Ep 34: Case Study: Tax-Smart Distribution Planning

Ep 34: Case Study: Tax-Smart Distribution Planning

The Smart Take:

Things in life and planning aren’t necessarily cut and dry. You may take several paths to reach your destination. But which one may be best?

Listen to Kevin discuss a retirement situation where several strategic paths existing and how he and his team came to the preferred path in creating an integrated, tax-smart distribution plan.

Prefer to read? See below for the transcript of the show.

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The Host:

Kevin Kroskey – AboutContact

Announcer:                        Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to retire smarter.

Walter Storholt:                This is Retire Smarter. The podcast that helps you do what the name says, Retire Smarter. Walter Storholt here alongside Kevin Kroskey, President and wealth advisor at True Wealth Design, serving you throughout northeast Ohio and beyond. Check out all the episodes and subscribe links by going to truewealthdesign.com. That’s www.truewealthdesign.com. This is part 2, or maybe even a part 3 if we  bridge it back to the first episode from November where we’ve been focusing and spending a lot of time on taxes. You could probably listen to today’s episode on its own, but I would encourage you to go back and listen to some of those previous tax episodes, in particular, episode #33 would be worth checking out, the one before this one where we dive in and set the stage for a lot of the base information about different tax strategies, or as we said last time, Kevin, the stuff that goes into a tax plan.

Walter Storholt:                Now we’ve going to talk about synthesizing all of those things, prioritizing the different strategies that come up. But, of course, we’re going to start with actually laying out what these different strategies are and what they look like.

Kevin Kroskey:                  Yeah, you got it. I’ve been looking forward to this, Walter. I tried to set an expectation about what’s to come, and I got excited myself just thinking about it. What I’m going to go through today is we helped a few people, few new people recently. A lot of times when you’re first working with somebody there’s just a lot to do. Maybe they’ve been working at the same employer for 40 years or so and just socking money away in the 401(k), getting some benefits that the employer is providing for your compensation package, and then you get serious about retirement and say, “Wow, I better go talk to somebody that knows what the heck they’re doing here because things are getting complex and I want to make sure that I don’t screw up. Whenever we have somebody like that’s coming in a lot of times, there hasn’t been any pruning or work done for maybe forever. They’ve accumulated a lot of things, but there is just a lot that you have to do and go into a new relationship with.

Kevin Kroskey:                  We’ve had some interesting cases recently. They had a couple of similarities. What I thought I’d do today is blend two of them to protect the innocent and confidentiality and talk through them. What was the situation, what was the fact pattern, what were some of the things we considered and how did we come up with what we came up with. To go ahead and go down that path we’ll use the very creative names of Jim and Sue. Jim and Sue came into the office and we started working with them. They are both in their late 50s and getting ready to retire here next year. Jim had been working for the same company for literally it was about 40 years or so, a company here locally in northeast Ohio, one of the largest employers is Progressive Insurance. Progressive has some good benefits for their people and also has had quite a run in their stock price. Jim happened to have some Progressive stock in his 401(k) for quite some number of years and had that appreciate a lot. That’s going to play into one of the things, one of the opportunities that he had here.

Kevin Kroskey:                  Sue is getting ready to retire. Also had been at an employer, couple different ones over the years, and she was an office manager and was getting ready to retire. They were going to go out at the same time. So, they had some money. Most of their money was in the 401(k) plan at Progressive. Some of the money was in Roth accounts that both Jim and Sue had and put a little bit into over the years. They had a good chunk down at the bank. They had about $100,000 of cash that had already been taxed, just sitting in the bank account, get a small 1099 in January for the interest that you earned over the prior year. They also had a joint account with about $100,000, too, with some different investments, mutual funds, and stocks that Jim had picked over the years and what have you. He had a pretty good run in the market over the last, particularly the last ten years, and he certainly had some gains in there.

Kevin Kroskey:                  We had a lot of these tools at our disposal. Jim and Sue had already done the plan. We showed them that, sure, yes, you guys live below your means. You probably could have retired a couple of years ago if you would have come in and seen us sooner, but you can retire now, as well, and you have the benefit of having more cushion or being able to spend more, whatever it is that you would like to do.

Kevin Kroskey:                  After we had gone through that initial phase and formulated the plan, and they did confirm that “Okay, yeah, we feel good. We’re going to go ahead and cut the cord on our paycheck and retire.” Then, that second part of the plan, that distribution plan,  this Tax-Smart Distribution Plan, if you will. We had to figure it out. Jim and Sue had some different competing objectives. They had a lot of opportunity, but we had to figure out, well, what’s going to make the most sense for them?

Kevin Kroskey:                  If I go back to Jim’s 401(k) for a moment, he had this Progressive stock and whenever you own employer stock in your 401(k) plan, and I’m not a big proponent of going out and buying your employer’s stock. There’s a lot of talk for another day, but there’s a lot of good examples where that can go awry. If something happens to the employer, not only could you lose your job, but your 401(k) goes down because the stock price just went down. It happened for a lot of companies back in 2000 and 2008, and even some of the local banks. National City used to be in northeast Ohio, and now it’s called PNC or Previously National City.  That’s supposed to be a bit of a joke, but if you’re local, it’s not too funny, especially if you worked for National City and owned their stock in your 401k. You don’t want to put a lot of employer stock, but Jim did if, for no other reason, it was just inertia. A lot of employers used to match with employer stock back in  pre-2002, and a lot of people just let it ride. Jim was no different there.

Kevin Kroskey:                  What had happened over the years, Progressive stock had done well, and the cost basis of his stock was fairly low. It was only about 20% of the value. So, just to put some numbers to this, let’s say that the Progressive stock was worth about $500,000 in his 401(k). His 401(k) was a few times that. The stock, just the stock portion itself, not the mutual funds there were in there, but the stock was worth about $100,000.

Kevin Kroskey:                  So, there is something called NUA, which is short for net unrealized appreciation. I’m not going to get in on all the details, but this is something if you have this opportunity I would strongly encourage you actually to talk to a professional. There are a lot of little details here, and if you screw them up, you could get some adverse tax consequences. In principle, what you can do is use a special distribution option where you take the stock in kind, meaning you move stock from the 401(k) over to an account in Jim’s name into a nonqualified account or what we also call a taxable account. What happens when you do that is he has to pay ordinary income tax on the $100,000, but he doesn’t have to pay any ordinary income tax on the growth.

Kevin Kroskey:                  In this example, it’s to say that he moves all $500,000 of his employer stock over to an account in his name. He has to claim $100,000 of ordinary income on his tax return for the cost basis of his stock, but the $400,000 gain is not taxed until it’s sold. When sold, it’s going to be taxable at long-term capital gains rates. So,  a quick aside here, but we went through bracket management last time. In the last episode, we talked about how the tax rates get higher with higher incomes. We didn’t dive into capital gain or qualified dividend rates, but, in short, they’re preferential. Preferential in a sense that they sat on top of ordinary income and taxed at a lower rate than ordinary income.

Kevin Kroskey:                  So, why would it make sense to do this NUA thing? Well, if you take $500,000 out of your 401(k) and you don’t do it, then $500,000 is going to show up on your tax return, and you’re going to have to pay tax on it. If you use this NUA fancy-schmancy option, then the $100,000, in this case, shows up on your tax return, and you get to control as far as when you want to realize the capital gain at that lower preferential rate. So, if you’re somebody that’s done well and you have probably going to be in a high tax bracket forever, maybe you’re close to 40% tax rate, well, the capital gains rate for you would be 23.8%. So, Walter, tough question here. I know you got beat up a little bit in the last episode, so I’ll give you a chance of redemption here.

Walter Storholt:                That was just some bad listening in the last episode.

Kevin Kroskey:                  What would you rather pay a 40% tax rate or 23.8?

Walter Storholt:                Okay, I can make this one happen, 23.8 sounds good to me.

Kevin Kroskey:                  Winner. Yes.

Walter Storholt:                You can increase the difficulty on the next one now that I got one right, right? So you just-

Kevin Kroskey:                  I’m building the coffin.

Walter Storholt:                You can keep adjusting, yes.

Kevin Kroskey:                  So, this is definitely an oversimplification, but the point being here, Jim had a big opportunity, and the opportunity was maybe to get a lot of money out of his 401(k) and pay a lower rate than what he otherwise would. That was one of the tools that we had in the tool belt here, do we want to do this NUA, and to what extent? We don’t have to do all $500,000. Maybe we do half of that, and maybe only $50,000 shows up on the tax return. That’s something that we have to be mindful about. So that was one.

Kevin Kroskey:                  The other thing that he had. So, they were both 59, and they did not have any retiree medical insurance, so they were going to have to go out and get their insurance. If anybody’s done this, they’ll know what a pain in what it’s been. It keeps changing every year, getting more costly. There is something quite beneficial, and we have probably a couple of handfuls of clients that are getting it and have the opinion like, “You got to be kidding me. This is almost too good to be true.”

Kevin Kroskey:                  Under the Affordable Care Act, there’s a tax credit that you can get for buying insurance, individual health insurance, on the exchange through healthcare.gov. Basically the way that this works is so we went through the tax return and we talked about AGI last time, adjusted gross income. When you look at it for this healthcare tax credit you could have two people, a family of two … It’s basically based on your family size, and then it’s tiered based on some percentage of the poverty level. I’m not going to get into all these details. It gets a little complicated. In short, you could have about $64,000 of adjusted gross income in 2019 and get a tax credit. The way that the tax credit works,  pausing here debating whether I should even mention this. Again, it gets a little wanky.

Kevin Kroskey:                  I’ll tell you what, here’s a way to simplify and think about it. The way that the tax credit works is it’s going to try to limit what you pay for health insurance to about 10% of your adjusted gross income. For Jim and Sue, let’s say that we plan their income to be about $60,000, then it’s going to try to limit what they pay out of pocket for their premiums, not any out of pocket costs, but their premiums, to about $6000. If you’re working right now, you hear $6000. You may be saying, “Well, that doesn’t sound that great. That’s about what I pay.” You may even be saying, if you have a very generous employer, “Wow, that’s a lot.” I can tell you that if Jim and Sue would go and get this health insurance, and they don’t have a tax credit and it’s completely unsubsidized, they’re probably going to be paying on the order of about $14,000 per year. Walter, we’ll build up the difficulty.

Walter Storholt:                Oh, boy, …

Kevin Kroskey:                  … here again …

Walter Storholt:                … here again.

Kevin Kroskey:                  We’ll walk today before we run.

Walter Storholt:                That’s right.

Kevin Kroskey:                  So, if supposing that they are going to pay $14,000, and the tax credit is going to limit what they’re going to pay to $6,000, what’s the amount of tax credit that Jim and Sue are going to get.

Walter Storholt:                So, they’re getting an $8,000 credit.

Kevin Kroskey:                  Ding, ding, ding. Yes.

Walter Storholt:                Your pause there scared me for a moment.

Kevin Kroskey:                  I definitely have to make these a little bit harder, Walter. I know you’re a sharp guy.

Walter Storholt:                I can add and subtract. Multiplication, division, oh it starts getting dicey. Trying to do it on the fly while you’re talking, it’s like walking and chewing gum at the same time.

Kevin Kroskey:                  You got it. This $14,000 that they would pay and, frankly, it would probably be actually a little bit higher than that. I can tell you in the case of Jim and Sue; it was actually a little bit more than that. It was about $16,000. So, if your income is lower than that $64,000 adjusted gross income, the tax credit is higher. Again, let’s say if your income is $30,000, then, again, use that 10% rule of thumb. The way that the formula works is it’s going to try to limit what you’re going to pay to about 10% of AGI or about $3,000 in that example. So, your tax credit’s going to be higher. As you look at this, there’s a big incentive to keep your income low.

Kevin Kroskey:                  I can tell you, Jim and Sue, round numbers, had about two million dollars that they had worked hard, and saved, and lived below their means, and accumulated over time. They inherited a little bit of money from Sue’s folks, and they were able to retire early in their 50s. As I said, they probably could have retired a few years sooner. They had several years from the time that they were retiring here come early next year until they were 65 and eligible to go onto Medicare. So, we’re potentially looking at about five years of credit. Jim had this NUA opportunity, but in order to do that, we were going to have to go ahead and realize income in the sense of ordinary income hitting his tax return, and then if we wanted to sell that stock we were going to have a lot of capital gains that were going to be hitting the return. That was going to go ahead and mitigate some of this tax credit that we could get for healthcare.

Kevin Kroskey:                  Again, for Jim and Sue, this was a $15,000 tax credit per year, $15,000. Incredibly substantial. Again, take that over five years. Okay, Walter, let’s do some multiplication now, so what’s $15,000 tax credit over five years?

Walter Storholt:                We are in the 75 range?

Kevin Kroskey:                  Yes. Nice, Walter, flexing some of those mathematical muscles. I knew I picked the right cohost.

Walter Storholt:                Those calculator muscles.

Kevin Kroskey:                  Hey, you still have to have fast fingers.

Walter Storholt:                Fast fingers, you got it.

Kevin Kroskey:                  So, literally, 75 grand in terms of tax credits that they’re going to get over the next few years. Now, a quick aside here. I can tell you that they were completely unaware of this coming in before they met us. There was almost a bit of disbelief at first, and I can tell you they are not going to pay us $75,000 in advisory fees over the next five years, so we’re already in the black, and they’re pretty happy that they met us. So, so far, so good. So that’s one.

Kevin Kroskey:                  That tax credit is quite beneficial. Again, if we did this NUA on the surface it looks great. Who wouldn’t want to go ahead and get money out of their 401(k), pay a little bit in ordinary income tax on that cost basis for the NUA stock, that employer stock, and then maybe get those capital gains out, and maybe even get them out at 0%. If they were to do that, then it’s going to blow up that tax credit that they didn’t even know about before they met us. So, those are two things that we’re looking at there.

Kevin Kroskey:                  The other thing that you could get into and say, “Wow,” a lot of things people talk about we’ve been big proponents of for many, many years, and have executed for many clients over those years, is our Roth conversions. Roth conversions are moving money from your IRA, your 401(k) in the yet-to-be-taxed bucket over into the Roth IRA in the tax-free-forever bucket. In order to get it there, you pay whatever today’s tax rate is. We don’t move all of the money over from your IRA or 401(k). We do a targeted amount.

Kevin Kroskey:                  Something we talked about last time was bracket management, basically filling up those low brackets certainly makes a lot of sense. One of the things that we mentioned last time was you could have a little bit more than $100,000 of taxable income, coming off from your IRA hitting your tax return in retirement, and you’re not going to pay a higher rate than 12%, so not too bad there.

Kevin Kroskey:                  If you are in  that nice low bracket and you have room there then something that we do, I don’t know, probably for maybe 30 different of our clients, or 40 different of our clients, that are in retirement and have some range of motion in that low bracket we just say, “Look, here’s about how much room we have. Let’s go ahead and move that money. We’ll pay the tax at today’s low 12% tax rate.” Even if rates just revert back to what they were in 2017, which is current law, that 12% rate goes to 15%. Another softball, Walter, before I got to find a hard one for you. What would you rather pay 12 or 15?

Walter Storholt:                Yeah, 12%. We’ll take it every day.

Kevin Kroskey:                  You got it. For Jim and Sue …

Walter Storholt:                I was waiting for you to have some sort of catch there. Yeah, but I didn’t tell you that you were going to get a 5% cashback on your 15% investment, or something like that.

Kevin Kroskey:                  I know I’m asking you some very easy questions here, Walter, and it’s not-

Walter Storholt:                To be fair, I  blew that last one on the previous episode, so I don’t blame you for taking us back to square one.

Kevin Kroskey:                  I just haven’t come across a better one yet. It’s not indicative of how I think of you, or your mental capacity. I’ll do my best to give you a tougher one here. Most of the two million dollars that Jim and Sue had was in this yet-to-be-taxed account. She had a pension that she was going to have from working at an employer for a while. They both had very healthy Social Security benefits. They were going to have, when their income sources just from the pension and Social Security started, they were going to have about $100,000 of income hitting their tax return, and then they have all the money that’s in their IRA and 401(k) yet to be taxed. That grows over time. Maybe that’s going to be three million dollars by the time they get into their 70s and have to start taking that money out because of those required distributions.

Kevin Kroskey:                  If that plays out, roughly speaking, that’s going to be about another $100,000, 110,000 that’s going to be hitting their tax return. Now, all of a sudden, they find themselves to be in a higher tax bracket than what they ever were, and because they’re doing that good, too, now their Medicare premiums are paying IRMAA adjustments on it, which we  briefly mentioned last time. Point being, generally if you can pay a lower tax rate today than you are going to in the future that’s a good thing to do. But, it was not a good thing to do for Jim and Sue. So, again, we had this idea about, “Hey, this NUA thing looks  great.” They definitely have a tax problem long term because they’re going to have all this income coming in from Social Security and pensions and, wow, their IRAs are going to keep growing over time and getting larger, and then that’s going to make the required distributions even bigger and more income hitting their tax return. Maybe we should just go ahead and start moving it out now.

Kevin Kroskey:                  If we had done that, that would have been the exact wrong thing to do, because we would have been blowing up there Affordable Care Act tax credit, which is just way too beneficial to go ahead and pass by. So, they had this credit. Again, for them, it’s going to work out to be about $15,000 per year, as Walter quickly calculated about $75,000 over five years. We want to do everything that we can to go ahead and capitalize on that and make sure that they get that credit.

Kevin Kroskey:                  So, we’re going to go ahead and hold off on moving money out from the IRA and moving it into a Roth IRA. We’re going to use a little bit of that money for spending but, basically, we’re going to do everything that we can to go ahead and keep their adjusted gross income somewhere around the $20,000 a year neighborhood to maximize that tax credit, because it’s just more valuable than any other tool that we have in the tool belt. Now, that sounds great. Hey, let’s go ahead and keep our taxes  low. But, Walter, here’s an open-end question, definitely not a softball by any means. If we’re going to keep our taxes  low, how are we going to get the money to them that they need for living expenses?

Walter Storholt:                So, if we’re going to keep taxes low, how are we going to get the money? Well, we run into problems, right, because the more we withdraw, the more taxes we create, so then where does that money come from? Is that  what you’re getting at a little bit?

Kevin Kroskey:                  Yeah, like the old Tom Cruise movie, show me the money.

Walter Storholt:                Yes.

Kevin Kroskey:                  You don’t want just to do planning here to save taxes, and meanwhile you can’t spend any [crosstalk 00:21:00]

Walter Storholt:                That’s right, we got you down to only paying 1% in taxes, but you can only take out $1000 a year from your account.

Kevin Kroskey:                  Yes. No electricity. You are using candles, and you better chop some wood, right. We’re not going to do that. That’s not the business that we’re in. So, what we’re doing for them, it’s a couple of things. So, they’re working this year. We’re actually going to go ahead and forego one of the years of the tax credit. We’re not going to blow it up completely, but it’s not going to be a $15,000. We’re going to have adjusted gross income closer to the $64,000 level that I mentioned. So, the credit is going to be more on a magnitude of maybe about $8,000.

Kevin Kroskey:                  We’re going to forego some of the credit because we need some money, so we’re actually going to go ahead and use Jim’s NUA. We’re going to go ahead and take some stock of the 401(k). We’re going to use that this year sell the stock. We’re going to plan, so the NUA is going to be at a level where the ordinary income that comes out, coupled with the capital gains that we’re going to have to realize when we sell it, is not going to blow up the tax credits completely. It’s going to be at the upper end of the range and  phase out some of the credit but not in totality. That’s going to give us some dry powder to use for the years to come, and then we’re going to supplement that with the cash that they have on hand, which is about $100,000. Then from years 2021 through the time that they turn 65, we’re going to take about $20,000 out of his IRA/401(k) per year.

Kevin Kroskey:                  He’s still going to be around the $20,000 target. We’re going to have to pay very, very little tax, almost no income tax whatsoever, but that’s going to give them some of the money. The other money that we’re going to free up from basically taking his employer’s stock out and then selling it is it’s going to give us a lot of dry powder to go ahead and bridge the gap. It should pretty much last until they turn 65. Again, cash on hand, employer stock that we’re going to take out pays a little bit of ordinary income tax on, have to pay some capital gain tax on, but then future IRA distributions up to about $20,000 per year.

Kevin Kroskey:                  All this is, basically, being synthesized to go ahead and meet the amount of money that they need. Depending on how much they spend. They want to take some trips. They’re going to have to buy a car. There are some expenses every year we know that are going to be there for Jim and Sue. Other things going to be a little bit more, a little bit less. It’s just going to have to be flexible. Frankly, if we get all the way out to year 64, and we say, “Hey, we’ve  run out of dry powder, we don’t want to blow up this tax credit again, so here’s the choice that we have, Jim and Sue. We have another year to bridge here. We’d like to keep your taxes, year adjusted gross income very low, maybe around this $20,000 threshold, get you this $15,000 credit, but if we pull more money out of the IRA then your adjusted gross income is going to go higher, your tax credit’s going to go lower.

Kevin Kroskey:                  What we could do, and this is something that has some emotional considerations that’s built into it, as well, but Jim and Sue have a house that’s completely paid off. We say, “Look, let’s just go ahead and any gap that we need to go ahead and fill for spending in this year of you being 64, and assuming that the spending is  consuming all the resources that we’ve  freed up from all these different strategies we just talked through, but why don’t you just go ahead and maybe get a mortgage, or use a little bit of a home equity line of credit and then as soon as you’re 65, and this tax credit is gone, because now you’re on Medicare, let’s just go ahead, and we’ll just pay it off. Walter, think about this with me for a minute, but interest rates are pretty low. If I’m not mistaken, I believe you and your wife just built, or just bought, a new house not too long ago?

Walter Storholt:                Yep, last year.

Kevin Kroskey:                  All right, where’s your mortgage interest rate, Walter?

Walter Storholt:                So, we are at 5%, although probably about to refinance into the 3s, hopefully.

Kevin Kroskey:                  Yeah, I was just going to suggest that. So, you got it. You can even get a home equity line of credit. We have some clients now in like  the mid to high 3 range. Let’s just say it’s 4%. Let’s say you borrow $100,000 on a line of credit for your spending. This is what Jim and Sue do and the year that they turn 65 to go ahead and bridge the gap. Well, if you have a 4% rate on $100,000 home equity line of credit, how much interest do you pay per year in that one year?

Walter Storholt:                Four thousand bucks.

Kevin Kroskey:                  You got it. Walter, you are shining today.

Walter Storholt:                I didn’t even have to use the calculator on that one.

Kevin Kroskey:                  Nice. So, let me ask you. Now, this is going to be tricky, Walter. Would you rather pay $4000 in an interest expense or get a $15,000 tax credit? Cue the Jeopardy music.

Walter Storholt:                (Singing) All right $4000 in interest credit, you said?

Kevin Kroskey:                  Would you rather pay $4000 in mortgage interest, or would you rather get $15,000 tax credit for your healthcare? Obviously, no brainer, right?

Walter Storholt:                Oh, okay. I’m sorry. I thought both were expenses. Yeah, I’ll take the credit.

Kevin Kroskey:                  I set you up there. It’s like, I think my-

Walter Storholt:                Again, I overthought it. I’m like, “All right, would I rather lose $4000, but is it going to have tax implicit …?” I got you now. I got you.

Kevin Kroskey:                  Yeah. A lot of times people-

Walter Storholt:                You’re going to have to go back down to addition. I messed that one up.

Kevin Kroskey:                  Sorry. I thought I was tossing you a softball. It turned out to be a curve.

Walter Storholt:                See, I kept expecting them to get harder and harder. I didn’t know you were going to go backward. I hadn’t retrained … Isn’t that interesting, though. I’m not going to blow this whole off into another track, but how the brain works of like because I was expecting it to be a harder question I missed the very, very obvious answer because you’re just, your brain expects it to be something harder than it  was.

Kevin Kroskey:                  It could be that. It could also be that … Walter, you’re fairly sharp-

Walter Storholt:                It could also be that you’re from the South, but…

Kevin Kroskey:                  No, I was not going to say that, but it could be that, Hey, we’ve talked about a lot of stuff here and I’ve rattled this stuff off. Hopefully, it’s clear to everybody, but I would venture that for some people it’s not clear. Somebody in my office, one of my team members, a couple of years ago, bought this placard for me that I have on my desk. It says, “I can explain it to you, but I can’t understand it for you.”

Walter Storholt:                I love it.

Kevin Kroskey:                  This is what we do every day. We’re in the thick of this fourth-quarter tax and distribution planning stuff that we’re doing for clients. We’ve been doing this for years. I’d say that we’re experts in this area, but this may seem for some people like it’s coming at them like a fire hydrant. Walter, you talk with a lot of people like me. This is what you do, and you’re certainly no slouch when it comes to this stuff, but, frankly, maybe you’re not even immune to it either. I mean, it’s just a lot of stuff to go ahead and synthesize and prioritize, and maybe I haven’t done a good job explaining it. That’s certainly possible, too. It’s just maybe we all need a little humility about how difficult this stuff could be, as I said last time, Walter, as we move up Bloom’s taxonomy to go ahead and synthesize this stuff into a cohesive strategy.

Walter Storholt:                I love it. I think just to put a bow on that before we move onto  the next tax strategy here is that this is an audio medium, so for somebody listening to today’s show if there are things that you’re like, “Ooh, I don’t get that,” or “That was  hard to understand,” I don’t think it’s because you fall in the category, Kevin, of advisors who try to make things sound complicated so that people don’t understand it and say, “Just do it for me.” You seem to attract a lot of response and feedback from folks who appreciate the depth at which you tackle some of these things, and the fact that you’re helping educate people along the way.

Walter Storholt:                If on the podcast every once in a while, you lose a step as I do, it’s fine. But, in the office, I’m going to imagine that it’s a lot easier for you with visuals and showing people on paper. When you’re, specifically, talking about their situation, not a hypothetical, it sinks in a lot easier when folks are face-to-face with you, or at least going through their own particular situation, if I had to venture a guess.

Kevin Kroskey:                  My goal when I go over something like this with a client is they come away with it being crystal clear and seeming to be easy. If that’s the case, that will tell me that I’ve done a great job simplifying it and giving them what they need to know to make a smart, informed decision to help themselves. Meanwhile, there could be a ton of complexity belying it. It’s like teaching or writing. You could write something in 2000 words, but if you had to write only in two paragraphs to be succinct and clear, it is much more difficult.

Kevin Kroskey:                  I think over time, the more experience you have and the more wisdom you have allows you to get the crux of what matters. I want clients to feel like, “Hey, this is pretty simple. It’s clear. This is the decision we’re going to make.” For this case that I was talking about, there’s another advisor that I was working with and helping on this.

Kevin Kroskey:                  We worked on this one, and this was one where, frankly, there was a lot of spreadsheets, custom spreadsheet, in here because the answer wasn’t clear. Any of the software that’s out there can’t  do this stuff, and you have to know it and know how to work it and synthesize it and, most importantly, work around the client’s cash flow constraints. They want to live the life that they want to live, and we have to figure out, “Well, what’s the smartest way to get them the money in light of all these competing objectives?”

Kevin Kroskey:                  In this case, there was a lot of complexity. Sometimes after you’ve been doing this a while, I can look at something and solved this problem ten times before, and I know the answer. You can just tell somebody off the cuff, “Here’s what it’s going to be.” They may still need to see it. I can do the numbers, but this is what it’s going to end up at.

Kevin Kroskey:                  These cases, however, had unique attributes. Yes, they needed money for retirement, which is common but deriving the money tax-efficiently was complex — they had NUA; they were retiring in their 50s and had the ability to convert IRA money to Roth at a low tax rate; bridging the healthcare gap to age 65 and Medicare, and the healthcare tax credit. Integrating these and prioritizing strategies was complex.

Kevin Kroskey:                  The other thing I’ll mention here. I’ll  go off on a tangent and go outside of Jim and Sue. I mentioned Roth conversions .. at least I think I did. He also has his Progressive stock that he takes out through the NUA, and he’s got this capital gain whenever he sells it out of his individual taxable account. Well, again, if he does that and he’s in this 12% tax bracket, what happens for those capital gains are that they’re taxed at a 0% rate Federally. We have to pay a little bit of state income tax here in Ohio on it, but 0% Federal.

Kevin Kroskey:                  So, what we talked about last time in terms of the bracket management was, “Hey, you want to be mindful about these jumps. You go from 10 to 12, not a big deal there in terms of the tax rate jump. You go from 12 to 22, much bigger jump. You go from say 0% capital gains, long-term capital gains rate, to 15, that’s an even bigger jump,  going from 0 to 15. So that’s a jump. Or, you look at the Roth conversation and say, “Hey, I can pay 12% today but, as in the case of Jim and Sue, when they get in their 70s, and they have to take out these required distributions, they’re probably going to paying 25 or 28%, and if the alternative minimum tax comes back maybe even a little bit more. The differential there is, is it 12 versus 25?

Kevin Kroskey:                  So, they have all these tools in their Tool Belt, and we as advisors have to go through this and figure out, “Well, again, here’s how much money they need.” That’s  rule number one, meet the cashflows. Have that retirement paycheck set up. Do that Tax-Smart Distribution Plan. We have all these other strategies that we then have to work through and say, “Well, okay, do we want to go ahead and realize gains at 0%?” Let’s take the tax credit off the table for a minute and say, “Well, or do I want to do a Roth conversion?” Well, look the rate between 12 and 25, the current rate for what you would pay on a Roth conversion for Jim and Sue versus what they’re probably going to pay in their 70s, 12 versus 25 is a 13% tax rate differential.

Kevin Kroskey:                  If I go to the long-term capital gains and say that he sells some of that Progressive stock, he could pay 0%, or he could pay 15% later, so it’s a 15% rate differential. Walter, you’re going to get back on the softball wagon here. What would you rather pay, or what would you rather save, I should say, at a 15% rate or at a 12% rate?

Walter Storholt:                The 15. You’re trying to flip it around on me there.

Kevin Kroskey:                  Yeah. You’re good. So, for Jim and Sue, the money that they have in their taxable account, again the stuff that capital gains, unrealized capital gains, they could go ahead and realize it. Let’s take the tax credit out of the equation and just say, “Look, hey, we can go ahead and live on some of this. We can pay a 0% rate now. We can go ahead and save potentially a 15% rate later if we’re going to use it for spending.” That 15% difference looks pretty attractive. We say, “Let’s go ahead and do that.” However, let’s say that Jim and Sue aren’t going to use that money. In fact, I would argue that they’re probably not going to need to. Again, $100,000 in retirement income from pensions and Social Security, have the required distributions that are going to come out down the road when they get in their 70s, they’re probably going to have more income than what they know to do with.

Kevin Kroskey:                  In a case like that when this money that’s in this taxable account is going to be either left on, more likely than not, for their kids, may be used to donate appreciated securities to their charity, their church, something that they support and can get a charitable donation for, I would say that “Hey if the money’s going to be there, and we already invested it very tax-efficiently, so there’s very, very little tax drag on it, let’s just go ahead and do that.” Even though on surface that 15% difference between 0 and 15 initially looks more attractive than saying, “Hey, I’m just going to go ahead and do that Roth conversion and save at 13% tax rate,” I would just go ahead for Jim and Sue because that taxable money is going to be left on I would go ahead and prioritize a Roth conversion (at the lower tax rate differential).

Kevin Kroskey:                  Where the reverse would be, maybe there’s not as much money in that taxable account. Maybe Jim and Sue don’t have the  … Maybe whoever it is, Dave and Toni, don’t have enough money, as much money as Jim and Sue do. Their required distributions aren’t going to be as high. They’re going to use the money for spending that’s in the taxable account, I would go ahead and prioritize that, because it’s not going to leave-alone money, it’s going to be money that they’re going to live on.

Kevin Kroskey:                  Again, I’m  talking through a few different things here, but the point being is Jim and Sue themselves had a lot of different things that they could do to save on taxes. Which one is better? Again, you have to be mindful about you got to meet their cashflows first and foremost. So, the tax rate differential matters a lot. That bracket management that we talked about last time and went into a little bit further this time matters a lot, but everybody’s a little bit different.

Kevin Kroskey:                  We started talking at the beginning of the last episode about very few financial advisors actually do tax work. Even if they do they’re talking about it, they’re just talking about the stuff, as I so eloquently put it last time, the stuff that goes into here, but they’re not doing the work. They’re not getting into the analysis of, “Well, which one’s better?” Which one am I actually going to do for this client, and why after synthesizing all the information and crafting what is  going to be a Tax-Smart Distribution Plan for them. By doing so, it means their money is going to last longer. They’re going to be able to spend more. They’re going to keep more in their pocket, leave more to their kids, you name it. All those things that come out of just controlling things that we can control. When we do that, as well, one of the things I  like is it’s going to make all of our clients less reliant on the investment returns that the market is going to give us or take away temporarily.

Kevin Kroskey:                  So, that’s what we’re getting into. My hope is that it was somewhat clearer than mud for most people and maybe something that some want to go back and listen to again. I’m quite confident it’s probably something that a lot of people have not heard before. How you actually bring this stuff all together and get beyond the surface stuff that most people commonly talk about.

Walter Storholt:                Sounds to me like Jim and Sue made out with a pretty robust and in-depth financial and tax plan that, again, I hearken back to that stat you dropped on us about only 7% of advisors are doing this true  planning out there, which is just  astounding.

Kevin Kroskey:                  I should say it’s tax work, the 7%, but if you’re not doing that part of it, maybe there’s a little bit higher portion that does some planning. I can tell you that, again, my experience I’m very well connected in the financial planning community. We’ve hired a lot of advisors over the years. The knowledge on taxes, it’s just not there.

Walter Storholt:                You’ve got anecdotal evidence to back it up, too.

Kevin Kroskey:                  Yeah, and if you start asking … If you’re working with an advisor, just start asking some of these questions. Start asking about, “Hey, how do you manage the tax brackets?” I think I shared this on a prior podcast episode, but we have a client that is helping her brother out, and she’s Power of Attorney for her brother. Unfortunately, her brother is ill and  can’t manage his finances anymore. She called his advisor and said, “Hey, we need about $25,000 for my brother’s healthcare.” The advisor responded, “Well, that’s great. He has plenty of money. Just tell me which account you want to take it out of.” Her response was, “Well, I thought that’s your job to tell me which account it’s best to take it out of?” Sadly, that was something that they didn’t help with.

Kevin Kroskey:                  Again, it  just gets back to, “Hey, what makes the most sense for the client?” We have to figure this stuff out. They’re coming to us for guidance. We’re in the position to help them rather than just point the finger and try to tell them to go to their CPA or tax advisor and then, oh, by the way, there’s a catch 22 there because most CPAs tend to work with big business owners and don’t do individual income tax planning. So, a lot of people are left to their own devices. Even if they think there’s something that they could do, they can’t  get the help to get it done. That’s why we  developed this expertise over the last 10 years or so.

Walter Storholt:                Well, the expertise was on display in today’s episode, and I did enjoy the walkthrough that you gave the theoretical Jim and Sue in this case. Of course, a couple of details changed in here to protect the innocent whenever we go over client details and stories and those kinds of things. Amazing to see the level of depth that is required sometimes for a true financial plan to get put in place. If nothing else, that’s a great takeaway on today’s show, just to realize that there are lots of opportunities out there but you’ve got to know where to look, how to implement them and then  that extra nuance on today’s show, how to prioritize the different strategies. Just because you can do something, as you illustrated multiple times, doesn’t mean you should when you look at the larger picture. That will be something that I certainly take with me on today’s show.

Kevin Kroskey:                  Hey, Walter-

Walter Storholt:                Go ahead.

Kevin Kroskey:                  One of the things I would mention is, and you mentioned this already, but sometimes it’s better to read this stuff and digest it. I have a report that I wrote. It’s called Plan For a Tax-Smart Retirement. It’s about a 20-minute read, but it talks through a lot of these things that we went through today verbally. I think only the teaching community, or the learning community, would say that I think only about 7% of the population are auditory learners. Many more learn by reading. Some are kinesthetic. A lot are actually kinesthetic, learn by doing. If anybody wants to read, just go ahead and go to our website. If you click on the Contact Us page, put in the note that you would like the report for a Tax-Smart Retirement, and we’ll be sure to get that out to you.

Walter Storholt:                Again, we’ll put a link in the description of today’s show, as well. It’s truewelthdesign.com. Click the contact us button. We’ll also put a link in the description of today’s episode, so if you’re listening on Apple Podcasts, or Google, or Spotify, or something like that, just look in the show description. You can click on the link right there. That will take you to the page where you can make that request if you want to get that helpful guide. Good read it sounds like to get some more details on the things we talked about today. You can also call the team at True Wealth Design at any point in time, 855-twd-plan. That’s 855-893-7526.

Walter Storholt:                Something else, by the way, I talk a lot about, Kevin, and your team serving northeast Ohio and that you have offices in Akron and Canfield. I think it would be good to mention, too, we get a lot of listeners who are from outside the northeast Ohio area, and you’ve got clients that are all over the country, as well. So, if you  want to engage with Kevin and his team but you don’t live in northeast Ohio, Kevin, I’m right that people can still reach out and talk to you about working together and getting some help with their plans?

Kevin Kroskey:                  You got it. If you are a snowbird or thinking of becoming a snowbird and maybe having a second home in a low or no-tax state, oh my gosh, we got even more tools in the tool belt to do some planning.

Walter Storholt:                There you go, and some personal experience from us spending some time down in Florida, right?

Kevin Kroskey:                  You got it. As I see white stuff out the window right now, we’ll be looking forward to make the great migration here after Christmas.

Walter Storholt:                You’re ready to jettison right now, I can feel it. That’s too funny. That will get you away from all the sickness, too, right, get you to a warmer climate without everybody hacking and coughing. Not bad at all.

Kevin Kroskey:                  Fingers crossed.

Walter Storholt:                Fingers crossed. Again, truewealthdesign.com, you place to go on the site if you want to get in touch that way, truewealthdesign.com. Well, Kevin, that is our final episode of 2019. It was a great year.  I enjoyed doing the show with you, and I’m looking forward to what 2020 will have in store for us, as well.

Kevin Kroskey:                  Likewise, Walter. You’re a great cohost. I very much appreciate it, and I look forward to 2020.

Walter Storholt:                We’ll see you in the new year. Thanks for joining us, everybody, for Kevin Kroskey. I’m Walter Storholt. This is Retire Smarter.

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