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A
We'Ve talked about the investment order of operations here on biggerpockets money in order to minimize taxes during the accumulation phase but just as important for those pursuing early or traditional retirement is how we withdraw or decumulate from our portfolios sean mulaney the fi tax guy and cody garrett cfp from measure twice financial planners have pioneered the withdrawal order of operations and we are very excited to share this with you today.
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B
Hello hello hello.
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A
And welcome to the bigger pockets money podcast my name is mindy jensen and with me as always is my not yet drawing down co host scott trench.
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B
That'S right mindy i'm accumulating both a portfolio of financial assets and a portfolio of introduction funds all right we are so excited to be joined today by sean mullaney and cody garrett on the podcast we have had them several times here at biggerpockets money and they were most recently here in our last episode to talk about taxes in early retirement and how your effective tax rate will almost ass assuredly be lower after you leave your job today we're going to cover the mechanics of how that actually works and a order of operations about how to minimize those taxes in early retirement sean and cody welcome back to biggerpockets money thanks so much for having.
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C
Us back we're glad to be back.
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B
All right sean can you please without further ado tell us what these four fundamentals of retirement drawdown are yes scott.
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D
And i'm going to give you just a little ado if you don't mind all of us come into retirement regardless of when it is with different portfolios portfolios different backgrounds different investments different mixes of taxable roth traditional but what we do is we sort of break it down if we could just anchor us four simple fundamentals for retirement drawdown and then we can do the tangents and but in my case and all that sort of stuff we wanted to start off with like an anchor with a framework and so in a theoretical ideal world we would draw down with the following four rules and that's it one we spend our taxable accounts first in retirement our first spend assets are our taxable accounts then when those taxable accounts are depleted we then start spending down our traditional retirement accounts that's the old traditional four hundred one traditional iras that sort of account generally speaking we delay social security until age seventy now there are variations of permutations on that but we're generally talking about single people the higher earning spouse very financially successful there are several benefits of delaying social security until age seventy particularly from a tax planning perspective and then our fourth rule of drawdown is we use our tax free pools like our hsas and our roths strategically so what i mean by that is we use them to help manage for premium tax credit if we're early retired and on aca medical plan we use them maybe to fund a car purchase or other major purchase in retirement or maybe we use them to help avoid creeping into the next tax bracket so in a theoretical ideal world those are our four drawdown fundamentals and then we can think about well wait a minute in my case i've got this i've got that we could start doing little tangents off those awesome can.
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B
We let's boil this down to something into that next layer of practicality here right like this is not true in all circumstances in every situation or whatever but it's the fundamental pillars of drawdown here how does that translate to the lived reality that most people go through when they retire the way cody and.
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D
I approach it is we think of retirement in five general phases first phase is our retirement date to the depletion of our taxable accounts the second phase is what we refer to as the golden years these are generally our birthday years for sixty six sixty seven sixty eight and sixty nine then it's age seventy to the beginning of rmd's so that's going to be for those born in nineteen sixty and later a five year period then we have our beginning of rmd's and if we're born in the year nineteen sixty or later that's age seventy five and then we have our widow and widower years for those singles out there just combine phases four and five and you have a four phase retirement instead of a five phase.
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A
Retirement i have a question though why am i focusing on taxable accounts first.
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D
Great question mindy there's several reasons for this first is what we talked about in the previous episode low capital gains and basis recovery a great way to keep our income low in the first part of early retirement is to live off capital gains right so we live off one hundred fifty thousand from our portfolio but we only trigger you know one hundred thousand of income or fifty thousand of income because of basis recovery and it's tax favored two other advantages of that one is sequence of returns risk and that's a whole other series of podcasts but one thing that amps up sequence of return risk is expense in the early part of retirement a great way to limit or just eliminate income tax expense at least federally is to live off capital gains that's a really good time from a sequence of return risk perspective to have very low tax expense because if we can keep our expenses lower in the first part of retirement and mitigate our sequence of return risk so that's helpful the second thing is something we talked about in the first episode dividends yes we live in a low yield world but one they still do pay dividends one percent two percent three percent depends on your fund and two it's not guaranteed we're going to keep living in a low yield world one way to tax those dividends and we talk about this in the book what we could do maybe we're sixty years old we start retirement we say oh we have this taxable portfolio but i'm worried about rmd so what i'm going to do is i'm going to live first off the traditional ira to reduce the future rmd what's a valid playing tactic but it comes with a drawback that one percent two percent three percent dividend from your taxable portfolio you just found a way to tax that if you just lived off capital gains instead the odds are now yeah if you're living off four hundred thousand you're probably going to pay tax on it anyway but for many early retirees the way to avoid dividend tax at the beginning of retirement is to live off the taxable accounts first and then a last reason is a more general and creditor protection so traditional iras traditional four hundred one ks roth iras roth four hundred one ks have varying degrees of generally speaking pretty strong creditor protections taxable accounts don't so you know if everything else was equal from a tax perspective we'd still rather draw down our taxable accounts first because those are the least protected basically generally speaking not protected assets why spend down a creditor protected asset when you could spend down a non creditor protected asset now look folks should be thinking about personal liability umbrell insurance you know tax or asset location is not the only consideration here but why not belt and suspenders it at least a little bit so yeah i'm very fond of spending down those taxable accounts first that was a great.
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A
Answer thank you we are going to take a quick ad break but more from cody and sean when we're back.
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B
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D
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C
Than anything.
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B
All right thanks for sticking with us we're back so we get that we are going to spend down the taxable accounts first what else should we be thinking about in phase one.
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D
Of retirement so the big one for many early retirees is the so called premium tax credit we're on an aca medical insurance plan it costs thousands of dollars but that cost could be significantly reduced based on the premium tax credit now the premium tax credit is income limited so that means that if you get above a certain income you get very little or no premium tax credit so you have every incentive to the extent you can use planning to do this to keep your income low how do we do that there are different levers you could pull in this regard one is this asset location thing we talked about last time let's keep our taxable bonds in our traditional retirement accounts not in our taxable accounts something cody loves to talk about specific identification this is where we go into our taxable accounts and we look up the lots in each holding or the holding and they slice and dice it based on every time you purchased or dividend reinvested in that investment you can have higher basis lots lower basis lots you can essentially elect to sell the higher basis lots and reduce gains and reduce income that way one thing i think that's worth considering is turning off dividend reinvestment so you go buy a mutual fund at vanguard fidelity schwab during your accumulation years you just generally elect to reinvest the dividends it's a great little trick to help keep building up your portfolio at least a little bit well why not in early retirement turn off that dividend reinvestment so the check comes home to you so that you then use that check to fund some of your living expenses and you have to trip fewer capital gains both these two are somewhat marginal plays they're timing plays but on the margins they can matter and then the other thing to consider is an hsa contribution starting in twenty twenty six if you're on a bronze plan you'll automatically be able contribute to a deductible health savings account you can be retired deduct the contribution that lowers income that might help increase the premium tax credit and then just the last thing to think about is roth conversions and i think we need to be measured and conservative and cody i'm curious your perspective on this but one thing i think about is too often when we think about folks out there thinking about retirement they sort of perceive this quote unquote need to do roth conversions i think need is too strong of a word and i think in early retirement roth conversions can have two drawbacks one is it can increase your federal and state income tax and two it could reduce or eliminate your premium tax credit which argues for maybe being very conservative and very strategic about roth conversions but cody what do you think about that.
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C
Yeah so i think you know first of all this this need for roth conversions i think that comes from the excitement of this word roth because everybody wants tax free money and you just start hearing it's roth now or never so you better either contribute to roth retirement accounts or you better convert to roth so the first part is stepping back and saying like will i do it now later or never also just understanding that this is kind of fun that most people pushing roth it's really this fear of being crushed by taxes in retirement and a big part of our book is actually showing over one hundred twenty step by step calculation examples to show like that's not actually the case you're not going to get crushed and i will say in terms of roth conversions yes roth conversions might be able to reduce your lifetime tax liability but i have never seen roth conversions make or break a retirement i've never seen somebody be able to have a successful retirement because they did roth conversions or contributed to roth versus those you know those who did and those who didn't so i would say first of all you don't need roth conversions but in phase one something that's really important even though we don't necessarily need roth conversions we also don't want to waste the standard deduction right so the standard deduction you know actually got increased a little bit with this new the new tax law changes in twenty twenty five you know but one example a married couple in twenty twenty five under age sixty five they have a standard deduction of thirty one thousand five hundred dollars another way to think about that is your first thirty one thousand five hundred dollars of income is federally income tax free we would want to take advantage of that zero percent tax rate and we want to take advantage of that standard deduction with what income would be the least favorable which is your ordinary income in the phase one of retirement again what's most important is being able to maintain your desired lifestyle so that means you know hey take the money out of your checking account your savings account maybe sell some securities you know in your taxable brokerage account once you've maintained your desired lifestyle in that year then you can say hey i'm going to calculate how much income did i just create with creating the income source the cash flow i need for my life and you might end up saying wow like you know by strategically taking money from these accounts first i actually only have income of five thousand dollars and my standard deduction married filing jointly is thirty one thousand five hundred i actually have some space in that standard deduction at zero percent how can i fill that up right and the best way to fill that up is with ordinary income and better yet converting that money from traditional to roth you don't need that money to live because you already got that money from your checking savings taxable brokerage account so i'm going to take advantage of quote unquote taxable income that's actually being taxed at zero percent by again you know instead of contributing to roth four hundred one k at work i actually have the opportunity now in retirement to take my what were traditional four hundred one k contributions and earnings i'm going to convert a little bit of that over to roth ira completely tax free again up through the standard deduction but also sean you can kind of carry with this that yes there's the take advantage of the standard deduction but we also have to consider is there kind of like a phantom tax or like a tax torpedo that even though i'm being taxed at zero percent how is that additional income affecting my premium tax credit which is another way saying by paying zero percent on roth conversions am i actually paying quote unquote tax by getting less of a discount on my health insurance yeah.
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D
Cody and well there's three considerations one if you have zero income then you might want to do a roth conversion to just get to the level needed to turn on the premium tax credit generally speaking you got to look up your state medicaid income eligibility it's usually one hundred thirty eight percent of federal poverty level not always though look at your own state's rules but if your income is just so so low you may need to do a roth conversion to qualify then once you do qualify based on income then you're looking at a diminution in the premium tax credit and this very much varies usually for planning purposes you think nine point five to fifteen percent roughly speaking so every dollar of roth conversion reduces you know ten cents on the dollar fifteen cents on the dollar the premium tax credit so that's like a backdoor ten percent or fifteen percent twelve percent whatever tax the third thing is this four hundred percent of federal poverty level cliff in twenty twenty six all the premium tax credit goes away if your income is over four hundred percent of the federal poverty level if i am recalling correctly for a household of two so a retired married couple no dependents i think that would be about eighty four thousand six hundred dollars of income so that is something to think about oh boy i want to keep my income low you know to avoid that cliff and going from a few thousand of premium tax credit to zero and that's part of the reason that the golden years are the golden years so going to our sixty sixth through sixty ninth birthday years the premium tax credit has just fallen off the table it's not a plan consideration anymore we also don't have the rmd's we don't with social security we can delay so now the world is our oyster from a tax planning perspective and to our thinking there's sort of two paths during the golden years the first path is the retiree still living off taxable accounts so this is somebody who didn't diminish their taxable accounts prior to getting on medicare at age sixty five so what this person could do is what we refer to as tailored taxable roth conversions ttrcs and what this is doing is we're doing a roth conversion up to the level of the available deduction which is going to be a combination of the standard deduction or itemized deduction and generally speaking the senior deduction that's a new development in twenty twenty five from the one big beautiful bill passed in july okay what we could do is we could add up our interest income or non qualified dividends and say oh well that's that's three thousand dollars well what's my available standard or itemized deduction plus the senior deduction for many retired married couples in twenty twenty five the total is forty six thousand seven hundred dollars so we would consider a roth conversion that subtracted the deduction from the other ordinary income my little example three thousand dollars and quick math on a podcast forty three thousand seven hundred dollars roth conversion and that would go against the available deductions the is we want to leave our total taxable income no greater than the top of the zero percent long term capital gains tax bracket so a limiter on that forty three thousand seven hundred roth conversion i proposed would be okay let's just run that through total taxable income just to make sure all our dividends and capital gains still go off at the zero percent rate that's why we called it taylor taxable roth conversion what we're doing there is we're measuring twice as cody says so that we can essentially pay zero federal income tax on our roth conversion we don't push any cap gain income from zero to fifteen percent yeah maybe we pay a little state income tax but that's no big deal and that's a pretty advantageous path this is a path again only if we're in our mid to late sixties and we still are living off taxable accounts and i'll add a note.
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C
Here that this idea you know some people say well if i am married my spouse isn't the exact age as me right so sean maybe i'll ask you this question so let's say that spouses are like ten years apart like how might you think about kind of these spouses being in different phases simultaneously.
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D
Yeah i think then you got to balance it so you got to balance premium tax credit with this potential opportunity and it may be that hey that retired spouse has retiree health care from an old employer that exists maybe they worked for a state government or just a legacy corporation that happens to have a retiree health benefit or maybe they're on a bronze plan and it's not all that expensive and you prioritize the roth conversion now it's it's just a it becomes a balancing act i will say that and there's no you know again that's part of the reason why we have the four fundamental rules and then we sort of could go on these tangents and yeah absolutely sometimes you're just going to have to think about your own circumstances i will say too.
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C
Like there's a lot of concern about the cost of health care especially people go oh my gosh like now they're putting in this new they're bringing back the cliff the four hundred percent federal poverty level and they're thinking i'm not going to get a premium tax credit in retirement i cannot retire but i want to just let you know here that you know looking at real numbers the other day kind of you know for a single taxpayer in early retirement on the aca if they didn't receive any premium tax credit right meaning their income is over four hundred percent the federal poverty level you know starting twenty twenty six like they might be paying five or six thousand dollars a year for a bronze or silver plan again you know it's really you have to be thoughtful about like which you know if you have any medications or chronic health conditions thankfully you don't need evidence of insurability for those aca plans but just keep in mind that you know five six thousand dollars a year expense for health care most likely won't derail you assuming you already have sufficiency to retire early to begin with this is.
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B
Amazing how much thought you guys have put into this and how detailed these assumptions and analysis are how it's not just the tax brackets in the federal and state level but also the premiums for health insurance that you're optimiz for here it's just it's just a fantastic analysis i have so little to add here so thank you yeah thank you.
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D
Yeah well thanks scott you know the other thing is we could think about is many early retirees are going to run out of taxable accounts by the time they're age sixty six and that's okay so what happens then well all right we got to live off these traditional retirement accounts for the most part maybe we have some roths we could talk about that but we now mostly have to live off these traditional retirement accounts and oh no isn't that taxable isn't that a bad outcome well to my mind it may not be that bad of an outcome because of what we refer to as the so called hidden roth ira so what this does is it says well okay you're in your mid to late sixties you're not collecting social security yet yeah maybe you have two thousand dollars of interest income but you don't have taxable brokerage accounts so there's no dividends no non qualified dividend dividends the only ordinary income is the two thousand dollars of interest income well that means the common essentially when you take out from that traditional ira the combination of the standard deduction or if you're itemizing plus the senior deduction is essentially a hidden roth ira it's reduced by ordinary income so that two thousand dollars of interest in my example but essentially you're taking money from a retirement account traditional iraq you know it could be over forty thousand dollars if you're a married couple you're both sixty five or older forty thousand plus could come out at a zero percent tax rate well wait a minute i'm paying zero federal income tax on a retirement account distribution isn't that a roth ira no it's a hidden roth ira because it came from a traditional retirement account now some might say well that's only because of the standard deduction well i say okay well the alternative was to only do roth contributions right at least a theoretical alternative when you were working was to only do roths well okay you only do roth so at sixty six you only have roth accounts well that means you're wasting years of standard deductions and senior deductions you could have taken a tax deduction in your working years and then bailed the money out at the zero percent rate because of the standard deduction and senior deduction the other thing i'll just mention is well okay you may need money beyond the hidden roth ira okay it's taxed at ten percent twelve percent and you know we don't like paying tax but it's not all that onerous to have a good chunk tax at ten percent or.
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B
Twelve percent tax out your four hundred one k people for the people in the back that's that's what you're saying here first yeah and i want to.
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C
Add there that you know in this example of somebody kind of in their you know their late sixties before social security if they only took distributions like they only have ordinary income from you know taking money out of a traditional retirement account again after sixty five that person if they distribute one hundred thousand dollars from that traditional ira they're paying about seven thousand three hundred dollars in federal income tax right so again about a seven point three effective tax rate and you consider like what is that tax rate that effective tax rate of seven percent on one hundred thousand dollars in retirement of all ordinary income versus what tax rate might they had excluded or deducted when making that traditional four hundred one k four hundred three contribution right again a lot of the listeners who are still on the path to early retirement we might be in the twenty two twenty four thirty two and you know higher brackets when we're excluding deducting these contributions and we just talked about somebody in you know in retirement you know taking one hundred thousand dollars out again that's not a small amount of money for a lot of our listeners you know distributing one hundred thousand dollars or converting one hundred thousand dollars and paying an effective tax rate of a little over seven percent you know in the book we call that you know the so and so beat the irs right we're trying to just pay the least amount we legally owe not just in a single year but throughout our working years and our retirement years.
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B
You guys are very precise in the amounts that we're talking about here how to not trigger you know as little income tax as possible but i think the goal is again not you said it earlier as well not to pay the least amount of taxes it's to live the lifestyle that you want while paying the least amount of taxes here as well so you know i go back to basic personal finance strategy here this is where where you know an advantage like a paid off home comes into play right when your home is paid off you don't have to realize the income from these other sources to pay the mortgage for example paid off cars those types of things need to be set up here but let's say that and i think there's another component here of spending the taxable accounts first is great tax advice as we as we've learned here and then the four hundred one k the pre tax accounts next how do i bleed into those like when do i just spend i literally spend down the taxable account all the way to zero in a certain search situation before taking my first distribution from the pre tax accounts or is there any like hybridization of this that.
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D
Goes on at all scott in a world without the premium tax credit it is a one hundred percent one hundred percent analysis spend down the taxable accounts to zero and then start traditional ira distributions traditional four hundred one distributions and.
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B
Then spend them down to zero and.
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D
Then do the roth i would argue there for most americans you're probably not going to get down to zero but there's an argument for that although i would say at some point point maybe you would want to take some roths to avoid say the twelve percent of the twenty two percent bracket i would say be much less doctrinaire on spending all the traditionals before the roth but there is at least some component of that but i will say this premium tax credit comes into the picture so in the book we have an example of someone who they're fifty eight when they retire it's a married couple i believe and they have three years worth of taxable accounts and so what we say there is oh you know what they might want to do to help optimize for premium tax credit they may want a blended strategy so they would take some amount of income from the traditional retirement account starting at fifty eight like a seventy two t or rule of fifty five and they would do some taxable account distributions so that over the seven year premium tax credit window they sort of moderate their income versus oh in the first three years we have very low income because we spend down the taxable accounts but in these last four years we have very high income because it's all the traditional retirement accounts and we we lose out on premium tax credit so there is some hybridization when we sort of layer on the premium tax credit now like i said there are some people who have former employer health care and this is just an academic issue for them i tend to come be a little extreme on this one i mean you got to do you but i tend to say yes spend down those taxable accounts first and then go to the traditional.
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B
Retirement accounts do you think in practice that means that people will just never spend their roth iras in many or.
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D
Most cases it's an interesting question scott i think think there's a bias towards roth and so many financial planners love roths and there's nothing wrong with that but i do think we're getting to a point where we need to start thinking about spending these things down so it's not just for the next generation it's great to leave some money to the next generation you got to do you in terms of your family dynamics and what you want to leave to the next generation but i think we do need to start being a little more intentional around wait a minute we do have these roth balances and maybe we're buying a new refrigerator or a new car this year or replacing the roof or we're just trying to manage for premium tax credit i think one of the little subtle messages in the book is maybe we should be thinking about doing roth distributions earlier in retirement rather than later because of the premium tax credit essentially when we do tax planning in the first part of retirement if we're on an aca medical insurance plan we're essentially subject to two taxes later in retirement we're only subject to one tax because we're now no longer on this premium tax credit issue so maybe what we do is in the early part of the retirement we reduce our income more by you know spending less from traditional or even taxable do some roth tax free optimize premium tax credit and then keep going after getting on medicare at sixty five and i've.
- [30:16]
C
Got a little visualization here this is a kind of a real kind of example right so let's say a married couple fifty five they retire early they go on to aca they're controlling for the premium tax credits but let's assume that even at their age they have kids on their health insurance as well so they've got dependents their total cost of health care might be fifteen twenty thousand dollars a year and they really want to go on a viking cruise like that was one of their first things they're like we want to do that traditional retirement thing as soon as we retire i'm taking them and their significant others if they you know we're going to go all on a viking cruise it's going to be a massive trip trip but guess what if we pay all of that from you know spending down taxable brokerage selling things maybe even taking money out of traditional retirement accounts maybe we've just completely blown that opportunity to get twenty thousand dollars of health care free so they might take money out of their hsa sean calls this the previously unreimbursed qualified medical expenses he calls this the pucme p u k p u q m e just in case you needed more but taking those tax free reimbursements from the hsa or taking money out of the roth ira even for the early retiree what's cool about that is again assuming they can take it out tax free maybe they're just taking their contributions back from the roth ira not diving into the the earnings portion like what's cool is they might get free health care in retirement as millionaires going on a viking cruise with their family some people might say this is morally wrong to take advantage of that right being a millionaire getting free health care but sean and i more take the just kind of play within the game we've been given again don't pay more tax don't tip the irs if it's not necessary i'm.
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B
Thirty five here and i'm very well off have been very fortunate in those types of things and i personally will not take the subsidy or i will not plan my finances to take the subsidy there but more than that i will not plan on it being there for me in fifteen years because i do not think that the the electorate wants a multimillionaire early retiree to be the recipient of that that is not the intent of the tax code or the affordable care act does that basic assumption of a change in the political dynamic for the aca act begin to impact any of the quick key assumptions in your presentation here so scott really.
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D
Good point that early retirees have sort of backdoored into pretty significant benefits on the medical insurance side a few thoughts on that though one it's going to be somewhat difficult to take away the benefits from the early retiree without hitting the self employed and i think we're moving into a world where there's going to be more and more and more self employment and so you're going to have more and more self employed folks on aca plans and how do you balance taking away the benefit from a early retiree versus taking away the benefit from a self employed person and the other thing i will say is all we're talking about here is how much do you pay for your medical insurance which people sort of treat as a tax it behaves like a tax but it's technically not a tax it's just another expense you have in your life right you have your rent expense or your mortgage interest expense you have your grocery expense you have your health insurance expense and a political decision was made fifteen years ago to run that for many americans through the internal revenue code code so that means it behaves like a tax but it's not a tax i absolutely think there could be changes in this regard what those are i have no idea and yes this is definitely one of those where you can't just set it and forget it and yeah especially scott if i was as young as you are i would not just say oh well the rules of twenty twenty six are just going to be the rules when i early retire i don't think that's a good assumption where they're going to go is definitely.
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B
Speculative i will say that as if you're looking for this kind of the kind of thing the health insurance even if you don't qualify for these subsidies and you're looking for them it's like it's like a thousand bucks a month for a family of four and the health share programs are really growing and that risk profile that i think people associate with those is going to flip over the next couple of years as well i mean that that's like five hundred bucks for a family of four these considerations can can make a big difference if you're a multi millionaire early retiree because you can self insure to an extent and get the catastrophic protection with these types of programs here did.
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A
You say health insurance is one thousand dollars a month for a family of four with no subsidies scott that's right mine is one thousand eight hundred dollars.
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B
With no subsidies i got a cigna plan at that level when i went shopping so and that that's that's a high deductible plan but it's for the four of us and thousand bucks a month cigna is a good insurer too so that you know there's another one that's slightly cheaper like a five or eight dollars a month cheaper with kaiser but cigna is better i want to.
- [34:56]
A
Know where you're shopping because that's not what i found although i did i did have a specific doctor that i needed to have covered so maybe that's it maybe she wasn't covered on your.
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C
Plan and one important piece moving into twenty twenty six that you know even without a premium tax credit a lot of people have effectively cheaper options for health insurance especially we talk about starting in twenty twenty six all bronze plans through the aca will be high deductible health plans for hsa contributions not only the ability to contribute to an hsa with a cheaper plan but also keep in mind that hsa contributions are adjustments to income that lower your income for eligibility for that premium tax credit so there's kind of like a roundabout way at least in twenty twenty six forward and again i don't know if health insurance will always have cheaper options but there are some kind of pros and cons of how we're moving forward with the health insurance marketplace all right we're.
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B
Going to withdraw for one final ad break and then we'll be right back after this when i evaluate debt funds i look for things like first position loans personal guarantees deep experience by the fund operator low fund leverage fast liquidity and consistent returns these are some of the reasons why i'm excited to partner with pine financial group their fund six offers investors exposure to real estate credit largely for construction and rehab largely here in colorado with loans originated by an experienced originator with over one billion dollars in origination volume seventy five percent of their borrowers have been repeat customers over seventeen years they offer investors an eight percent preferred return paid monthly and a seventy thirty lp gp split of everything over ten percent paid annually the lockup period is nine months with liquidity available within ninety days after that nine month commitment the fund is open to accredited investors only the fund's minimum investment is typically one hundred thousand dollars but pine financial is able to reduce that minimum for some investors and have agreed to do so for biggerpockets money listeners to a minimum of twenty five thousand dollars full disclosure i am personally invested in this fund through my self directed ira and of course pine financial is sponsoring this message and our podcast if you'd like to invest or check out their perspective go to biggerpocketsmoney dot com pine today that's biggerpocketsmoney dot com pine please note that returns are not guaranteed and may vary based on fund performance finances can be messy and confusing and it's a lot of work for many of us just to get to the starting point in personal finance which is understanding what you've got and where your money's going that's why virginia my wife and i use monarch money as our personal financial command center for our bank accounts credit cards investment portfolio and as our budgeting and spending tracker monarch automates everything it's all linked and every transaction is automatically categorized into each category of spending in just a few minutes a month i have a complete picture of where every dollar is being spent and i have a real time net worth statement i've recommended and personally used monarch money for years i am thrilled and proud to be sponsored by and partnered with monarch money here at biggerpockets money bigger pockets money listeners get fifty percent off their first year which is usually ninety nine bucks with the code pockets at monarchmoney dot com that's monarchmoney dot com with the code pockets you just realized.
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A
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- [39:15]
B
We booked an incredible airbnb in scottsdale arizona so that we could get a little escape from the colorado winter we had a wonderful time taking our two year old to see some of the highlights of phoenix trying out some new restaurants and we even used the beautiful heated pool every day of the trip trip i'll never forget it this trip made me think while we were looking for a little break someone else was likely looking for that authentic colorado winter experience and they could have enjoyed our home to do so while we were away if we hosted it on airbnb and even though we would be hosting others while on vacation ourselves it'd be totally doable with airbnb's co host network now you can hire a local co host to be on the ground and to help take care of your guests it's so great they do the work for you and you could earn a little extra money co hosts can create your listing manage reservations provide on site support and message guests they really help make it so easy it definitely could be a great opportunity for you find a co host at airbnb dot com.
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D
Host tuesday on nbc jimmy fallon and bozma saint john host the highly anticipated new competition show i hire ten creatives from all walks of life they will.
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B
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D
Can impress the world's biggest biggest brands this is a huge opportunity this is the battle for the next big idea this is not play play we're spending millions of dollars i'm so excited to.
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Embark on this adventure with all of.
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A
Let'S jump back in i.
- [40:47]
B
Think that the direct primary care coupled with the health share thing is going to continue to be a trend even though many people are uncomfortable with it right now and i think it's gon first adopted by the early retirement community most in there especially those who don't don't qualify for these subsidies but anyways.
- [41:02]
D
It'S a key i think it's worth.
- [41:04]
B
Worth this tangent here because so much of the thesis in this deck is centered around not just tax planning but also minimizing the income that that could disqualify you or diminish the subsidies you're.
- [41:19]
D
Getting for healthcare that is absolutely a fair point and yeah like your mileage might vary based on one actual cost as scott and mindy these costs can vary and two maybe have retiree healthcare that's a you know there's just different permutations and combinations here and i think going back to sort of the phases of retirement one of the big themes of our book of our sort of planning approach that we favor is keep your ordinary income low as best as possible and delaying social security just helps do that and if you're otherwise affluent why not do that to keep the planning window open whatever your planning is going to be be if we move to our age seventy so age seventy is important because there is absolutely no ability to keep delaying social security at that point right you got to take it or you're just leaving free money off the table so you're going to take that money that's going to create taxable income that you know fills up the standard deduction the ten percent and your planning opportunities become somewhat more limited however we're not subject to rmd so that's helpful this could be a time to use some strategic roth distributions hey you know the last ten thousand dollars of distributions this year are going to bump me into the twenty two percent bracket all right forget that i'll take that last ten thousand dollars from my roth ira and the big one that i'm very fond of for retirees is qualified charitable distributions this is where when you're donating to your charity you don't write a check to the charity you go online to your ira portal and you say hey ira custodian send this five hundred a month or this one thousand dollars contribution or whatever it is directly from my traditional ira to this charity that is a taxable amount that is excluded from taxable income and oh by the way you're probably taking the standard deduction as well so you're getting a high standard deduction plus a charitable deduction look it really only works for those who are otherwise charitably inclined but many retire are charitably inclined so at seventy and a half you start doing qcds qualified charitable distributions instead of writing checks to charities and you're now hiving down your traditional retirement account balance in a tax free way and oh by the way that's going to reduce the future rmd's the required minimum distributions we'll talk about in a minute because you've taken that money out of your traditional ira so very helpful in that regard the party doesn't go on forever so what i mean by that is eventually you have to take required minimum distributions out of your traditional ira or traditional four hundred one k now for those in the audience born in the year nineteen sixty or later the secure two point zero act says all right you get to start those rmd's at age seventy five that's really interesting because that means that rmd's last for a rather narrow slice of your life life go on social security or ssa dot gov the actuarial tables are very interesting when we're thinking about seventy five year olds and how much longer they have to live it's not as long as you might think sadly and so these rmd's may not be as big of a issue as you might be originally worried about the other thing to think about is there are plenty of ways to mitigate the negative effects of rmd's right because who wants to be subject to a rule who wants to be required to take an amount out of your traditional four hundred one k or ira but do well okay what are those tactics that we can employ to reduce the harmful impact to the extent they're harmful of rmd's and we have a list of seven here roth conversions in various phases of retirement particularly in the golden years that reduces the traditional ira balance qcds like we just talked about asset location so we've talked about oh we like having our taxable bonds in a four hundred one k because that interest income is hidden away from our tax return we like that well a secondary benefit is from an expected return perspective and look we're not giving investment advice but if we want our portfolio to have some stocks and some bonds okay we generally expect returns on bonds to be more modest than returns on stocks your mileage may vary but that's our expectation generally speaking so why not have the lower growth assets in the traditional retirement accounts if we're going to have somewhat lower growth somewhere in our portfolio a traditional retirement account is a really cool place to have that because our rmd is computed as a percentage of the account balance if we use asset location putting our bonds in our traditional retirement accounts to help mitigate the size of those things boy that's helpful from an rmd perspective as well as keeping current year interest income off the tax return one thing that helps reduce rmd's is living off our retirement accounts before age seventy five most early retirees are before age seventy five going to need to access their traditional retirement accounts for living expenses well guess what that means your nfl sunday ticket subscription helps reduce your future rmd's so enjoy watching football and enjoy a slightly lower rmd in the future and less tax so that's good rmd's themselves rmd's are a self correcting problem to at least a small degree so every year's rmd comes out well that means that that balance isn't there for next year to be taxed under the rmd rules again number six is something i already alluded to life expectancy people worry about rmd's and it's like wait a minute how long do you think you're going to live when you start these things at age seventy five how long do you think this is going on now look i hope it goes on for a long time i hope this is a good problem to have for a long time but we just don't know and then in the early retiree community there's a seventh mitigator which is the early withdrawal strategies so people worry about rmd's but then they're on a seventy two t payment plan and i'm sort of like well wait a minute you're taking money out of this traditional retirement account in your mid fifties so twenty years before rmd's start and you're worried about this you're already reducing this problem twenty years in advance you got a twenty year head start on the irs so if you're using the rule of fifty five or governmental four hundred fifty seven b or a seventy two t payment plan well by definition that means you are getting ahead of the game when it comes to rmd's you probably don't have to be all that worried about rmd's because you're already ahead of the game so yeah i mean i think you know rmd's and cody i'm interested your thoughts on this rmd sort of have this rap as being this bad thing and boy they're going to hurt your retirement but you know in our analysis we find they're generally not all that detrimental and if they're detrimental it also also has the happy accident of oh you're really rich and you have some tax inefficiencies so you know cody what are your thoughts on rmd's i have.
- [48:14]
C
Worked with clients they're in their nineties their rmd's are four hundred thousand dollars a year you're like oh my gosh that's so much taxable income but you think wait a minute how much money does this family have if that's just a portion of their ira how much do they have in their ira right and also just keep in mind you know filling up those even as somebody with four hundred thousand dollars of ordinary income income they still get to fill those lower brackets you know zero percent standard deduction the ten the twelve right so we actually have examples of even you know a late traditional retiree or even a surviving spouse a surviving widow they call this the widow's tax trap you know we've got traps all over the place and retirement planning but what's fascinating is first of all you know moving into phase five the surviving spouse you think typically in terms of their age if they're already taking rmd's their predeceased spouse was taking rmd mds like how many more years even if they're like subject to this tax trap or this tax penalty how many more years do they have to be subject to that penalty maybe just a few years maybe you know five ten years women actuarially live longer than men for a variety of reasons that we you know we don't know all those cases but just keep in mind that even if something's a penalty by the way we've put the word penalty this little sidebar we say the word penalty in a lot of cases you know the early withdrawal penalties penalty the irs calls it the additional tax so sometimes we kind of create this language to make this stuff sound way more intense than it is but even with these so called penalties we've seen surviving spouses widow widowers still have very low effective tax rates they have again it's a good problem to have as we call it they have sufficiency they can still maintain their desired lifestyle and yes pay a little taxes along the way and also when their heirs inherit this money they might have another ten years to distribute those traditional retirement accounts so you know we're really focused on the lifetime tax liability including going into the next generation your financial family tree as we say but just i think we can kind of close here in the phases that in each of these phases fear isn't the driver of our decisions right it's optimized tax planning really focusing on the quantitative optimization of tactics and strategies while maintaining your desired lifestyle having those memorable experiences with your family while you're alive rather than just leaving this big hunk of they always say that unrealized capital gains can also mean unrealized experiences in life right so if you're holding onto these things forever you know what are you saying no to by saying yes to you know deferring as long as possible.
- [50:37]
D
Your taxes and that leads us to the widow or widower phase of retirement sometimes pejoratively called the widow's tax trap and it's absolutely true that the death of the first spouse is going to increase effective tax rates in almost all cases what happens is the income drops but not by fifty percent but what generally happens is now you're subject to the single tax brackets the single standard deduction and whatnot so the odds are that effective rates are going to increase at the first spouse's death but just how bad is it so we have a bit of an extreme example picture a two hundred thousand dollars rmd in twenty twenty five dollars in the widow's tax trap and how much of that rmd is going to be subject to a federal income tax bracket over twenty four percent and our quick and dirty math on this says very roughly speaking approximately thirty two thousand of that two hundred thousand is going to be in the thirty two percent bracket so that means that even for a two hundred thousand dollars rmd which most americans will never hit right it's just an amount we'll talk about the size of the ira that generated that even in that extreme case most of the rmd comes out and is taxed federally at twenty four percent or less so even in this really extreme case basically what happens is your two hundred thousand dollars rmd suffers a tax inefficiency for sixteen percent of it not nothing but certainly not something to fear and you say well wait a minute how do i have a two hundred thousand dollars rmd well roughly speaking you could have a two hundred thousand dollars rmd if it was a little bit more than a four million dollars traditional ira of an eighty year old so how many people are going to have four million dollars traditional iras will it happen absolutely is it a common outcome no and you know the other thing i think i just add here is it's actually not a really bad place for it to happen because picture this eighty year old widow what's she doing with that two hundred thousand dollars right her lived experience is just fine even though she has a bit of a tax inefficiency it's actually a pretty good place to have a bit of a tax hike because you're not married with three young kids at home and you're not at the beginning of retirement where your finances are more paralyzed she pays a little higher taxes as an eighty year old widow who's probably not living that large anyway she's going to do just fine with her two hundred thousand dollars rmd plus social security and probably some other assets and the other thing too is even that inefficiency could be overcome it might just be that this woman this widow in our example is charitably inclined she could do a thirty two thousand dollars qcd and now not a penny of her two hundred thousand dollars rmd would suffer negative ten tax rate arbitrage it would all go out at twenty four cents on the dollar or less now yeah she'd have some they call it irmaa it's a small surcharge on medicare it's not that there's no ancillary you know bad consequences but it's certainly not something to be feared is i think the theme that cody and i keep coming back to and generally speaking it tends to be that the widow's tax trap is a little overstated and oh by the way two other things on the widow's tax wrap trap one all those mitigation tactics we talked about on rmd's asset location qcds roth conversions you know on and on and on those reduce the widow's tax trap and then the other thing about the widow's tax trap in order for it to be a very relevant consideration you need distance between the spouse's deaths which is very possible but it's also possible there's not that much distance if one spouse dies in twenty forty and the other spouse dies in twenty forty one one the widow's tax trap is just not a big consideration in their financial life so that's just something to keep in mind so mindy we've said a lot have we blown your mind away and you don't even want to retire now you're just going to keep on working or are you now looking forward a little bit more to retirement first of all we.
- [54:41]
A
Should never let the tax tail wag the dog so i am going to continue doing what i'm doing and when i have to pay a lot of taxes it's because i have a lot of money they're not taxing me at eighty six percent and i'm just left over with almost nothing they're taxing me on a large portfolio so i think that more taxes you have to pay the better off you are and that's i don't think that i know that that's how it works it's percentage of what you've got so no i'm not going to discontinue my investments i'm still investing right now in you know now it's like we've hit our fine number and then have a little bit more than we need so now it's like it's a game how big can i.
- [55:29]
D
Grow that one of the subtle themes of our book is assets tend to become income very efficiently and scott raised this previously you know they tend to tax investments whether it's traditional retirement accounts taxable accounts roth accounts relatively lightly and look we can politically agree or disagree with that but it is what it is right you know retirement as cody's talked about effective tax rate it may be that a lot of folks listening to this today get to retirement they're like wow basically retirement could be the best tax cut of your life you leave the workforce and you're now living on investments whether it's traditional retirement accounts taxable roth and it turns out you tend to be relatively lightly taxed and mindy you made a great point the exception to that rule is for the very financially successful and too often the tax discussion in the personal finance realm focuses on one or two of the trees and misses the forest if you're going to have tax inefficiencies in retirement the odds are it's because you are wildly successfully financially now that doesn't mean we don't do tax planning we had seven mitigation steps now one of them was your own mortality so that's not so much planning but we had all these different planning things we're all for planning but we're also for planning done in the context of rational analysis analysis not in the context of fear and.
- [56:50]
A
Slogans well and i think that this community really really really likes to diy their financial planning and i don't think that they should be diying their tax planning and tax planning doesn't mean they're doing it every single year especially after retirement you can get a pretty holistic view of where you should be going and then check in with your tax planner but i do want to encourage people who are listening to to this who are like wow that really was a lot of information you know sean's been doing this for a minute cody's been doing this for a minute so you take all of this information and you you know you keep learning and you keep like this is second nature to them you need to have a conversation with somebody for whom this is second nature so i do want to encourage people who are listening to meet with the tax planner and see the best way that they can can you know meld their diy ideas with actual tax reality yeah i'll just quickly add.
- [57:47]
C
There that the books tax planning to and through early retirement is not necessarily meant to be read like you know front to back right that would be a lot of information it's thirty eight chapters three hundred fifty pages of you know pretty much we took everything in our heads that's running around all day we like we packed you know we put it all in a little container for you in a book but i'll say that the book also serves as this guideline of saying hey i'm in phase two what was like there was something they said about phase two so you can just go to those chapters right so thirty eight chapters all the each tactic even tax gain harvesting tax loss harvesting you know sudden job loss each one of those has a small chapter so just eat the elephant one bite at a time and don't feel like you have to know everything before you can retire early and what's that book called again it's called tax planning to and through early retirement i just.
- [58:30]
B
Want to chime in here and say this has been a wealth of information and it's exhaustively researched you can tell you guys are not just experts in ethereum but down to the very detailed tactical levels for what the vast majority of people are going to experience i'd like to attempt now to see if i can regurgitate the key points that really people need to take away from this so if we go into the fundamental components because mindy i agree with you people shouldn't be doing their own tax planning necessarily but you do need to have a grounding in this because most people are not most experts in the cpa world are not as well versed as sean and cody for example example in this and they can't put together a twenty year early retirement strategy that's your job as the listener like if you're hearing bigger pockets money trying to retire early you need to be well versed in that to know the core strategy here pretty well and i think that if i boil down what i've learned from sean and cody in this week right in the discussions we've had it's a couple of things first let's start with the order of operations right forgetting all the details all eleven order operation steps we have here here it's if you can if you're a normal middle class or upper middle class wage earning american max the four hundred one k first versus the roth then you know do the roth afterwards if you have money left over but take that hsa and put those pre tax dollars shoved those dollars from taxes now the second are these four themes that you said here when you begin to transition to a retirement portfolio for example something like a risk parity portfolio something that is not all stocks one hundred percent stock portfolio something that is actually conducive to early retirement portfolio spend the taxable accounts first then go to your traditional accounts delay your social security until seventy and then use your tax free pools like your hsa roth maybe other specialty accounts to fund the remaining be smart and strategic about that like reimbursing yourself for medical expenses from the hsa at appropriate times and then a third component that i want to add in here you didn't explicitly state this until later on and i think that when we take those order of operations from the accumulation phase and we take take these fundamentals of drawing down from a portfolio that translates to this kind of investment or portfolio principle design theory where you want to hold the more aggressive positions in your roth and hsa the more conservative positions in your traditional or pre tax accounts let's say you're going to have a sixty forty stock bond portfolio you'd want most of that stock exposure likely to be in the roth and hsa positions you'd want most of that bond exposure to be in the traditional account and whatever that wiggle room is that's not going to perfectly map in those two accounts you're going to want to balance that with the remainder in the after tax brokerage accounts that you're going to harvest first do you guys agree with that is that a good way to tie in some of the theory that we you know the tax theory that we just went through into kind of practical principles people can.
- [61:14]
D
Follow scott i generally like this approach that you're proposing one thing i'll just quickly mention is we tend to really favor domestic equities in tax in the taxable account accounts but even you know some international equities in the taxable accounts could be fine it's all about limiting the ordinary income that the investments are kicking off on your tax return every year and your general approach is about the best way folks can do that and yeah i think you're definitely barking.
- [61:45]
B
Up the right tree yeah and i.
- [61:46]
C
Would say that most retirees early or otherwise most of them can actually fit most or all of their bonds in their pre tax retirement accounts especially retirees who had significant traditional four hundred one k traditional ira balances of their total asset allocation of stocks versus bonds a lot of them can keep all of their bonds in their pre tax accounts and then that leaves them great room to you know to fill up their their taxable brokerage with the domestic equities and then the roth and hsa with kind of what's left but again i think this general framework is is well.
- [62:16]
B
Put together scott awesome now now let's open a huge can of worms just kidding on this but i'll put it out here and then we can we can do it another time if you're a real estate investor of course then what you do is you put everything into the pre tax retirement accounts you lend in a private lending capacity to someone that asset is now illiquid it's marked down your one hundred thousand dollars loan is marked down to a thirty thousand or forty thousand dollars valuation you convert it to your roth at that point paying taxes on the thirty or forty thousand dollars conversion and then when you're paid back the full one hundred thousand dollars balance that's settled in your roth account and that completely blows up your whole strategy that one we'll talk about next time right yeah and we.
- [62:58]
C
Actually have a chapter in the book chapter twenty nine is called return on hassle what's not worth optimizing i love.
- [63:05]
A
It that's awesome that is perfect i am definitely looking to reduce my hassle even and it's a privilege to be able to reduce your hassle but i am definitely in that era of my my retirement life is reducing my hassle i'm trying to consolidate all of my accounts too because we've got all these little random accounts everywhere thanks carl because he's a former optimizer he's let's be honest he's still an optimizer that was.
- [63:31]
B
Fantastic response cody sean cody thank you so much for joining us twice this week you're a wealth of knowledge definitely encourage people to go and check out the book tax planning to and through early retirement thank you for writing it and thank you for showing sharing such a major portion of the knowledge that you poured into that book here with bigger pockets of money cody garrett before.
- [63:50]
A
We say goodbye where can people find out more about you and where can.
- [63:54]
C
People buy the book sure so let's start with the book so you can go to amazon or really the best link for you is measure twicemoney dot com book those will have the direct links to amazon if you want to check out the paperback or the kindle.
- [64:09]
A
Ebook version and sean where can people.
- [64:11]
D
Find you online thanks so much mindy folks can find me at my blog fi tax guy dot com all right.
- [64:17]
A
That was another fantastic episode huge thanks to sean and cody for joining us this wraps up this episode of the bigger pockets money podcast he is scott trench i am ade jensen saying goodbye.
- [64:28]
D
Magpie trip planner by expedia you were.
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B
Made to outdo your holiday you're hammocking.
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D
And your pooling we were made to.
- [64:40]
B
Help organize the competition expedia made to travel.