Podcast: Mike Piper — Social Security and Tax-Efficient Retirement Planning
Episode 62 of the NewRetirement podcast is an interview with Mike Piper — a CPA, author, and creator of the Open Social Security and the Oblivious Investor websites. Steve and Mike discuss Social Security planning, Roth conversions, and retirement account distributions.
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Full Transcript of Steve Chen’s Interview with Mike Piper:
Steve: Welcome to The NewRetirement Podcast. Today, we’re going to be talking with Mike Piper, a CPA, author, and creator of the Open Social Security and the Oblivious Investor websites. He’s got expertise in Social Security planning, Roth conversions, and retirement account distributions. We’re going to be discussing these topics and lessons he’s picked up over the course of his career. Mike joins us from St. Louis, Missouri home of the iconic 630-ft Gateway Arch on the Mississippi River. And with that, Mike, welcome to our show. It’s great to have you join us.
Mike: Thanks for having me.
Steve: Yeah, I appreciate your time. You’re a popular guest I put it out in our Facebook community that you’re going to be joining us and we got a lot of questions that have kept up piling in, so I want to save time for those. But before we get started, I just was curious as we’re exiting the pandemic here and that people are getting vaccinated. There’s been a ton of writing about remote work and people moving. And I know many people even in our company are making moves to wider range of areas. And I was curious, is that affecting St. Louis? Are you seeing people move there over the course of this pandemic?
Mike: On an anecdotal level, I would say yes. I know more people who have moved here rather than moved away from here during the COVID era, but at a statistical level I couldn’t tell you the answer, honestly.
Steve: Okay. Yeah. I was just curious to get your take on it. All right. Just a little bit about you, you’ve been blogging since 2008 and I was looking at your site, you’ve written over a thousand posts. I think you had like 16 guest posts so definitely your editorial voice is coming through loud and clear. But you’ve also written several short, concise books including Investing Made Simple kind of retire question mark, Taxes Made Simple and Social Security Made Simple and you’ve got other ones as well. But what led you to start your blog and to write these books?
Mike: Yeah. The books actually came before the blog. The first one was in 2007, I was working as a tax accountant. And at the time a number of my friends and family members were self-employed, either full-time self-employed or they had side gigs. And every tax season I would get the same questions over and over and over because there’s somewhat more going on for self-employed people from a tax perspective. And so I’d just be answering these same questions every year.
Mike: And eventually I just decided you know what? I’m going to write down the answers to these questions basically just to explain the very basic tax topics for self-employed people, put it in a short book and I can just give that to them. And that was my only plan. But people ended up buying it on Amazon. And then people ended up emailing me to ask me to write books about other topics. So I did, and then it basically became my business. It was an accidental business basically.
Steve: Nice. So is that your full-time business? Have you stopped working as a CPA?
Mike: It is not entirely all I do. I do a limited amount of tax planning with clients but it’s overwhelmingly writing and research.
Steve: That’s awesome. That’s cool. So yeah, one of my questions was, is this a labor of love or is this a money making enterprise? And it sounds like it’s the latter.
Mike: It’s both. But yes, it is definitely money making, it’s my primary source of income. It started as a labor of love because it was something I was interested in and that hasn’t changed.
Steve: Right. Yeah. I remember we had Ben Carlson on the podcast and he does the Wealth of Common Sense and he said, “I started writing and I would be doing this even if I wasn’t getting paid.” So that’s what he loves to do. As you think back and you look at some of these books, what are some of the top lessons you would have for people that are approaching retirement?
Mike: Approaching retirement? I would say, first is just get a handle on your spending. It amazes me how many people are asking the question of can I retire? They’re already starting to think about doing this in the very near term future. And they don’t really have any idea how much they’re spending every year. And without that very basic piece of information, there’s no way to do it much further analysis. But yeah, all the time I see people who they know how much they earn and they know that they’ve been saving a little bit every year, so they’re spending somewhat less than that but they don’t really know.
Mike: So obviously step number one, you have to know how much you’re spending. And that should be pretty easy. You can find that information from your own records. So that would be my first suggestion is just to handle on that. Then basically it’s a multifaceted decision, right? You got to be looking at tax planning, portfolio, Social Security. And so just try not to leave anything out, I guess so, either whether you’re working with a financial professional or doing it yourself, try not to leave out one important piece of the picture because a lot of people do that. They get so focused on one piece just exactly what the portfolio should look like. And then they’re missing enormous tax planning opportunities, for instance. So try to look at the whole picture.
Steve: What are the biggest oversights that people have that you’ve seen?
Mike: Social Security comes to mind because of course that’s what I deal with often. But so many people put no thought at all into their Social Security claiming decision. As soon as they stop working, they file for Social Security. And both spouses and a married couple do that and then you end up with situations where their expected payout over the course of their lives is 50, $60,000 less than it would’ve been by doing a different strategy. And that’s not a huge amount of money as financial planning decisions go. It’s not the single most important one you’re going to make in your life, but it’s such an easy decision. There’s no work to be done, right? It’s no more difficult to file for Social Security at one age than at another age. So given how easy it is to just adjust that, that’s such a big win for such an easy change, and people miss that opportunity all the time.
Steve: Right. And once you’ve filed, there’s a few month kind of take back, but it’s no longer like-
Mike: Only 12 months.
Steve: It’s what? How long?
Mike: Yeah. It’s 12 months.
Steve: It’s 12 months?
Mike: Yeah, it’s called withdrawing your application and you have to pay back the amount that you had received so far.
Steve: Got it. Okay. So if you’ve claimed Social Security within the last 12 months and you’re not quite sure it’s right take the time to do the analysis and you can still do a redo. Got that. Got it. Yeah. I know before you used to be able to kind of do it for quite a while and then switch it around, right?
Mike: Mm-hmm (affirmative). Yeah.
Steve: I know they’ve made that more difficult to do. Okay. Any other big areas that you think people really don’t think about enough when or that you see a lot people making mistakes around preparing for retirement and as they transition into it?
Mike: Sure. Like I said tax planning is another thing that a lot of people don’t pay enough attention to. Once you’re retired, you have quite a bit more control over your level of taxable income from one year to the next, because when you’re working of course, you have your work income every year, and that’s not really going to change. You’re not going to intentionally just ask your employer to pay you less, that doesn’t make any sense. But during retirement you choose how much you take out of this account as opposed to that account. And that gives you more control so you can navigate various phase out levels for various deductions or credits. You can navigate the tax brackets, the Medicare Irmaa, all these different things that happen at different levels of income, you have more control over which ones of them you are and aren’t defected by during retirement.
Steve: Got it. Have you seen any great tools that let you manage withdrawals and work against the tax brackets and various benefit thresholds?
Mike: Yeah. My favorite as a financial professional is, Holistiplan is the name of it. And so admittedly, it’s priced for advisors. It’s priced for somebody who’s going to be doing this, not just for themselves but you upload a tax return and it immediately does an analysis on the return and shows you what your actual marginal tax rate would be. So not just your tax bracket, but your marginal tax rate, including all of the various deductions and credits and so on at various levels of income.
Mike: And it gives you a nice little chart and that’s extremely useful. But there are a lot of tools. Really the only thing I would encourage people to do is don’t try to do it yourself in a spreadsheet because when people do that, it’s so easy to forget about one particular gotcha in the tax code, this deduction or that credit. And then you miss one of those thresholds where your marginal tax rate changes. And so you accidentally end up paying more tax than you needed to.
Steve: Got it. Yeah, that’s great. Yeah. And just on our side, we are doing more and more, we give people insight into their marginal tax rates by income and we show how these things cascade together. We do Irmaa testing but I have heard about Holistiplan and what they’re doing with the uploading of returns, something we’ve thought about as well. But it’s cool. It’s great. And definitely our users they have a lot of these questions, especially the ones that have more money and they’re subject to RMDs. They’re really thinking a lot about the dynamics between future RMDs that are coming and what that’s going to mean. And should they be doing Roth conversions? We will be talking a lot about that in this podcast, but you know how to manage that stuff, but I think it’s still early innings in the technology space here.
Steve: All right, great. So let’s see. I want to kind of dive into Social Security. So the big topics going to talk to you about are Social Security, Roth conversions and then retirement account distributions and then user questions of which there are a lot. And those questions are bucket into Social Security and Roth conversions. That’s where they really came in. But let’s start with Social Security. What are the biggest things people need to keep in mind and I guess also rules of thumb as someone goes to claim Social Security?
Mike: Yeah. Rules of thumb I would say for a single person, it usually makes sense to wait, not necessarily all the way until 70, but possibly all the way until 70, and if not then usually close to 70. And that’s just because life expectancies have gone up somewhat since the system was devised and interest rates right now are very low, which makes the take the money early and invest it option not as appealing as it would be, a bunch of rates were higher. So both of those two things point in favor of waiting. So for most people waiting is advantageous.
Mike: Also, there’s the fact that in retirement the financially scary scenarios, they’re the ones where you live a long time. If you retire at 60 and then you have a heart attack a year or two later and you die, you probably didn’t run out of money, right? It’s the cases where you retire at one age and then 30, 35 years later, you’re still spending from your portfolio. Those are the financially scary scenarios. And those are the cases where delaying Social Security works out well.
Steve: Good plan.
Mike: And one more rule of thumb though, is that for a married couple it’s a more complicated analysis. And it often makes sense that for a married couple it’s usually extremely advantageous for the higher earner to wait until 70. But it often makes sense for the lower earner to file earlier.
Steve: Right. Yeah. Can you describe the strategy there? Because I know that there used to be a lot more flexibility around trying to optimize how you claim these things and get the benefits, but now it’s simpler, but I would love to hear it in your words.
Mike: Yeah. It’s simpler for most people. Basically when the higher earner waits to take benefits, it increases the amount that the couple receives as long as either of the two people is still alive, because it’s going to increase their own retirement benefit. But if the lower earner outlives the higher earner, then the lower earner’s survivor benefit will be higher as a result of the higher earner having waited to file. So that’s why it’s super advantageous for that higher earner to wait. But basically all of those things are exactly the opposite for the lower earner. So when they wait to file, it only increases the household’s benefit for the period of time that both people are still alive, which is by definition a shorter period of time, so it’s less advantageous for that person to wait. It’s less advantageous for the lower earn to wait for benefits.
Steve: So the lower earner should file at their full retirement age or should they file as soon as they can get the benefit?
Mike: Often 62 makes sense. Sometimes waiting until full retirement age makes sense. It’s going to depend obviously on both people’s health and life expectancy, the better the health that you’re in and the longer your life expectancy is the more sense it makes the weight. There can be tax planning considerations as well that could point in either direction for that lower earner’s decision. But what you’ll actually find most of the time is that for that lower earner, it’s roughly actuarially neutral, which is to say that it doesn’t make a huge difference, whether they file a little bit earlier or a little bit later, it’s expected to work out about the same.
Steve: Yep. Can you summarize for people that don’t know Social Security as well, what the rough benefit levels are? So the earliest age you can get is 62, then there’s your full retirement age, which is 66 to 67, depending on when you’re born and then there’s the maximum age, which is 70 and you get basically varying levels of your benefit across those ages. Can you just summarize how that works for people?
Mike: Sure. The increase from one year to the next is not the same. If you file at 70, this is if we’re talking about retirement benefits as opposed to spousal benefits or survivor benefits. If you file at 70, you get about three quarters more than if you filed as early as possible at 62, basically.
Steve: So if you would’ve gotten a dollar in benefit, you’ll get a dollar 75.
Mike: Yeah. Roughly.
Steve: Right. Yeah. So that’s a pretty material difference for waiting eight years.
Steve: Yeah. What I was going to say earlier was one of our advisors at one point said, essentially waiting to get Social Security is the most efficient way of buying a lifetime annuity. It’s much more efficient than you could get going to an insurance company, just you’d be essentially buying it by waiting.
Mike: Yeah. Economically that’s exactly what’s happening. You’re giving up some money right now and you’re getting a stream of income that’s going to last for the rest of your life. So that’s a lifetime annuity and it is a better deal than you’re going to get from an insurance company. And it’s also the only inflation adjust the annuity that you can buy anymore, at least actually tied to the consumer price index. You can still buy annuities that have a fixed cost of living adjustment, but you still have inflation risk there, if inflation turns out to be really high, you can still be in trouble. So yeah, it’s the best annuity deal around.
Steve: Awesome. Yeah. One more related topic. For open Social Security, why did you take your time to create that?
Mike: At the time there hadn’t been one pretty good free Social Security calculator, but it disappeared basically and got taken offline. There are two paid ones that I think are quite good, Social Security Solution and Maximize My Social Security. But the free options were frankly not good at all so I wanted to put a free one out there. Also I was hoping that by making something that’s open source, so people can see exactly how it does the math, that it’s not a black box, right? If people are concerned about whether they agree with the assumptions being used, well, they can see what the assumptions are. And I set it up so that you can adjust the assumptions if you want to as well.
Mike: One other point that motivated me to make it was that in my opinion the mortality models that are used by other calculators aren’t very realistic. They don’t have a way to reflect joint life expectancies. They just force you to tell the calculator the age at which you’re going to die as opposed to being able to use a actual mortality table that can reflect the fact that you don’t know how long you’re going to live. There’s uncertainty there but we have good data about how likely it is that you live to age 80, 81, 82, 83 and so on. And so I wanted to make a program that can reflect that uncertainty and let you plan in the face of that uncertainty basically.
Steve: Got it. And I guess you’ll be updating the actuarial tables as time goes by.
Mike: Yep. That’s what I’ve been doing for the last few years.
Steve: Awesome. Well, thanks for doing that. We definitely looking at it and on our side we think the future, these tools should be free or low cost and also integrated, so we’re about to roll out a Social Security optimization capability inside our platform that will automatically run I think 12,000 simulations, basically every combination of ways you can claim the benefit but we’ve been definitely talking about open Social Security, so thank you for doing that.
Steve: So let’s move on to Roth conversions. Can you just describe for our audience what a Roth conversion is, how it works and why people do it?
Mike: Yeah. The general idea is that you take money from a tax deferred account, so a traditional IRA or a traditional 401(k), it’s something like that, and you move it into a Roth account. And in most cases, that money that you move over is going to be taxable income. And so the idea is that you’re paying tax now so that you don’t have to pay tax on this money later when it otherwise would’ve come out of the account. And so the general idea is that you want to do that when your tax rate right now is lower than you expect it to be later on. Basically, you’re going to say, “I’m going to pay tax right now at this low rate so that I don’t have to pay tax later at a higher rate.”
Steve: Yep. Perfect. So there’s two other topics the backdoor Roths and mega backdoor Roths.
Steve: How are those different?
Mike: Yeah. A backdoor Roth IRA is for people who earn too much to be able to contribute to a Roth IRA in the normal way. So if you earn over the applicable threshold for your filing status, you can still do what’s called a non deductible traditional IRA contribution. So you do the same dollar amount of contribution as you would do to a Roth, but it’s going into a traditional IRA, and then you immediately do a Roth conversion.
Mike: Now the key point to know, so if you have no money in a traditional IRA other than this money that you’ve just put in, then if you do the conversion immediately it’s not going to be taxable. So you get essentially a rough contribution even though you earn too much but if you already have money in a traditional IRA, right? Like if you have a 401(k) that you rolled over from a prior employer and now you’ve got a bunch of money in a traditional IRA, that’s going to get in the way of the back door Roth, because when you do those conversions they’re going to be largely taxable.
Steve: Got it. Understood. And then for the mega backdoor, How is that-
Mike: The mega backdoor is kind of a similar concept. It’s in a 401(k) plan rather than an IRA. If your employer allows you to make non Roth after tax contributions… So these are contributions that are not Roth but they’re also not deductible. If your employer allows you to make those contributions, then you can contribute quite a bit more than the normal contribution limit basically. And so you make these contributions and then the idea is that you either roll them out into a Roth IRA or if the plan allows… I’m sorry. To be able to do that, the plan has to allow for what’s called in-service distributions or the other option, some plans allow conversions within the plan. So you could convert it within the plan from this traditional 401(k) account to the Roth 401(k) account within the plan. So many people have 401(k) plans that won’t allow for that. But if you do, it’s a much higher contribution limit basically.
Steve: Do you see people with their own businesses, small companies, doing this kind of strategy because they have more control, they created their own 401(k) plan or maybe can you do this from a solo 401(k)?
Mike: Well, with a solo 401(k) it’s less of an issue often anyway, just because you can do the regular employer contribution beyond… So you’ve got the regular employee contribution but then you can do the employer or contribution on top of that anyway. So far, that’s not to say it’s not relevant to self-employed people, but for self-employed people often they have as much contribution space as they need anyway.
Steve: Got it. Yeah. I was just curious, I know that basically us tax code is pretty friendly to small business owner and there’s a number of strategies you can run.
Mike: Yeah. That’s true. The small business owners definitely have a lot more options for retirement accounts than people who work as employees do.
Steve: Okay. Are there any, since we’re on this topic, strategies that you’ve seen that work really well? For instance, is there a reason to you go, you leave your main career in your 60 or something, is there a reason to start a small company, between 60 and 65 to find ways to be even more tax efficient?
Mike: Just for tax plan? I wouldn’t necessarily encourage somebody to do it just for tax planning sake. Because, obviously there’s so much more to that decision than just taxes. If you were thinking you were retired and now you’re starting a business, well, is that just something you want to do in the first place? But yeah, definitely self-employed people have… The solo 401(k) is a fantastic retirement account. It’s better than most people have access to. So definitely if you are self-employed, that’s something you should be looking at, but obviously there’s much more to the decision of starting a business than just tax planning.
Steve: Yeah. Although I think one thing that we’re starting to see more and more of with the gig economy is that many folks as they’re at the tail end of their career, are offered the opportunity to consult back to their firm. And so they could perhaps front run that and say, “Okay, you know what? I want to retire in five years but how about I go 1099 now, create my own enterprise, set up a solo 401(k), jam up my contributions to a really high level.” Because of the solo 401(k) I think you can put away 50 or $60,000 a year pre-tax, right? So if you’re paid 150,000, you can take a third of it and just throw it into a tax deferred savings vehicle.
Mike: Yeah. It depends on your income level. So there’s the normal contribution limit the 19,500 or 26,000 if you’re age 50 and up. And then another contribution that it’s a little bit more complicated than this, but it’s roughly 20% of your self-employment income. But yes, the total contribution limit can be very high. It’s limited to I think it’s 59,000 this year, I could be wrong on that, off the top of my head. But yeah, absolutely if you are at a stage in your life where your income considerably exceeds your spending, being self-employed is the way to contribute the most to retirement accounts generally.
Steve: Right. Okay. Well, we’ll have to do a whole other podcast on exactly how these mechanics can work. I think that career path is becoming much bigger and more common route for many people. All right. Great. Just in your own practice or in your work, do you see many more people doing Roth conversions? A lot of people are talking about it, but are you seeing people actually do the U.S every year or are increased in numbers?
Mike: Yeah. I think it’s catching on, specifically the idea of Roth conversions in the early stages of retirement, because this is something that doesn’t always make sense, but it frequently does. And the word is finally starting to get out. Basically, once you retire, of course your work income has disappeared. And if you’re waiting to take Social Security, there’s this window where your work income is gone, Social Security hasn’t started yet, required minimum distributions haven’t started yet. So there’s a window of, could be a few years, could be several years where you have a lower amount of taxable income, which generally means a lower tax rate. And that often means that’s a great time to be doing Roth conversions. So I think people are finally starting to catch on but that it doesn’t make sense in every single case, but it often does.
Steve: Right. Essentially what you’re doing is you’re leveling down your marginal tax rates. So if we did the strategy we just talked about you’re in your career making $200,000 a year, you go 1099 and you start taking that as income, you try to throw a ton into qualified to bring your AGI, your adjusted gross income down, so bring your marginal tax rate down while you’re still working. If you then stop working but don’t claim Social Security in a few years of low income, you then pour the money out of these qualified accounts into Roth accounts, filling up those marginal tax brackets to whatever degree you want and getting your assets positioned in the Roth, which is super tax efficient for the rest of your life and potentially for your heirs.
Mike: Yeah, that’s exactly right. The general idea is to smooth out your marginal tax rate over time. You want to shift income out of years where your tax rate would be higher and into years where your tax rate is lower.
Steve: Great. Awesome. So last question this topic before I get to use the questions, do you think that the tax treatment for Roth will change in the future?
Mike: I don’t know. I really don’t think that tax planning based on changes that you’re predicting is a very fruitful endeavor. I just wrote an article about this for my blog. People often talk about timing the market as something that is so hard that you shouldn’t even bother to try. Trying to predict tax legislation is way harder than that because you still have to do the timing. You still have to predict when it’s going to happen, because let’s say, you’re going to assume Roth distributions are going to be taxable. Well, you have to come up with a prediction for when that change will happen. And if you get it wrong, your tax planning will be wrong.
Mike: But then there’s also, you have to get the specifics right. Because there’s a lot of different ways that that can happen. It might be only for people over a certain income level. And if you guess the income level wrong, well then again, whatever tax planning decisions you made, they’re not that beneficial. They may even be harmful. So you have to get all of the specifics right. You have to get the timing right.
Mike: And then anytime the tax legislation has passed, it’s never one little change. It’s always tons and tons of changes. It’s usually the bills and the law is normally hundreds of pages long, it changes a ton of stuff all at once. And so even if you get this one thing right, then maybe they change something else at the same time, that messes up your whole planning. So I really don’t think that it’s beneficial to try to predict what legislation we are going to see, because it is impossible to predict with the degree of accuracy that you would need in order to actually make tax planning decisions based on that.
Steve: Got it. All right. Great answer. We get this question all the time as well. What’s going to happen with the TCJA tax, is it tax cuts, are they going to get rolled back in 2026 or not? We’re operating off of what is written in law today not what may or may not change in a couple of years. Okay. Last topic before I use the questions. So retirement account distribution planning, can you summarize for folks the general rule of thumb for draw down order and then any kind of big considerations people should have when they’re thinking about this?
Mike: Yeah. Now, this is a very rough draft plan. And the rough draft plan is that your taxable accounts are usually your least tax efficient accounts because you have to pay tax every year on the earnings within the account. So it usually makes sense to be spending from those first. And then other than that, of course you have tax deferred accounts and Roth accounts. And that decision on a year to year basis, it’s how does my marginal tax rate right now compared to the marginal tax rate I expect to have in the future? And whenever your marginal tax rate right now is lower than the rate you expect to have in the future then you want to be spending from tax deferred accounts to take advantage of that low tax rate right now, and whatever your tax rate right now is higher than you expect it to be in the future then you want to spend from Roth accounts so that you can keep your taxable income this year low.
Mike: But that’s a really rough draft plan. And so it’s important to do an actual personal analysis, but also it’s important to recognize that that analysis it’s not all or nothing in one year, right? You’re not just saying this year I’m going to spend completely from Roth and this year I’m going to spend completely from tax deferred. Normally in most years you’re doing a little bit of everything often. So it’s important to recognize that it’s not all or nothing and that the analysis has to be revisited every single year because things change, tax law changes, your personal circumstances change and your account balances change.
Steve: Yep. Well, that’s the argument we’re trying to make with our planning platform is that, essentially all these things are moving around you, taxes, your wealth, your estate taxes, what’s happening with your housing, your health and everything else. How do you make these trade off decisions, and then what you want can change as well.
Mike: Yeah, exactly.
Steve: One thing that occurred to me as we were talking about the smoothing and long term tax planning and trying to make these trade offs, when you’ve worked with folks, do you see many people that they get later into retirement and they’re like, “Man, I wish I’d retired earlier because I’m ending up with this big pile of money. I actually have a lot more money than I thought, and I probably could have stopped and had more control of my time earlier in the process.”
Mike: Yes. Short answer is yes. A lot of people. That happens but there’s also another thing that has a similar result basically in retirement, unless you annuitize your whole portfolio. So assuming your portfolio is a mix of stocks and bonds, you basically have to spend at a rate that assumes you’re going to get unlucky in terms of returns, right? You have to assume that you’re not going to get great returns because if you spend on the assumption that you are going to get great returns, well, obviously that could go poorly. So you have to spend at a relatively conservative rate, but most of the time you don’t get unlucky. Most of the time you have decent returns.
Mike: And so, because they’re spending at this low rate, most people’s portfolios, if they’re taking a plan like that, they end up growing over time. And so you get well under retirement and often the amount you want to spend is declining anyway. And so your spending is going down by a little bit and your portfolio keeps going up. So that happens frequently if people have more assets later in retirement than they had expected.
Steve: Yeah. We’re having this discussion right now. We’re doing a lot of work around Money Carlo and scoring people’s plans and everyone looks at it in terms of your probability success and you’re right everyone’s like, “Oh, well I want to have a 90% chance of success.” And so, great you’re working against that, but in the 10% cases everyone thinks it’s terrible. What you’re saying is pretty insightful. They index their spending for that 10% so that in the 90% of cases where it is successful, oh, they actually had a lot more than they thought.
Mike: Yeah, exactly.
Steve: Is there a better way to reframe this for folks or hedge it? You can buy annuities that you can have visibility into what you must spend versus like to spend, any strategies you’ve seen for folks that let them feel more confident that to enjoy the money and their time when they’re younger?
Mike: Yeah. Annuitizing is the theoretically best solution for that problem, because then you can spend based on, you know how much it’s going to be. Of course the big issue or one of the big issues is that again, there aren’t inflation adjusted annuities anymore other than Social Security, so that’s one of the issues. And the other issue is that just like with any insurance product, there’s a profit margin built in for the insurance company, right? So to some extent that makes it somewhat less desirable whereas if you’re keeping your own portfolio, you’re not essentially paying that, but still annuitizing is the way to safely spend the highest amount from your portfolio.
Mike: But if you’re going to keep a regular non annuitized stock and bond portfolio, then I think the answer is to stay flexible and basically redo the analysis every year, because if you were spending at such and such level and now your portfolio has grown dramatically and you’re older so your life expectancy is shorter, then you don’t have to keep spending at that same rate, it’s okay to bump your spending up.
Steve: Right. I know Fritz over at the retirement manifesto talks a lot about also the bucket strategy and that’s kind of how he looks at it, having a lot of liquidity in the near term and gradually more risk and less liquidity farther out in time. So it’s another way to handle it.
Mike: Mm-hmm (affirmative).
Steve: Although I believe that’s a little bit less efficient, right? Mathematically than say Karsten Jeske. Karsten Jeske, who’s been on a podcast is like, “Just invest everything, keep an optimal portfolio and just draw down as you need it.”
Mike: I think it depends. One thing that I think makes a lot of sense is if there are years early in retirement where you’re going to be spending more from the portfolio, right? Because the most common cases, Social Security just hasn’t kicked in yet, I think it often makes sense to have specific, safe assets dedicated to that extra amount of spending. But other than that, so when we’re looking at the part of the portfolio that is intended to last through your whole life, it often does make sense to just invest it pretty aggressively and use a low spending rate basically.
Steve: Okay, awesome. Appreciate it. All right. So I want to dive into some of the user questions. Here we go. These are on Roth conversions, so we have Cody Garrett he’s asking, how do you approach Roth conversions between 63 and 72 while staying below the higher Medicare premium Irmaa thresholds?
Mike: Sure. The unique thing about Roth conversion analysis is that it’s conceptually exactly the same regardless of your age and regardless of your personal circumstances. The general idea is what’s my current marginal tax rate? What’s my marginal tax rate going to look like in the future? The thing that changes is just the specific pieces of the puzzle that you have to include, right? So if you’re age 50, you’re obviously not looking at Medicare Irmaa, if you’re 66, you are. So it’s conceptually exactly the same.
Mike: And the general idea again, is just if your marginal tax rate right now is lower than you expect it to be later, Roth conversions probably make sense. And the key point Medicare Irmaa is that your marginal tax rate can include things other than just your tax bracket. If you cross one of the Medicare Irmaa thresholds, it’s not a gradual effect, as soon as your income crosses that threshold, boom, your Medicare premiums go up two years from now. And so that $1 of income can cost you hundreds or thousands of dollars.
Steve: Right. So you have to layer that in, you have to be aware of what they are and layer it in. Yeah.
Mike: Yeah. Definitely much better to be just below one of those thresholds than just above it.
Steve: Yep. Yeah. We actually do note that for people in our system, so people can see how they’re bumping up against it. Okay. So next question from Cody is how do you balance tax efficiency with cash flexibility and retirement?
Mike: I’m not entirely sure I understand what he’s getting at. Because one of the best parts financially of being retired is that you’re almost completely liquid. Generally your portfolio is fully liquid assets. You likely own a home as well, which is not liquid, but you’re extremely liquid in retirement, just the portfolio of stocks and bonds. So I’m not sure I entirely understand if he’s getting it.
Steve: Yeah. Unfortunately he’s not here, so we’ll have to move on. All right, next question. Which investment accounts are most appropriate for bonds?
Mike: That’s a question that is a hot topic and always is. Theoretically, what people have been saying for many years is that bonds are less tax efficient because the income is fully taxable, which means you’d want to put them in retirement accounts and then if you have to have something in taxable accounts you want it to be stocks because dividends from stocks and long term capital gains are both taxed at advantageous rates, lower tax rates than ordinary income. However, interest rates have been really low for really long time now. And what we’re concerned with, if you have to have something in a taxable account, it’s not just the tax rate that you’re paying on it, it’s how many dollars of return am I actually giving up? And so a high tax rate on an interest rate that’s practically zero is still not that much tax that you’re paying.
Mike: Plus there’s the fact that if you live in a state with state income tax, treasury bonds are exempt from state income tax. And treasury bonds are significant part of most bond portfolios, right? If you even just own a total bond market fund, treasury bonds are a big part of that. And so bonds aren’t bonds are actually pretty tax efficient when interest rates are very low, that’s I guess the point I would make. And unfortunately to guess at what is going to make sense for the next 20, 30 years, a very long period of time, you have to be able to know what interest rates you’re going to do. And unfortunately I don’t know that.
Steve: Yeah. No, it’s been tough times for folks trying to run the playbook of, “Hey, I’ll throw a lot of my money into fixed income and live off the the interest from that. Doesn’t really work these days.
Mike: Right. Exactly.
Steve: All right. So Don Clark has a question regarding Roth conversions. If at age 57 you have low after tax savings balance, large IRA balance, a paid off mortgage and access to a HELOC. Is it advisable to use a HELOC to pay taxes on IRA conversions?
Mike: Wow. There’s a lot going on there. Tax planning is always very, very case by case. So to give a real answer would require more information than that. What I will say from that information is carrying debt often does not make sense when you have an invest portfolio, unless you have a 100% stock allocation, you are borrowing money at one interest rate and generally lending it back out at a lower interest rate because you have bonds in your portfolio. And so it generally doesn’t make sense to borrow in order to invest or at least borrow in order to invest in the normal stock of bond stuff. And that’s basically what you’re doing if you are borrowing to the Roth conversion, you’re borrowing to basically buy the government’s share of your tax deferred account. So it’s conceptually very similar. So in most cases I would not be especially enthusiastic about a plan like that, but it’s going to be a case by case analysis.
Steve: Well, I think especially like when you’re younger and if you’re trading stocks on margin, you’re borrowing to buy stocks, which many of these Robinhood traders are doing and some of them are learning some lessons but what they have is they have the human capital to, if things go against it against them work to make income, to pay back their debt, when you as your approach retirement, if you’re not interested in working anymore and you take debt and it goes against you, then you got to figure out how to pay off that debt. And that could be a painful exercise.
Mike: Yeah. If you’re early in your career and 100% stock allocation, you want something even more risky than that. That’s where borrowing to invest comes in. But for most people that’s not the level of risk that they’re interested in.
Steve: All right. Awesome. So Darren Arnlind has a question. If living abroad temporarily, perhaps long term and doing Roth conversions, the local tax laws and possible consequences need to be considered. It sounds like this may be too detailed. It sounds as though some countries may consider the conversion as tactical income while others may not. Do you know if there are specific countries that would be more favorable than others when doing Roth conversions, this is a kind of interesting question because people are taking this window of time to be when they’re younger and retired to like, “I’ll go live in Mexico or something.” Right?
Mike: Yeah, exactly. And that’s a great question but the reality is that at least for me, I’m busy enough just trying keep my knowledge of U.S. tax law up to date and cover all the things that I need to know. So I don’t know the tax law for literally any other country. And unfortunately that’s what you’re going to run into with almost every financial professional. There’s probably some people out there but for instance, I recently had somebody ask me about living abroad in the UK, so obviously a popular country. For people in the U.S. that’s one of the most likely countries that you might go to, right? And I couldn’t even find a financial planner to refer this person to because there was nobody who I reached out to who said, “Yes, I have the knowledge to handle that situation.”
Mike: And that’s just with one particular country, that’s even one of most likely countries that the tax professionals, if you knew about some other country’s tax law, that would be one of the most likely ones that you would know about. Then I couldn’t even find somebody to refer this person to. So it’s going to be hard unfortunately to find someone with a knowledge to answer that question. There’s a good chance that Darren, I think you said, is going to be on his own in terms of learning what he needs to learn to do the analysis that’s necessary.
Steve: Got it. Well, if trends continue and more and more people spend more time abroad, sounds like there will be a need for more of these international or any international and U.S. tax draw down experts.
Mike: That’s probably true. So perhaps 10 years from now it might be a very different situation.
Steve: Got it. Yeah. And a quick side note. I know that there used to be ways where you could go live abroad and as long as you didn’t come back to the U.S. for I think more than 30 days in a year in certain countries, essentially you could shield all your income. I think that’s changing and maybe that’s a questionable practice. But I know of some folks who have lived in different places for years and shielded income that way.
Mike: There is still a foreign earned income exclusion. The details of it are probably more complex than it makes sense. Then you can really even get into in a podcast, in my opinion. I would struggle to explain everything necessary without being able to put it down in writing.
Steve: Yep. Okay. Yeah. Okay. So let’s see. John Baumgartner Arnlind, probably related here, is asking Roth conversion ladders planning for 10 years or more. If both spouses married finally jointly have similar size IRAs and are two years apart in age, should we be converting the same amount from each person’s account or converting one individual’s before the other? And they’re looking for while they’re tax optimization while they’re alive versus maximizing their estate.
Mike: Okay. Short answer is that it probably doesn’t matter very much at all. And there’s probably a slight argument to be made in favor of doing somewhat more conversions from the IRA of the spouse who is older, because RMDs are going to kick in sooner from that IRA. And because that spouse will always be the older one, the RMDs will be a slightly larger percentage. But it’s not going to be a huge difference. So yeah, doing 50-50 would be fine or doing a little bit more from the other IRA would also make sense.
Steve: Okay, awesome. Thank you. Also, I’m going to take a moment to do a disclaimer that none of this is financial advice, and you should definitely talk to your own financial expert who’s a fiduciary before you take any action.
Mike: That’s a great idea.
Steve: So Social Security questions, Diane Rosco is asking, I’d love Mike to talk about Social Security claiming strategies when the much lower earning spouse is hit by WEP, Windfall Elimination Provision and GPO, Government Pension Offset on the higher earning spouses, Social Security benefits. Does this negate the usual advice to wait as long as possible to claim Social Security benefits since lower earning spouse will get basically zero when the higher earning spouse passes away?
Mike: That’s a really astute question. It doesn’t necessarily negate it. The first thing I would want to know, so the effect of the government pension offset, the GPO is that it reduces the amount you can get as a spouse or as a survivor by two thirds of your monthly pension amount. So the first thing I would look into is for that higher earning spouse, if they did wait all the way until 70, that monthly benefit how does that compare to two thirds of the other person’s government pension? And so basically I would check to see, do we know that the survivor benefit would be completely eliminated or if the person waited until 70, is it possible that the spouse of the pension could get something of a survivor benefit? So I would just check the math real quick.
Mike: But in a case in which two thirds of the government pension exceeds the other person’s age 70 benefits so there’s no survivor benefits in the picture. Then for that higher earning spouse, the Social Security analysis is basically exactly the same as it would be for a single person. We’re just looking at a single life expectancy. So it’s definitely not as advantageous to wait as it would be in most couples for the higher earner to wait. But there’s still a fairly compelling point in favor of waiting because even a single life expectancy is greater than the life expectancies that are effectively baked into the system. And again, there’s a risk offset, you’re offsetting your longevity risk if you wait, there’s often tax planning reasons to wait. So it still likely makes sense to wait, but it is definitely less compelling than it is in a lot of married couples.
Steve: Got it. Well, thanks for the answer. That was a pretty detailed question. If folks want more really detailed questions, you can go into our Facebook group and see what people are discussing, which is stuff like this. All right. Chris Schleider asks, why don’t most Social Security comparison calculators factor in COLA? I don’t know if that’s actually true or not but maybe-
Mike: Yeah. I was going to say I think most do. I think most are doing it in real terms basically. They’re doing everything in today’s dollars so they’re assuming that what you want to know is today’s dollars. So rather than forcing you to guess at the COLA, you’re just doing a real rather than nominal analysis. And I think that’s the easier way to do it. And in most cases it eliminates one source of potentially being wrong, basically.
Steve: Yeah. I think this is where everyone learns the difference between real and nominal dollars, inflation adjusted versus non inflation adjusted, it’s a complicated idea. All right. David Foltz, does Mr. Piper plan to claim Social Security at age 70?
Mike: If the rules are the same when I am of Social Security eligibility age, then yes, that’s what I would be doing. But obviously at age 37 right now, there’s a good chance that the rules change between now and then.
Steve: Right. And actually this goes to the next question which is, I would like to hear Mike’s crystal ball outlook view on the sustainability of Social Security and how retirement plan should plan for this uncertainty.
Mike: Yeah, that’s an important question. First I want to just take a minute to point out a lot of people have a critical misunderstanding about the funding situation of Social Security. A lot of people are here but the trust fund is being depleted, which is true. It’s projected to be depleted in about 2033 or 2034, somewhere around there. But a lot of people take that to mean that then there’s no money left for Social Security and that’s not how it works. There’s still the ongoing tax revenue every year. So the current projections are that even after the trust fund is depleted, the ongoing tax revenue every year would be enough to pay for roughly three quarters of the promised benefits.
Mike: So if nothing at all is done, right? We don’t increase taxes, we don’t cut benefits at all. Three quarters of the promise benefits would still be able to be paid roughly. As far as what is likely to happen I would bet that it’s some from column A and some from column B. I bet we see some increase on the tax side, whether it’s increasing the cap as far as the amount of earnings, that’s subject to tax or increasing the actual tax rate, either one of those or both of them seem likely. And then I bet we do see some benefit cuts, an increase in the full retirement age for younger people, which is it doesn’t change the age at which you can file for benefits basically just means that no matter what age you file, you’re going to get less than if your full retirement age was a lower number.
Steve: So they’ll push it up from 70 to 72 or something like that?
Mike: Well, no. Because right now it’s between 60 and 67, right? We’re talking about full retirement.
Steve: Okay. Sorry. Excuse me. Yeah.
Mike: So it’s probably going to be 68, 69, 70 for younger generations.
Steve: But you don’t think they’ll lift the maximum retirement age?
Mike: I doubt it because that wouldn’t really improve the funding status of the program at all.
Mike: If anything, it makes it worse because filing at 70, most of the time means you get more over your lifetime.
Steve: Right. Well, but you’d be paying it for hopefully a shorter period of time. I guess if they’re going to keep it actuarily the same then maybe it doesn’t matter.
Mike: Right. Yeah. If they need they could make some actuarial adjustments and bump that age up certainly.
Steve: Yep. Got it. So they won’t explicitly lower benefits but they’ll just push out when you can get them?
Mike: Well, an increase in the former retirement age is just the cut and benefits. It’s a complex way of saying it but that’s all it is. It means everybody gets less, everybody who is affected by that change gets less.
Steve: Right. Got it. And how about Medicare since we’re on the topic? Because I know the Medicare trust fund is also actually going to happen sooner, it’s going to be “depleted.”
Mike: Yeah. The truth is with Medicare my level of expertise is not what it is with Social Security. So I’m even less qualified to guess what’s going to happen as far as legislative changes. But again, it’s by definition we’re going to see something just like with Social Security, something has to happen, but it’s hard to know exactly what it will be.
Steve: Yeah. And that’s actually by far, it’s even bigger program. I know that one headline I read and this is all in non-converted dollars, but it was like the average person pays in $140,000 to Medicare and claims over $400,000 in benefits. It’s hard to make that sustainable. I’m sure won’t go. I don’t think it’s going away, but same thing.
Mike: Yeah, exactly. I wouldn’t imagine either program ever just gets eliminated. That would be politically unpopular to say the least.
Steve: Third rail, right?
Steve: That’s third rail. Okay, great. So appreciate you answering those questions. So just before I wrap up, any thoughts on… I usually ask what’s next for you? Any big changes coming up for you over the next couple years?
Mike: I don’t think so. There’s some more work I want to do on the open Social Security calculator. Certainly need to continue updating books as tax law has changed, the last year has been a whirlwind of tax legislation. So I don’t think there’s any new projects because the existing projects are keeping me busy enough.
Steve: Got it. Any forecasts on the market and inflation and feel free not to go there but-
Mike: Yeah. No, thank you.
Steve: Okay. What do you worry about? What keeps you-
Mike: What do I worry?
Steve: With regard to these topics, with regard to retirement and tax planning is there anything that keeps you up up at night?
Mike: Yeah. With our own personal finances, not particularly, but the thing that I see all the time is people who just completely miss one aspect of financial planning and it varies from one person to another. But the thing I see frequently, I hear from people who I know are extremely knowledgeable about investing. They have very well informed opinions about very technical set allocation topics, right? They can speak intelligently about minutiae of portfolio allocation. I’ve been communicating with this person for several years and I know exactly how knowledgeable they are, then I find out that they have an S corporation and they haven’t been running payroll. So they’ve got this enormous tax problem and things like that.
Mike: So it’s just people completely missing one aspect of the financial planning picture. And most of the time it’s people getting hung up on investing because that’s the fun stuff, for a lot of people that’s the upside, and missing the risk related parts of financial planning. So insurance analysis, a lot of people don’t have disability insurance or don’t have any good disability insurance. And a lot of people don’t have nearly the amount of life insurance that they need if they have young children. And a lot of people haven’t done any estate planning because a lot of people think that estate planning is just trying to minimize your estate tax. And so they say, “Oh, I’m not going to have a portfolio big enough to have to worry about that.
Mike: But there’s a lot more to it, right? There’s just making sure that your beneficiary designation is on your IRAs and 401(k) or who you want them to be, making sure that you have a will, just the basic documents in place. And a lot of people ignore that stuff because it’s not fun to think about. It’s not fun to think about the downsides and the things that can go wrong, but those are the big problems I see most often, is people completely missing a piece of financial planning.
Steve: Yeah. I’m going to share one quick story on that. We were talking with someone, they were thinking about investing and they were kind of like accumulated quite a lot of wealth. And I remember hearing in passing that they had located a ton of very valuable assets that were relatively illiquid in their qualified accounts. So through self-directed IRAs and then they were looking forward and they were like in their sixties looking forward, but like, “Wow, these RMDs are going to kick in and I’m going to have hundreds of thousands of dollars a year in RMDs that I’m going to have to take and I don’t have the liquidity or coming up with liquidity for that was going to be a problem.” That’s an extreme example that you can run into these situations where you get caught because you don’t understand how these things unfold over time.
Mike: Yeah, exactly.
Steve: And then yeah, on our side, we’re definitely thinking a lot about delivering the full financial services solution in a much lower cost because I agree with you people have to think about insurance, they have to think about estate planning, their power of attorney, medical directives, stuff like that, have it in place.
Mike: Yes, precisely.
Steve: Including myself. Okay, great. Just before we wrap up, any last resources you want to mention? We’ll definitely point to your website and your books and open Social Security. Any other things that you found useful, you want to call out?
Mike: I’d say that’s mostly it as far as my own work. I dearly love the Bogleheads forum. I think that’s a great resource on a number of topics. But it is also the sort of thing that you’re going to run into exactly what I was talking about, people who they’re investing hobbyists, that’s what they think is interesting. And so you’ll see so much discussion about things that are way down the list of financial planning importance and not enough discussion of some of the other things that should probably be taken care of.
Steve: The Bogleheads forum thread runs through many of the top thin con and personal finance influence as yourself, White Coat Investor, John Clements and many other folks. It’s a pretty amazing community. I think that there’s still a huge opportunity to unlock a lot of the human capital knowledge that’s in that community and make it more approachable and accessible to folks who really need it, which are high school kids that are just getting started. How do you teach them in quickly what they need to know beyond credit cards and balancing a checking account? Although that’s a great start, but what are some of the rules of thumb that will help them make great decisions over the course of their life?
Mike: Yeah. Yeah. That is a challenge.
Steve: Yeah. It’s a huge opportunity. Okay. Well, look this was great. I appreciate your time. So thanks for being on our show. Thanks Davorin Robison for being our sound engineer. For folks that are out there listening, appreciate your time, hopefully you’ve found this useful. And if you’ve made it this far, definitely check out Oblivious Investor or Open Social Security, we’ll link to these sites. Feel free to do in our Facebook group that’s where we have over 4,000 people asking questions and helping each other in a big open community or our tool @newretirement.com. We definitely are trying to make it better. We are learning with our audience and with experts like Mike Piper and any reviews are also welcome. So with that, thank you and have a great day.
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