Don’t Forget The Personal Side of Financial Decisions
Today I have a guest post from a long-time blog reader, Bill Hines. I’ve gotten to know him through exchanges in the comments and ensuing email conversations.
Like me, Bill is an advice-only financial planner. He offered to share some key lessons he’s learned working with financial planning clients.
You can learn more about Bill at his firm, Emanicpare’s, website. He has also written several books, including recently publishing Plan Your Money Path to help DIY planners use Pralana’s high-fidelity retirement calculator to build their own financial plan. (Disclosure: Pralana is a long-time affiliate of this blog. Bill and his firm have no financial relationship with this blog.)
Take it away Bill….
What Are You Optimizing For?
Chris and I are both financial planners. We work with tools that do math for our clients. They include:
- Social Security optimizers
- Roth conversion optimizers
- Tax optimizers
- Retirement Success Historical and Monte Carlo calculators
It’s not always about the math. Life isn’t just about money. Life is about happiness… or should be. This is especially true in retirement, after working and perhaps raising children for decades.
Although I’m a math nerd, I try to keep the focus on the decisions clients and I make together about happiness. “One of these choices is more optimal mathematically, but which do you think will make you more happy or less stressed?”
Planning for Couples
I encounter countless situations where one spouse or partner is the financial driver in the relationship. The other is more or less on the sidelines.
The financial driver is typically more risk-tolerant, and thus more aggressive in the family’s investments. I often find the other person in the relationship is secretly, in the background, stressed out because of a much lower tolerance for risk.
When a down stock market is in the news, they’re like a back-seat passenger without a seatbelt on a windy road, white-knuckled and hanging on. They’re often afraid to question, as they don’t feel confident in their financial knowledge.
The driver is often oblivious, or reassuring with simple language. “I know what I’m doing, honey. It will be fine.”
This isn’t a recipe for happiness and low stress in a relationship. That’s why a risk tolerance exercise is one of the first things I do with a new couple. I want them each to be well informed not only about their risk tolerance level, but their partner’s as well.
The results on both ends are usually surprising! Know this about yourself and your partner, and be considerate of the tendencies.
Here’s a free risk tolerance test you can each take. Do it separately, and don’t influence each other!
You’re an Individual, Not a Rule of Thumb
Let’s look at some other examples. Social Security is a good one.
We’re constantly subjected to click-bait articles imploring us to wait and wait. Of course, the government would prefer we wait until we die to preserve that ailing trust fund!
The math may say the “sweet spot” for you and your spouse is a mathematically perfect scenario such as the higher earner waiting to the maximum age of 70, and the lower earner claiming earlier, and using spousal benefits at the opportune time. Sounds great.
But, what if you both have terminal health conditions and have been advised by your physicians that you may not have a long life trajectory? That changes the calculus in a non-math way. Enjoy the money now.
When I run the Social Security optimizer for my clients, and we game out claiming early versus claiming later, it’s amazing that most times there isn’t much bearing or change in their overall chance of success, retirement income, or net worth.
When I show them the payback point for waiting is in their mid-80s, they often comment, “What will I do with the money then? I want to enjoy it while I’m young!”
In most scenarios, the difference is negligible. Yet folks agonize over this decision.
If someone has very little savings and will be relying on this benefit primarily to live, of course it’s a different situation. Remember, the actuaries and mathematicians at the Social Security Administration do a lot of careful math to ensure folks receive the same amount of money, on average, no matter when they claim.
Related: A Framework for Claiming Social Security Benefits
Roth Conversions: What is the goal?
Emotion versus math often comes up in conversations about Roth conversions. Roth conversions are frequently discussed in the personal finance blogosphere. They can be an excellent tactic.
It can be surprising when a planning or optimization tool doesn’t recommend aggressive conversions. The tool is looking at this decision in a purely mathematical context.
For example, if the tool sees that you aren’t planning to spend the money, it may not see a reason to pay taxes on conversions. The tool thinks, “That’s someone else’s problem–whomever you leave the money to!”
Money Likely Going to Children?
However, as a human, you decide it’s a great reason to convert, as the Roth money will grow tax-free until you pass, and then become a wonderful tax-free gift to your heirs.
By the time we pass, our children may be in the prime of their careers. If you don’t convert, the required distributions they’ll receive if they inherit a tax-deferred account may push them into higher tax brackets or have other unwanted financial consequences.
Are You Charitably Inclined?
Don’t convert money you plan to leave to charity. They don’t pay taxes on these dollars like you do!
Do You Have Long-Term Care Insurance?
Perhaps don’t convert money you plan to use for long-term care. That may result in a tax deduction if it’s enough to itemize in those years.
What If One Partner Dies Young?
If you’re using a high-fidelity planning tool like Pralana Online or Boldin, you may have optimistically set your longevity to 90 for both you and your spouse.
Part of that planning should always involve the unpleasant scenario of one of you passing away earlier in life. That would leave the surviving spouse to pay the single filer “widow/widower” tax!
To avoid that, couples will often do Roth conversions to build up their tax-free reserves, even if the “math” says it’s not optimal.
What Lets You Sleep Better?
Our government carries a lot of debt, and that can be scary. Someday, the piper will have to be paid!
If you’re worried about future tax hikes, you may want to do Roth conversions more aggressively now. Retirement should be about enjoying your life, not worrying.
Related: When are Roth Accounts Better than Tax-Deferred?
The Hidden Cost and Risk of Complexity
I often encounter people who are excited to implement every latest complex scheme they encounter in blogs and on social media.
Should you build a bond ladder rather than using bond funds? What about putting all your bonds in regular brokerage accounts, and all your equities in your pretax accounts?
Yes, that will optimize every dollar, tax-wise. But how much do you really save compared to the simple path of deciding your optimal asset allocation and implementing it identically in each of your accounts and locations? I have seen clients doing these tax-saving financial gymnastics when they have fairly low financial assets and not much of a tax bill to begin with.
There are several downsides to adding this kind of complexity. First, we begin to lose our financial acumen as we age. We become more prone to mistakes. Errors can be expensive!
More tricky hacks mean our non-financially oriented spouse or partner may have trouble understanding what’s going on. This can cause stress in relationships.
What if the financial driver passes away? The survivor, on top of grieving, is now left with something they don’t understand, and may then be taken advantage of when seeking help.
The happiest retired couples I’ve worked with keep things simple. They have an occasional meeting where they review their plan and make decisions together.
I could go on, but in closing, please don’t forget to consider the emotional, happiness, and stress factor analysis when making financial decisions. This is the beauty of having a high-definition financial plan.
Should You DIY Retirement Planning?
Use a professional planner, or one of the few available high-definition tools available to consumers, as reviewed in the past articles here at Can I Retire Yet. Be cautious, as there are many variables to consider in a financial plan.
If you DIY, consider having an advice-only financial planner review your plan. Don’t be penny-wise and pound-foolish with such important decisions. Mistakes can be expensive!
Chris’ $.02
As we head into the end of the year and the start of a new one, many people have financial planning on their mind. Bill shared a number of key messages. I want to focus on what I consider the most important.
Don’t make things more complicated than necessary! Darrow made simplicity a foundational message on this blog from its earliest days.
This is a theme I frequently need to be reminded of. Bill has been a person who played that role for me. He called me out on this in the comments of this blog several times over the years when I stray from simplicity. I appreciate him for it, and encourage you to keep this message in mind and you build your financial plans.
Related: Financial Simplicity — What is your time worth?
* * *
Valuable Resources
- The Best Retirement Calculators can help you perform detailed retirement simulations including modeling withdrawal strategies, federal and state income taxes, healthcare expenses, and more. Can I Retire Yet? partners with two of the best.
- Boldin (formerly New Retirement): Web Based High Fidelity Modeling Tool
- Pralana Online (formerly Pralana Gold): Online and/or Microsoft Excel-Based High Fidelity Modeling Tool
- Monitor Your Investment Portfolio
- Sign up for a free Empower account to gain access to track your asset allocation, investment performance, individual account balances, net worth, cash flow, and investment expenses.
- Our Books
- Choose FI: Your Blueprint to Financial Independence
- Can I Retire Yet: How To Make the Biggest Financial Decision of the Rest of Your Life
- Retiring Sooner: How to Accelerate Your Financial Independence
* * *
[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]
* * *
Links on this site, like the Amazon, Boldin, Pralana, and Personal Capital links are also affiliate links. As an affiliate we earn from qualifying purchases. If you click on one of these links and buy from the affiliated company, then we receive some compensation. The income helps to keep this blog going. Affiliate links do not increase your cost, and we only use them for products or services that we're familiar with and that we feel may deliver value to you. By contrast, we have limited control over most of the display ads on this site. Though we do attempt to block objectionable content. Buyer beware.
I agree with everything said. And I got a lot out of using the RISA test designed by Wade Pfau and outlined in his book, Retirement Planning Guidebook.
I was really wrapping myself around an axle, studying all the options as I prepared my portfolio to begin retirement. The RISA test allowed me to understand why I would not need to study many of the tools other people believed in, because my profile was different from theirs. Very worthwhile reading and gives couples an opportunity to understand just where each of them are, and choose options that will satisfy both parties.
Thanks for the feedback Laura. I actually have Wade’s book on my reading list for early 2024.
Cheers!
Chris
Long term reader of the column.
I am a DIYer…and one reason is that I have not been able to find anyone I trust more than myself with reviewing my plans. I am 2+ years into retirement so it’s more about execution now than planning, but without a strong reference, how do you know if you are throwing thousands of dollars away (or not) on a financial person? The few I have spoken to didn’t seem to be able provide much more direction than what I was already doing.
And I agree with everything above…especially the simplicity part. You can get fancy with numbers and tools, but it never felt like it was worth all the extra effort when one market shift (or election) can throw it all off anyways.
Thanks!
Rich,
Unfortunately you don’t know. You can go a long way towards limiting conflicts of interest by understanding how your advisor is paid. IMO, an advice-only model where you pay directly either by check or on a credit card for the advice you receive is the least conflicted model.
Two caveats here.
1. Even this model does not eliminate conflicts of interest. The largest conflict is overcomplicating things to create reliance on an advisor.
2. Unfortunately, minimizing conflicts still does not guarantee competence.
This is a hard problem for consumers. Even the terminology is confusing. Don’t confuse advice-only with fee-only (which can include opaque assets under management fees) and definitely don’t confuse it with fee-based (which means you may pay fees in a number of ways.)
This is why I am so passionate about promoting the advice-only model and the firm I work with, Abundo Wealth, that is committed to scaling the process while focusing on developing standards for advice and keeping costs low.
Best,
Chris
I’m in your corner when it comes to “not been able to find anyone I trust more than myself.” Every time another news report tells us about someone who lost most of life savings to a dubious investment scheme, it always includes the role of a trusted financial advisor.
Chris
I have read your blog for years and have benefited immensely from your sage advice at this time of reflection on our good fortune I wanted to say Thank you and Happy Holidays to you and your loved ones. Your efforts are much appreciated. Communication and simplicity is the foundation to financial success for couples.
Thanks for the kind words Mike W! Best wishes back to you and yours.
Chris
Hello Bill and Chris,
Bill, thank you for your insights! I do have one question, or comment, on the giving of money to children from a tax-free Roth. Instead of making conversions, and paying tax on the conversions, why not just give the amount you would convert directly to your children now? This way, it is totally tax free! No tax for converting and no tax liability on your children! Plus, as a bonus, they can start enjoying and putting the money to good use now and I can enjoy giving it to them while I’m alive. This is a great win/win in my opinion. Your thoughts?
Happy Holidays!
King-Joey,
That’s not exactly correct.
You would take the money from the account before gifting, so there would be tax on the WD (which is the same as the tax you would pay if converting all else equal).
You are correct that there is generally no tax on the gift. This is a great idea IF the kids need the money now. I talk to clients about this frequently, focusing on giving for more impact now vs. a leaving a larger amount later when it may be less impactful.
However, this is not a good idea financially if they don’t need the money now. By converting the money, it can continue to compound tax-free for the remainder of your life. It can then compound for an additional 10 years after your death before your heir ultimately will be forced to take the money from the account.
This is a perfect example of Bill’s point of the optimal financial decision being driven by your individual circumstances and goals vs. rules of thumb or numbers on a calculator.
Great question. Thanks for reading.
Chris
Hi Chris,
After reading your reply and then re-reading my post, I see that I wasn’t clear. My thinking was:
– Do not convert to a Roth and save the tax money.
– Gift the money that you’d have to pay in taxes, if you converted, to your children now from non-IRA funds.
– No tax is paid on these gifts. Ever.
Of course, the assumptions are that you have the money available without converting anything and that the giver won’t need these funds in the future. In my case, those assumptions are true.
For example, if we put numbers on this:
Say you want to convert $50,000 and this still keeps you in the 22% tax bracket. You’d have to pay $11,000 to the feds (and for me, $3,000 or so to the state). That would leave $36,000 in the new Roth to grow tax free.
What I’d be proposing is to gift the entire tax due amount of $14,000, give that from non-IRA funds and leave your $50,000 in your IRA to continue to grow tax free.
This is what I’ve been doing, because I figure my kids can better use the money now, with growing families, than the much bigger amount they’ll get later on. Who knows what will happen later on, especially with tax laws, but my gamble is that the undisturbed $50,000 will grow at the same rate as the Roth $36,000 and that tax rates will not change. In the meantime, I know that the $14,000 is helping now.
I know that taxes (most likely) will be paid on the larger traditional IRA, but again, these laws have changed on these distributions at least once already (to the 10 year rule) and who knows how they will change in the future.
Plus, I’m hoping that by the time my kids receive the traditional IRA amount, that they won’t need it as much as now, and that the tax issues will be a minor inconvenience or a small dent to the total amount received.
Your thoughts now?
Thank you!
King Joey, Generally it is advisable to convert the entire $50,000 and pay the taxes from your taxable account. Mike Piper did an excellent presentation on this topic at the Bogleheads conference. Sorry I don’t have the link handy.
Hi Pete,
I’ve used conversion calculators and attended seminars (free dinners, of course). For my particular situation, it turns out that not converting is the better way. If I followed what you are saying, where would I get the $14,000 that I want to give my kids? The Roth money is now locked up for 5 years before I can withdraw it, unless you want to pay an additional 10% penalty. And now I’d have used the $14,000 to pay taxes instead of gifting the kids.
I have yet to attend a presentation where this 5 year withdrawal rule is brought up, unless someone asks about it. And that person is usually me. Also, these presenters usually say things like “taxes are only going to go up” and “you’ll probably be in a higher tax bracket” later. Statements like that raise my blood pressure because that is simply speculation. Do you or anyone else think that taxes are going to go up in the next 4 years under the new administration?
Pete, to be clear, I’m not attacking you. I’m attacking the “general” belief that people should convert to Roth’s.
Merry Christmas!
KingJoey & Pete,
Joey, in your second comment, the math makes more sense to me. However, everything I wrote in response to the first comment also still applies.
I would start with what you want to do and what would most benefit the recipients of the gift. Your solution allows for a gift now from money that would have been needed to pay taxes. That is great if this is your primary concern.
But this is not a free lunch because now the money in the tax-deferred account will remain taxable later where it would have been tax-free if you had converted to a Roth. That is fine if you anticipate the heirs will be taxed at the same (or a lower) rate than you are today, but if that is the assumption, why were you doing the conversion in the first place? I think this is the point Pete is trying to make. If not, Pete, feel free to chime back in and add your additional $.02.
So kind of a mixed bag. There is no universal “right” way to approach this problem. The answer is it depends on what you are trying to accomplish.
Cheers!
Chris
Wife and I are 78. She took SS early, I took it late. We’re in good health but have bad genes (or something) and I’m not expecting we’ll reach 90.
One sentence grabbed me: “The happiest retired couples I’ve worked with keep things simple.”
I’ve never “played” the market, but a couple years ago I started going really simple, moving almost everything into Vanguard’s Total Stock Market, funding it with two $500 purchases every month, and never trying to time the market. (Yes, easier to say when the market keeps going just one direction, up.)
We’re not rich but we’re not ever losing sleep over running out of money. (Sometimes I do worry about the national debt, but then no one else seems to be, so like Mad’s Alfred Neuman, “What, me worry?”)
The biggest investing mistakes I made were: 1) being too conservative all my life; as we speak I’m about 80% in cash and bonds, and 2) not buying tech stocks though I have some work experience and training in IT and could have identified some winners.
Ah well, water under the bridge. Right now I’m watching as our life’s savings gets destroyed by inflation (a millionaire ain’t what it used to be) and looking for Trump’s second term to address the SS/Medicare bills we simply can’t afford. Ha, fat chance.