring Income. If you are in the market to add own occupation, disability insurance, term life insurance, or both, Insuring Income would love to be a resource. Insuring Income has relationships with all of the high quality disability insurance and life insurance carriers you should be considering and can help you design coverage to best protect you and your family.

Head over to insuringincome.com/yourfinancialpharmacist or click on the link in the show notes to request quotes, ask a question or start down your own path of learning more about this necessary protection.

[OUTRO]

[00:34:27] TU: As we conclude this week’s podcast, an important reminder that the content on the show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog posts and podcasts is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analyses expressed herein are solely those of your financial pharmacists unless otherwise noted and constitute judgments as of the date publish. Such information may contain forward-looking statements which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer. Thank you again for your support of the Your Financial Pharmacists podcast. Have a great rest of your week.

[END]

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YFP 272: How Much Is Enough? (Retirement Planning)

Posted on by yfpadmin

How Much Is Enough? (Retirement Planning)

On today’s episode, sponsored by APhA, Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, to discuss how much you need for retirement in part one of the four-part series focused on retirement planning.

Episode Summary

Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, to discuss how much is enough when it comes to retirement planning in part one of the four-part series focused on retirement planning. In this discussion, Tim and Tim cover finding a balance between saving for the future and living a rich life along the way, factors to consider including determining how much is needed when building a nest egg, what the 4% rule is and why it is commonly used as a safe withdrawal rate during retirement, and why time in the market and savings rate matter more than the rate of return on investments. Tim Baker shares his opinion on financial planning as an exercise in goal setting for the long term while balancing experiencing life in the present and how financial planning and even minor changes in your investment portfolio can have a significant impact on your total retirement amount. They dive into what many folks consider a safe savings rate and considerations for increasing that savings rate dependent on numerous factors in the financial plan. Tim and Tim explain the rule of 25, which is popularly used in the FIRE (Financial Independence Retire Early) community as a guideline for retirement savings, how it works, and how it compares to the 4% rule. They close with general calculations and formulas for determining the nest egg for retirement and tease next week’s episode on the “alphabet soup” of retirement accounts.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

On this week’s episode, Tim Baker and I kick off a four-part retirement planning series by discussing how to determine how much is enough when it comes to saving for retirement. Highlights from the show include finding a balance of saving for the future, while also living a rich life along the way, as Tim Baker says, “It can’t be just about the ones and zeros in the bank account.” Factors to consider when building a nest egg and determining how much is needed. What the 4% rule is and why it is commonly used as a safe withdrawal rate during retirement. And why time in the market and savings rate matters more than rate of return. Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does, and working one on one with more than 270 households in 40 Plus states.

YFP Planning offers fee only, high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one on one with a certified financial planner, who may help you achieve your financial goals, you can book a free discovery call at yfpplanning.com. Whether or not YFP Planning financial planning services are a good fit for, know that we appreciate your support of this podcast and our mission pharmacists achieve financial freedom.

Okay, let’s hear from today’s sponsor, and then jump into my conversation with certified financial planner, Tim Baker.

[SPONSOR MESSAGE]

[00:01:33] TU: Today’s episode Your Financial Pharmacist Podcast is brought to you by The American Pharmacists Association. APhA has partnered with Your Financial Pharmacist to deliver personalized financial education benefits for APHA members. Throughout the year, APhA will be hosting a number of exclusive webinars covering topics like student loan debt, payoff strategies, home buying, investing, insurance needs, and much more. Join APhA now to gain premier access to these educational resources and to receive discounts on YFP products and services. You can join APhA at a 25% discount by visiting pharmacist.com/join, and using the coupon code YFP. Again, that’s pharmacist.com/join, and using the coupon code, YFP.

[INTERVIEW]

[00:02:19] TU: Tim Baker, welcome back on the show.

[00:02:21] TB: Thanks, Tim. Yeah, good to be back.

[00:02:23] TU: It’s been a while. I mean, you’ve done some case studies with the planning team, which have been awesome. But we haven’t been back on the show together in some time, so I’m looking forward to this series that we’re going to be doing on retirement planning. We’ve got a four-part series plan, all about retirement planning, starting with determining how much is enough, what do we need as we look at preparing towards retirement, and ending with strategies and considerations for actually building that retirement paycheck. And a topic that’s often overlooked, we’ll talk about that in detail when we get to that fourth and final part.

I believe we’ve constructed this, Tim, in a way that whether it’s a new practitioner who’s just getting started wondering what’s this big scary number for off in the future, or someone who’s mid-career checking in to see if they’re on track, or pre-retiree thinking about, “Hey, this is coming up, and are there some tweaks that I need to make, or adjustments or perhaps confirmation that I’m on track.” I think this topic is relevant, regardless of where someone is at, at their career.

So, we’re going to get into the dollars and cents. We’re going to nerd out on the nest egg and some of the X’s and O’s. But first, I think it’s valuable that we consider what is the purpose, what’s the vision for what we’re trying to do before we start thinking about, is it 3 million? Is it 4 million? Is it 5 million? So, Tim, talk to us about number one, why is this so important before we actually determine how much is enough, and then how are we going to get there? And how do we practically begin to accomplish defining the vision that we have when we think about retirement, and what that life will look like?

[00:03:57] TB: Yeah, so comprehensive financial planning, to me, it really boils down to the idea of how do I best go about living a wealthy life today, say in my 20s, 30s, 40s, 50s, and a wealthy life tomorrow. We typically think of tomorrow, more in terms of like the long-term horizon of in my, 60s, 70s, 80s, 90s through retirement. It can be really difficult for us, Tim, to kind of conceptualize time, or like, feel time. So, the further, when we kind of talked to clients, and we say like, what does success look like a year out, two years out, three years out, five years out, those conversations are a lot easier to have. But as that time horizon becomes more and more, we kind of lose sight of how to even like think in decades.

So, to me, that’s what comprehensive financial planning, is about is kind of coming up with solutions where you feel good about what you’re doing today and then what you’re planning for the long tomorrow. And I think what often happens is that individuals, kind of swing one way or the other. So, like in our household, I’m thinking about, “Oh, man, are we saving enough for retirement? Are we doing everything from the long term?” Whereas my wife is like, “Bro, we have two young kids, we need to make sure that we’re doing things with them while they’re young, and they’re still under our roof and all that kind of stuff.”

I actually think some people think that that’s like not a good thing, if you have two partners that are kind of diametrically opposed. I think it’s good, because I think it leads to balance and leads to address some of those conversations. So, if you’re all one way, then sometimes it’s really hard. If you’re like, save, save, save, it’s really hard for you to open up your hand and spend. But the other thing, sometimes people are afraid to talk about a planner is like, “I’m very spendthrifty. I’m not saving enough for the future, because I can’t see two feet in front of my face”, or just, “I grew up in an environment where we didn’t really save. We just kind of live for today and hope for the best.”

So, to me, this whole thing of like, how much is enough? It’s kind of an exercise in that and projecting out, okay, what is a reasonable number that we should be shooting for? And are we doing what we need to do to get there? I think the disconnect with this is, oftentimes, you’ll get a statement, Tim, or you’ll talk to a financial planner, and it’s like, “Oh, you need $4 million to retire.” It’s like, that’s such a big number and I look at what’s in my account, and I’m like, “Yeah, right.” It doesn’t even calculate or compute. So then, it’s almost like you give up, right?

But the problem is, is that the number for a lot of our listeners, it’s going to be multi millions that they’re not going to need to save more than likely. And we’ll get into things like, where does security play a role? And if that’ll be there, and all that kind of stuff? But to me, that’s really the exercise. Are we doing what we need to do today? And then are we doing what we need to do to ensure that we’re good to go for tomorrow. I think it’s about as simple as that, and I think when you talk about retirement planning, you’re looking at the full breadth of the timeline, and making sure that – because it just gets – the longer that you wait, I kind of look at it as, if you started in your 20s, you’re climbing like a steady grade. If you start in your 60s, its Mount Everest, because you literally can’t save enough to kind of overcome that, and the alternative is just a huge cut in your lifestyle, and what you’re going to be able to afford when you do turn off that W-2 or income that’s coming in every two weeks.

[00:07:47] TU: Yeah, and I think so many people, as you mentioned, feel defeated by and we’ll talk about the nest egg numbers and kind of how we get there. I think for many folks, maybe there’s confirmation of, “Hey, I am on track.” And for others, they’re like, they hit the stop button, because they’re like, “No way this is going to happen for me in the future.” Because of, it’s hard to really believe in trust the process and time value of money and compound interest and growth, and that’s a future thing. That’s a tomorrow thing. And as you mentioned, it’s hard to see and imagine our future selves, especially when we’ve got things right in front of us today. And so, this is where the balance comes in. We’re going to go through this exercise of how much is enough. But as we talked about over and over and over again on the show, like an investing retirement plan is another great example of that, we can’t look at any one of these in a silo because for many, if not everyone listening, this is not the only thing they’re worried about, right?

[00:08:39] TB: Yeah. And just to go back to that, like in terms of the numbers, basically, I was doing some research for the case study that we recently recorded with Kelly and Robert, and I was trying to construct, what was the reasonable purchase price for a home in Portland, Oregon. The average, I think, was something like $88,000, or something like that in the late ‘80s. So, think about that, like those numbers. And again, when I typically talk about investments, and I talk about the secret ninja, the termite that is inflation, I always say that, what is it, that $4 latte at Starbucks in 30 years is going to cost north of 10. Or my dad will say, “A nickel would buy the whole candy store.” Now, a nickel doesn’t buy anything. When he’s grown up, he’s growing up in the ‘40s and ‘50s.

So, yeah, and to your point like, it is one – the investment and the retirement piece is one of many, many things that you have to consider. Just the overall risk to your wealth and planning for a catastrophic event is huge. Things like taxes, which are so overlooked, and how to pay your fair share, but then mitigate how much your – there’s so many things that kind of go into this, and a lot of it, we will talk about today, it’s not even about the rate of return or anything like that. It’s just about putting money in bucket.

[00:10:00] TU: Time and money.

[00:10:01] TB: Yeah, and it’s more about the savings rate, then the rate of return. So, even those mechanics and like the behavioral finance, that kind of bleeds into everything, it’s just so imperative that we’re looking at this and examining it. And unfortunately, because either it’s a boring topic, or it’s a painful topic, or we have head trash related to it with our upbringing, or name a number of reasons why we don’t necessarily want to look at this or work on it, it just becomes harder and harder as we go.

To give you some numbers, Tim. So, if you look at a pharmacist with medium pay, and they’re saving about 15% of income with an average annual rate of 6%, which is about what the market returns. So, that’s a fairly aggressive portfolio. If you started at age 25, by the time that you reach age 60, you have a portfolio of $2.6 million. Now, if you’re at age 25, and you’re saving 15%, and you’re an aggressive, that’s pretty good. The fact of the matter is, is that you’re probably not doing – a lot of people are not saving 15%, right off the bat.

At 30, when you get to – so you have 30 years now of accumulation, it goes to 1.8 million. So, a pretty big drop. At 35, just five years later, so 35 to 60, 1.2. If you start to the ripe age of 40, turning 40 this year, Tim, to age 60, so just 20 years, now, you’re not even crossing that million dollars. You’re at 822,000. So, a lot of this is just the mechanics of it’s better than what it was in the past. In the past, if you had a 401(k), you actually had to like sign up. Now, a lot of them will auto enroll you, so you are getting out of the way. But what I would encourage people if they’re not thinking about this, is add that 1% or that 2% every year, so you can get to that 15% or 16%.

During one of my recent courses, they were looking at what is the – everyone talks about the safe withdrawal rate. We’ll talk about that, the 4%. But what’s the safe savings rate? And the number that I remember is about 16%. So, if you are enrolled in your 401(k) and auto enrolled you at five, you are ways away. So, then the flip side of that is for you to make up, you’re going to have to be saving 20%, 25%, 30% later in your career to kind of make up for that. So, these are all things to kind of be mindful of as you’re navigating this minefield, so to speak.

[00:12:24] TU: Yeah. I think we’ve all had a parent, grandparent, friend, mentor, colleague. Somebody has told us, you got to start saving as early as you possibly can. And the numbers you just gave highlight that. If you start at 25, instead of 30, you’re adding about a million dollars. If you started 25 instead of 35, 1.5 extra, and that’s just simple math savings calculator, time value of money. And those numbers are hard to believe. But it becomes at a point where you see the exponential growth of those funds, but it feels like a grind for that first 10, 12 years, and you start to see the time value of money work, it’s magic. It really is 76ers style, trust the process long-term.

[00:13:03] TB: Trust the process, Jojo.

[00:13:04] TU: It’s hard, though, right? Because what did we talk about in this show? Homebuying with student loans, all these competing priorities. We got to have an emergency fund, we’ve got to be – we know folks are working hard to save for kid’s college while they’re also caring for elderly parents. We want to travel. I mean, all of these competing priorities, and pharmacists make a great income. But at the end of the day, there’s only so much to go around. And so, we’re not suggesting that this is an easy drop in the bucket, but something that we need to be intentional and consider with the rest of the plan.

[00:13:34] TB: I’ll say like, in our household, I’m always like, “Hey, can we increase your 401(k)?” “No.” It’s a battle in my household. And I’m like, “I do this for a living. Trust me.” But it’s that pool again. So, I’m like, “Okay. But if that’s taken away from what’s actually in our bank account, and then funding some of these other goals.” So, it’s a struggle. I mean, it’s a struggle in our household. And again, I probably am too diligent on the future, and not so much on the present, although I think some of the things that we’ve done in our financial plan is kind of said otherwise. But this is – it’s such a human thing, right? Because it’s that delayed gratification. But it is one of those things that if you can understand how to tweak it now, potentially early in your career, or even to say, even later in your career, knowing what to do for the final 5 to 10 years of your career can make all the difference.

The other side of that is, things like, what is your asset allocation when you’re in your 50s, if you’re trying to retire at 60? What do you what are you doing from a Social Security claiming strategy? Is there a way to lock an income through like an – there’s a ton of things that you can do to shore up your prospects, that just like what we see with student loans is kind of, sometimes you just follow the crowd. “Oh, my co-worker is doing this, so I’m doing that.” That never go goes away. “My brother in law is doing this, so I’m going to claim here.”

So, to me, it’s what I often say is like, you don’t have the same goals or the same balance sheet as whoever that is. But it’s hard to basically discern, “Hey, this is my situation. This is what I’m trying to do.” And wave through all of the stuff that’s out there to say, “Okay, this is the right – this is a clear path.” It’s just tough, and there’s so many variables that go into it.

[00:15:27] TU: Tim, one thing I want to share, and you’ve done a good job of opening my eyes to this, and we see this with clients over and over again, before we get into the numbers in the weeds is that we often talk about saving for retirement from a scarcity standpoint, as a, “Hey, I might not have enough, or are we going to fall short.” But we see many instances where you could argue like, is someone saving too much? And I think the value of this exercise, as you mentioned, is we have to find this balance between taking care of our future self and living a rich life today.

So, if we have a quick start in our retirement, we run the nest egg, and we see we’re not running a monthly deficit, perhaps there’s a surplus there, that begs the question of like, are we living the rich life today? So, just like an opportunity cost, of having too much in the emergency fund, there could be an opportunity cost of too much in a retirement account. Maybe a good problem to have, but it’s a problem, nonetheless. So, we’re going to talk about the balance of that, and I think that side gets overlooked often when we talk about retirement planning.

[00:16:24] TB: Yeah, I mean, we’ve definitely had clients that come in, where we actually do the analysis and it’s like, “You’re going to be fine.” So, we can afford to dial this back. And it’s not just retirement accounts, it’s education, especially if we kind of reframe what is the goal around education? What is the goal around retirement? A lot of the times, Tim, especially if you’re on the younger end of things, we’re planning as if so security’s not going to be there. So, you’re shouldering this all yourself. But the fact is, is that there’s a stat that says today, about 50% of people have Social Security makes up 40% of their income, or it’s flipped, the other way around. So, that’s not going to zero. It might be 25, it might be 30, and we can talk about Social Security more in detail. But if you think about that, and we say, okay, for every $10 that you’re going to spend on Social Security, or every $10 in your paycheck, $4 of that is going to come from Social Security. And if you claim right, that number gets bigger and bigger. If you kind of go through a proper claiming strategy, that’s huge.

So, we kind of plan as if like the worst-case scenario, that’s not going to be there. But if we can kind of back some of those numbers. If we use today’s averages, or maybe even like, on the low end, it really lends itself to saying, “Hey, this is not so bad. Again, if you have a lot of time.” Now, if you’re up against it, there’s a lot less wiggle room. It’s almost like you’re trying to steer the Titanic away from the iceberg. The closer that you are, the harder it is just to get around it. If you have miles, like a lot of younger pharmacists do, a few tweaks here and there just makes all the difference. And that could just be from again, the contribution rate, the allocation, or even just doing it and saying like, where am I tracking to like where we’re currently contributing, and then maybe back that off to then enjoy more today. Which I think is something that’s very unusual, because I feel like most financial planners will say, as much as you can, save. Because the more money you have, the more options you have.

But my view is, you can do that, and I kind of look at it as you can stick your head and run through the rose bushes to get your soccer ball. But you’re not really enjoying yourself on the way through. So, I think that’s where that balance comes through. I remember having conversations with clients about this very early when we were going through this of like, we back this off, we buy the home sooner, maybe we start our family sooner because of what this analysis shows us.

[00:19:03] TU: Start the business.

[00:19:05] TB: Yeah, exactly. Exactly, right. And to me, that is power. That’s options, right? So, that’s why I’m just a big believer in a plan and planning. It’s a dynamic thing.

[00:19:15] TU: Yeah. And I bring that up, because again, I think we don’t talk about much of that side of it, and it is more from that scarcity mindset. But I just heard from a client yesterday, it said, one of the greatest values I’ve gotten from the planning team is the permission to spend in an area that they have determined as richest in their own lives. And that was around hosting and welcoming people into their home. And obviously, there’s costs that come with hosting. But at the end of the day, if you’ve got 3.2 versus 4.1, but you’re going to look back on all those memories of friends and people in your home. What are you going to remember, right? I mean, it’s an obvious – so yeah, we got to take care of the future self, but also are we making sure that we’re living a rich life today.

Let’s talk dollars and cents. How much is needed? How much is enough? And there’s different ways of doing this. I want to start him kind of back of napkin math. Disclaimer here is that, this is certainly not the advice of, “Hey, I run some numbers. I punch some things in a calculator, and I know exactly what I need for retirement.” So, we’re going to plant some seeds. But there’s obviously a lot of in-depth analysis that goes into this. But I want to start with the rule of 25, which is a common quick math that’s used in the Financial Independence Retire Early Community, the FIRE Community, which says take 25 times your annual expenses, and that’s roughly the estimated amount that you’ll need to achieve financial independence.

So, let’s say someone’s listening and they look at okay, if I had about $100,000 per year of annual expenses, 25 times 100,000, I need about $2.5 million to get to the point of financial independence. And what that is really referring to, is the amount that you would need to have invested in a conventional stock and bond portfolio. We’ll talk a little bit more about that throughout this series, to probably, keyword “probably”, consider yourself financially independent, that you could not depend upon work income and be able to draw from that portfolio without concern that you’re going to be running out of money sooner than would be desired. And that comes from, Tim, and I want you to break this down a little bit further. That rule of 25, the inverse of that comes from the 4% rule, which as you mentioned just a few moments ago is about this concept of safe withdrawal rate.

So, break that down a little bit more for us. We’ll talk about this in depth when we get to the retirement paycheck piece. But what is the 4% rule? And I know this has been debated, but why might this be a good starting point for us to think about what’s needed in a portfolio?

[00:21:38] TB: Yeah, so the safe withdrawal rate is based on the work by William Bengen. And what he did was he looked at all of the historical rates of return for a portfolio and I think he did like a 60/40, portfolio 60% in equities, 40% in bonds, and he used a time horizon of 30 years. Basically, what he was trying to figure out is, what is the amount of money that can draw from the worst 30-year period where at the end of that 30-year period, there would still be money left over? So, the money would not run out.

He did the analysis and basically came out with – and I forget what the year. I think it was like 1961 to 1991? Or maybe it was like –

[00:22:31] TU: Yeah, it sounds right.

[00:22:32] TB: Yeah, right around, I think it was like ‘60s and ;90s and 4% — so what that presumes is that all of the other roll on your peers, you could actually take out more, and still be okay. But the worst period in, I think, he did it since like the 1920s all the way up until I think 2012. The worst period of that 30-year period was from the ‘60s to the ‘90s, and the safe withdrawal rate where their money was not going to run out was 4%. Now, there’s been a ton of debate of whether that is. It disregards things like taxes, it disregards things like fees associated, so whether you’re working with other fees, it disregards, kind of adjusting portfolio as you go through those 30 years.

And then the other thing is that, one of the observations of late is that for a lot of retirees in this low interest rate environment, obviously, it’s ticked up here this year, and equities performing what they’re performing, maybe 4% is not necessarily a good role going forward. So, there’s a lot of debate about that, and can you set it for 4% and be good to go? Maybe. But that’s basically what it’s based on. It’s like, okay, what is the worst, and when they’ve tested it in other, say, like, Italy, it failed, where this basically was successful 100% of the time, in that same period, it failed 80% of the time in Italy. Not to say that we would have, but they were dealing with a lot of inflation and things like that.

So, that’s basically it. So, the inverse to your point is 25 times your annual expenses. The problem with the annual expenses, Tim, is that if you ask somebody like what’s your annual expenses, unless they’re a FIRE nerd, they’re not going to know. And even that, when you’re trying to back into building a retirement paycheck, I know some financial planners, they don’t even ask the client for their annual expenses. They just assume that everything on their W-2 is basically they’re going to spend.

[00:24:29] TU: Their income, yeah.

[00:24:29] TB: And there’s other ways that you can discount and things like that. But that’s kind of where you get to it. I wouldn’t say that rule, I like rules of thumbs because they’re easy to remember, right? We talk about rules of thumb and other parts of the financial plan. So, if it’s $100,000, 2.5 million, I don’t think that that’s necessarily something that is not a bad thing to at least have in your back of your mind to shoot for. But there’s a lot of gray and again, a lot of gray with the accumulation but then also the kind of withdrawal phase of like, “Okay, I have this pot of money where there’s 2.5 or 4 million. How do I actually turn that into a paycheck that’s going to sustain me for the rest of my life?” And that’s a difficult kind of thing to tackle.

[00:25:09] TU: Yeah, and we’re going to cover that in more depth in the retirement paycheck part of the series. And obviously, we’ll dig into that after that as well. But just to bring my example back here. So, 2.5 was the number that we determined. Again, 4%, inverse of the rule 25. So, 2.5, 4% of 2.5 would be $100,000. So, that would be the idea, and correct me if I’m wrong, Tim. But I think the 4% rule also suggests that you’re essentially bumping that up 3% per year for inflation. So, the 100 would become 103, and then you would continue that on into the future.

So, there are a lot of nuances in there. You mentioned tax is one. Obviously, what types of accounts do you have saved up. We’re in a time period like we’re in right now, where inflation is obviously a lot higher than 3%. That can have an impact. So, if folks want to just back up napkin, okay, maybe three, three and a half, well, three would be 33 times annual expenses, you can run some of these numbers and kind of see what they would shake out to be.

Tim, let’s get a layer deeper then, which is the nest egg calculation, something that our planning team and works with our clients a lot on, which is we’re trying to get more specific about the individual circumstances for that client, what they currently have, say, projected age of retirement, how long they might live, how does Social Security factor in. And then ultimately, I think one of the great outcomes of a nest egg calculation is getting out of this monopoly money state of mind of 3, 4, $5 million into the future that I can’t relate to, to what I actually need next month, and the month after, and making this tangible as a part of the monthly planning.

So, tell us a little bit, high level, about the nest egg calculation and what are some of the factors we’re considering to ultimately get to that? Are we on track? Or are we not on track for what it’s enough?

[00:26:58] TB: Yeah, so I feel like very early in my financial planning career, I looked at the different approaches to this particular question of like, do we have enough? There are other things like Monte Carlo analysis, which we can talk about, or bootstrapping, which we can talk about briefly after this. But I found that doing the nest egg calculation was really important. But when I did it in my last firm, we would basically stop at, “Hey, you need 3 million, Tim.” And then we would move on to, “This is what you need to do for insurance or your state plan or whatever.” It was, like you said, it was like monopoly money. Nothing about that connect it to the client, especially if the further away they were. I went out to reference that. If it’s like you have a million dollars and need 1.5, and you’re four or five or six years away, then that obviously connects.

So, what I basically did was, I was like, okay, I asked the question, how can we make this more digestible? I’ll walk through kind of high level of the nest egg, and then I kind of see how we pivot from there. What we do is we take a client, we take their current age, we take what their target retirement age, which for a lot of people, it’s like, I don’t know, 65, or maybe it’s full retirement age for a lot of – 67. And that gives us the work life expectancy. That’s basically the amount of time left that you have to work for the man. That’s your timeline, your career timeline.

And then we look at what their life expectancy is, which you can go on to socialsecurity.gov, right now, put in your birth date, your gender, and it’ll spit out the year and the month you’re going to die. So, for me, it’s like 86.8 years old. Now, what most financial planners will do is they’ll go a little bit beyond that. So, 90 to 100. A lot of like financial planning software will go to age 100. You just kind of pick what is a good timeline for you. If you take the number that you’re going to retire at 67, for an example, and then say, we’re going to die at 95, then you have 28 years of basically, retirement, senior unemployment. And that’s what makes us really hard, Tim, is that we’re trying to solve an equation without all the variables, right? We don’t know when we’re going to pass away. So, we just make some assumptions. And then we look at what do we currently have in retirement savings, so that’s all the 401(k)’s, IRA’s, all the alphabet soup that we’ll talk about in the series.

And then what is your current income? Now, we use current income because we use a discounted amount called your wage replacement ratio, to kind of figure out what the need is in retirement. So, a lot of planners will use 60% to 80%. You just kind of figure out what that is. The logic behind that is that, as you are leading up to retirement, a big part of your paycheck, 20%, 30% is going to be just saving for retirement, and then when you retire, you’re not going to be doing that anymore. Then you have to make assumptions about what your portfolio looks like, so that’s where we kind of go into like a 6%. That’s a pretty aggressive portfolio. And then what that would look like in terms of draw down, and that gets your total needs.

So, as an example, if we look at a pharmacist that makes $120,000, and has $40,000, in the retirement accounts. They’re age 30. They’re going to basically work to 67. That’s 37 years. So, we start with at $120,000, and say, the wage replacement is 70%. That means that we need to plan for, 84,000. So, that’s 70% of 120. Now, if we zero out Social Security, that means that we’re planning the whole need ourselves, that’s 84,000. Now, in 37 years, Tim, when I’m 67, that’s going to be equivalent to about a quarter million dollars. What that means is that every year from 67 to 95, when I die, I need a quarter million dollars to live, which that’s where that kind of gets wonky, because you’re saying, okay, 84,000 is the same as 250,000 in 37 years. And the answer is yes.

[00:30:59] TU: Yeah. Tim, that’s the piece, like, as we’ve talked to so many groups on this. And obviously, for those listening that are near retirement, again, the disconnect is not there, because you’re close to that dollar, and you understand what the inflation that’s happened over time. But when we’re speaking with a group that’s earlier in their career, this is where they see the 3, 4 or 5 million and they’re like, “You all are crazy. The numbers don’t add up. How much money you need?” It’s because we’re thinking about in terms of today’s dollars versus future dollars.

[00:31:27] TB: Right. Correct. So, if we look at that, and you’re like, “Okay, quarter million dollars”, what do I need in the portfolio to sustain a quarter million dollars, essentially, for 28 years between ‘67 and ‘95? And the answer is about 4.4 million. Now, we know that social security is going to be there. So, even if we use something like nominal, and we say that the annual Social Security benefit is going to be something like 30,000, that drops it down to 2.8. So, it is a huge thing, but again, we zero that out. So then, we say, okay, let’s go at 4.4. And you say, okay, Social Security is going to be there. But let’s plan this, we’re going to do it all by ourselves.

That means that for us to get to 4.4, if we assume that we have $40,000 saved already, it’s basically a thousand bucks that we need to invest monthly with that current $40,000. So, to me, this is like the special sauce where I’m like, “Okay, 4.4 doesn’t really mean anything to me. So, how do I make it mean something?” We basically discount it back to like, how will it mean for me today? So, if we basically make a payment, this is a time value money calculation of $40,000, and we assume certain return everything, it’s $1,000. So, then what we do is we say, “Okay, client, how much are you putting into your 401(k), 5%? Okay, so 5% of 120? What’s your max, 3%? Okay, 3% of 120. That’s actually $800. So, 1,000 minus 800, the deficit is about 200 bucks. That’s basically on a monthly basis, where we have about $200 per month drag to get to that 4.4 million.

[00:33:07] TU: But 4.4 just became tangible, all of a sudden, right?

[00:33:10] TB: Right. That doesn’t necessarily account for everything like, fees, and taxes and all that kind of stuff. We’re just going to drag. But the idea is that, then we can say, okay, well, what happens if we max out the IRA? Or what happens if this isn’t an 80/20 portfolio, which is more conservative than like the example that we gave? What happens if we take a little bit more risk? What happens if we do this or that? That, to me, is where you could say, “Wow, we’re actually a lot further along than we thought. We have more options here.”

So, to me, the nest egg calculation, it’s a time value money calculator, that usually gives you this big pot of money that you need. But I think, the special sauce is to kind of discount it back for it, actually means something to me today. And that’s where, I think, great planning can kind of come from there.

[00:33:58] TU: Yeah, and I think one of the things we hear a lot from prospective clients. I know Justin does when he’s talking with folks, and we certainly see the value of this coming to clarity in the planning process, is this is one of those topics for good reason that there’s a lot of anxiety and uneasiness, because it’s a, as we’ve talked about, big number. It’s out in the future. We get into the what if scenarios. What if I don’t have enough? What about this? Am I going to be able to care for my family? Do the things I want to do? And we underestimate, in my opinion, we underestimate the mental toll that that running conversation has in our head. Do I have enough? Will I have enough? What about this? Could we be doing more? And whether we like the numbers, whether we punch this number and we see a thousand, we’re like, “Tim, I’m never working with you again. Don’t show me this number again.” But we have a picture of what’s it going to take each month. And just like we talked about budget and other things, what do we need to do? What do we need to change? Or perhaps nothing to make this goal a reality. So, we’re bringing the unknown, big scary parts of the plan into reality, and something that we can address on a month by month basis, and begin to work a plan if we don’t have it yet in place, that allows us to hopefully make this goal a reality.

[00:35:09] TB: Yeah, it’s so true. And I think that’s why it can be such a cliff to get over, is because when you’re going through this process, you’re setting things up. But idea is that, once you get past the initial setup, life is going to change, and you’re always going to have challenges. But if you know, it’s kind of like what we were talking about, I think before we turned the mic on. If you know in the background, that you’re funding these goals, whether they’re near term or long term, it’s like, that can kind of create scarcity, because you are kind of being very deliberate with how you’re directed money. In the back of your mind, you still know that you’re doing the pay yourself first, or you’re putting those goals that are really important for you and your family at the forefront.

Whereas, if you just throw everything into a pot of money, you’re not clearly distinguishing what are we actually doing? So, to me, that’s super important. A lot of it is like for retirement is, in this case, jacking the employee contribution up 1% or 2%, fixes it, without doing anything else at all. The other thing you could do is just change the allocation to aggressive, and you’re 200 to the to the front side of it. You’re 200 to the good side of it. And that’s what we talk about when we speak about investment, and kind of aggressive Jane and conservative Jane, and kind of highlight in what little tweaks to your portfolio can do. It’s huge. And not doing that, is to your point, can cause that mental bandwidth and kind of caused you to not do anything at all, which is not necessarily good either.

[00:36:49] TU: Yeah, Tim, this is a great start to this series, and starting with a question of how much do I need? And even before that question of where am I going and why am I going in that direction? Right? So, we talked about living a rich life today, making sure we’re taking care of our future selves. And before we talk about, which we’re going to on the next episode, some of the actual X’s and O’s. What are the vehicles that we could use to be able to begin to build this portfolio? So, once we identify, we need three, we need four, we need four and a half, whatever that number is. The next natural question is, “Well, how do I get there? What do I do? What are the options that I have available?” So, we’re going to talk about that on the next episode, but this episode is really about laying the foundation around how much is enough? And what are some of the factors that I may use to begin to make that determination?

Of course, we’re biased, but the team at YFP Planning, whether you’re a new practitioner, whether you’re in the middle of your career, whether you’re nearing retirement, or maybe have already gotten to the point of retirement, our fee only financial planning team of five certified financial planners and our in-house tax team, including a CPA, and an IRS enrolled agent, they’re ready to work with you to build a retirement plan among other financial goals that you’re working on as well.

So, if you’re interested in learning more about our one on one comprehensive financial planning services, you can book a free discovery call. To learn more about that service, determine whether that’s a good fit, and you can do that by scheduling an appointment at yfpplanning.com. Again, that’s yfpplanning.com.

Tim, this wraps up our first four episodes, and we appreciate everyone listening and we’re going to pick back up next week, talking about some of the alphabet soup of retirement accounts.

[SPONSOR MESSAGE]

[00:38:28] TU: Before we wrap up today’s episode of Your Financial Pharmacist Podcast, I want to again thank our sponsor, the American Pharmacists Association. APhA is every pharmacists’ ally advocating on your behalf for better working conditions, fair PBM practices and more opportunities for pharmacists to provide care. Make sure to join A Bolder APhA to gain premier access to financial educational resources, and to receive discounts on YFP products and services.

You can join APhA at a 25% discount by visiting pharmacist.com/join and using the coupon code YFP. Again, that’s pharmacist.com/join, using the coupon code YFP.

[OUTRO]

[00:39:08] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog post and podcast is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analysis expressed herein are solely those of your financial pharmacist unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward looking statements, which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you again for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

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