Welcome to Pension Attention, the best show for first responders who want to take control of their finances.
After advising Los Angeles city firefighters for over 12 years, financial advisor, Brad Barrett now shares how you can grow your wealth, build your legacy and enjoy a life of freedom. And now here's your host, Brad Barrett. [00:19.9]
Brad: Welcome to Pension Attention, the show for you, first responders who want more out of their deferred compensation and pension plan. My goal with this podcast is to reach you where you are at whatever stage in your career you are in to provide my nearly 15 years of experience working with both active and retired service members on their investment and retirement planning. My team of fiduciary advisors here at ONE Fire and Police are dedicated to ensuring you take control of your finances and build the life you deserve. If you want to find out more about me or my team here at ONE Fire and Police, you can go to our website at PensionAttention.com, or you can give us a call (805) 409-8150. [01:00.3]
Death and taxes, kinda morbid, right? We've all heard it, the two certainties of life. And today we're gonna be talking about taxes a little bit and some tips to minimize your taxes in retirement. And I've said this to clients before, and as a fellow, taxpayer myself, like all of us, you know, if you're paying taxes, it's, it's probably a good problem. It's still not a fun thing and it's still a problem, but it's still taxes, right? I always love the quote from my good old Ronald Reagan, “The problem is not that people are taxed too little. The problem is that government spends too much.” So, look we know we have to pay taxes. It's a part of it. So, we don't want to pay more than we have to. And it all starts with a thorough understanding of the basics of how retirement income is taxed and we're going to go through some of the ways to help minimize that tax and retirement. So, we all know, and you've heard me say before, whether it's at a station or during our meetings, if you're a client of ours, or if you listen to some previous episodes here at Pension Attention that the sooner you begin saving for retirement, the more you will benefit from the power of compounding, right? [01:56.0]
And the sooner you prepare for the impact of taxes in retirement, the more likely we'll be able to generate more income for more years. So that's what we're going to be talking about this as it relates to our conversations around investment management taxes have to come into play when it comes to when we build this mountain that I keep speaking about, right? And as we come down the mountain, right, we want to make sure we do it, what I call effective and efficiently. And a large part of that conversation is taxes. According to the nationwide retirement institutes, tax efficient retirement income study, more than a third of current retirees, 35% did not consider how taxes would affect their retirement income when planning for their retirement. And many of those express regrets and roughly one third, which they had better prepared for paying taxes in retirement. And roughly one fourth, believe they've paid several thousand more than they expected. Now it should be noted here that ONE Fire and Police and ONE Capital Management, we are not a tax advisory shop by any means. But as a financial advisor, when it comes to discussing the holistic plan, we have to know enough about the tax code, know how it impacts your investment returns and your overall planning. And so, we want to make sure we incorporate that in our discussions. [03:06.9]
And if you're listening to this right now, and you're not working with us currently, or you're working with another advisor, make sure that tax conversations and tax planning is involved in your overall retirement plan because it's very important. And it has a lot of impact when it comes to your retirement income. Now, what are the ground rules to, to minimize taxes in retirement and to generate really more retirement income, it's important to know the tax treatment of your different income sources in retirement, right? It's like the old surfing analogy. Know before you go, right. You know, when in doubt don't go out. So, make sure let's, let's remove that doubt and truly understand how this works and, and how those sources interact will help determine the right sequence for drawing down accounts. You should also keep in mind those of you that are either retiring right now after the last year of 2020, or looking to 2021, that how the secure act may or may not have changed, which took effect on January 01 of 2020, it's changed some of the rules around qualified retirement accounts, including contributions and withdrawals. So again, these are some of the specifics that you'll get into when you talk with your advisor, or again, if you are looking for an advisor, you want to use some help, you can give us a call (805) 409-8150. You can also go to our website at PensionAttention.com [04:12.7]
And to finish up with the ground rules here a little bit, remember taxes, aren't static. They could go up or down in the years ahead. I mean, as the retirement safety net remained under threat, while the country's deficit continues to grow something, we talk about, it's a good idea to be prepared for rising taxes, potentially, and to think in terms of tax efficient, retirement planning. Now that isn't to say that it's a foregone conclusion, that just because of our current economic situation, that we're going to have taxes increasing, but it's a logical discussion to have. And something that pertained to your overall retirement plan, especially with, with regards to your investment management and then the ultimate distribution of your income to either supplement your pension or to take a trip for example, or maybe it's even just a small draw each month to sustain your lifestyle. So, if you're listening to this and whether you are already retired or are still in the planning process, so to speak, here are four tips, okay to ensure that you don't end up paying higher taxes in retirement. [05:06.6]
All right, tip number one, know the benefits of tax diversification. What do I mean by that? Tax diversification is important to control how much we pay in taxes, right and when those taxes are paid. So, in the same way that you diversify investments say across different asset classes, you can also diversify across different types of taxation. This also gives you flexibility, should tax laws change, right? Tax diversification starts by knowing I would say the differences between tax deferred, tax-free and taxable accounts. So, we'll start with the first one. This is the big daddy for all of us listening here, because this is basically your deferred comp plan, right. Tax deferred vehicles, tax deferred vehicles allow you to delay paying taxes on investment gains and potentially accumulate more over time through tax deferred, compounded growth. So, some tax deferred vehicles allow you to contribute pre-tax dollars, which reduces your current tax bill to keep more of what you earn. Your withdrawals on retirement will be taxed at ordinary income tax rates with that. But in many cases, your income and tax rate in retirement will be lower. Something we talk about with our clients as it relates to your pension, pension being lower than base and sod. So, we'll go through those kinds of conversations and where the tax code is around that. [06:12.7]
And so, it's really good to understand that tax divert vehicles allow for that tax deferred growth, which is something we utilize in our deferred compensation strategy around building a portfolio for our clients. Tax-free vehicles are funded with after tax dollars, right? So, you will pay taxes when you contribute, but your investment will benefit from years of tax-free compound growth and withdrawals and retirement are also tax-free. This is a category in and of itself that is very custom and specific to each one situation. So, this is something to bring up and that can be in the form of insurance, cash value, potentially, and items like that, so that's a good topic to bring up is that mid-range bucket planning sometimes I call it for clients. And it's a good additive potentially to tax deferred vehicles in this last account we'll talk about when it comes to taxable accounts. So, on that when it comes to taxable accounts, right, these include brokerage accounts or after-tax accounts, whether it's a trust, an individual account, maybe a joint account. If you sell your investments inside of a taxable account, you'll pay taxes on the gains, which I think everyone probably understands that concept and if you don't, that's where advisors come in to help with right. [07:13.0]
Now, basically investments held for less than a year will typically be taxed at a higher rate for short-term capital gains while investments held for more than a year, 12 months will be taxed at a lower rate for long-term capital gains. You may also incur taxable income on certain types of investments like dividends or distributions inside of funds if you're using those, which, which we want to talk about, even if the asset is not sold. So other assets may be tax exempt, such as municipal bonds, for example, inside of those vehicles. So, given where everything's at right now, as well with the tax code and some of the, the, the change in regime so, to say, obviously it's something that we, as advisors are, are monitoring and we want to talk about with our clients. That's what we have, it's good to have not only diversification and a good healthy mix within our own investments, but also within our tax planning strategies as I mentioned at the top of the episode. [07:58.8]
All right, tip number two, understanding your asset location. So not all investments have the same tax impact, right as I mentioned before, so some are more tax efficient than others, depending on whether they are taxed at lower long-term capital gains rates or higher rates for short term capital gains and ordinary income. Asset location is a proven strategy to help minimize the impact of taxes and help you potentially increase returns without increasing risk. The tax savings can be substantial, especially, you know, if you're in a higher tax bracket, so to speak, right? This is something that I bring up with my clients in particular here at ONE Fire and Police. And if you haven't heard this before, I think it's a really good strategy and it's a good concept to understand is, it's not always what you own, but how you own it. I want to repeat that. It's not always what you own, but how you own it, right? [08:42.5]
So, owning a security, like a stock or even a fund or an ETF or an investment in general in say a taxable account, right will be treated in, it might be a little bit of a different return versus say, owning it in a tax deferred vehicle, like an IRA or your deferred comp plan. So again, understanding what you own and how you own it are really important topics when it comes to building your overall plan. And to tip number two that I mentioned, you know, what should go in a taxable account? You know, ETFs are, or funds are buy and hold type stocks and tax exempt, municipal bonds, those are good for taxable accounts. Now what should go on a tax free account? You want to locate tax inefficient investments, such as say, a fixed income or a REIT, or even commodities, if you're looking at that right liquid alternatives or other actively managed strategies, right? In a tax deferred or tax-free accounts, which is, which helps preserve the gains without the drag of taxes. Again, this is specific situations that are really important as it comes to what to invest in and then these are just the broad range of things I'm mentioning here. Not necessarily we hear ONE Fire and Police utilize each one of those, because again, those are utilized. [09:49.0]
Any investment strategy should be, should encompass the entirety of the plan, which really encompasses the person you, you and your wife, you and your family, and what the risk tolerance is, your goals and objectives are. So, although I mentioning all the different types of investments, right, what I really want to focus on is a tax efficient investment would go on something like a taxable account because we're, we want to be mindful of taxes throughout the year. And you can look at somewhat more tax inefficient investments that may generate some, some returns or dividends and things like that that would go in a tax-free account or tax deferred account. [10:20.4]
Do you know how much you should be contributing to your deferred compensation plan? Are you getting the most out of your current investment options? Looking at entering or about to exit the drop program? go to www.pensionattention.com to find out how we can help. [10:37.7]
Tip number three, I want to bring up, this is something I probably talk about the most with when at stations or with our clients, or with perspectives is really knowing the differences between retirement savings accounts. And there are a range of different retirement savings accounts and qualified plans, retirement plans, basically that provide tax advantages for long-term, but savers, right? And they vary in several ways, including contribution limits and the tax treatment of contributions and withdrawals. I mean, the secure act now allows you to make contributions to these accounts after age 70 to half. So there've been a lot of changes even on those things that we keep up on, you know, as long as you meet certain requirements. And in certain cases, you need to consider the impact of RMDs required minimum distributions, something we're going to talk about next. [11:21.9]
I would say the two most popular tax advantaged accounts, or I guess, so to speak the differences between types of retirement savings account would be tax deferred or traditional deferred comp or traditional IRA and Roth deferred comp or Roth IRA, essentially the basics here. And again, I want to go rudimentary because it's sometimes it's we overlook these right. A tax deferred 457 plan or a tax deferred deferred comp plan, which many of you are in, right? You contribute pre-tax dollars. Okay. And eventually your withdrawals will be taxed, ordinary income. Okay. So, you can invest and that's where the limits come in, right? The limits for 2020 and into 2021, which haven't changed right are 19,500, for those of us that are under the age of 50. Okay. And there is a 6,500 catch-up contribution if we're over 50, right? So those are the, the maximum contribution limits. And by the way, those limits apply to both traditional deferred comp plan and Roth deferred comp. And sometimes you get the question, you know, can I do 19,500 in my traditional and 19,500 in my Roth? The answer's no, right. It's encompassing. It's all in. You either choose one or the other, or you can do a percentage of each, right. You can do 50 50, but the entirety of the maximum contribution limit, can't go above 19,500 if you're under 50 or 26,000, if you're over 50. [12:42.0]
Now, when it comes to Roth on the contribution limits, they're the same. Okay, like I just mentioned. But if you fund a Roth with after-tax dollars, so you're not getting that tax deduction for it, your withdrawals are tax-free right and penalty free, as long as you've had the account for more than five years, or at least 59 and a half. Now, one big point here when it comes to deferred comp plan, right. And something we'll talk about on a more specific basis is there are first responder rules that differ than other retirees. If you separate from service right after the age of 50, and it's still in the veil of the deferred comp plan, something we'll talk about with our clients, you actually can avoid the early withdrawal penalty. This is right where you talk with your CPA to make sure that, you know, go through everything. And we'll talk about that as well, but there is that rule that applies to all first responders. [13:27.9]
So, if you contribute to a traditional deferred comp plan, right, it goes in tax deferred against subject each one are taxes, but tax deferred and then it'll come out taxable and Roth, the inverse, right? You'll put it in after tax and it'll come out Tax-Free. Now right here, there is no one size fits all. This is probably the largest conversation I'll have when it comes to, should I contribute to traditional deferred comp plan or Roth? And the reality is it has a lot to do with your concept. I sometimes prescribe to the notion of the eye of the beholder. Would you rather work with the taxes, you know, now, or plan for something later, or if you're inverted and say, Hey, I might be in a higher tax bracket, or I truly believe back to the top of the episode as I mentioned, we might be in a higher tax bracket. I really believe that's the case and therefore I'd rather pay taxes now and just suck it up now and I'll, you know, not pay taxes later. And again, it's not a one size fits all. This is where custom planning comes in. So, if you haven't already done so, or you currently have an advisor it's really important to involve your tax planning conversations within your investment management, your deferred comp plan, your drop and your overall retirement planning, because it's important. [14:36.3]
Now, as I was touching on deferred comp plan, there are a lot of my clients that come in within for sponsors that either have individual retirement accounts or IRAs. And by the way, the same types of IRAs exists within the deferred comp plan as IRAs. You can do a traditional or Roth. Now the contribution limits are different between IRAs and your deferred comp plan, but the types of vehicles right back to the, the third tip, which is knowing the differences between your retirement savings account and for our fourth and final tip on how to minimize and maybe reduce taxes, or really just plan for your taxes in retirement is understanding your required minimum distributions or otherwise known as RMDs. Yes, at some point, Uncle Sam will come calling and will, if you have monies in a deferred arena, whether that's a 457 plan, like your deferred comp plan eventually drop or an IRA or things like that, there are required minimum distributions that will need to begin taking every year after you reach a certain age. [15:36.5]
Now last year, the Secure Act, if you turn 70 and a half in 2020, or later, you can now take your first RMD by April 1st of the year after you reached 72. Now it's worth noting here that 70, 70, and half 72 of these agents I'm throwing around may seem far off. And I just want you to know, and anything that required minimum distributions are around something that we advise on for our clients. So, we help you take care of that. So, it's, it's one of those things that's just really important to know about that will come down the pike for us, as we, as we get into retirement, by that point, it's probably, you know, 15, 10 or 15 years into retirement at that point, but it's something we want to go through because it does have an impact. And RMDs can be complex. And although I don't want to sound like that, it's something that we help our clients with. So again, if you're working with an advisor, make sure you have this conversation with and make sure that they're on it, because it may seem like it's 10 or 15 years now, or if you're 30 or 40, it may seem like it's 30 years from now, but it will come around. And it's important to make sure that's involved in your overall tax planning, because, you know, you don't want to, you don't want it to lead to an unpleasant surprise, you know, when they're not handled correctly, such as a spike in taxable income, maybe even a higher tax bracket pulling that out. Right. [16:42.4]
So, we should also keep in mind that there is a 50% penalty you'll pay they on any portion of required minimum distributions that you don't withdraw by the deadline. So that's why we make sure for our clients that we, we take care of that. So again, it's a full compassing thing, and that's why having an advisor along the way to help you is really important, I think. So, knowing the benefits of tax diversification, as I mentioned, understanding the asset location, right? The type of investments that would go into the type of retirement account, knowing the differences between your retirement savings account and just keeping an eye on that required minimum distribution that will eventually come down are all really good tips to help minimize and should be involved in your overall retirement plan as a planning feature. Because it is important and it's important to make sure that the taxes, the tax conversation, whether it’s from, should I contribute to traditional or, or, you know, tax deferred or even into the investments on what we're owning and how you're owning it back to my concept there, because we talk a lot clients about the types of investments and those kinds of things that we help manage for our clients at the same time, too. It's also good to know how we own those, right? Whether it's in a Roth or whether it's in a traditional, that can be key. [17:50.3]
And to squeezing out the most juice you can with, from the return you're getting and making sure that taxes don't eat away at those returns. Look like I mentioned, when it comes to having a wealth management plan or a financial plan in place, there really is no better time than now to get started on that plan. And there's no better time to have that plan also involve tax efficient retirement income discussions. So, you want to start with the plan, incorporating a variety of solutions to grow and protect your investments, right? But knowing the tax treatment of your different income sources in retirement and understanding how those sources will interact when making withdrawals is really your next step, and really should be the next step in the planning conversation. I'll say this and almost 15 years of doing this, those who prioritize their tax diversification up with getting their plan in place, making sure that the deferred comp plan is being invested to their liking, we'll be in a better position than those who don't. [18:44.3]
I mean, there are many other decisions from choosing the right sequence of withdrawals to managing RMDs eventually, and maybe even Roth conversion, something we'll talk about as well. I mean, they'll, these will all help you minimize taxes and generate more income in retirement, potentially by making sure that taxes don't eat away at the returns. You know, I've said this before, and I've had an episode on this of why a financial advisor is important, but an advisor in a conversation just like this one, a tax conversation, right. Even though they're not a tax advisor, they can help manage the complexities, you know, as market conditions and tax laws continue to change. Now it's good to have a team approach so making sure that that plan comes in coordination with your actual CPA or your tax repairs plan is important. So, making sure you build this team and those of you listening to this say all, you know, I'm only 30, I'm only 35, I’m only 50 or whatever the age is, but I only have a certain amount in my deferred comp plan. I mean, these guys don't want to talk to me or, you know, I'm not, I don't, I don't need that team approach, Brad. I promise you; you do. And the one reason why I've been doing this for so long first responders, because I grew up in a first spawner family, I want you to know that you deserve this just as much as maybe some executive in a fortune 500 company, you and deserve it more in fact. [19:53.1]
So that's why I've built my career around making sure that the concepts that we talk about with say our executives, right at fortune 500 companies, you also have those same strategies building that team, having the advisor, be the quarterback, so to speak your team owner, you know, your head coach, right? And we're making sure we find the players out there on the field, whether it's a CPA or an insurance agent or something like that, to fill the gaps of the plays that we want to run to build this overall retirement plan that you should be putting in place. [20:19.5]
Before acting on anything discussed today, remember speak with your financial advisor or your tax advisor near you about your specific situation, or if you'd like our help on the financial advising side and help you coordinate that team. As I was mentioning, give us a call (805) 409-8150. You can also go to our website at PensionAttention.com. Thanks for listening to Pension Attention. Next week, we're going to be talking about estate planning basics. We talked about that team approach about having that advisor with you to help build the investment management and retirement planning and we touched on some of the tax efficiency conversations we should have and bring in your CPA. I think next week is a great conversation for us around protecting those assets that I mentioned today a little bit, and what are some of the estate planning basics that we'll go through and coordinate that plan and that asset protection into your overall retirement plan. I'm looking forward to it, but until then stay safe. [21:11.2]
The information in this podcast is educational and general in nature and does not take into consideration the listeners personal circumstances. Therefore, it is not intended to be a substitute for specific individualized, financial, legal, or tax advice.
To determine which strategies or investments may be suitable for you consult the appropriate qualified professional prior to making a final decision. [21:34.6]
