00:00:00
Welcome to personal finance for
00:00:02
long-term investors, where we believe
00:00:04
Benjamin Franklin's advice that an
00:00:06
investment in knowledge pays the best
00:00:08
interest both in finances [music] and in
00:00:10
your life. Every episode teaches you
00:00:12
personal finance and long-term investing
00:00:14
in [music] simple terms. Now, here's
00:00:17
your host, Jesse Kramer. Welcome to
00:00:19
Personal Finance for Long-Term
00:00:21
Investors, episode 121. I'm Jesse
00:00:23
Kramer. By day, I work at a fiduciary
00:00:25
wealth management firm helping clients
00:00:27
nationwide. You can learn more at
00:00:28
bestinterest.blog/work. [music]
00:00:31
The link is in the show notes. And by
00:00:32
night, I write the bestinterest blog and
00:00:34
I host this [music] podcast. I put out a
00:00:36
weekly email newsletter as well. All of
00:00:38
which help busy professionals and
00:00:39
retirees avoid mistakes and grow their
00:00:41
wealth by simplifying their investing,
00:00:43
their taxes. And today is our 10th Ask
00:00:45
Me Anything episode, and I'll answer
00:00:47
questions like, is this new fad called
00:00:49
direct indexing something amazing worth
00:00:52
pursuing, or just another fad to ignore?
00:00:55
What happens when a couple has a
00:00:56
lopsided retirement plan with one spouse
00:00:58
retiring years if not decades before the
00:01:00
other? We'll do a deep dive into
00:01:02
deumulation, the order of operations and
00:01:05
best practices around selling your
00:01:07
investments to fund your retirement. But
00:01:09
first, as always, we'll do a quick
00:01:10
review of the week. This one is from
00:01:12
Ally in Sacramento, who left a five-star
00:01:14
review saying, "Just the right balance.
00:01:16
What a treasure this podcast is. Jesse
00:01:18
strikes just the right balance between
00:01:19
being fun and lively to listen to and
00:01:21
sharing superdetailed information. and
00:01:23
he considers the total picture of
00:01:25
personal finance. Very glad to have
00:01:26
found his podcast and blog. I signed up
00:01:28
for his emails and read each and every
00:01:30
one. Ally, thank you for those very kind
00:01:32
words and I'm glad the weekly email has
00:01:33
been helpful to you. I'd be happy to
00:01:35
send you some treasure, Ally. That is a
00:01:37
super soft podcast t-shirt. So, please
00:01:39
drop me an email to
00:01:40
00:01:42
so I can get that sent out to you. And
00:01:43
now on to the first question of our AMA.
00:01:45
Question one is from Nikki. Nikki says,
00:01:47
"I've appreciated everything you have to
00:01:49
say about tax loss harvesting and how it
00:01:51
can be overoptimized, but what are your
00:01:53
thoughts on direct indexing? The
00:01:55
approach is being sold like you can get
00:01:57
all the gains from a fund like VTI or
00:01:59
total market index fund, but with tons
00:02:01
of losses you can harvest. It sounds
00:02:03
intriguing, but is this placing too much
00:02:05
emphasis on the wrong thing?" Nikki, I
00:02:07
think that's an excellent question. So,
00:02:09
let's do this. I'll talk a little bit
00:02:10
about tax loss harvesting to provide
00:02:12
some background there. And then I'll
00:02:14
[clears throat] explain direct indexing
00:02:15
through some rosy colored glasses. Then
00:02:17
I'll play devil's advocate and explain
00:02:19
the downside. And ultimately I'll let
00:02:21
you know where I land on the topic and
00:02:23
whether it's worth pursuing. So again,
00:02:25
tax loss harvesting is this strategic
00:02:27
investment practice where investors sell
00:02:29
assets at a capital loss to offset other
00:02:32
capital gains. This minimizes their
00:02:34
total taxable income. It's commonly
00:02:36
employed to optimize investment
00:02:38
portfolios and enhance your your after
00:02:40
tax returns. And people might ask, why
00:02:42
bother doing it in the first place?
00:02:44
Well, you have assets in your portfolio
00:02:45
with unrealized losses. Selling those
00:02:48
losses turns the lame asset into a tool
00:02:50
in your in your toolbox. And that tool
00:02:52
can neutralize taxes, lowering this
00:02:54
year's tax bill. That's not bad. And
00:02:56
sometimes losses can actually carry
00:02:58
forward and neutralize future year's tax
00:03:00
bills. any unused losses this year,
00:03:02
they're tracked on your tax return and
00:03:04
eventually can be used to cancel a
00:03:06
future year's capital gain. Now,
00:03:08
personally, I think that there are good
00:03:09
and bad uses of tax loss harvesting. I
00:03:11
think a really good use of tax loss
00:03:13
harvesting is to offset some sort of
00:03:15
liquidation event that would otherwise
00:03:17
be occurring in your financial life.
00:03:18
Maybe you're selling a business or a
00:03:20
second home cuz usually primary homes
00:03:22
don't suffer capital gains taxes
00:03:24
usually. And so, that's why I say you're
00:03:25
selling a second home and you might be
00:03:27
facing a significant capital gain from
00:03:29
that sale. Tax loss harvesting makes a
00:03:31
lot of sense there because in that
00:03:33
scenario, you are making the sale
00:03:35
anyway. You might as well seek out ways
00:03:37
of saving money and reducing your taxes
00:03:39
because you're you're in the process of
00:03:41
doing the sale and then realizing some
00:03:44
capital losses. You are fundamentally
00:03:46
reallocating your net worth away from
00:03:48
the real estate or away from the
00:03:50
business into something new. Perhaps
00:03:52
it's just a traditional stock and bond
00:03:54
investment portfolio. The gains and the
00:03:56
losses are from different pools of money
00:03:58
which permanently offset one another and
00:04:00
that's a good thing. But as we'll see in
00:04:03
a few minutes, that isn't always the
00:04:04
case. Another good way of using capital
00:04:06
losses, usually a usually good way, is
00:04:08
to offset income. You can use tax losses
00:04:11
to offset up to $3,000 a year in annual
00:04:13
earned income. It's generally an
00:04:16
excellent way of using tax loss
00:04:17
harvesting. And the reason is simple tax
00:04:19
rate arbitrage. Many taxpayers here in
00:04:22
the US have a a federal marginal tax
00:04:24
rate of say 22% or higher. And every
00:04:27
dollar of income they can offset with a
00:04:29
capital loss results in a 22% or greater
00:04:32
savings. Meanwhile, harvesting losses
00:04:35
usually it'll kick a can down the road
00:04:37
creating some sort of 15% again usually
00:04:40
15% capital gain in the future. And by
00:04:42
saving 22 cents on the dollar today and
00:04:44
spending 15 cents on a capital gain in
00:04:47
the future, taxpayers can arbitrage that
00:04:49
net 7% on their $3,000 for free. And the
00:04:52
benefit becomes even more stark in
00:04:54
higher tax brackets, 24, 32, 35%. And
00:04:58
becomes even more stark if your future
00:04:59
capital gains you can actually realize
00:05:01
at 0%. Cuz that's possible, too. Another
00:05:04
common tax arbitrage occurs when an
00:05:06
investor might owe capital gains at the
00:05:08
23.8% 8% bracket, which if we're being
00:05:11
technical here, is 20% on capital gains
00:05:14
and 3.8% on the net investment income
00:05:17
tax, 23.8 total. Well, in that case, a
00:05:20
loss can offset those gains, saving
00:05:22
23.8%.
00:05:23
Again, probably resulting in a 15%
00:05:26
capital gain in the future or maybe a 0%
00:05:28
capital gain in the future. But either
00:05:30
way, that arbitrage is a deal that we
00:05:32
would take every single time. I think
00:05:34
whenever we're talking about tax gain or
00:05:36
tax loss harvesting, we should remember
00:05:38
there's a very specific order of
00:05:39
operations that the IRS uses a specific
00:05:42
order for how losses can offset gains.
00:05:45
First, short-term losses offset
00:05:47
short-term gains. So, think of this as
00:05:49
the short bucket and then long-term
00:05:52
capital losses offset long-term capital
00:05:54
gains. So, that's the long bucket. Then
00:05:57
if you still have net losses in either
00:05:59
bucket, they will be used to offset the
00:06:01
net gains from the other bucket. So
00:06:04
capital losses always offset capital
00:06:06
gains first, no matter what. Short
00:06:08
offsets short, long offsets long, and
00:06:11
then if you have any losses left over,
00:06:13
they kind of leak over into the other
00:06:15
bucket. After you've already offset all
00:06:17
of your capital gains, then you can use
00:06:20
any remaining capital losses to offset
00:06:22
your earned income up to $3,000 of
00:06:25
income per year. And then any remaining
00:06:28
capital losses carry forward into the
00:06:30
next year. It's important to remember
00:06:32
that there is this order of operations
00:06:33
for the way that capital gains are used.
00:06:36
And then last, I'll use an example
00:06:38
actually to talk about this one, a a
00:06:39
good way that tax loss harvesting can be
00:06:41
used because actually I have two clients
00:06:43
going through this right now. They have
00:06:45
extremely concentrated stock positions
00:06:47
in a specific company. Coming into this
00:06:49
year, both of these families had
00:06:50
probably 20, we'll call it 20% of their
00:06:53
net worth. In this one company, due to
00:06:55
years of stock options, years of
00:06:57
restricted stock units being given to
00:06:59
them. And then in 2024, this stock was
00:07:01
up about 55%. So far this year, this
00:07:04
stock is up another 70 to 80%. And I
00:07:07
suppose the first listener who emails me
00:07:08
with a correct guess on this stock and
00:07:10
this company, I'll send you a SuperSoft
00:07:12
podcast t-shirt for getting the guess
00:07:14
right. Up 55% in 2024, up another 70 to
00:07:18
80% so far here in 2025. But anyway, the
00:07:21
point is that it was very valuable for
00:07:23
these families to put a plan together to
00:07:26
diversify out of their concentrated
00:07:28
positions. But that realizes a lot of
00:07:30
capital gains and using some capital
00:07:32
losses to offset those gains makes a lot
00:07:34
of sense. Anyway, the point is we put a
00:07:36
plan together for these families to
00:07:38
begin diversifying out of their
00:07:39
concentrated positions. And despite our
00:07:41
bestlaid plans, the concentration is
00:07:43
actually worse now than ever before
00:07:44
because the stock is going up so
00:07:47
quickly. It's kind of a wild situation,
00:07:49
but okay, that's a good problem to deal
00:07:50
with. But the point is that these are
00:07:52
capital gains that both of these
00:07:53
families should be realizing. And the
00:07:56
reason they should be realizing them is
00:07:57
because of portfolio construction and
00:07:59
investment merit. There are important
00:08:02
portfolio investing reasons to
00:08:03
diversify. Whether they'd pay zero or 15
00:08:06
or 23.8% in capital gains, they need to
00:08:09
diversify anyway. Thus, for these
00:08:11
families, tax loss harvesting is very
00:08:13
smart. You might as well intentionally
00:08:15
realize losses to offset the mammoth
00:08:17
gains that they are incurring from their
00:08:19
diversification needs. And I'll contrast
00:08:22
that to someone who owns a lot of, say,
00:08:24
the S&P 500 index fund, and they've been
00:08:26
buying shares of that index fund every
00:08:28
month now for years and years and years.
00:08:30
And back in April of 2025, just a few
00:08:32
months ago, at the bottom of the quote
00:08:34
unquote tariff tantrum, that person
00:08:36
would have found that many of their more
00:08:38
recent S&P 500 shares are underwater,
00:08:40
sitting at a loss. The index was down
00:08:43
almost 20% from its from its high water
00:08:45
mark. And that person could have sold
00:08:47
all their newer S&P 500 shares for a
00:08:50
loss, but then also sold some even older
00:08:53
S&P 500 shares for a gain. The losses
00:08:56
could have offset the gains, negating
00:08:58
any tax impact, which feels good. And
00:09:00
then they could have used all the
00:09:01
proceeds from those sales to buy a
00:09:03
different index fund because we have to
00:09:04
be careful of this thing called the wash
00:09:05
sale rule. You have to pick a different
00:09:07
index fund. It's within 30 days before
00:09:09
or after your sale. But then boom, they
00:09:12
they stay invested in the market and
00:09:13
they avoided some taxes. Well, not
00:09:15
quite. That's not right. Because if you
00:09:17
actually look at how all the numbers
00:09:19
work out, they took a bunch of gains and
00:09:21
a bunch of losses and those numbers
00:09:23
offset each other. And therefore, they
00:09:25
sold a bunch of their S&P 500 shares at
00:09:27
a net zero gain or loss. Then they
00:09:29
turned around and bought say a total
00:09:31
market index fund at current market
00:09:33
price, which by definition means there's
00:09:35
a net zero gain or loss. And what I'm
00:09:37
describing is that the cost basis has
00:09:39
not changed. The point from which we
00:09:41
measure capital gains hasn't changed.
00:09:43
All they've done is shifted net zero
00:09:45
gains from the S&P 500 index fund to a
00:09:48
net zero gain in the total market index
00:09:50
fund. Their tax situation, their capital
00:09:53
gain situation was net zero yesterday
00:09:55
and it is net zero today. They changed
00:09:57
from a S&P 500 index fund to a total
00:10:00
market index fund, not because of
00:10:02
investment merit, but because they they
00:10:03
falsely believed they were saving on
00:10:05
taxes. Okay, but what does this all have
00:10:07
to do with direct indexing? Direct
00:10:09
indexing lets investors build their own
00:10:12
personalized version of an index, say
00:10:14
like the S&P 500 index, by not owning a
00:10:17
fund, but by owning all of the
00:10:19
individual stocks directly. So, right,
00:10:21
you're not buying an ETF, you are owning
00:10:23
all of the indiv individual stocks
00:10:25
directly. This approach gives more
00:10:26
flexibility. Investors can customize
00:10:28
their holdings maybe by excluding
00:10:30
certain companies or industries. Yes,
00:10:33
they can harvest tax losses on specific
00:10:35
positions. That's kind of one of the
00:10:36
appeals. They can control when capital
00:10:38
gains are realized. Another one of the
00:10:40
appeals and direct indexing used to be
00:10:43
limited to the ultra wealthy investors
00:10:44
because of some of the complexity and
00:10:46
the cost of setting it up. But new
00:10:48
technology and then also fractional
00:10:50
shares has made direct indexing much
00:10:52
more accessible to everyday investors
00:10:54
like us. So in short, it is indexing but
00:10:57
with a little bit of personalization and
00:10:59
tax optimization built in. Now here's
00:11:01
the rosy colored optimist sales pitch
00:11:04
for direct indexing. It's that it's for
00:11:07
investors who want the power of indexing
00:11:08
with a personal touch. It keeps broad
00:11:11
diversification, which we like. It keeps
00:11:13
relatively low costs, which we like, but
00:11:15
it adds in customization and it adds in
00:11:17
control. We can tailor our portfolios to
00:11:20
reflect our values. Maybe if we are into
00:11:22
green energy, we avoid fossil fuel
00:11:25
stocks and we double down on clean
00:11:26
energy. So, we have our values in our
00:11:28
portfolio. And then we optimize taxes
00:11:30
through loss harvesting. And then over
00:11:33
time that tax efficiency should
00:11:35
meaningfully boost our after tax
00:11:37
returns. And it's also very transparent.
00:11:40
We see every single stock we own. So in
00:11:42
a best case scenario, direct indexing
00:11:44
delivers higher returns, lower taxes,
00:11:45
and a portfolio that perfectly reflects
00:11:47
our personal goals and beliefs. But
00:11:50
here's the pessimist's rebuke. It's that
00:11:52
direct indexing sounds revolutionary,
00:11:54
but much of the hype really has outpaced
00:11:56
reality. It's sold as better returns and
00:11:59
lower taxes and more control. But those
00:12:01
benefits really depend on active
00:12:03
management and some discipline that many
00:12:05
investors don't maintain. The tax
00:12:07
harvesting edge is something that I
00:12:09
think shrinks over time and actually can
00:12:11
disappear in rising markets just like
00:12:13
markets we've seen recently. And then
00:12:15
the customization part of direct
00:12:17
indexing leads to something called
00:12:18
tracking error which I will define in a
00:12:20
minute where your your portfolio doesn't
00:12:22
match the index at all. And while fees
00:12:25
of direct indexing have dropped, they
00:12:28
still carry significantly higher fees
00:12:29
than traditional indexing. And for many,
00:12:32
many reasons, in many cases, I should
00:12:33
say, investors would just be better off
00:12:35
sticking with plain lowcost ETFs. So,
00:12:38
let's actually dive into a little
00:12:40
example. In any given year, we know that
00:12:42
some of the 500 companies in the S&P 500
00:12:44
will be up and others will be down. A
00:12:47
direct index allows us to sell some of
00:12:49
those down companies or some of the
00:12:51
shares of the companies that are down to
00:12:53
realize those losses and then to use
00:12:55
those losses for tax minimization in
00:12:58
other areas of our financial plan while
00:13:00
still maintaining this greater skeleton
00:13:02
of the S&P 500 index. But a direct index
00:13:06
doesn't exist inside of an ETF wrapper.
00:13:08
Instead, you directly own the individual
00:13:10
stocks. And that ownership is what
00:13:12
enables our customization and and loss
00:13:14
harvesting in the first place. So that's
00:13:16
something that ETFs can't do internally,
00:13:18
but it also introduces some natural
00:13:20
inefficiencies. More trading, smaller
00:13:23
tax slots to manage, and then higher
00:13:26
transaction costs and more tracking
00:13:28
error. An ETF, though, in contrast,
00:13:31
extremely efficient. It nets out trades
00:13:33
internally. It defers capital gains out
00:13:35
to the future. So while direct indexing
00:13:37
offers flexibility and personalization,
00:13:40
it cannot fully replicate the structural
00:13:42
efficiency and simplicity of an ETF. And
00:13:44
now I've used that term tracking error a
00:13:46
couple times. Tracking error is the
00:13:48
difference between your portfolio's
00:13:50
performance and the benchmark it's
00:13:52
trying to mimic. Like in our case so
00:13:54
far, the S&P 500. Tracking error is a
00:13:57
measure of how closely or not your
00:13:59
results follow the index. And and that
00:14:02
tracking error is caused by the
00:14:04
customization choices or the trading
00:14:06
delays or the intentional realization of
00:14:08
losses along the way. And one of the
00:14:10
problems with direct indexing is that
00:14:12
the better it works at realizing tax
00:14:14
losses, the greater its tracking error
00:14:17
will be. Next thing you know, you're not
00:14:19
really going to own the S&P 500 anymore.
00:14:22
you've created a portfolio that has some
00:14:24
of the S&P 500 companies but also has
00:14:26
some holes where other S&P 5 companies
00:14:29
used to be because those are the
00:14:30
companies that had the losses that you
00:14:32
realize to make it a direct index and
00:14:35
you end up with these not huge
00:14:37
concentration risks but still an
00:14:38
accidental concentration risk where you
00:14:40
wanted to have an index instead. And
00:14:42
then last, we need to think back to the
00:14:44
previous stanza about good and bad uses
00:14:46
of tax loss harvesting on the whole.
00:14:48
Because if you're realizing losses
00:14:50
simply for the sake of realizing losses
00:14:52
and then you're somehow redeploying
00:14:54
those proceeds back into the portfolio,
00:14:57
you might not actually be changing the
00:14:58
cost basis of the portfolio, right?
00:15:00
You're just playing hot potato with a
00:15:01
cost basis, deferring capital gains out
00:15:03
to some future date. And all of these
00:15:05
are examples where we're choosing the
00:15:07
tax tail over the investing dog. And
00:15:09
that's usually, not always, but usually
00:15:11
the wrong thing to do. Direct indexing
00:15:13
at the end of the day, it's sold as this
00:15:15
mimic of the index itself, but with the
00:15:17
ability to realize more losses. And in
00:15:19
reality, I would say that we're choosing
00:15:21
to accept tracking error in exchange for
00:15:23
losses. And unless we have a smart way
00:15:26
to to utilize those losses for
00:15:28
legitimate reasons, for actual
00:15:29
investment merit, for actual financial
00:15:32
planning merit, then we never really
00:15:34
needed those losses in the first place,
00:15:36
right? Unless we're using them really
00:15:37
well. And in the example of a S&P 500
00:15:40
direct indexing, the fees might be in
00:15:42
the range of 30, 40, 50 basis points,
00:15:45
that aren't necessarily outrageous fees,
00:15:47
but they're 10 to 20 times greater than
00:15:49
the fees for a simple S&P 500 ETF. So my
00:15:53
final verdict, if you showed me, you
00:15:55
know, again, I'm I'm working here and
00:15:56
under the American tax system. If you
00:15:58
showed me a hundred typical Americans or
00:16:00
even 100 typical listeners of the show
00:16:02
who tend to be more financially
00:16:04
literate, wealthier than normal, more
00:16:06
apt to have some complexities in their
00:16:08
financial lives. Even that being said, I
00:16:11
would bet you that fewer than 10 of
00:16:13
those 100 people would be a truly good
00:16:15
fit for direct indexing. Or another way
00:16:17
of saying it, I I bet that 90 of those
00:16:19
100 people would be worse off for
00:16:21
pursuing direct indexing than if they
00:16:23
stuck with a simpler path in the first
00:16:25
place. Here's a quick ad and then we'll
00:16:27
get back to the show. Every week I send
00:16:29
a quick free email to thousands of
00:16:31
readers that shares three simple things.
00:16:34
One, my new articles and podcasts. Two,
00:16:37
the best financial content of the week
00:16:39
from all over the internet. And three, a
00:16:42
financial chart that explains some
00:16:43
important concept in the news that week.
00:16:46
It's a great primer to boost your
00:16:48
financial knowhow.
00:16:49
>> But Jesse, I don't want another email.
00:16:52
Well, this might not be for you, but I
00:16:54
do hear you, which is why I make it very
00:16:56
short, sweet, and full of only the
00:16:58
essentials. A whopping 66% of
00:17:01
subscribers read my email at least once
00:17:03
a month. They're enjoying it, and maybe
00:17:05
you will, too. You can subscribe for
00:17:08
free on the homepage at
00:17:09
bestinterest.blog.
00:17:11
Again, that's a free, no strings
00:17:13
attached subscription at
00:17:14
bestinterest.blog.
00:17:16
Thank you for that awesome question,
00:17:17
Nikki. And now on to question two from
00:17:19
Kevin Jesse. A future podcast idea. How
00:17:22
to approach financial and tax planning
00:17:23
when a couple has a lopsided retirement.
00:17:26
One spouse early, the other spouse
00:17:27
retires late. This is my fortunate
00:17:30
situation with my wife working in the
00:17:31
financial services industry, making a
00:17:33
very good living. We have always filed
00:17:35
our taxes as married filing jointly when
00:17:37
I was working. But I wonder if there
00:17:39
would be an advantage to me if we
00:17:40
changed our tax filing approach so that
00:17:42
I could benefit now that I'm in a lower
00:17:44
tax bracket if I were filing single.
00:17:46
It's a long suggestion, but I hope this
00:17:48
idea makes sense over email. Kevin, it
00:17:49
definitely makes sense. Uh, so let's
00:17:51
make sure listeners we answer both parts
00:17:53
of Kevin's question today. The first
00:17:54
part is what are some general
00:17:56
considerations for a couple who plan on
00:17:58
retiring at vastly different times. And
00:18:00
then the second is more specifics on
00:18:02
those tax thoughts whether to file
00:18:04
separately or jointly. We'll kind of
00:18:05
dive into that a little bit. Again, not
00:18:07
an accountant. This isn't tax advice per
00:18:09
se, but I've done enough tax planning to
00:18:11
to know my way around this conversation.
00:18:14
First, the general thoughts. I don't
00:18:16
want to discount the soft side of
00:18:17
retirement. So let me first point out
00:18:18
the psychological impact. There might be
00:18:20
a really big change in household
00:18:22
lifestyle when one spouse retires years
00:18:24
if not decades before the second one.
00:18:27
Most retirees face new unforeseen shifts
00:18:30
in identity, activity versus boredom,
00:18:32
social circle changes, that kind of
00:18:34
thing. And I would assume it's probably
00:18:36
uh exacerbated when the two two spouses
00:18:39
are retiring at vastly different times.
00:18:41
My first thought, Kevin, is about cash
00:18:43
flow. It's true for just about any
00:18:44
single retirement plan. when you guys go
00:18:46
down to one income, my main question
00:18:47
would be, will you now have to start
00:18:49
living off of some of your investments
00:18:51
and investment income or does your
00:18:53
wife's salary cover all the household
00:18:55
expenses? If you do have to draw on your
00:18:57
assets, Kevin, that opens up an entire
00:18:59
can of worms. The next question today
00:19:01
will be all about accumulation, so I
00:19:03
won't dive too deeply into deumulation
00:19:05
right now. I think that medical coverage
00:19:08
is another thing to be aware of. I'm
00:19:09
assuming you could probably both easily
00:19:11
and relatively cheaply go on your wife's
00:19:14
employer's coverage, but it's worth
00:19:15
knowing in advance. Let's pivot now
00:19:17
specifically to the tax question, and
00:19:19
we'll talk about the difference between
00:19:20
married filing jointly and married
00:19:22
filing separate, which I'll just call
00:19:24
joint and separate to be clear. The vast
00:19:27
majority of the time, filing jointly is
00:19:29
going to be better than filing
00:19:30
separately. It's only beneficial to file
00:19:33
separately in a few specific
00:19:34
circumstances. Namely, those are
00:19:36
circumstances in life where maybe you
00:19:39
can't trust or you can't get along with
00:19:41
or you can't contact your spouse in some
00:19:43
cases where your spouse owes back child
00:19:46
support. Maybe if you have to file a
00:19:48
state return and it comes out better
00:19:50
filing separately than jointly. And also
00:19:53
the state requires you to match your
00:19:54
federal filing status. That can happen.
00:19:56
And then there are certain student loan
00:19:58
and other kind of federal loan repayment
00:20:00
situations where filing separately makes
00:20:03
more sense than filing jointly. They
00:20:04
really are a corner cases. In general,
00:20:07
Kevin, it does not make sense for
00:20:09
retirees to file separately. Even in
00:20:11
your situation, filing jointly means
00:20:14
that the higher earnner can essentially
00:20:16
use the unused space from the lower
00:20:18
earners lower tax brackets. Filing
00:20:21
separately disqualifies you from that
00:20:23
idea. It also disqualifies you from a
00:20:26
variety of credits and deductions. Also,
00:20:28
if one spouse itemizes deductions, the
00:20:31
other spouse is required to also itemize
00:20:33
deductions and cannot take the standard
00:20:34
deduction, which would probably hurt in
00:20:36
your situation. Filing jointly usually
00:20:39
has lower tax brackets and rates,
00:20:41
allowing more income to be taxed at
00:20:43
lower rates. Filing separately, rates
00:20:45
are generally higher at lower income
00:20:47
levels, meaning you often pay more tax.
00:20:49
I'll just use a round number, Kevin, in
00:20:51
your situation. Let's say that your
00:20:52
wife, your spouse, earns $300,000.
00:20:55
Kevin, I'll assume no other income just
00:20:57
to make it easy. No interest, no
00:20:58
dividends, just $300,000 of W2 income.
00:21:01
If you file separately, the tax on that
00:21:04
income would be $69,000 and change. If
00:21:07
you file jointly, the tax would be
00:21:09
$50,000 and change, a full $19,000 less
00:21:13
in federal taxes. Now, to your point,
00:21:16
Kevin, maybe you're in early retirement.
00:21:18
So, what if you, Kevin, are trying to do
00:21:19
Roth conversions? So, what if you now
00:21:21
have your wife's $300,000 plus $100,000
00:21:24
in your Roth conversions? The income is
00:21:27
Kevin's wife's. The Roth conversion is
00:21:30
Kevin's. If they file separately, those
00:21:32
burdens would be separated out. So, if
00:21:35
you do file separately, the two taxes
00:21:37
would be 69,000 and change, the same as
00:21:39
we just discussed for the W2 income. And
00:21:41
then on your Roth conversion, Kevin,
00:21:43
would be 13,600 for a grand total just
00:21:46
shy of $83,000 in taxes. If you file
00:21:50
jointly, the combined tax would be
00:21:52
74,000 and change. 83,000 versus 74,000.
00:21:56
These numbers are closer than the first
00:21:57
situation, but married filing jointly
00:22:00
still makes sense. The difference in
00:22:02
standard deduction is another important
00:22:03
difference here. Filing jointly for a
00:22:06
couple under the age of 65. Here in
00:22:08
2025, you would get $27,700
00:22:12
in deduction. And if you file
00:22:14
separately, you each get half of that
00:22:15
amount. You each get $13,850.
00:22:18
But Kevin, if your income in retirement
00:22:20
is extremely low, it might mean that
00:22:22
some of your standard deduction
00:22:24
essentially goes unused, which is
00:22:26
another reason to file jointly so that
00:22:27
your high earning wife can use the
00:22:29
entire the entirety, I should say, of
00:22:31
both your standard deductions. I
00:22:34
mentioned earlier that credits can
00:22:35
change. So, when you file jointly, you
00:22:38
basically get to claim all of the
00:22:40
standard credits, the earned income tax
00:22:42
credit, child tax credit, education
00:22:44
credits. When you file separately, many
00:22:46
of those credits are disallowed. There's
00:22:48
some other ones worth knowing, too.
00:22:50
There's issues when you file separately
00:22:51
about itemizing deductions. There are
00:22:54
much much lower phase outs for IRA
00:22:57
deduction limits. There are much much
00:22:58
lower phase outs for Roth IRA
00:23:00
contribution limits. There's usually uh
00:23:04
higher social security taxation. And and
00:23:06
then there really are only a few corner
00:23:08
cases where filing separately makes
00:23:10
sense. The student loan repayment corner
00:23:12
case is one which if you're interested
00:23:14
you can kind of Google some examples of
00:23:16
that and then I would say the liability
00:23:18
issue is the other one where if you file
00:23:20
jointly both spouses are jointly liable
00:23:23
for any underpayment or adjustments
00:23:25
whereas if you file separately each
00:23:27
spouse is only responsible for their own
00:23:29
return which in situations where your
00:23:32
spouse is separated or you don't trust
00:23:34
your spouse can protect you if from from
00:23:36
your spouse essentially making a mistake
00:23:38
on their tax return. So, in short,
00:23:40
Kevin, I think there are rarely any
00:23:42
cases where married filing separately
00:23:43
makes sense, even in a case where you're
00:23:45
retiring a decade before your spouse.
00:23:48
But, as always, something I would
00:23:49
encourage you to do is there are some
00:23:51
1040 calculators on online. I use one on
00:23:54
the guidest website, the Guideste 1040
00:23:57
calculator, and I'd encourage you plug
00:23:59
some numbers into the 1040 calculator,
00:24:01
change the filing status from joint to
00:24:02
separate, and just see in your situation
00:24:04
if it makes sense or not. So, thank you,
00:24:06
Kevin, for that great question. And now
00:24:07
on to question three from Isaac. Isaac
00:24:09
said, "If you were to dedicate a whole
00:24:11
episode to one topic for me, the most
00:24:13
useful topic would be on the ins and
00:24:14
outs of deaccumulation in retirement.
00:24:16
I'm hoping to retire in a couple years,
00:24:18
so this would be really helpful. I know
00:24:20
hiring a financial planner is one
00:24:21
option, but what about for the DIY
00:24:23
folks? It looks like annual withdrawals
00:24:25
would be the easiest way to approach
00:24:26
this and would really like your
00:24:27
thoughts. Bill Ben's 4% rule, I believe,
00:24:30
is based on a 30-year retirement, but
00:24:32
what would be the good draw down rate
00:24:33
for someone retiring at 55? I know a
00:24:36
fixed withdrawal amount doesn't make a
00:24:37
lot of sense. However, it would be good
00:24:39
to know what appropriate draw down rate
00:24:41
would be as a reference point. Yeah, I
00:24:43
think it's easiest, Isaac, to start
00:24:45
tackling the second part of your
00:24:47
question first and to answer it
00:24:49
relatively subjectively, at least right
00:24:51
now, because there's been a ton of
00:24:53
really good work, extremely good
00:24:55
articles and podcast content and YouTube
00:24:57
videos, depending on what you're if
00:24:59
you're listening to a podcast, maybe you
00:25:01
like listening to podcasts. So, so I'll
00:25:02
start with that one. But there's there
00:25:03
have been so much good content uh over
00:25:05
recent years about the good, bad, and
00:25:08
ugly of the 4% rule, whether the 4% rule
00:25:10
is still valid, whether it should be
00:25:11
more like the 4.7 or the 5% rule,
00:25:14
misunderstandings of what the 4% rule is
00:25:16
even based on in the first place. And
00:25:18
then to your point, Isaac, the fact that
00:25:21
the 4% rule shouldn't be static, the
00:25:23
fact that it should be dynamic, and how
00:25:25
exactly is it dynamic? Do we use some
00:25:28
sort of guardrails approach? Do we just
00:25:30
accept the fact that there's variable
00:25:32
spending in retirement and then try to
00:25:33
plan that spending as best we can and
00:25:35
then run a Monte Carlo analysis on that
00:25:37
spending to see how it would survive
00:25:39
over 25, 30, 40 years or more. You can
00:25:42
try all these things and and they all
00:25:44
have merit to them. But I think at the
00:25:46
end of the day, the point is that for
00:25:48
any 55year-old, in your case, Isaac, to
00:25:51
look at their portfolio, let's say it's
00:25:53
got a million dollars in it to keep it
00:25:54
easy, and to say, "Yeah, I'm going to
00:25:57
spend $40,000 here in year 1, 4%. I'm
00:25:59
going to spend $40,000 exactly. And then
00:26:02
in year two of retirement, I'm going to
00:26:03
adjust that up for inflation." So 40,000
00:26:06
becomes, you know, 41,500, something
00:26:09
like that. And that's exactly what I'm
00:26:10
going to spend in year two. on and on
00:26:12
and on to have that rigid of a structure
00:26:14
of spending. We just know that's
00:26:16
unrealistic. And so rather than doing
00:26:18
that, I think the much smarter way and
00:26:20
and the way that I usually approach it
00:26:21
myself involves using some financial
00:26:24
planning software, estimating as best we
00:26:27
can what our cash flows will look like
00:26:29
at least over the coming 5, 7, 10, 15
00:26:33
years. I mean, most of us can make
00:26:35
pretty reasonable assumptions on that. I
00:26:37
know we don't know how inflation will
00:26:38
affect us, but we can look at our lives.
00:26:41
We can look at maybe our children. We
00:26:43
can look at big events coming up and we
00:26:45
might know when we have college payments
00:26:47
due. We might be able to just pencil in
00:26:50
when we're going to contribute to a
00:26:51
child's wedding or something like that.
00:26:53
And then we know our lifestyle costs.
00:26:55
And so we can look out and we can even
00:26:57
build in some lumpy costs intentionally.
00:26:59
We can say, I assume every 3 years I'm
00:27:01
going to have this extraordinary cost
00:27:03
that's $15,000.
00:27:05
The point is that we can build out a a
00:27:07
cash flow in a way that um more
00:27:10
resembles reality, isn't static, but has
00:27:12
a little dynamism to it. And then we can
00:27:15
run a Monte Carlo analysis on that.
00:27:18
There's some really cool guardrails
00:27:19
approaches out there that exist that
00:27:21
basically say at any given time using
00:27:24
some sort of historical back test, I
00:27:27
want to have an 80 or 90 or 95% chance
00:27:31
of retirement success or maybe even
00:27:33
lower, maybe a 60% chance of retirement
00:27:35
success. It's really in the eye of the
00:27:37
beholder. It's up to you as the one
00:27:38
who's deciding to pull the retirement
00:27:40
trigger how you want to approach it. But
00:27:42
the point is that you can adjust your
00:27:43
withdrawals over time such that when
00:27:46
times are good, in order to have your
00:27:48
90% chance of success, you can actually
00:27:50
increase your spending. And then when
00:27:52
times are bad, in order to maintain that
00:27:54
90% chance of success, you have to
00:27:56
throttle down your spending. It builds
00:27:58
dynamism into it. Dynamism though in
00:28:01
that case isn't necessarily based on
00:28:03
what you want to do with your money in
00:28:05
that particular year. Instead, the
00:28:07
dynamism is a function of how is the
00:28:09
market performing and how much have I
00:28:10
withdrawn before. You know, in other
00:28:12
words, there might be some times using
00:28:14
those guardrail strategies where you've
00:28:16
been planning this trip to Europe for 3
00:28:18
years and you have every single detail
00:28:21
pencled into your notebook and yet
00:28:24
because the market happened to drop 20%
00:28:26
6 months ago, your guardrail strategy
00:28:28
informs you that you can no longer
00:28:30
afford that trip. So my point is that
00:28:33
you know there's gives and there's pros
00:28:34
and cons and gives and takes I suppose
00:28:36
that do you want the market to dictate
00:28:38
exactly what you spend at all times.
00:28:41
Maybe I'm not explaining that perfectly.
00:28:42
Maybe I'm I'm being a little overly
00:28:44
critical of guardrail strategy cuz I I
00:28:46
do think the guardrail strategy is
00:28:47
really interesting, really smart
00:28:49
actually. It's just a matter of whenever
00:28:51
we do financial planning, we have to
00:28:52
accept certain risks. And one of the
00:28:55
things we have to accept from a
00:28:56
guardrail strategy is that the strategy
00:28:59
itself and the returns that the market
00:29:02
gives us might at times throttle down
00:29:04
our spending when we've been hoping to
00:29:07
spend more and and that's just something
00:29:09
we have to accept. So now that's my
00:29:11
subjective answer to Benan's 4% rule to
00:29:15
altering it to live a more dynamic
00:29:17
retirement to live a retirement that is
00:29:19
fewer than 30 years or more than 30
00:29:21
years to avoid the fixed withdrawal
00:29:23
amount. So that that's where I'd start
00:29:26
that answer Isaac and I'd encourage you
00:29:27
to go out and and check out some of the
00:29:29
resources that I kind of referred to
00:29:30
there. Now, when it comes to the actual
00:29:34
retirement order of operations,
00:29:35
retirement withdrawal order of
00:29:37
operations, I'm going to throw a link in
00:29:39
the show notes to an article I wrote in
00:29:40
June. The article is titled Your
00:29:42
Retirement Withdrawal Order of
00:29:44
Operations. It is a long and and kind of
00:29:47
deep article. And one thing I' I'd point
00:29:49
out about this article, it's not a light
00:29:51
read, but I encourage you to read it
00:29:53
nonetheless. I think it's a very deep
00:29:54
and and good read. And what I've done in
00:29:56
there too is I've linked to a bunch of
00:29:58
other helpful deaccumulation articles
00:30:01
like how much can you safely withdraw
00:30:03
from your portfolio each year, how
00:30:05
should you tax optimize, where your
00:30:07
assets live, what assets should you own,
00:30:10
how much risk should you take, how do
00:30:11
you design a good portfolio, questions
00:30:14
like that. But enough preamble. Let's
00:30:17
start with the foundational concepts of
00:30:18
retirement withdrawals. The core of
00:30:21
retirement withdrawals, usually we have
00:30:23
one of the following goals. We want to
00:30:26
maximize our after tax lifetime income.
00:30:29
We want to ensure we can always spend
00:30:31
what we want to spend and we want to
00:30:34
ensure that we can give in life or in
00:30:36
death to people or causes that we care
00:30:38
about. And no matter that personal goal,
00:30:41
it's essential to understand among many
00:30:43
other things some of these following
00:30:45
aspects of your situation. And we'll
00:30:47
dive into each of these as over the next
00:30:49
few minutes. We need to understand
00:30:51
investment longevity requirements. We
00:30:54
need to understand how to minimize
00:30:56
market and longevity risk, tax
00:30:58
efficiency, the various tax status of
00:31:00
our accounts, our income needs and our
00:31:02
lifestyle goals, required minimum
00:31:04
distributions, Medicare IMA brackets,
00:31:07
ACA subsidy cliffs if we're retiring
00:31:09
before 65, and legacy or charitable
00:31:12
goals among some other things. So, those
00:31:14
are some of the keys that we that we
00:31:16
need to follow. But first, let's start
00:31:18
with the standard withdrawal order of
00:31:20
operations. My metaphor, my analogy
00:31:23
here, maybe it's not the best one, but
00:31:25
imagine we're sitting inside of an
00:31:26
auditorium. And in the auditorium, it's
00:31:28
kind of like one of the kind of classic
00:31:30
concert halls. And there are a lot of
00:31:32
these doors on the side. There's some
00:31:34
doors behind the stage. There are many,
00:31:35
many side rooms in this auditorium. So,
00:31:38
when you walk into the back of the
00:31:39
auditorium, you can look around and you
00:31:41
get a really solid overview of the space
00:31:43
that you've just stepped into into this
00:31:44
large hall. You see the size, you see
00:31:46
the seating, you see the stage, you see
00:31:48
all the main aspects, but from where you
00:31:51
are in the back of the auditorium, you
00:31:53
can't really look into all the little
00:31:54
side doors and side rooms. If you want
00:31:57
100% understanding, you need to spend
00:31:59
some time exploring each of those small
00:32:01
rooms. And I think the retirement
00:32:03
withdrawal landscape is kind of similar
00:32:05
to that. So over this time over the next
00:32:08
few minutes I'm going to describe the
00:32:10
large auditorium of retirement
00:32:12
withdrawals and I'm going to provide a
00:32:13
solid overview of that space and I'm
00:32:15
going to allude to many of the small
00:32:17
side rooms and maybe even peek inside a
00:32:19
few of them. So I think most of you are
00:32:21
going to walk away with this adequate
00:32:22
lay of the land and quite a few of you
00:32:24
in fact will walk away with enough
00:32:26
information to probably completely plan
00:32:28
your retirement withdrawal strategy. the
00:32:30
rest of you at least will feel
00:32:31
comfortable, but maybe you'll want a
00:32:33
little bit more details about the
00:32:34
specific side rooms that apply to you.
00:32:37
Here's a quick ad and then we'll get
00:32:38
back to the show. I still remember it
00:32:40
was 2019 and a guy from Fidelity came in
00:32:43
to speak to my then employer about
00:32:45
personal finance in general and about
00:32:46
our 401k plan in particular. There were
00:32:49
60 or so of us who attended, mostly 50
00:32:52
plus years old, clearly with retirement
00:32:54
on their minds. And nothing against this
00:32:56
individual from Fidelity, but
00:32:58
unfortunately the guy just didn't really
00:32:59
know what he was talking about. It ended
00:33:01
up being a major disappointment. And a
00:33:03
bunch of my colleagues afterwards said,
00:33:04
in short, you know, man, we're really
00:33:06
thirsty for good financial retirement
00:33:08
information. Where do we go find it?
00:33:11
Now, does that sound true listeners for
00:33:13
you and your colleagues? Last year,
00:33:15
either in person or via Zoom, I spoke to
00:33:17
about 800 employees at 11 different
00:33:20
organizations. sometimes about personal
00:33:22
finance in general, sometimes about
00:33:23
specifics of their retirement plans,
00:33:25
sometimes about the the nitty-gritty
00:33:27
details of social security and
00:33:28
withdrawal planning and retirement math.
00:33:30
The point being, if you're interested in
00:33:32
inviting me to come talk money to you,
00:33:35
to your colleagues, where you work, that
00:33:37
is absolutely something I'm interested
00:33:38
in talking to you about. Simply drop me
00:33:40
an email to [email protected]
00:33:43
and let's start a conversation. So,
00:33:45
let's talk about that large auditorium,
00:33:47
the standard withdrawal order of
00:33:49
operations. What follows are rules of
00:33:51
thumb, not laws. You know, they're
00:33:52
rooted in in logic and tax math. At its
00:33:56
core, this particular framework is about
00:33:58
maximizing after tax income over your
00:34:00
retirement years. And if I neglect to
00:34:03
say it, I want you to continually
00:34:05
imagine the phrase if you still need
00:34:07
money. And so, this might go without
00:34:08
saying, but if you don't need the money,
00:34:10
you shouldn't withdraw anything. You
00:34:12
should allow your portfolio to continue
00:34:13
to compound. But rather than say if you
00:34:15
still need money a million times over
00:34:17
the next five minutes, please imagine
00:34:19
it's there. So in the order of
00:34:21
operations here, taxable accounts come
00:34:23
first. You should first withdraw money
00:34:25
from your taxable accounts. If you have
00:34:27
extra cash in your bank account that is
00:34:29
extra beyond your emergency fund, spend
00:34:31
that first in retirement. It's a
00:34:33
no-brainer. Next, you want to tap into
00:34:35
the interest and dividends that might
00:34:37
have acred in your taxable brokerage
00:34:38
investing account. You're going to be
00:34:40
taxed on that money anyway in the year
00:34:42
that it's been paid out to you. It's
00:34:43
better to use that money on your monthly
00:34:45
spending needs than reinvest it and
00:34:47
realize other taxable income elsewhere.
00:34:50
Typically, though not always, and this
00:34:52
is why this is one of those small
00:34:53
sidearms. So, typically, though not
00:34:54
always, you should next realize capital
00:34:57
gains in your taxable account. Long-term
00:35:00
capital gains have preferential tax
00:35:02
treatment compared to normal income. And
00:35:04
when I say normal income, one example of
00:35:06
that would be withdrawals from
00:35:08
traditional retirement accounts.
00:35:10
Traditional tax deferred retirement
00:35:11
accounts come out as normal income.
00:35:14
You'd rather realize long-term capital
00:35:16
gains than realize normal income.
00:35:18
Selling from a taxable account also
00:35:20
creates cost basis flexibility. You can
00:35:22
choose which lots to sell. You can
00:35:24
manage gains and losses to control your
00:35:26
taxes. In some cases, you can realize
00:35:28
capital gains, maybe even at a 0% tax
00:35:30
rate in years with little to no other
00:35:32
income. Not bad. After you've realized
00:35:35
taxable accounts first, tax deferred
00:35:38
accounts come next. traditional 401k and
00:35:40
IRA accounts. These are accounts where
00:35:42
you haven't paid a lick of tax yet, but
00:35:45
each dollar you withdraw will be treated
00:35:46
again as income and therefore subject to
00:35:48
income taxes. Ideally though, you won't
00:35:51
touch these accounts until after age 59
00:35:53
and a half. Though, here's another small
00:35:55
side room. There are interesting
00:35:57
workarounds to this age limit such as
00:35:59
72T substantially equal periodic
00:36:02
payments or SEP. The rule of 55 is
00:36:05
another one which applies to I believe
00:36:08
it's 401k accounts. If you retire from
00:36:11
an employer when you are 55 years old or
00:36:13
later, you can pull money out of those
00:36:15
401k accounts without paying any sort of
00:36:18
early withdrawal penalties. So these
00:36:20
withdrawals out of your traditional IRA
00:36:21
accounts are taxable as income and they
00:36:23
will affect other parts of your
00:36:25
financial plan such as your marginal tax
00:36:27
bracket, social security taxation,
00:36:29
Medicare, Irma brackets. Nevertheless,
00:36:31
starting with withdrawals from tax
00:36:33
deferred traditional accounts from an
00:36:35
earlier age can be a smart thing to do.
00:36:37
Doing so helps mitigate larger RMDs in
00:36:41
the future that might push you into
00:36:43
higher tax brackets or affect your
00:36:44
Medicare premiums. Roth conversions can
00:36:47
certainly accomplish the same exact
00:36:48
goal. Although the converted dollars
00:36:50
don't end up as spendable money usually,
00:36:53
I mean, they go into your Roth IRA and
00:36:55
you might not want to immediately spend
00:36:56
them out of your Roth IRA. Something
00:36:59
called bracket stuffing is a pretty
00:37:01
common tactic here too. Not to be
00:37:03
confused with the Thanksgiving dish
00:37:04
depending on when this uh episode comes
00:37:06
out, but bracket stuffing describes the
00:37:08
process of intentionally taking tax
00:37:11
deferred withdrawals or more commonly
00:37:13
using Roth conversions to stuff your
00:37:16
particular tax bracket until it's quote
00:37:18
unquote full of income before getting
00:37:20
pushed into a higher bracket. The goal
00:37:23
is to maximize or to fill your lower tax
00:37:26
brackets every single year, especially
00:37:28
again if high large RMDs are somewhere
00:37:30
in your future. The caveats here are to
00:37:33
ensure that you have enough cash on hand
00:37:34
to pay your taxes, to be wary of Irma
00:37:37
territory if you're already of Medicare
00:37:39
age, to understand how your social
00:37:41
security taxation might be affected. I
00:37:43
can't recommend this enough. you or a
00:37:45
professional you hire should understand
00:37:47
enough about the federal 1040 tax return
00:37:50
to at least lightly dig into your
00:37:52
specific tax scenario. Again, I'll link
00:37:54
in the show notes the Guidest 1040 tax
00:37:57
calculator. The reason why I'm talking
00:37:59
about it right now is cuz it's free and
00:38:00
it's easy. It's certainly not a
00:38:02
professional tax planning software, but
00:38:05
it's a free easy Googleable 1040 tax
00:38:08
calculator that at least it's enough
00:38:10
that to be dangerous. It's enough to
00:38:12
know if you're if you're kind of walking
00:38:13
into murky waters. And then last in this
00:38:16
order of operations are tax-free
00:38:18
accounts. Roth and HSA accounts. Taxfree
00:38:21
accounts are the holy grail of
00:38:22
retirement planning. No, they don't
00:38:24
provide eternal life. But perhaps a
00:38:26
better metaphor is like a joker or a
00:38:27
wild card. In a tight tax bind, you can
00:38:30
withdraw money from Roth accounts or in
00:38:33
the case of HSA for qualified purposes
00:38:35
for medical purposes with zero tax
00:38:37
consequence. And so why do we want to
00:38:39
save them for last? I mean, they are
00:38:41
your MVCs, not MVPs, but MVCs. They are
00:38:44
your most valuable compounders. Unlike
00:38:47
your dollars that compound with capital
00:38:48
gains taxes attached to them or your
00:38:50
dollars in tax deferred accounts that
00:38:53
compound with an income tax attached, a
00:38:55
Roth or an HSA dollar compound tax-free.
00:38:59
Second, they're not subject to RMDs. You
00:39:01
can let them compound forever. Third,
00:39:03
your Roth dollars are ideal for legacy
00:39:05
giving and estate planning. Your heirs
00:39:07
can inherit those Roth assets. let them
00:39:09
continue compounding and then withdraw
00:39:11
them after 10 years without any tax
00:39:13
consequence. So again, that's the
00:39:14
10-year rule of an inherited IRA. And
00:39:16
I'll say this idea of leaving these
00:39:19
tax-free assets to heirs, very good for
00:39:21
Roth. This idea does not apply to HSA
00:39:25
dollars. You can do what you want, but I
00:39:27
would not recommend that you leave HSA
00:39:29
dollars to a non-spouse heir. And we'll
00:39:32
discuss the reason why later. And last,
00:39:34
when it comes to HSAs and Roths, these
00:39:36
dollars provide a lot of tax flexibility
00:39:39
later in life when RMDs and andor Irma
00:39:41
sir charges can become bigger concerns.
00:39:44
Again, not always, but they can become a
00:39:45
bigger concern. So, imagine an
00:39:48
additional surprise expense pops up in
00:39:49
your late7s. You already have medium to
00:39:52
high RMD income, and to cover your
00:39:54
unexpected need, you might have to
00:39:57
realize capital gains at 15 or 20% tax
00:40:00
plus the 3.8% NII tax. Or you might have
00:40:03
to realize income at 24 or 32% or higher
00:40:07
tax plus state tax. Or you could just
00:40:10
withdraw some money out of your Roth
00:40:12
accounts taxfree. That's a pretty nice
00:40:14
safety battle to have at all points
00:40:16
throughout your retirement. So Roth
00:40:18
dollars and HSA dollars should generally
00:40:20
be the last dollars you withdraw. And
00:40:23
that's the auditorium. That's the big
00:40:24
room that we've just walked into.
00:40:26
taxable accounts first, especially with
00:40:28
the cash you already have and with the
00:40:30
cash that's foisted upon you from
00:40:32
interest and dividends, tax deferred
00:40:34
accounts next, mainly because you don't
00:40:36
mind realizing some taxes at lower rates
00:40:39
and you'd rather not touch your Roth
00:40:40
accounts too soon. And then tax-free
00:40:42
accounts last because these are your
00:40:44
MVCs, your most valuable compounders.
00:40:46
And this is the starting point. We
00:40:48
haven't explored the small rooms yet. As
00:40:50
your retirement unfolds, many other
00:40:52
scenarios can affect when and how to
00:40:54
tweak that order. The first side room
00:40:57
we'll explore involves Roth conversions
00:40:59
and tax bracket management. I've written
00:41:01
extensively on these topics before. I
00:41:02
recommend you start with the previous
00:41:04
articles I've written. Should you
00:41:06
consider Roth conversions and the
00:41:07
powerful benefits of Roth conversions?
00:41:09
These links again are in the article.
00:41:12
The article is in the show notes,
00:41:13
retirement withdrawal, order of
00:41:14
operations. The critical details though
00:41:16
are that we want to use our early
00:41:18
retirement years for Roth conversions.
00:41:20
Usually these years tend to be lower
00:41:22
income and you'll typically be premd.
00:41:24
You might not have started social
00:41:25
security. Even those lowinccome years
00:41:28
can be used to intentionally and
00:41:29
artificially realize income in lower tax
00:41:32
brackets by converting dollars from our
00:41:34
tax deferred accounts into our tax-free
00:41:36
accounts accomplishing the very bracket
00:41:38
stuffing that we described before. Now
00:41:40
is that a guaranteed smart tax move?
00:41:43
Well, we each have to make a judgment
00:41:44
call. How do we feel about today's known
00:41:47
tax brackets versus tomorrow's uncertain
00:41:49
tax brackets? It's not always an easy
00:41:52
wager, but if we feel comfortable that
00:41:54
taxes will remain stable or increase,
00:41:56
then Roth conversions are a smart move.
00:41:58
The goal is to avoid these nasty future
00:42:00
tax scenarios, kind of like the unholy
00:42:03
interference of RMDs and Social
00:42:04
Security. In retirement, these extra
00:42:07
dollars of income that you realize don't
00:42:09
just create their own tax bill, but they
00:42:11
can also pull more of other earnings
00:42:13
into the taxable column. So the goal
00:42:15
here is to utilize the tax base that you
00:42:18
can smartly and to simply add more into
00:42:20
your most valuable compounders on the
00:42:22
balance sheet. So the next side room I
00:42:25
want to explore is when and how to break
00:42:26
our standard order of operations here.
00:42:28
And the first reason why is to fill gaps
00:42:30
with Roth withdrawals. So in general,
00:42:33
again, your plan should be measured in
00:42:35
decades. We want to think far ahead. And
00:42:38
after looking far into the future, you
00:42:39
might realize that you'll pay high
00:42:41
marginal taxes during your early
00:42:43
retirement years. And that might stick
00:42:45
out like a sore thumb compared to the
00:42:47
rest of your plan. So instead of paying
00:42:49
those high marginal taxes, you might
00:42:51
want to fill the gap with early Roth
00:42:53
withdrawals. So again, rather than
00:42:55
realizing capital gains at a 20% plus
00:42:58
38.8% 8% NIIT tax. Rather than
00:43:02
withdrawing from uh traditional tax
00:43:04
deferred accounts at 32% at the federal
00:43:06
level and 7% at the state level, maybe
00:43:09
you just make a simple Roth withdrawal
00:43:11
with no tax consequence. The same
00:43:14
strategy can manage Irma cost or ACA
00:43:17
subsidies or other income cliffs. And
00:43:19
when I say cliff, what I mean is that
00:43:21
most tax rules have a gentle slope to
00:43:24
them such that, you know, being $1 over
00:43:27
a certain limit doesn't punish you
00:43:29
immensely. But other tax rules have a
00:43:31
cliff where if you're $1 on the wrong
00:43:33
side of that cliff, you fall all the way
00:43:35
down. And usually tax cliffs are, in my
00:43:38
opinion, stupid where, you know, going
00:43:40
just $1 over can result in thousands of
00:43:43
dollars of extra cost or penalties. And
00:43:45
so if you need $500 more in a particular
00:43:48
year and withdrawing five that $500 from
00:43:51
a traditional IRA would push you into
00:43:53
the next Irma bracket into that cliff,
00:43:55
well stop. You can make a strategic
00:43:57
tax-free withdrawal from a Roth account
00:44:00
instead and avoid falling off that
00:44:02
cliff. I think another potential uh
00:44:04
reason to break some of the standard
00:44:07
order of operations is to look at the
00:44:09
cost basis in your taxable accounts and
00:44:11
realize strategic opportunities for tax
00:44:14
loss or tax gain harvesting. Again, we
00:44:16
already talked about tax loss harvesting
00:44:18
today. I won't go into that. Tax gain
00:44:20
harvesting is when we can sell an
00:44:22
appreciated investment and realize the
00:44:24
gains intentionally realizing those
00:44:26
gains while we're in a low tax bracket,
00:44:28
often resulting in little or no tax
00:44:30
owed. you know that opens up other
00:44:32
strategic doors in this auditorium and
00:44:34
it's interesting where different
00:44:36
strategies can take precedence in in
00:44:38
different years. So in some years tax
00:44:40
loss harvesting might open up an
00:44:42
opportunity for extra Roth conversions
00:44:44
in other years tax gain harvesting might
00:44:47
be smarter than pursuing those extra
00:44:50
Roth conversions. And if you're
00:44:51
interested I did write a pretty
00:44:53
comprehensive article about when and how
00:44:56
to choose Roth conversions over tax gain
00:44:58
harvesting and vice versa. We can link
00:45:00
that in the show notes. But taxable cost
00:45:02
basis is a pretty funny thing because
00:45:04
any sort of tax loss or tax gain or
00:45:07
capital gains minimization strategy
00:45:09
highly depends on your age. And not to
00:45:11
be crass here, but costbasis
00:45:13
optimization basically becomes a moot
00:45:15
point when you die. Your heirs are going
00:45:17
to inherit your taxable assets at a
00:45:19
stepped up basis. So if you're 60 years
00:45:21
old and healthy and considering the side
00:45:24
room of cost basis manipulation and
00:45:26
optimization, good for you. Go for it.
00:45:29
If you're 85 and you're in a nursing
00:45:30
home and you're taking a hard look in
00:45:32
the mirror, well, you might not want to
00:45:33
do any of this stuff in your taxable
00:45:35
account. On that note, another side room
00:45:37
we can explore is optimizing for post
00:45:40
death. So, it's worth asking yourself,
00:45:42
will I be leaving money to heirs after I
00:45:44
die? And if I am, how do I do that
00:45:46
optimally? Leaving money to your spouse
00:45:49
differs drastically from leaving money
00:45:51
to every any other person in your life.
00:45:53
Leaving money to charity has special
00:45:55
rules about it. Some accounts are much
00:45:57
better going to charity than others. And
00:45:59
if you're giving to charity while you're
00:46:00
alive, there are really smart and really
00:46:02
dumb ways that you should be doing that,
00:46:03
too. Leaving money to high earning heirs
00:46:06
should be fundamentally different than
00:46:08
leaving money to low earning heirs
00:46:10
because their tax situations can affect
00:46:12
the benefit or the annoyance of your
00:46:14
bequest to them. So, leaving money after
00:46:16
your death is another important side
00:46:18
room when it comes to optimal retirement
00:46:20
withdrawal strategies. Next, I want to
00:46:23
talk about the role of social security
00:46:24
timing. When designing someone's
00:46:26
retirement paycheck, we generally think
00:46:27
about fixed income sources first. We
00:46:30
want to understand your social security
00:46:31
income before determining your
00:46:33
withdrawal order of operations. But I
00:46:35
still wanted to touch on a few key
00:46:37
points today. Perhaps the biggest
00:46:38
question is when should I start taking
00:46:40
social security? So rather than
00:46:41
reinventing the wheel, I suggest you
00:46:43
read my article titled when should I
00:46:45
take social security? The key takeaways
00:46:47
are that social security can and in some
00:46:50
cases should be a pressure release valve
00:46:52
on your portfolio withdrawals, but
00:46:54
delaying social security can be a very
00:46:57
important door in your withdrawal
00:46:58
strategy. Namely, it increases
00:47:01
opportunities for Roth conversions and
00:47:03
provides longevity insurance. Social
00:47:05
Security taxability is another important
00:47:07
topic. It's worth knowing how other
00:47:09
retirement income may affect your Social
00:47:11
Security taxation. I recently wrote an
00:47:13
article about spousal benefits, survivor
00:47:15
benefits, and even divorce a benefits.
00:47:18
We'll link that in the show notes, but
00:47:19
it's really important to understand how
00:47:21
to optimize or maximize the different
00:47:23
spousal and survivor benefits that you
00:47:25
might receive. Okay, I've got a couple
00:47:27
more side doors. The first one is when
00:47:29
people ask, well, what about my HSA
00:47:30
account, my annuities, my pensions, etc.
00:47:33
So, HSA accounts, health savings
00:47:35
accounts are highly valuable. Again,
00:47:36
they're somewhat like Roth dollars. When
00:47:38
used for medical expenses, HSA dollars
00:47:40
are tax-free, most valuable compounders.
00:47:43
But what happens if your HSA is too big
00:47:45
such that you might never spend it? So,
00:47:47
first we should answer, what happens if
00:47:49
you die with HSA assets? If you leave
00:47:51
the HSA account to your spouse, the
00:47:53
account effectively becomes their HSA
00:47:55
with all the excellent tax-free benefits
00:47:57
for them. But if your spouse has passed
00:47:59
or you simply want to leave the HSA to
00:48:01
another person, then the entire account
00:48:03
becomes taxable income to that
00:48:05
beneficiary in the year of your death.
00:48:08
Ouch. So that is not an ideal outcome.
00:48:10
You've taken your most valuable
00:48:12
compounders and you've basically given
00:48:15
it away entirely as taxable income all
00:48:18
in one year. For that reason, it's worth
00:48:20
considering a second option. If your HSA
00:48:22
is too big and you might never spend it,
00:48:24
do you have another option? Yes.
00:48:26
Starting at age 65, you can essentially
00:48:29
utilize HSA dollars as if they were in a
00:48:31
traditional IRA. You can spend that
00:48:33
money on anything, not just on medical
00:48:35
expenses. Those withdrawals, though,
00:48:37
will be treated as taxable income, no
00:48:39
longer as tax-free income. So, there's a
00:48:41
trade-off there. The best choice in my
00:48:44
opinion would be find health related
00:48:46
reasons to to spend that money on or
00:48:49
even better when you're younger is to
00:48:51
start tracking your medical spending and
00:48:53
at some point in life start paying
00:48:55
yourself back out of that HSA account
00:48:57
which you can always do again if this is
00:48:59
your first time hearing this quick
00:49:00
little aside. You can save receipts. I
00:49:03
could have saved a receipt from 2012
00:49:06
and built my HSA over years and years
00:49:08
and years to wherever it is now. And
00:49:10
here in 2025, I can pull out that
00:49:12
receipt from 2012 for, you know, $111
00:49:16
for a checkup and I can reimburse myself
00:49:19
today using my HSA for a receipt that's
00:49:22
13 years old. Or another way of putting
00:49:24
it is as a retiree, right, you could
00:49:26
have tens of thousands, if not hundreds
00:49:28
of thousands of medical receipts over
00:49:31
the past 40 years of your life that you
00:49:33
could reimburse yourself for from your
00:49:35
HSA. And it is much better to do that
00:49:37
than to die with an HSA. leave it to a
00:49:40
non-spouse heir and make it taxable
00:49:43
income for that person. What about
00:49:44
annuities? So, all of us being equal, I
00:49:46
prefer not to purchase annuities in the
00:49:48
first place, almost all the time, even
00:49:51
the few good annuities like a SPIA,
00:49:54
which I'll talk about right now. Even
00:49:55
the good annuities to me don't have
00:49:57
enough investing merit to really
00:49:59
interest me. I think the math is pretty
00:50:00
clear. So, a SPIA, a single premium
00:50:03
immediate annuity is about as good as
00:50:05
annuities come, but I just the rate of
00:50:07
return math isn't attractive for me.
00:50:10
Again, it's a very simple annuity. A
00:50:11
SPIA, you trade in a chunk of your money
00:50:13
today for lifetime income. Again,
00:50:16
usually starting today. Usually, it's
00:50:17
immediate. Well, I shouldn't say usually
00:50:19
it is. The I stands for immediate. You
00:50:21
should think of this as longevity
00:50:22
insurance where you and other SPIA
00:50:24
customers are essentially pulling your
00:50:26
risk together. It's exactly like the
00:50:28
inverse of term life insurance. you and
00:50:31
a bunch of other people are pulling your
00:50:32
assets together. And with life
00:50:34
insurance, those who die early get a
00:50:36
payout and those who die late do not.
00:50:39
With an annuity, those who die early
00:50:42
basically don't get their money back and
00:50:44
those who die late get their money back
00:50:46
and a lot more. As I'm speaking this
00:50:48
into the microphone, a 65-year-old male
00:50:50
can purchase a SPIA with a 7% annual
00:50:54
payout. And note the payout is not the
00:50:56
same as a rate of return because the
00:50:58
annuity first pays you back your own
00:51:00
money. But if we use simple internal
00:51:03
rate of return IRRa math, we see what a
00:51:06
seven or in in this case, I think right
00:51:07
now the SP rates are 7 or 7 1/2%.
00:51:10
[clears throat] I'll round up. I'll say
00:51:11
7 1/2. A 7 1/2 payout rate means that if
00:51:15
our 65year-old male dies at age 80, he
00:51:18
would have received a a 1.5% rate of
00:51:21
return for 15 years. If he dies at age
00:51:24
85, he would have received a 4.2 annual
00:51:27
rate of return for 20 years. If he dies
00:51:30
at age 95, he would have received a 6.3%
00:51:34
rate of return for 30 years. And you
00:51:37
know, we can look it up. We know that
00:51:38
the average 65-year-old American male
00:51:40
will live to age 82 on average. So in
00:51:43
this annuity, if someone lives to age
00:51:45
82, would provide a 2.8% annual rate of
00:51:48
return for 17 years. To me, that math is
00:51:51
simply not good enough. But okay, let's
00:51:54
assume you already own some annuities
00:51:55
and you really like them. Much like
00:51:57
[clears throat] social security, your
00:51:58
annuity income can create a fixed floor
00:52:00
from which you build the rest of your
00:52:02
withdrawal strategy. Pension income
00:52:04
works the same way. It creates a floor.
00:52:06
Now, if you have control over collecting
00:52:08
your pension or annuity income, it's
00:52:10
definitely worth understanding if and
00:52:12
how delaying those income sources might
00:52:14
open other doors for you. Again, maybe
00:52:16
it's income doors, maybe it's tax doors.
00:52:19
again the off-ion Roth conversions, but
00:52:22
everybody's pension and a lot of
00:52:23
annuities work in unique ways. So, last
00:52:26
I want to talk about some common
00:52:27
mistakes when it comes to the retirement
00:52:30
withdrawal order of operations. Common
00:52:32
mistakes and how to avoid them. The
00:52:33
first common mistake is just not having
00:52:34
a plan. I know this is a copout, but
00:52:36
this exercise is about building a plan
00:52:38
to maximize your after tax wealth
00:52:40
throughout retirement. It's about
00:52:42
planning ahead. And perhaps there's no
00:52:44
greater mistake than deciding not to
00:52:46
plan. The one cliche is, you know,
00:52:48
failing to plan is planning to fail. And
00:52:50
it's very true here. The second common
00:52:52
mistake is assuming that every year will
00:52:54
be the same. Your spending will change.
00:52:56
Your portfolio will grow and
00:52:57
occasionally shrink. You'll hit age
00:52:59
milestones such as your social security
00:53:01
window, Medicare at age 65, RMDs at age
00:53:04
73 or 75 or beyond depending on
00:53:07
legislation. You cannot assume that
00:53:09
every year will be the same. Your
00:53:10
withdrawal strategy cannot be static.
00:53:13
The third common mistake is missing
00:53:14
annual windows. If you get to stuff your
00:53:16
brackets, if you neglect a Roth
00:53:18
conversion in a particular year, you
00:53:20
can't get that opportunity back. Once a
00:53:22
year has passed, so have your tax
00:53:24
opportunities for that year. So, don't
00:53:25
miss your windows. The fourth common
00:53:27
mistake is the ignorance of adverse
00:53:29
interactions. You know, oops, you didn't
00:53:31
realize that extra IRA withdrawal would
00:53:33
push you into the next Irma bracket. You
00:53:34
didn't know that Roth conversion would
00:53:36
make social security more taxable. One
00:53:38
of the challenges of a withdrawal
00:53:40
strategy is understanding how these
00:53:41
puzzle pieces all fit together. So don't
00:53:43
make the mistake of not knowing your
00:53:45
adverse interactions. The fifth common
00:53:47
mistake is spending the wrong assets too
00:53:49
soon. So again, Roth and HSA assets tend
00:53:52
to be your most valuable compounders.
00:53:55
Taxable assets should usually be spent
00:53:57
first, but not necessarily if a
00:53:59
near-term death might prevent large
00:54:01
capital gains realization. So the fifth
00:54:03
common mistake is spending the wrong
00:54:04
assets too soon. Your ideal retirement
00:54:07
withdrawal strategy will be a function
00:54:09
of you and your unique circumstances.
00:54:11
But the framework provided here today in
00:54:13
this episode should give you an
00:54:14
excellent starting point going forward.
00:54:16
I mean, think about it. You spent
00:54:18
decades of time saving and accumulating
00:54:20
and investing. And getting this step of
00:54:22
retirement planning of of withdrawal
00:54:24
optimization is just as important as
00:54:27
those decades of time. A little math and
00:54:29
a little planning can add so much value.
00:54:31
Isaac, thank you for the awesome
00:54:33
question. And listeners, thank you for
00:54:34
all the awesome questions. I hope you
00:54:36
keep them coming. And now that we're
00:54:37
doing monthly AMA episodes, I should be
00:54:39
able to tackle more questions more
00:54:41
often. So, thanks for all the emails.
00:54:42
You can send them to
00:54:43
00:54:45
and we'll talk to you next episode.
00:54:46
Thanks for tuning in to this episode of
00:54:48
Personal Finance for long-term
00:54:50
investors. If you have a question for
00:54:52
Jesse to answer on a future episode,
00:54:54
send him an email over at his blog, The
00:54:57
Best Interest. His email address is
00:54:59
00:55:01
Again, that's jessevestinterest.blog.
00:55:05
Did you enjoy the show? Subscribe, rate,
00:55:07
and review the podcast wherever you
00:55:09
listen. This helps others find the show
00:55:11
and invest in knowledge themselves, and
00:55:14
we really appreciate it. [music] We'll
00:55:15
catch you on the next episode of
00:55:17
Personal Finance for Long-Term
00:55:19
Investors. Personal Finance for
00:55:21
Long-Term Investors is a personal
00:55:23
podcast meant for education and
00:55:25
entertainment. It should not be taken as
00:55:27
financial advice and it's not
00:55:28
prescriptive of your financial
00:55:30
situation.