2022 EP0604 - Richon Planning - Inflation & Taxes in Retirement

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Welcome to Planning Matters Radio. Hey Peter, it is very good to see you and today we have a very important topic, how to fight inflation. Of course, inflation was the story of last year. It's still the inflation this year, the story of this year.

Now, I want to show you some interesting numbers because this is, you know, maybe kind of good news. The U.S. inflation rate dipped to 8.3% in April, marking the first slowdown in eight months. Some experts say we are past the peak of inflation, but the upward pressures remain. So Peter, the question is, you know, is there anything that we can do now to guard against inflation? I unfortunately am skeptical about the insights of those experts on whether we are past the peak.

And we're certainly not past the pain by any stretch. We are seeing prices increase, it seems like almost on a daily basis. And I know that the CPI has adjusted slightly downward, but the real life expenses that we pay in the grocery store and at the pump and for medical bills or everyday routine expenses certainly has not seen any decrease. And the fact that these companies have been able to charge prices that people have up to this point been willing to pay doesn't really give any company incentive to drop those prices either. And what we're seeing is with the shortage that we have seen, with the supply chain issues that we have incurred, a lot of companies are just now renegotiating prices for their supply chain for the goods that they are receiving, that they in turn sell to consumers. And those renegotiations of the contracts and the storage and the shipping and the trucking and the supplies, those are getting more expensive as well. I mean, we saw Walmart and Target stocks tumble, they missed earnings. But a lot of that was due to the fact that they cannot raise prices fast enough on consumers to offset the cost that they are having to pay to buy more goods to replenish their supplies. And so I'm hoping that we see some type of stabilization in inflation, but I don't see it going away or being a non-issue anytime soon. All right.

Well, it does hurt to go grocery shopping to fill up the car. You are so right. So let's talk about what we've seen though in the markets. We've seen a break in yields as investors move out of stocks and into treasuries. Are there any actions that we should be taking now to guard our investments against inflation? Well, that's a move that I think is sort of a natural reaction when we see market volatility.

No one wants to leave the party when everything's going really well, when everybody's having a good time and the stock market is rising, everybody wants to be in it. But as soon as we see volatility in the markets, it's sort of the natural reaction for many investors to try to exit what they think is early. But ultimately, oftentimes it's a little too late and it's kind of just locking in losses. Now, what we are seeing is that with the Fed's approach to controlling inflation, rising interest rates, that the interest rates on borrowing money, for instance, for mortgages, seems to be reacting a whole lot faster than on savings and deposits and investments. I mean, the mortgage rate has almost doubled already this year, whereas the rate on your checking, savings, CD, money market has not seen nearly the increase. Also, the rates seem to be reflecting much quicker for short-term rates than long-term rates. So the 30-year Treasury has not adjusted nearly as much or as quickly as like the five-year rate on treasuries. And so we are nearing that territory of the dreaded inverted yield curve, which has in previous times been a precursor that signaled the potential for recession. Now, there have been times where it has inverted where we have not seen a following recession as well. But it is one thing that economists do pay attention to. What can we do?

Well, there are options out there. The market and inflation do not always coincide in an agreeable way. We flash back to like the 1970s and early 80s where inflation was a big factor.

The market did not help us to offset inflation during that time. And so we're looking to things like structured notes, defined outcome investing. I bonds are a fantastic option right now because they do reflect what the Fed advertises as the inflation rate. So as of right now, you can get as much as anything can be said to be guaranteed or risk-free in the financial world, a rate of 9.62 from your federal government, government backed on I bonds. Now, anytime the government gives us something good, they limit how much we can take advantage of. So you can only do $10,000 per year per person.

I wish we could do more, but those are the limitations. I don't see inflation going away anytime soon. So while that rate can adjust, I don't see it falling precipitously or dramatically in the course of the next year or so.

Okay. Well, that was some good actionable advice for people who have maybe a longer time horizon. But I'm sure that that advice is a little bit different for somebody who is in or near retirement. So during this period of high inflation, what should pre-retirees and retirees be doing?

Right. Yeah, it's definitely got to be different because during your earning years, during your working career, hopefully your wages adjust with the cost of living. You can negotiate pay raises or work into better, higher paying jobs. Whereas during retirement, you've got a fixed income and a set finite amount of money on day one. You've got to make it last.

Therefore, Aaron, we've got to be proactive. You can't wait until periods of high inflation to plan for high inflation. You've got to plan for higher inflationary periods, even during periods of low and relatively stable inflation.

Those are conversations that really a prudent planner, a cautious, experienced advisor is going to have pre-retirement or in the very first planning years of retirement. Because costs do go up over time. That's a fact. That's inevitable. The value, the purchasing power of the dollar has dropped considerably over the years. And that's not going to stop.

It's going to continue that trend. And so we need to plan for retirement in a way that either has increasing ability to generate more income throughout the years or separate segmentations of money that can be kicked on over time throughout the years or identifying basically a time optimized portfolio that has now money, soon money, later on down the road money and growth money. And during good periods, we can sort of harvest some of that growth money to supplement those other buckets. Well, these are really important considerations. And you brought up some specific investment opportunities. If somebody would like your help to design a portfolio that can withstand these periods of high inflation or some of those, again, hedged equities and structured notes that you mentioned, what's the best way to reach you?

Yeah. Call the office, 919-300-5886, 919-300-5886. You can email me, Peter, at rashanplanning.com. It looks like Rich on Planning. It's my last name. Peter at rashanplanning.com.

Go online, rashanplanning.com. All the ways. All right, Peter, thank you. Always a pleasure, Erin. Thank you. Hi, Peter.

Good to see you today. We are doing a little myth busting, which is always fun. And today is the myth of retiring in a lower tax bracket. I've heard before that if you don't have a tax plan, you do not have a retirement plan.

Right. It's an often ignored facet of holistic planning and it can have major ramifications. A lot of us assume that in retirement we are not making an income anymore. Therefore, we're not going to be in as high of a tax bracket. But that's not necessarily true, right?

It is not true. Retirement doesn't mean that expenses go away. It means that the paycheck goes away.

But you do still have income. I mean, the majority of Americans have Social Security and tax deferred savings. And so the I wouldn't call it a myth necessarily, but I think that it is an older way of thinking that we need to readdress and reconsider that taxes will be lower in retirement. I think that this came about as we were in a previously much higher tax environment. But today rates have fallen. And I think that the thinking up to this point was pretty spot on and accurate.

But looking forward, not going to be the case. Social Security was once a tax free stream of income. But most Americans are going to pay tax on their Social Security. 50% or 85% of Social Security can be taxable. And most Americans who have done some proactive savings for retirement have done so in tax deferred accounts. So when we create income from those in retirement, it also is taxable income. Now, historically, we are in a comparably low and attractive tax environment today. Tax rates have been much, much higher in times past than they are today, at one point up to as high as 94%. In fact, I've heard that's why Ronald Reagan got into politics, that he realized that if he made more than two movies within one year, basically, he was only going to net 6% of his pay for acting in that third movie. And he didn't like that.

So he ran for governor and then subsequently for president, obviously. But, you know, we are today in a much lower, more friendly tax environment. However, the writing's on the wall here. And in fact, it's already in law. Tax rates will be going up in 2026 unless this administration turns around and says, hey, the policies of that last administration were the way that we should handle things, which I really don't care who's in the White House or in the administration.

It almost never happens, but certainly not with these two dynamically different groups. So the 2026 tax rate will be the expiration of the Tax Cut and Jobs Act that went into effect in 2017. And the 12% bracket is slated to go up to 15%. The 22% bracket is slated to go up to 25%.

The 24 is slated to go up to 28. So it's not just on the evil rich millionaires or those making more than $400,000. This is really an across the board tax increase on just about everyone, which makes it a great time to do some proactive tax planning.

Aaron, you mentioned it. If you don't have a tax plan, you don't really have a retirement plan. It's not what you have in those retirement accounts. It's how much of it you get to keep. And for most Americans, that involves some amount of proactive tax planning.

Very careful, very prudent to keep as much as possible without getting into any gray areas, because there are some fantastic opportunities to control and manage your tax liability. Right. And I think that you've hit the nail on the head, right? Everybody is in agreement, essentially, that taxes are going to go up. We've talked about the U.S. debt before, right?

It's over $30 trillion right now. So you mentioned some options then to prepare for those hikes now. Is there anything that I can or should be doing? Well, I think that if you can harvest dollars out of those tax deferred accounts and convert them to Roth, it's a fantastic time to do that and let no crisis go to waste. Identify opportunities where you have them. I know that everybody's really nervous and focused on the market right now, but for savvy, proactive planners, they may be looking at this as an opportunity to convert over dollars, get them into that Roth account where any recovery that we do see is going to happen tax free rather than tax deferred. There are other places that you can generate some tax free income as well. I mean, we've heard of tax free municipal bonds. There is the opportunity for cash withdrawals. You can access the equity in your home. I think that that is a measure of last resort, but the reverse mortgage is a place where you can essentially get tax free income.

And I've seen people use that planning strategy in a couple of different ways. I mean, ideally, I like to continue to let tax free dollars grow for as long as possible and be kind of the last thing that we access. But if you are retiring before age 65, then building up some kind of tax free income to utilize as a stopgap measure in the doughnut hole and building up non-retirement assets if you are looking to retire before 59 and a half especially is very important in your planning process. So if that's a goal for you or a situation that you are facing, you need to think about taxes and penalties on accessing your money and how to go about doing that in the most efficient, effective manner possible.

Well, this was really helpful, Peter. I think it helps me understand why having that tax plan, it has to be part of your retirement plan. If somebody would like your help creating that tax plan, what's the best way to reach you?

Yeah, definitely reach out. Whether you're saving on an ongoing basis or you already have a sizable amount built up in those tax deferred accounts, now is the time to plan proactively and we can run some side by side comparisons and show people the numbers. Quantify how much it would cost if you simply defaulted to the IRS's plan versus if you were a little bit proactive in identifying these opportunities now. And the difference is often staggering.

A lot of times, Aaron, if I'm talking to like a 60 to 65-year-old and they're looking at that retirement account in an IRA or a 401K, the ultimate tax bill, if they just default to the IRS's plan, is oftentimes more than the account value is today. And we can pay it for a fraction of that price if we plan effectively. So get in touch. I can run those numbers for you, ladies and gentlemen. Give me a call, 919-300-5886, 919-300-5886. You can go online, richonplanning.com. It looks like richonplanning.com, richonplanning.com.

Email me, peter at richonplanning. And I wrote an article last year that was featured in several magazines about proactive tax planning. But the gist of it was the more wealth that you have, the more expensive this is to overlook taxes. So it means that really everybody needs to look at this, but specifically if you have more affluence, more wealth in those tax deferred accounts. Yeah, that makes sense. All right, Peter, thank you.

Hi, Peter, good to see you today. We have a million dollar question. Is the 4% rule outdated? As you know, for decades, retirees have relied on the 4% rule to know what was safe, a safe amount to take out during retirement. But now the rules inventor says that current market conditions may require an even more conservative approach.

So let's start at the tippy top. What is the 4% rule? So the 4% rule is a general guideline for how much income you should be able to create given a lump sum on the starting date of retirement. And it has been projected, it has been utilized by most Wall Street firms and assumptions for retirement that you should be able to generate a 4% cash flow.

So with a hypothetical million dollars, that's $40,000 a year of income. And the inceptor of this rule, Bill Bengen, was a financial advisor and analyst, and he incepted the rule back in the early 1990s, nearly 30 years ago. And under a very different set of market circumstances, interest rates were much higher. The market was doing well. He's been interviewed many times, including on the Planning Matters radio program.

I interviewed him several years ago. And he said, this was actually before the recent market volatility that we have seen and before COVID, he said that he felt comfortable still maintaining that 4%. But two things, two caveats. It was always intended for institutional investment, not individual investors. So right there, that's the law of large numbers rather than me as an individual specific investor. And then he said it also completely negated the possibility of a large market downturn happening in the first few years of retirement. That's a big if to negate. Now, I don't know if you've ever heard of the island of California, Erin?

I don't know that I have either. So back when maps were first being charted of California, cartographers who explored that area went up the peninsula and didn't continue all the way to the end. They actually showed California as an island on the first maps that were drawn. And even though new information came out as little as three years later, in some instances, California continued to be drawn as an island for nearly 300 years. So this is an example of people just using old information and continuing to duplicate it rather than taking into account new information, which disproves the old information. And I think with that 4% rule, largely that's what's been happening. Wall Street has simply used what was at one point generally accepted rather than actually including the new information that has happened since, that has proven that this is possibly a problematic way to go about forecasting retirement income. Well, hey, Peter, thank you for teaching me something new.

I had never heard of the island of California. So when you talk about that new information that's coming in, I think chief among them is going to be inflation, right? I mean, this is the headline of the year. CPI hit 8.5% in March. These are numbers we haven't seen since the 80s. So what should retirees be taking into consideration when they're trying to determine this percentage? Yeah, well, even the Inceptor of the Rule, Bill Bengen, said that given these new inflation numbers, retirees also have something else to consider if relying on or utilizing his rule, really a theory. And he said that this is something that we need to strongly consider, as well as the much, much lower interest rate environment that correlates and has fallen over the last 15, 20 years, really.

And the additional market volatility that we have seen, all factors to include. So Vanguard, Morningstar, Wharton School of Business, the several, American College for Retirement Income Planning, several kind of major entities that study retirement, that study finance have all come out kind of across the board and said we really need to pull back our expectations to lower our expectations for how much income a portfolio can generate for us. Now, here's the thing, Aaron, it's maybe the model that they are using to create that income rather than the income cash flow rate.

Because if we use a market-based type of asset allocation, the traditional 60-40 model, there's volatility and there's low interest rates to contend with. Whereas if we are using alternative tools and methods, there are places out there that you can actually contractually guarantee an even higher cash flow around retirement age. And if you take the market risk out of things and base things on an actuarial life expectancy, you may actually even be able to increase that cash flow rate.

So it's really all about that model. But if you go to the Vanguard tools and retirement calculators, Vanguard being very famous for sort of the do-it-yourself investor and so they give you access to a lot of tools and calculators. If you run their retirement income calculator and you project the numbers out with a traditional 60-40 portfolio, they give you about a 90% probability of success following the 4% rule.

What does that mean? Well, there's a 10% probability of failure, which means running out of money. And if the weatherman tells me that there's a 10% probability of rain, I may feel comfortable leaving my house without my umbrella. But if my retirement model, if my plan for retirement is based on a theory or a rule with a 10% accepted probability of running out of money, I'm really carefully examining that plan and deciding whether I'm comfortable with those assumptions and those projections. So what I'm trying to suss out then from what you're saying, Peter, I mean, I understand that this is incredibly complicated, but it's so important because it addresses the number one fear for retirees of not running out of money in retirement.

Is there a number? Is there a percentage that you're recommending to clients? Well, I think that 4% is a place to begin the conversation. You know, if people are expecting that, oh, well, I've heard the market has averaged 10%, so I should be able to generate a 10% cash flow. We need to have a real come to earth meeting about what expectations are and what the difference between rate of return and cash flow is. But if we start that conversation with approximately a 4% expectation for cash flow, we can probably say that those expectations are pretty reasonable.

And then here's the important part, Aaron, make adjustments based on real world conditions as we go along. First and foremost, we have to have a proper allocation to begin with in order to start to think that we can achieve this type of cash flow. But maybe we have a little bit of diversification with a safe money bucket that's not going to lose if the market goes down, with some type of long-term yet conservative money bucket that isn't going to fluctuate a great deal, and then our risk bucket. In good years, maybe we can create the income exclusively from the risk bucket. If we've got a 10 or a 20% rate of return on that side, it may be a good time to take some of those gains off the table and use that for income. But in down market years, we've really got to tap into a different source because we don't want to remove dollars at a loss, lock in those losses, and remove those dollars' ability to participate in any recovery.

And so it's really about the proper allocation. During our working years, our paycheck pays for our bills and actually supports our ability to take risk with investment, but that really changes in retirement. Now the investment portfolio or the life savings represents the paycheck. It's an opposite equation there, and we really need to take a different approach to how we're handling the potential risk of market losses early on, and especially how to create that income with a realistic expectation that we don't know the future of the market, and we need to be prepared for kind of any scenario, up, down, or sideways.

Right. I like that you're mentioning income because that is such an important part of the equation. And so what I'm hearing you say, too, is that I wish we all could follow one rule, right?

If we could all just say 4% and forget it, that would be great. But of course, it has to be a little bit more personalized. And something that you and I were talking about offline here was how things can change when your money is managed by a professional.

So what am I looking at here? Yeah. Not only does it need to be more personalized, but it does need to adjust for conditions. So what we're looking at on this chart is kind of a traditional buy and hold methodology versus a methodology that actually adjusts for real world conditions as they happen, otherwise known as tactical management. And what this chart shows is that tactical management actually helps investors outperform that traditional long-term buy and hold strategy where they're just riding out any market conditions, ebbs and flows, ups and downs. If we actually make proactive moves to adjust during those periods of time, buy in when things are low or move more aggressively, sell out when things are high, when there are profits on the table, even if it's just a strategic kind of regular quarterly rebalancing, it can dramatically improve results. So investment is not set it and forget it. That's what we're looking at on that chart. What we really need to understand is that we need to be a little bit more proactive. And if you don't do that yourself, then even with the potential additional cost of consulting with a professional advisor, you can probably make out even better in the long term, with better results long term, having that proactive tactical and strategic management on your money. Right.

Very well said. So Peter, if somebody would like you to kind of take a look at their income and their expenses to figure out what's right for them, what's the best way to reach you? You can call the office, 919-300-5886, 919-358-86. You can email me, info at rashanplanning.com, info at rashanplanning.com, or you can go to the website, rashanplanning.com. It looks like richonplanning.com. And you can download a copy of my book there, Understanding Your Investment Options.

It actually goes through a little bit of the transition from accumulation, preservation, distribution, the tax implications involved with all of those, and then what the spectrum of the financial world has to offer for each of those stages. Yeah, such a great resource for everybody. Peter, thank you. Always a pleasure.

Thank you. This has been Planning Matters Radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to seek investment, tax or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss principle. Advisory services offered through Brookstone Capital Management, a registered investment advisor. Piduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management, while insurance products pay a commission which may result in a conflict of interest regarding compensation.