For some people, deciding whether to work with a financial adviser can be a process fraught with uncertainty. Do you ever wonder if working with an adviser is “worth it,” or whether you could do the job better yourself?
The “value of advice” is a frequent topic at financial conferences, and it’s been the subject of industry blogs for many years. If you were to search “the value of financial advice,” you’d see that Google lists nearly 11 million results – but we still haven’t convinced everybody!
Admittedly, the financial advice industry often has a difficult time articulating its value to clients. In part, that’s because it’s difficult to be specific when every person’s financial situation is different. Also, “value” itself is relative. What’s valuable to you may be different than somebody else.
In this blog, I’d like to show you specifically how an adviser can add value to the lives of clients. While the names and identifying details in this case study have been changed, this situation comes directly from our AMDG Financial files. This is an example of how we were able to help a couple manage a large expense without depleting their retirement income sources.
Meet the Swansons
Roberta and Frank Swanson* are active 65-year olds who recently purchased their dream retirement home – a fixer-upper on a quiet lake, close to their children and grandchildren. With Frank already on Social Security and Roberta approaching her full retirement age of 66, the couple needed a strategy to help them afford a $30,000 repair while minimizing the impact on their future retirement income.
Frank began collecting Social Security at age 62, but with her 66th birthday approaching, Roberta needed to decide whether to begin collecting Social Security this year. Her full benefit at age 66 would be $1,609 per month, but if she were to wait until age 70, her benefit would increase to $2,335 per month.
Roberta and Frank have traditional IRAs. Frank’s account has assets of approximately $450,000, while Roberta’s account totals approximately $160,000. In addition, each has a Roth IRA with a balance of about $15,000, and the couple has a family trust amounting to $35,000, with unrealized taxable gains.
To supplement his Social Security, Frank began drawing retirement income from his traditional IRA account. The couple had unused accumulated investment losses of $9,000 at the end of last year.
Questions from the Swansons
- Social Security: Should Roberta begin collecting her full Social Security benefit this year, or wait until age 70?
- Traditional IRAs: Should Frank increase the distribution from his traditional IRA account, or should Roberta begin to tap her traditional IRA? Should they cash out Roberta’s IRA and take a lump sum to repair their new home?
- Roth IRAs: Should both Roberta and Frank cash in their Roth IRA accounts to pay for the repair?
- Family Trust: Should Roberta and Frank cash in their trust to pay for the repair in its entirety?
- Delay Repair: Should Roberta begin collecting her full Social Security benefit this year and postpone the repair until the couple has saved enough to pay for it?
AMDG Financial’s Recommendations
The Swansons had many options but needed a tax planning strategy to help them make the ideal choice. After a holistic review of Roberta and Frank’s financial situation, we presented a solution that would enable them not only to make the costly repair, but also to maintain their lifestyle in retirement.
If Roberta took her full Social Security benefit at her 66th birthday, 85 percent of the couple’s total combined benefit would be taxable, pushing their total taxable income into the 22-percent bracket. That would mean additional Federal taxes this year, and every year thereafter! To keep the taxable portion of the couple’s Social Security benefit lower (as well as their overall tax burden), we recommended that Roberta consider waiting and file at age 70 and augment the cash flow need from elsewhere. With this strategy, the Swansons would have fewer dollars taxed in the higher tax bracket this year – when they need to make the repair. Then, over the next four years, until Roberta turns 70, the Swanson’s could stay in a lower bracket without having to change their lifestyle.
Taking a lump sum from either of the traditional IRA accounts would increase both the taxable portion of the Swansons’ Social Security income, as well as their overall taxable income. In this scenario, the Swansons would face a steep increase in federal tax over the prior year. We advised the Swansons to keep their Roth IRA accounts intact – these are great, non-taxable assets that become even more valuable if they can pass them on to their children. These accounts should be liquidated last, and only if necessary.
Use the Family Trust and Largest IRA to Pay for Repairs:
Ultimately, we recommended that the Swansons liquidate enough from their family trust account to use up their $9,000 capital loss carry-forward (which totaled approximately $20,000). This distribution from the family trust is completely sheltered from tax and a perfect option to help the Swansons save money. In addition, we suggested taking the remaining $10,000 needed for repairs from the couple’s largest traditional IRA account (Frank’s). By doing so, the Swansons could reduce the future tax impact of taking required minimum distributions starting at age 70½.
To keep the Swansons in a lower tax bracket, we proposed that Frank continue to take increased IRA distributions of through age 70. Doing so would save the couple additional tax dollars later, when Frank must take required minimum distributions. While it’s common to postpone taxes for as long as possible, in this case, larger required minimum distributions later would be added to income, causing a larger portion of the couple’s Social Security to be taxable. (This would be in addition to Roberta switching her Social Security from the lower restricted spousal claim to her higher monthly benefit.)
Lower Taxes, Higher Income Opportunity
Our recommendations meant a slight current-year federal tax increase (much less than the Swansons would have paid under the lump sum IRA distribution scenario), plus only a slight additional amount for each of the next two years. By preserving the ability for Roberta to claim Social Security benefits for herself at age 70, she will receive an extra $726 per month, more than her full retirement benefit at age 66, for the rest of her life and this larger amount will include a larger adjustment for inflation.
These days, the Swansons are enjoying their new retirement home and the lifestyle they always wanted. With careful planning, they were able to make their $30,000 repair while lowering their tax burden and maximizing their future income. Investors value returns in a portfolio, but integrating strategic tax planning, financial planning and investment strategy minimizes tax burdens that an investor would otherwise experience, further stretching those retirement dollars. It is not always about how much you earn on your investments, it is how much you receive from cash flow over the long term and how much you keep after the burden of taxes.
A lot has changed since I first started working with the Swansons, including some Social Security rules and the implementation of the Tax Cuts and Jobs Act (click on the link above to watch our recorded webinar!) What hasn’t changed is the value we are able to create for our clients through prudent planning. If you’d like to explore the idea of working together, I invite you to schedule a complimentary, no-obligation appointment with AMDG Financial. We’d welcome the opportunity to show you our value.
*Names changed to protect privacy