#89: What Clients Miss When Talking With Financial Planners

Micah: Welcome back to another amazing episode of Plan Your Federal Retirement podcast. I’m your host, Micah Shilanski, and we got a special edition in store for you listeners this week. This is our busy time of year. We want to see all of our clients before the end of the year. We have a lot of things to go through and a lot of planning opportunities. So I invited two of our great advisors on with me as well. We got Christian Sakamoto and JT Ferrin, and we wanted to spend some time talking about things that have happened this week with actual clients and actual federal employees, whether it’s retired or pre-retired. And things that we need to be thinking about. So Christian, thanks for being on here.

Christian: Yeah, excited to join you and JT and talk about some pretty, pretty neat examples of clients this week. And we’re in the trenches right now, as I would say, helping clients and going through things, and I’m excited. It’s a lot of energy this time of year. There’s lots to talk about is when I would say, 

Micah: Yeah, we’re gonna nerd out on taxes for another couple of weeks. And it’s always something to be excited about. But JT, I know there’s been a lot going on; you’re in tune, kind of meeting with clients, and kind of helping some things out. So I’m going to kick this one a little bit over to you first and to say, what are some things that have come up this week that are like aha moments or big planning opportunities that it’d be really easy for us to miss if we weren’t looking for them?

JT: Yeah, like you said, nerding out on taxes. And this is not a joke when we talk to clients, and we started bringing up taxes, get really excited, and kind of to calm myself down and get out of the weeds a little bit and keep it kind of higher level, but we really do nerd out on taxes. And so that’s one of the big things I’m noticing here is Roth conversions. The fall, this time a year is always a good time to at least consider Roth conversions, whether you’re retired or still working. We need to be looking at Roth conversions to see if that makes sense. But we need to be looking at it from a long-term perspective. You know, one thing that we love to do for our clients is a 10-year tax projection to see how your income sources are going to change over a long period of time, and how they’re going to be taxed. And so it may seem the tax bracket that you’re in now is only high or low depending on where you’re going to be in the future, right? So, for some people, a 22% bracket may be high because in the future, they’re going to be 12. But for some people, that 22% bracket might be the lowest bracket they see the whole rest of their lives. And so looking kind of longer-term, where’s their income going and what does that tax ability it might make sense to do Roth conversion today.

Micah: JT I love the point that you brought up right there about the relative aspect to it right because I think that’s a really easy point to miss. We get into this misconception that when I retire, my taxes will be less. And it sounds really good. And it makes sense because you’re like, Wow, I’m kind of making all this income right now, while I’m working when I retire, I’m not going to have all these deductions from my paycheck. I’m just going to have my net pay coming in. And it’s going to be my federal pension which is less than my pay and it’s quick to justify to get us down this path. But Christian kind of like JT is talking about about you see the same things working with clients that even though clients’ gross income may change their taxable income, depending on where they have money may be the same, if not higher. in retirement.

Christian: Absolutely. What’s fun is planning for those future years and seeing, okay, we have this account over here, and it’s a pre-tax account. We’ve got some Roth money, we’ve got some non-retirement money, what spigots can we turn on in what years to maximize your tax savings? I know JT is going to be talking about I’m going to be talking about today. JT, did you have a good example of a client that you were working with this week relative to doing some Roth conversions? And can you walk us through what that example is and what the tax savings that you’re seeing?

Micah: Boy, I’m glad you brought JT on the spot, not me. So that’s that’s fantastic. 

Christian: You’re next, you’re ready. 

JT: Micah and I are meeting with a client who’s looking at a postponed retirement. So they’re going to put their benefits on hold and their pension included. And there’ll be a gap in time there from when they separate from service until they start their pension. That gap in income is going to be filled with after-tax money. They’ve done a great job of setting money aside and bank accounts and after-tax investments, and so during that gap over those few years, they’ll be drawing tax-free money, so their cash flow won’t change. They’ll still be collecting the same amount of cash flow per month, but their taxable income is going to drop to near zero. And so we’re looking at this and saying, This is why we’re getting really excited, right? And it’s like, okay, we gotta calm down a little bit because we get excited about taxes and the clients necessarily don’t, but just chomping at the bit here saying we can convert potentially $200,000 here and fill up the 22% tax bracket. Because once the pension starts and the withdrawals from the qualified accounts start now, we’re going to be triggering lots of sources of taxable income, and they’re going to be in a higher bracket than the 22% in just a few years. So really cool planning opportunity there. We got excited about it.

Micah: No, that’s fantastic, right? And so when we’re thinking about this, it’s that again, with the points you’re bringing up that relative nature of it now, we’d like to talk about our 10-year tax projection. Don’t be overwhelmed. This isn’t something really given out to a lot of clients because the 10-year projection, there’s a lot of things that go into it. But we look to look at it on the background, and when to say when are these income sources going to be coming in? And then also one of the things too, in a couple of years, our current tax laws expire. Our current tax doesn’t expire and they get repealed to a higher tax rate. Now, not everybody is going to be in a higher tax rate. But most of everyone listening to this podcast is going to be in a higher tax rate in a couple of years, assuming Congress does nothing. Now, this administration still is not returning my phone calls, so I don’t know what they’re going to be doing or not doing the tax law. But those are things that we always got to watch is we got to know what the current tax laws are. Where are they going in the future than being able to pivot on those, so don’t be afraid of large Roth conversions, assuming they make sense now to jump on this a little bit too Christian. We got to be careful when we’re doing Roth conversions, right because we’re under 59 and a half, and we’re doing Roth conversions. We got to be pretty careful on how those taxes get paid, right?

Christian: That’s correct. And the reason why we have to be careful under 59 and a half is we won’t be able to pay the taxes from the conversion itself. So what does that mean? Let’s say we did $10,000 as a conversion, going from our pre-tax traditional IRA and move that to Roth, and let’s say we’re in the 22% tax bracket. When you’re over 59 and a half, you can have the taxes be paid from the conversion itself. So you take your $10,000, you take out $2,200, which is 22%, you send that to the IRS as part of the conversion and then you end up with the difference in your IRA, which is $7,800. If you’re younger than 59 and a half we can’t do that because of the early withdrawal penalty for doing that. So we would have to find a different way to pay the taxes. That could mean a non-retirement investment account that could mean just paying the taxes as an estimated payment using checking or savings money, right but it’s got to come from a different account. That’s a very good point.

Micah: So think about this too, right with your TSP account that you have if TSP does not allow in-plan Roth conversions of your board this weekend. Jump on. Start harassing the TSP board about this right now they’re subject to their own rules, but this is something we should be boisterous about in Plan Roth Conversions can be a fantastic thing, especially if you’re still working for the federal government. Now you can contribute to the Roth TSP, which is fantastic, but 401K’s do allow for in-plan conversions; the TSP right now does not, that’d be a fantastic benefit to our federal employees. So one of the things when we’re thinking about this and the tax planning too, boy, not to think about too morbidly, but we also got to be thinking about the survivor benefits. One of the things Christian, JT, and I are always looking at is God forbid, when not if when one of the spouses passes away, what survivor income is going to be coming in. And if you guys are used to spending $8,000 a month and roughly you get $5,000 a month from you know between the spouses’ pension and Social Security and they pass away, you may only get half of their pension depending on the survivor benefit, but you only get one of the Social Security checks, whichever is higher, but you only get one. So you can have a huge loss and income, but you’re still spending $1,000 a month so that money has to come from somewhere. So that might mean you have to take more money out of the TSP, IRA accounts, we could put you in a higher tax bracket. So we’re kind of planning these out. The pre-planning and Roth conversions makes a ton of sense. But Christian on this kind of cue you up to there’s a little bit of planning that can come in here that God forbid, but when a spouse passes away in that year, I don’t know a great way to say it, but unfortunately in that year, there is some tax planning that you should be thinking about, right?

Commercial: How many times have you sat down with a financial professional who claimed to know your federal employee benefits but in the end, really couldn’t answer your questions? That won’t happen at plan your federal retirement.com. We specialize in working with federal employees across the United States on understanding how their unique benefits tie into their greater financial plan. We collaborate with the industry’s top experts like Tammy Flanagan, in order to come up with a financial plan that makes the most sense for federal employees who want to maximize their benefits. And because we’ve been in business for over 40 years, we also have the confidence to tell you when we don’t know the answer to something and when and if that happens, we don’t throw up our hands and say we just don’t know. Instead, we start researching and looking through our network and talking to other Federal Employee Benefits experts to find an answer that is helpful for you as a federal employee. If you want to meet with one of our Federal Employee Benefits experts, jump online to plan your federal retirement.com and see if a one-on-one consultation is correct for you. Isn’t it time to take the guesswork out of planning for your federal retirement?

Christian: Absolutely. So yeah, so regrettably, I had that same example happen this week meeting with the client where the husband passed away earlier on in the year he was working for the federal government and was planning to retire soon and yes, unfortunately, he passed away. So when I was meeting with the spouse, this was after several meetings, but this is the time of the year when we were thinking about doing a Roth conversion for her. And so one, like Micah mentioned, we can’t do that Roth conversion in the TSP, so that would involve doing a TSP transfer out to an IRA. That was the first thing, but the biggest thing we were looking at is her tax situation and what her income sources will be now that she is the surviving spouse and going to be single. And what we found is because her husband passed away earlier on in the year they were used to making a certain level of income, and this year she will be filing married filing joint for this year, and next year, in the years following, she’ll be filing single. So we took a look and said this is actually despite your husband passing and it being a very bad situation. A good opportunity from a tax perspective to do a larger Roth conversion this year, going in the current bracket that she’s in, which is the 22%, and possibly going into the 24 to just say, hey, we can do our taxes as married filing joint this year. So this is a bigger opportunity for doing a Roth conversion. And that made a lot of sense. And that was one of the things that is something to think about if this applies to you, unfortunately, or could in the future that Roth conversion planning is dynamic. It’s not that we have a plan, and that’s our rigid plan that we have that life can throw curveballs, whether we’re planning for it or not. And we have to adapt to those things that we can plan for sure. But then there’s a lot of things that we can’t, and in this case, this was something we weren’t planning for. But we’re going to make the most of it.

Micah: Yeah, that’s exactly right. Right. It’s it’s we got to look at the situations that we have of course, the loss of a spouse is is the most dramatic. The other things that we look for in doing Roth conversions is the market down last year market was down 20%. Right now, who knows what’s going to be down this year, but so it’s a great time to do Roth conversions when they’re down. When you know, you’re in a low-income bracket and a couple of years it’s going to be higher. Let’s talk about real quick chance, some reasons because we talk about Roth conversions a lot are because we like him so much. Let’s talk about some reasons not to do a Roth conversion. And I’ll kick it off. I’ll take the easy one. The first one, don’t do a Roth conversion If you can’t pay the taxes on the Roth conversion. If you can’t, if you’re under 59 and a half and you can’t pay it from the conversion, doing a conversion and not being able to pay the taxes. That does not sound like a good idea. So that would probably be a reason I would stop we’re not doing. JT, what about you? What’s a good reason put you on the spot. What’s a good reason not to do a Roth conversion?

JT: Well, I guess I’ll do one that maybe have some caution. Before you do the Roth conversion. If your income is close to some breakpoints, like the change in the tax bracket, like from the 22 to the 24 or from the 24 to the 32 right there’s a small jump from 22 to 24. But then that jump from 24 to 32 is pretty big. We probably don’t want to be doing conversions in 32% tax bracket. But one thing to watch out for is the Medicare brackets those IRMA thresholds, it may or may not make sense to break through that IRMA threshold and trigger a higher Medicare premium. When we say it may or may not because of course, it’s a depends question, right? Again, going back into some of that analysis that we do, but when you’re approaching that $194,000 or so where that Medicare bracket is, I just urge some caution to look at it again because you’re not just triggering a higher tax bracket. You could be incurring some higher Medicare premiums as well. 

Micah: That’s a great one. Right? What other effects does this have? Another example is it could affect your premium tax credit and maybe you separate from federal service, you’re doing to postpone retirement, you don’t have FEHB and you do a mass of Roth conversion and you’re getting a subsidy on your health insurance from the healthcare exchange right? Now that blows it up because you did this huge Roth conversion. So what other effects does it have? That’s great, Christian, hopefully, yours was in the premium tax credits. I just threw that one out there. But what’s what’s a good reason I wasn’t going, actually? Clients, I should not do a Roth conversion. 

Christian: Well, boy, I’m thinking of another client meeting I had this week where client is single, and 73 years young. And as we’re looking at his taxes over the next ten years or so, what we’re finding is we’ve done these conversions over the last several years, and he has a good portion in Roth now. He’s got still a good portion in his pre tax accounts, but as we’re looking at where his taxes will be, as best as we can plan for his income isn’t going to be higher; it’s in fact going to go down a little bit and with those RMDs that he’s getting right now and receiving now. He’s right at the top of a 22% bracket. So if we did that conversion into the 24, I just didn’t think it make a lot of sense for us to do that. So we have to think about the Roth conversions again as where will we be, and it is possible that our taxes could be lower in the future. And this was a good example of that. That being the case for this particular client.

Micah:  Yeah, it’s a great point, right? One of the things that came up in a class we were teaching Well, what, a month or so ago now, but someone was like, why don’t I convert all of my money to a Roth? That sounds fantastic. And you got to understand have a good understanding of how our tax codes work, and there are progressive tax systems as a Christian; that’s just what you’re talking about, right? Is that as you make more money more, not only dollars you pay in taxes, but more percent you pay in taxes on that calculation. So there’s times that make sense that says, hey, if I convert all my money at 32%, I’m going to be in a 0% tax bracket for the rest of my life and at first you’re like, oh, my gosh, this is amazing. I want to be at 0% for the rest of my life, and so the cash flow, but you did it at the cost of a 10% bracket or 12% bracket. And so it doesn’t make sense to do all of your money converted over there. So it’s one of those things that says okay, I can make an argument for a heavy portion of your money converted to a Roth. But in most cases, man converting everything to a Roth sometimes doesn’t make any sense. You end up paying more taxes than you have to. That’s why this shouldn’t be an emotional decision. It’s as a math decision. At the end of the day, we put pencil to paper and we go through it. JT and I were working with a client earlier this week. And I said, Hey, my gut said we need to do a Roth conversion. But we didn’t stop with my gut instinct. We put pen to paper and at the end of the day, the answer was no. This year for a couple of reasons. It’s different for the client the next few years. It doesn’t make sense for them to do a conversion. So we gotta be looking at the math of this every time, and our listeners like Micah, that sounds great for you. Because you like looking at taxes and we don’t. That’s there’s a lot of moving pieces that go into this. So JT, what are other thoughts about you know, client meetings you had this week, whether it’s Roth conversion, or something else, that clients have kind of maybe missed or maybe kind of not seen? That’s something that could be really important. 

JT: And one thing that we’re also looking at this year is in estate planning, and we say every couple of years it’s good to go back and review those documents because things change, right? You name a primary representative, you name a secondary representative. Kids get older, and so maybe it’s time to add those kids as a primary representative rather than a sibling. People pass away family members die things change. So it’s always a good idea to go back and review the estate planning documents and make sure that they’re updated. And they say what you think they say, because over the years making some of those changes, making some of those updates can kind of blend together so it’s good to review those again.

Micah:  Boy, I like that. I’m going to say Christian, I put you too much on the spot with this one too. But you’ll be next as the biggest one for me was understanding the rules in retirement. And it’s the basics right? It’s the fundamentals which catch people off guard. Rarely, it’s the super complex over complicated things. That I know we like to geek out on that catch people by surprise. It’s missing the basic understanding of rules. Simple one missing how SCD is different than RSCD. What is qualified service what time counts what time doesn’t count towards retirement? Also, how do you effectively do a separation? JT and I were working with another client this week and they’re doing a separation and the information they were hearing, right, I don’t want to say that they were getting but at least what they were hearing or relaying to us was completely inaccurate. And it’s like no, no, no, we don’t want to do it this way that comes with penalties. We got to be thinking about another way to do the separation. So really understanding what the rules are and what those consequences are. All right, Christian, bring us home. What’s one more thing that came up this week, that again, is a little bit of a misnomer can catch people by surprise.

Christian: I’ll choose an easy one. The difference between Roth conversions and Roth contributions, this comes up quite often in that that language is different and they’re two very different things. And as we are talking about today, with Roth conversions, that means we’re taking existing dollars and converting them moving them over into our Roth account. Contributions, on the other hand, we’re taking new dollars to put it into the Roth account. And that does have not only $1 amount limit, which is $6,500. If you’re under 50, and if you’re over 50, it’s $7,500 here in 2023, but it also has an income limit. So if you make between a certain amount, it gets phased out, and once you’re over a certain amount, it’s we can’t do Roth contributions. So just having that knowing the difference in the language is is important so that we’re talking about the same thing, right?

Micah:  I love it. That’s fantastic. All right. Well, this podcast is not just about us geeking out on taxes or other fun things that we get to see with clients; it is about sharing good information and action items. We want to make sure we’re giving you good actions that every single week you can take a peek at and move forward. So guys, I’ll kick it off and go first and be like, You know what, the first action item we really need to think about is know the rules for your retirement. Now, your friend thinks your retirement is but know the rules for your retirement and how it affects you. Christian wants another action on our listeners can do this week.

Christian: Yeah, I would say again on the Roth side. I’m a big fan and I love putting money into Roth. So if we’re looking at those contributions, one thing to look at is challenge yourself. If we’re still working and we’re still putting money into the TSP, if we’re not doing any dollars into Roth that maybe we should start, maybe we should start a portion of our contributions going into the Roth TSP and really seeing that impact. Now, disclaimer: if we do that, if we switch from pre tax contributions and do 100% into Roth, well, that just shows that we’re going to have more taxable income for the year so we have to be careful of making sure we’re adjusting for that increase in our taxable income. But I would say take a look at your contributions to the Roth or to the TSP rather. And if we’re not doing any into Roth, we’re doing a little bit try to bump it up a little bit into more and more into TSO. That’s right.

Micah: A lot a little bit more. It’s generally a great thing. Alright, JT what’s a third action item for our listeners this week?

JT: Yeah. Take a look at those estate planning documents and just make sure that the primary representatives are who you want them to be. If you don’t have the estate planning documents, that’s something that you can do is look at your TSP and see what who the beneficiary is there. That’s always a good thing to review.

Micah: I love it. You should always have a primary and a contingent beneficiary, and one of the things we’d like to say is if you don’t know who your contingent beneficiary should be, you spell Micah, M, I… No, I’m just kidding. All right, and everyone needs to have their own contingent beneficiaries and setup. This podcast, again is about action items about you, our listeners, help us share this content. We got a passion for what we do. We want you to have the best retirement you possibly can. And until next time, happy planning!