Mirror, Mirror on the Wall...

Welcome to Mr. Stillman's Opus, and John Stillman, of course, is here.

I'm Ron Stutz. Really excited about John's podcast today, because John says he wants to talk about the difference between the bedroom mirror and the bathroom mirror. And I'm as curious as anyone, what the heck that means?

How are you going to make financial sense of that? Well, I'm going to give this to everybody. But any time I look at myself in the bedroom mirror, hmm, looking good today, man. Oh, really? Yeah. But then I go look in the bathroom mirror, and the bathroom mirror is like, well, if it's not the king troll of blemishville, right? Yeah, the light's so much brighter.

Exactly. Completely different lighting. And you look fine in the bedroom mirror and not so great in the bathroom mirror.

I know what you mean. Now, there are financial parallels to this, because a lot of people are looking at their retirement plan with the lighting from the bedroom when they really should be looking at it with the lighting from the bathroom. Okay. And when we put the brighter lights on your retirement plan or your portfolio, we find that, oh, there's a lot more blemishes here than we thought when we were just looking at it in the bedroom mirror. So that bright bathroom light will illuminate all the blemishes and all the concerns. Exactly.

And then you can address them appropriately. So let's talk about what that might look like, bedroom mirror versus bathroom mirror. Okay. When we're looking at your retirement plan from the standpoint of generating income, you know, a lot of people say, well, so this is the bedroom mirror approach is, all right, well, I have $1.5 million, and I'm going to need, pick an amount, $10,000 a month to make. You can figure out exactly how much money you're gonna have coming in from rental and pension, Social Security, and then how much more you're going to need to generate from your investments to fill that gap, to get you to $10,000 a month. And then you can see, okay, well, how much am I going to have to take out of my portfolio each month to make that happen?

Okay. That's looking at things in the bedroom mirror. And if you say, all right, well, I need $4,000 a month, that's $48,000 a year that I'll be taking out of my 401k or whatever, you're looking at about a 3.2% distribution rate, withdrawal rate from your portfolio, which is not bad. That's pretty sustainable to take only 3.2% out of your savings each year. But when we look at it in the bathroom mirror, that's when we start to see, all right, well, maybe it's not so simple, because that money that you have in your 401k, what investments are you using to generate income from that account? And are we just taking things like interest and dividends, usually the things in your 401k are just mutual funds and aren't really set up very well to pay income, you have to sell shares of something in order to create that income.

So if that's going to be the plan, what are you doing? What is the what do the physical mechanics look like of how are you going to generate that income? Is it income producing investments? Or do you have to sell stuff to make it happen?

That's what the bathroom mirror wants us to look at. And then maybe things like, what if we have a market crash? How does that affect our ability to generate income? Or if we're selling shares of stuff to generate our income, and the whatever the stuff is, let's say it's $100 a share, and you know, we're selling a certain number of shares a month, and we have another 2008. And now that's worth $50 a share.

Well, now, you can do the math, we got to sell twice as many shares of whatever it is, to generate the same income. That's where the bathroom mirror looks at your plan for producing income and saying, all right, this is maybe not the best way to go about this. And so that's where the better lighting might help. You have a very demanding bathroom mirror.

Well, you know, if you want to look good in retirement, you want to be sure you're using the right lighting. Wow. Well, it makes a lot of sense. I'm surprised.

You know, I didn't have any idea where you were going when you started this conversation, but you shine the bright lights of Broadway on something you're going to see a lot more. Is there anything else that you might have revealed in the bathroom mirror that you might not see when you look into the bedroom mirror? Well, usually taxes for a lot of people. They haven't really shined the light on their tax picture that much in retirement. I think a lot of people say, well, I'm going to have to pay taxes in retirement, but they haven't stopped to think about the fact that in a lot of cases, every single penny of their income is going to be taxable.

Now, for some people, that's not the case. Maybe if you have a lot of money in Roth, or maybe you have a lot of money in an after tax, or you're going to be taxed on the gains, but not necessarily all of it taxed as income. That's something where we want to shine a little bit brighter light on there and have a better understanding of exactly what kind of taxes are you going to be liable for in retirement. So, as an example, in the bedroom mirror, you might say, I've been at a 21% effective tax rate, let's say, for the last 10 years in my working life. I'll assume that it'll probably be about the same, if not a little bit less in retirement, because you tend to pay less in taxes in retirement, right?

Well, maybe, maybe not. Again, it's going to depend on the type of assets that you're using to generate that income for you. The bathroom mirror would say, all right, well, let's actually look at what your projected income is going to be. Let's look then at how that's going to affect the taxation of your Social Security.

That's a big thing that a lot of people don't take into account. It's going to be not taxable at all. It's going to be half of it will be taxed, or 85% of it will be taxed.

The overwhelming majority of people listening to this are going to be in that 85% bracket. Now, that doesn't mean 85% of your Social Security is taken away in taxes. That means 85% of your benefit is going to be taxed as income.

So, for all intents and purposes, it's just as taxable as those IRA withdrawals you're making. The bathroom mirror helps us see, okay, well, we need to be planning for that, because what if? What if we're in a place where we could be taking a certain amount of income and our Social Security is only 50% taxable? But then we take just one or two more dollars more from the other buckets that takes us over the cliff, and now our Social Security is 85% taxable instead of 50%. We want to know where that cliff is. We want to know where the line is.

How much can we take from all these other sources and keep us still in this bracket? That's where tax planning can really play a big role, and that's what the bathroom mirror is going to take a look at, that the bedroom mirror isn't. It seems like a really unfair situation when you can be in a situation where you have 85% of your Social Security taxed, because that's your money that you're getting back after having put it in there for a very long time.

So, here's what they say, and you can draw your own conclusions as to whether or not this is accurate or fair. Essentially, what they say is that you put money into Social Security all those years. Let's say you're getting a benefit of, well, to make the math easy, let's just call it $1,000 a month. And you're in that 85% range where $850 of that $1,000 is taxable as income, the other $150 is not taxed. What the federal government is telling you is that that $150 is what you put in coming back to you, tax-free. And the $850 represents your growth on the money that you've put in over the years, and that's being taxed.

Well, like I said, that's what they say. You can do the math on whether or not that holds up. Yeah, that's really interesting. I can see how a lot of people might get upset over that. But at the same time, it's important for you to point it out, because a lot of people don't really realize that they're going to have to be taxed on so much of their Social Security in a lot of cases.

Yeah, and there definitely are cases. I do have clients where we've actually put together a plan where we've gotten them under the threshold so that they're not taxed at 85%, they're only being taxed at 50% of their Social Security. And that makes a pretty huge difference in their overall plan. We've had to use some tax-free sources like Roth IRAs very strategically in this plan, and it's not going to be realistic that they'll be in that phase for their entire retirement. But in a couple of cases, if we can have two or three years where their Social Security is being taxed less, that really makes a big difference in the grand scheme of things. What about the person who has 0% taxed on their Social Security? Well, usually that's the person who's in such a low-income bracket altogether. While it's nice to say that your Social Security isn't taxed at all, that means you're in a situation where you have really very little income. Now, having said that, if you were really strategic over the years, and I have a couple of clients who are in their 50s who are putting all of their money into Roth right now, so they'll actually be in a position by the time they're at this age, they'll have enough money in Roth that they can actually generate some tax-free income from that, and they can actually still have a nice overall income but be in that bracket where they're taxed not at all on their Social Security. Now, you've got to be far enough out where you can do the planning for that to make that work in your retirement.

But for some people, that's going to be a really effective strategy. Anything else, Wendy, to know about the bathroom mirror, I suppose the bedroom mirror? The last thing I would say is probably fees. A lot of people are looking at the light in the bedroom, which is not that bright when they're trying to figure out what their fees are. Maybe it's just looking at administrative costs within your 401k and not factoring in what the bathroom light would reveal, which is all of the costs inside of the mutual funds in your 401k. Variable annuities are pretty bad for this, where if you just ask, what are my fees? They're going to say maybe 1% or something like that, what they call the administrative fee. But then if you ask some very specific questions, like what's my mortality and expense fee, and what are the sub-account fees, and you start asking the right questions, well, suddenly they'll volunteer all that information, but they're not going to tell you unless you ask. If you just say, what are my fees?

They're going to give you the lowest, most basic one they can. That's a great example of bedroom mirror versus bathroom mirror. Well, it all makes sense. I have to hand it to you. I had my doubts when we started talking about what the bathroom mirror might reveal as opposed to the bedroom mirror, but now it all makes perfect sense. Well, I'm glad we could shed some light on that for you.

See what I did there? Thank you so much, and isn't that a nice reflection on you? John Stillman. This is Mr. Stillman's Opus. Thank you for listening. If you'd like to find out more bits of wisdom like this, then get in touch with John.