Part 2 – I’m 62 With $1.5 Million – Let’s Take A Look At My Tax Plan

Troy Sharpe: You’re 62 years old with $1.5 million saved. The questions are, when should you take Social Security? How much should you spend in retirement? How should you invest your portfolio? Now, we went through various planning scenarios in last week’s video. We focused on sequence of returns risk, which is if the market goes down while you’re taking income, how does that impact your security? We looked at different spending levels, different investment portfolios to see, from a financial planning perspective, how they could all possibly impact your security in retirement.

If you didn’t see that video, check it out. You can click on the link right above me and watch that video, then come back here for Part 2 where we’re going to explore tax planning because that’s a whole nother layer that needs to be looked at in a proper retirement plan.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, Certified Financial Planner professional, host of the Retirement Income Show, and certified tax specialist. Today is going to be Part 2 of this video series where, as I said, we’re going to look at the tax planning aspect of a financial retirement plan. Step 3, we’re going to change the variables and look at different spending levels and how that could impact the tax plan. Then Phase 4 of this video or Part 4 of this video series, we’re going to look at how different investment portfolios, are you more in stocks, are you more in bonds, are you more in conservative or aggressive investments, how they can impact the tax plan.

Then I might even do a Part 5 just to talk about, in real life, how this all comes together. What I mean by that is Mike Tyson said this best, he said, “Everyone has a plan until they step into the ring and get punched in the face or maybe punched in the mouth,” he said. In investing in retirement, the truth of the matter is we can have the best-laid plan ever, but then the stock market punches us in the mouth, or maybe our health deteriorates or something changes, which then we have to adjust on the fly and come up with an entirely new direction. Then support that with the facts and analysis and chart a new course based on what’s happened.

Maybe we’ll do a Part 5 video on that. I will do a Part 5 video on that. Just for a brief moment, before we hop into the tax planning analysis, I want to point out that I have the CFP Board’s practice standards behind me. The CFP is the Certified Financial Planner profession, this is the board, they lay out a series of practice standards of how the financial planning profession should operate or professionals should operate. Real quick, the first two steps, understanding the client’s personal and financial circumstances. Then identifying and selecting goals.

This is the blueprint of how a financial professional should act. Now, the reason I’m putting this here is because, as we go through today’s analysis, I want to show you from theory to how a financial professional should act to how that actually applies in practice and helps you to hopefully understand how we come up with some of these solutions and some of these recommendations and how it all comes together. I do think this is an important part. As far as understanding the client’s personal financial situation, remember from Part 1 of this video, we have a 62-year-old couple, they have $1.5 million saved. This is the objective, the quantitative and qualitative data.

Out of that 1.5 million, 1.25 is in retirement accounts, 250 is outside of retirement accounts. They have a life expectancy of age 90, both of them, and they are fairly conservative investors, moderate on the spectrum. All the projections we’re looking at here today is right around about a 6% after all fees net rate of return. Now, of course, if we have different rates of return, the accounts grow to different values, and the analysis is a bit different. We’re going to tackle that in Part 4 of this series, but today, we’re just looking at taxes. One of the things we hear often is, “I want to take my Social Security early in order to preserve the assets that I have.”

Well, what we have here is a Funding Sources schedule, and this is going to show you how inefficient this could possibly be for you. The orange line represents our spending goal with inflation adjustments over time. The dark blue is Social Security. We’re turning that on at age 62. The light blue is portfolio withdrawals. For spending a modest amount of money relative to our income base, we only pull out what we need to hit our spending goal until required minimum distributions turn on. When they turn on, we’re forced to take more out of the IRA because we haven’t taken much out sooner in the early years of retirement.

This puts us into a fairly inefficient position where we’re forced to take so much out of our retirement account and pay taxes on income that we actually don’t need. In addition to that, most people follow the conventional wisdom advice which is, “Let your IRAs defer and pull out of the non-IRA money first.” Now, for some of you, this could be the right strategy. Primarily those that are in poor health, or don’t have a long life expectancy, or don’t really care what happens to the money when they’re gone. Let the kids deal with it, or if you’re going to give it to charity, this could be a good strategy.

I just want you to understand the impact of making that decision for this particular spending level and also the client’s objective and subjective data. What we have here is a funding chart. When we build a retirement income plan for clients, one of the things that we’re looking at is which accounts are we withdrawing income from? Your non-IRAs, your IRAs? Are we doing Roth conversions? This is the conventional wisdom. This is what we’re looking at first, take Social Security early. If someone is doing that, they’re probably following the conventional wisdom advice of deferring their IRAs.

The green is John’s IRA, the blue is Julie’s IRA, and the yellow is taxable. This is your conventional wisdom, your non-qualified account, as we call it. Your taxable account. This just simply means if you have dividends or interest or capital gains, you’re paying tax as they occur, whereas the IRAs are tax-deferred instruments. One of the big premises of tax planning in retirement is we don’t want to let those accounts balloon too much because you get into a pretty difficult tax situation later. Here’s the funding chart. This is what this looks like.

As you’ll see, what happens is with Required Minimum Distribution, with this method down the road, we see a very clear spike because they’re not pulling much money out. They don’t need a ton of money, they have Social Security, They have to start taking 100, 150, it gets up to $200,000 plus in Social Security tax or in income from Required Minimum Distributions. Now, this has a domino effect. There will permanently be in what we call the IRMAA brackets which is a Medicare tax, which can increase your Medicare premiums per spouse pretty significantly. Not to mention also what we call a net investment income tax scenario, which is an additional 3.8% tax on investment income.

Of course, if we have to take these large distributions, we’re probably in a much higher tax bracket later in life as well, and that’s the inefficiency. We don’t need that income. We’re forced to take it. It tips over the domino of these different taxes that we’ll incur, and we’re 75, 80 years old. We’re just not spending this money. I’m more of a ledger-type person or spreadsheet-type person, and I have those same numbers here. This is the taxable withdrawals we see on top of Social Security. We’re not taking much out here. We’re meeting our goals, but what happens in retirement 2032, RMDs are forcing us to take all of this money out of our retirement accounts.

Most of you who have saved somewhere around $1.5 million, you think there’s no way in the world you’re probably going to end up having to distribute 100,000, 120,000, 140,000 150,000. Oftentimes what’s happening is you’re failing to extrapolate out your potential account values in the future and then multiplying by the Required Minimum Distribution percentages. This is what we have here. It’s obviously a lot of income, which as I said, puts you into these other tax categories, such as IRMAA taxes, net investment income, and plus whatever may be introduced in the future.

Both IRMAA and net investment income tax, those have not been around for decades and decades in this country, they’re relatively new taxes. Now, the good news with this strategy, we’re going to look at the tax impact today, and also the tax impact down the road, which is bad news. Total taxes here. If we see, we take Social Security, it’s 100% tax-free. That’s just because of the way that Social Security is taxed. You have $45,000 of Social Security, you pull the rest of the money from your non-IRA, you’re in the 0% tax bracket. That’s pretty cool.

For this particular person, they’re paying zero taxes for a very long time, all the way up here through 72, but then the taxes get to be $19,000, $25,000, 30, 35, 45, 50. Obviously, they continue to rise. 891,000 estimated taxes paid throughout the course of retirement. That’s a lot of taxes. For someone who is in poorer health or maybe doesn’t have longevity much past their late 70s or 80s, this could very well be the way to go. This could be the tax strategy for that person. The one caveat to mention here is just because you didn’t pay the taxes doesn’t mean someone’s going to pay the taxes.

This is your estimated before-tax account balance in this particular situation out to age 90. If we look, let’s say you think you’re only going to make it to 77, $3.3 million. Someone is still going to pay taxes on that. The money will have to be distributed from the account within 10 years of the date of death of the last surviving spouse. Someone is going to pay taxes on this, most likely it will be in the millions of dollars range, one, one and a half, I think is a pretty good guess. Taxes are going to be paid. Now, I want to compare that to the taxes paid taking Social Security at full retirement age.

Based on the last video that we watched, taking Social Security at full retirement age, for most of those scenarios, seem to be the better choice. Now, some of them are fairly close, but it seemed to be the better choice. Real quick, now I’m going to dive into it, but we see over here, this base strategy I’ve set this up to be identical to taking Social Security early.
The only difference is Social Security is turning on for both spouses at full retirement age. We see the total taxes paid, 950,000 versus 891,000, so we’re actually paying less taxes with the taking Social Security early strategy.

That’s simply because we had so many years there where everything was tax-free in the beginning. This strategy never catches up from a tax perspective. We also are estimated to end up with a bit more money with this strategy than taking Social Security at full retirement age. Now, here’s the Funding Sources table for taking Social Security at 67. We see, it’s not much improved, and you could tell from the numbers on the previous screen that the tax situation is pretty similar, the ending back situation is pretty similar. We still have a very inefficient tax plan no matter when we take Social Security.

The orange represents the spending line we see here. We are pulling more portfolio withdrawals in the beginning when we defer Social Security till 67, that makes sense. Social Security turns on. Then we have to take relatively small portfolio withdrawals until RMDs start because our Social Security benefits are higher at 67. Still inefficient though, look how much extra income that we’re taking out in these years where we don’t necessarily need that income. The rest of the information is pretty the same here. We have a tax problem. We have a ballooned IRA problem.

Just to show you the account distribution table, we’re still following conventional wisdom, as most people would if they’re following this advice. Taking from the taxable accounts first. Social Security turns on, so we have relatively small distributions coming from Julie’s IRA. Then John’s IRA and Julie’s IRA make up the rest of our Required Minimum Distributions. This is on top of our Social Security income down the road. Our required minimum distributions still have a problem here, $100,000, $150,000, $200,000 of forced distributions from your retirement account if we defer Social Security.

Now, there’s not much difference between those two strategies. No matter what you choose, if you’re not looking at the tax side of things, you’re probably making a mistake. Now that we’ve laid the foundation from a tax perspective that there’s not a huge difference long term from taking Social Security at 62 or 67, we want to actually look at what happens if we overlay a tax strategy and look at the positive impact or negative impact that that could have. I’ve done the analysis prior to this video, looking at the 22% bracket, the 24% bracket, and several others.

For this hypothetical example, given all of their objective and subjective data, the quantitative and qualitative, going to the 22% bracket made the most sense for this hypothetical example. For you, your situation I’m sure is much much different across the spectrum of the different variables that we’ve looked at in this example. For you, it could be completely different. When we look here, going up to the 22% bracket, all the variables that we’ve talked about so far, estimated taxes paid throughout the course of retirement 326,000. Ending value, 6 million versus 5 million.

We get an estimated $1 million in additional ending value, taxes paid about $600,000 less over the course of retirement. A bonus us here, for those of you who do care where your money goes, kids, grandkids, in this structure or this strategy the composition of your accounts will be a lot stronger, meaning the money will pass income tax-free to those beneficiaries in large part, versus over here, you’re just passing on a big tax infested mess. They have to take the money out over a 10 year period, and if not, get hit with a 50% penalty on top of income taxes due, whereas over here it’s all going to them tax-free.

Since taking Social Security early in the 67 or 62 example that we looked at earlier seemed to make the most sense if you’re not going to do any Roth conversions or any tax planning whatsoever because of that good 10-year period of paying zero taxes, I wanted to compare doing the conversion strategy that most optimal one up to the 22% bracket for this couple, two of the most optimal non-Roth conversion strategy so you can see a clear contrast between doing one versus the other. Here we see account balances. The blue line is the Roth conversion strategy, this is pre-tax.

Assuming we just look at our account values, not considering that if we have all that money in the IRA, and we need to take it out, we would actually pay taxes on it. We see with the Roth conversion strategy, we always have less money for the most part until down the road. Inevitably, I get comments that say, “Troy, well, what about the time value of the money that went to pay the taxes on the Roth conversion?” It’s always been calculated into these videos, most people are just looking at the wrong things. It’s calculated in the IRA balance because if we never did those Roth conversions, that money would’ve stayed in the IRA, it would’ve stayed invested.

It’s always been reflected inside the IRA account balances in the scenario where we don’t do Roth conversions. Okay, but if we compare it on an after tax basis, the crossover point or the break-even point happens in the late ’70s, meaning yes, we would have more money in the IRA, but if we actually needed to get it, we’d have to pay taxes on it. Still, here is the main issue. Required Minimum Distributions over here. We see in that take Social Security early, no conversion strategy. We have RMDs the green, very, very significant, whereas the blue very, very modest. That is the Roth conversion up to the 22% bracket.

Again, I’m a ledger or charts type person, Excel spreadsheet, so this helps me a lot more. We see this is the Roth conversion strategy where we’re actually taking Social Security at full retirement age. We’re paying taxes on the conversion, 30,000 for the first few years in taxes. Then we get into this 10,000 where we’re taking modest distributions from the IRA on top of a much higher Social Security benefit. Then once we hit 72, look, $1,500 in taxes. This is very, very manageable throughout the rest of retirement. We end up paying about 326 over the course of retirement.
We’re left with $6 million, most of that tax-free versus take Social Security early, do no conversions. We see Social Security starts early here. We’re in that really nice spot here of paying no taxes for the first 10 years of retirement, but then the taxman cometh. We see here, 38, 42 45, we get up to 50, $60,000 per year, age 85, about $60,000 a year in taxes.
Obviously, it’s a lot, and the situation doesn’t improve.

Very clearly, if we’re only going to live, we think, to 75, it probably doesn’t make sense to do Roth conversions. It doesn’t make sense to defer Social Security, but if we’re going to live to 80 to 85 or beyond, obviously we want to really be tax planning in the form of looking at Roth conversions and deferring Social Security out. Before we get into the comparison, I wanted to show you the funding source schedule, which accounts where our income is coming from with the Roth conversion at full retirement age, excuse me, Roth conversion starting immediately, but deferring Social Security until full retirement age.

I want to look at some of the numbers so you can compare to what we looked at earlier. As we see, this is a much more efficient stress structure. We have the spending goal in orange, increasing with inflation. Because of the Roth conversions, and this is part of the reason why it’s optimal, it gets us into a situation where we maintain as much money in our accounts, earning interest inside that tax-deferred, while also looking at how much our Required Minimum Distributions will be in the future. We don’t want to be in that excess income category. Deferral is good, but too much deferral can be bad.

Just one of the factors, but this very clearly shows doing the Roth conversions up to this level for this particular couple puts us in a situation where there’s not a lot of inefficiency as far as forced distributions of and beyond the spending need later in life. Account distributions is the light blue, Social Security is the dark blue. By deferring Social Security, we have a lot of security here because most of our need is being fulfilled by a guaranteed lifetime income stream, and we only have to take relatively small distributions. The rest of our money is growing and compounding inside that tax-free Roth.

This creates a lot of efficiency, a lot less tax risk, and of course, a lot more secure income because regardless of what the market is doing, this Social Security, this guaranteed lifetime income is still being deposited. All around, a much more efficient structure in my opinion. Now I just want to show you what targeting that 22% bracket, what it looks like from a Roth conversion standpoint. Here we have 2022, we see the years on the left-hand side here, and then we see the estimated conversions amount moving forward. We do some pretty big conversions here.

Now the 22% bracket under current law changes after 2025 because that’s how the current tax code is. After 2025, under current law, the Trump tax cuts expire, and there actually will be no more 22% bracket. We see these are the Roth conversions over time. Now, here we have the tax breakdown of what the estimated tax liability would be if we follow that Roth conversion strategy as well as take Social Security at full retirement age. Simple bar chart here, bar graph, 30,000, 32,000 for the first few years, then taxes reduce, and then taxes are very very manageable moving forward.
Now I want to look at doing the Roth conversions up to the 22% bracket, which we identified as the most optimal for this particular couple. Compared to taking Social Security at full retirement age or taking Social Security early. We’ll see they’re fairly similar. If we’re targeting the 22% bracket, this is taking it early, this is taking it full retirement age. If we’re targeting that bracket, the taxes are very similar in the beginning because we’ve now taken Social Security, so we get up to that 22% bracket. We do fewer Roth conversions because if you think of the bracket as something that’s being filled it’s partially being filled with Social Security.

Then the remainder of that will be filled with the Roth conversion. Whereas if we’re not doing Social Security early, the entire bucket can be filled with Roth conversions. In the strategy where we wait, with Social Security, we’re actually able to do more Roth conversions, but we’re still targeting the same bracket, the same number as far as the adjusted gross income or the taxable income that we can have. We’re doing more conversions with this strategy, less conversions with the early Social Security. Taxes are very similar. All the way, we look at this column, very similar to the early strategy all the way here.

Where we start to diverge is right around age 72. Because we’ve done more conversions by deferring Social Security, we have fewer Required Minimum Distributions. Taxes over here are still very manageable if we take Social Security early, very manageable if we take Social Security later. The difference is, by age 80, Social Security for this couple is 58,000 a year versus 81,000 per year. That’s an additional 23,000 per year, every year in Social Security benefits, so the same concept. If we’re healthier and we have more longevity, deferring Social Security allows us to get more converted and have more security with a higher guaranteed lifetime income later in life.

Now account balance-wise, we’re at about 3.2 million pre-tax versus 3.3 million pre-tax, 3.1 million after-tax versus 3 million. These are about the same around age 70 to 80. Again, not a huge difference in regards to security if we have 3.1 million or 3 million, but the higher Social Security income does provide a lot more security. A lot of information there but this is what we go through in the financial planning process. This is why I showed you the CFP Board’s practice standards earlier because the first two steps are really gathering that information, then analyzing the situation.
We then go into analyzing alternative possible scenarios or recommendations, and then coming up with the recommendations and presenting the recommendations, and then you move into the review and monitoring stage. That is how our process is designed here at Oak Harvest Financial Group. I just wanted to introduce you to the tax planning component and how that relates to when you take Social Security. We’re going to look at Part 3 and Part 4 how much income you spend, how that changes, all of this changes if you spend more or less income, and of course, how the investment portfolio is allocated, that changes as well.

By going through those first two steps, it lays a solid foundation for us to develop the Oak Harvest Retirement Process Plan, and go through that process with you. Big takeaways from today is if we’re going to live past 80, 82, 83 almost certainly, it’s going to make sense to look at these Roth conversions to defer Social Security probably till 67 at least, and then manage it as time goes on. If something big happens in the markets or health, we make adjustments, we chart a new course. Without a tax plan, if you take Social Security at 62 or 67, there really is no difference. The main determinant should be your life expectancy.

Subscribe to the channel to stay more connected to us, which allows us to keep you more connected to your money. Hit that thumbs-up button if you like the video, and comment down below. We’d love to hear your feedback. What are you doing? What’s your opinion? We look forward to seeing you on the next video in this series.