Where the Money Comes From: Building a Tax-Smart Withdrawal Order

Right. Welcome, everyone. Give everybody some time to get into the webinar. Good to see you all. Happy fall. Can't believe we're already in the last part of the year here. All right. While people are coming in, we have a lot of stuff to go over today, so I'll do the housekeeping. This is a webinar where we're offering a CE for CFP, so please stick around for at least 50 minutes. We do have you on the clock, so we cannot submit for less than 50 minutes. Unfortunately, it's always a shame when somebody's on for 48 or 49 minutes or something. Also, at the end of the webinar, there is a survey. Please fill it out. We always appreciate feedback and also you can let us know if you want to learn more about Income Lab. You can give us your CFP number if you haven't done that already. So very important that you do that. Also, I'll try to leave some time at the end for questions. Please do that in the Q&A rather than in the chat. You can use the chat. It's pretty hard for us to manage that because it gets pretty long if people are using it a lot, but you can feel free to. But hit the Q&A, up vote any questions that you want to make sure we answer, and we'll try to do that often. That's the three dots with the circle, and you should be able to... There. So I think that's all my items. And with that, looks like... Well, there still are a few people coming into the meeting. How do we get CE? So that is, you got to stick around at least 50 minutes, and when we close it off, you'll be able to put in your number if you haven't done that yet. Yep. So and then we'll submit it for you. We'll just show up automatically on your CFP. All right. Still people coming in, but even so, we'll go ahead and kind of get it going. I see people raising their hands, but I'm not entirely sure what I'm supposed to do about that. I can raise my back. Hello? All right, so let's get to the content for today. So today we're kicking off the first of two seminars on tax-smart distribution planning. Today is the more, I guess educational side of it, CE, and so on. On Thursday, we're doing a webinar getting more into the nuts and bolts of how to do things, where we'll do more demos of our software, show you how to do it. Income Lab has really extensive tax tools to help you do this stuff, but you can't learn how to use software for CE, so we do them in two separate pieces. So today is the more learning about how these things work. And I always like to start any discussion on financial planning topics by thinking about what's the point of financial planning? What are we trying to do? What are we trying to accomplish? And for those of you who've heard me talk before, I really think that financial planning is about helping people live the best life they can. The operative word there being they can, so with the resources they have in the time that they have, and the world they happen to live through. So that's why so much of what we do at Income Lab is about ongoing planning, helping people make adjustments when needed, and so on. And one of the first places where we kind of demonstrate, okay, if we're trying to help people live the best life they can given the resources they have, we want to just answer basic questions like, given what I have, how much can I spend? We also do things about adjustments and so on. But this question, how much can I spend? Although we've done webinars on answering that question, how it works, how we get to that answer, why it's important, how to present it to clients. Let's see here. There we go. I'm sitting on the wrong button. It does leave this extra question hanging in the air, which is, okay, maybe I can spend $13,500 a month. Maybe a portion of that is Social Security, maybe a portion of that is a pension. Maybe a portion of it comes from a rental property I have. But if there are withdrawals this month, next month, next year, 10 years from now, where should those withdrawals come from? And so one of the questions that we will be examining today is that, which is, okay, you have a plan. How can you take it from a great plan that has really considered people's resources and goals and timeframe and so on, and come up with a how much can I spend? An answer to that question, how can we take that to the next level and develop a plan for where the withdrawals will come from? The other part of today, we're going to be talking about how to deal with requests for withdrawals that are kind of outside of this plan. So when something new comes up, how do we help people make the best decisions about how to get extra money if they need it? I need $10,000 for this, I need $50,000 for that. Of course, part of it is you'll need to determine whether that's something they can afford. But assuming that it is something they can afford, there is that question that's just a real practical question that so many advisors deal with every week, sometimes every day. And these two things are very much connected. One is more long-term, one is more short-term, but we want to talk about both today. So, we'll start with the strategic side, the long-term side, which is how do we plan for long-term withdrawal phasing and systematic withdrawals to set the clients up for success, for living the best life they can, for more net of tax income or net of tax benefits to heirs? Right? Just the general financial well-being. And then secondly, how do we optimize ad hoc out of plan distributions as they come up? And typically, advisors have to do both of these things. So, let's start with the long-term strategic side of it. Typically, what you'll see, even in a lot of financial planning software, is an application of a kind of rule of thumb tax type waterfall. By which I mean, okay, we have this plan, we're going to spend this much. Of that, here's how much we need to take for withdrawals. First, we'll take from taxable accounts until those are exhausted. Then we'll take from tax-deferred accounts like IRAs, 401(k)s until those are exhausted. And then finally, if ever, we'll take from Roth tax-free accounts. And this is so common that it's often just kind of assumed without really thinking about, well, why did this ever become a common rule of thumb? Because once you start to look into some of the numbers behind it, it's not obvious that this would have been what we would do. But I think there are some good reasons for it. One is by taking from taxable accounts first, you're minimizing, typically, current taxation. Now you could say, well, why not take from Roth accounts? Which are tax-free if they're qualified withdrawals. Fair point. But as we'll see, the reason to put Roth accounts last is Roths are so valuable. The growth of tax-free assets in Roths is so valuable That in terms of tax savings, the longer they can be around, including to the next generation who might be able to stretch them, the better. And so putting taxable on one end and tax-free on the other end comes from those two concepts. Why minimize current taxation? It's just a matter of short-term thinking. It's the kind of thing where, hey, current pain is painful. If I can put that off, let's put it off. So taxable accounts typically have some basis in them, so there's even tax-free money that can come back to you. And even the gains are typically going to be long-term cap gains, and so available at a lower tax rate than the tax deferred money. So that puts tax deferred money right in the middle. It's just there by default because you wanted to maintain Roths as long as you could. You wanted to avoid taxation immediately, and so tax deferred goes in the middle. It's also relatively easy to implement in the sense that we don't have to do any kind of deeper analysis to figure this out. So that's really where the rule of thumb came from. But as we'll see, that's for somebody who's actually doing a real tax-smart distribution plan, that's not typically where we're going to end up. So let's start looking at just some baseline information about these different account types. For a lot of you, this is going to be review, obviously, but sometimes we dive too deep, too quickly. So let's set some of the baseline here. So taxable accounts, we're talking about taxable brokerage accounts, basically the kind of thing where you will be taxed on any realized income in the year it's received. So if you have dividends, whether those are qualified dividends or non-qualified dividends, short-term or long-term cap gains, interest, all of that is taxed in the year that it's received. And if you're going to be selling some holdings in this account in order to spend it, you're going to create cap gains in the year that you sell it, and you're going to pay taxes that year. Any income, meaning any of that growth that's realized, any dividends, any interest hits your adjusted gross income. If you're taking basis back out, that's not going to hit your AGI. So that's often when at Income Lab, we sort of have to juggle these couple concepts of income like that word, we can mean it in different ways. We can mean income for the purposes of taxation, like, does it show up on my 1040? We can mean income in the sense of, is it money that hits my checking account and I can spend it? So for AGI purposes, it's only the growth. For I can spend it purposes, it's also the basis. All of that income also hits what's called net investment income, which has its own tax ever since the Affordable Care Act. Does not have RMDs, required distributions, does not have QCDs, qualified charitable distributions. And as far as beneficiaries go, these are very good assets to inherit because they get a step up in basis. Tax deferred accounts, we're talking about IRAs, 401(k)s, 403(b)s, 457s, also 401(k)s, all sorts of tax deferred accounts where they are taxed at ordinary income only when you withdraw from them. Some kinds of accounts can have post-tax money in them as well. And in that case, you're going to get a mixture of taxable and post-tax money. But typically, you're talking about all pre-tax money. All of that hits your... All the taxable money hits your AGI, your adjusted gross income. It'll be clear in a second why that's important, because what we'll be talking about is some of the interplay between these two things and how it's important whether something increases your AGI or not. Withdrawals from retirement accounts do not hit net investment income, so that's an important and very nice thing. But they do have required distributions starting these days at age 73 or 75. They do allow qualified charitable distributions if they are from IRAs, so not from 401(k)s. This is actually a reason in favor of doing rollovers to IRAs at some point. Also, by the way, inherited IRAs can do qualified charitable distributions. So can SEP and SIMPLE IRAs. But beneficiaries, this is sort of the, at least for a beneficiary who is paying taxes, it's kind of the worst asset to inherit. So one of the reasons, as we'll see, that deferring taking money out of a tax-deferred account for as long as possible is not always the best choice when you look at sort of long-term net of tax proceeds to either the owner or the beneficiaries. And finally, we have Roth accounts where qualified distributions, which I'm going to assume all of the ones that people are going to do are qualified, not taxed, not AGI, not net investment income, no required distributions. That actually didn't used to be true for Roth 401(k)s, but that is now true. And therefore, no QCDs, not taxable to beneficiaries. And so you can see here why, okay, this Roth thing is incredibly valuable, and you can see why people would want to delay as much as possible. Okay, so now that we've got our common rule of thumb and our baseline of how these different things are treated, let's look at why following that rule of thumb isn't always the best thing to do. One reason is it's conceptually some of it makes sense, but actually, it's ignoring the actual tax rates and phases of a retirement. So a real plan would actually look at what's happening in this plan. When are tax rates higher? When are tax rates lower for this plan, right? When are things coming in where there's a high income year where we're going to be at a higher tax rate? When are they not? It's also leaning into our very human tendency to try to minimize the current tax rate to minimize current pain, but in doing so, it can create pain later. So it can lead to, in particular, high or very high required distributions from tax deferred accounts in later years. And often in years where really your spending needs are somewhat lower, and so those high RMDs aren't even going to be spent, so purely a tax bomb. So the main reason not to follow this rule of thumb blindly is we're not accounting for these variations over time. We're not accounting for RMDs. And we're not accounting for the possibility for uncertainty. So the idea that we don't know future tax rates, and so future tax rates might be higher. The alternative, the basic concept that many of you are probably familiar with is tax arbitrage, which is the value of moving taxable income across time, sort of reallocating it to, on the whole, provide more net of tax income rather than just always seeking to minimize it this year. Always seeking to have the lowest tax bill in any given year is not always the best thing to do. So the idea is to take money out of tax deferred accounts. Usually the best, in fact, I think potentially mathematically always the best thing to do is to do a Roth conversion if possible ... in those times when it's a good idea in order to pay tax when rates are relatively low, to avoid paying higher rates in the future when rates could be higher due to things like RMDs. So, distributions that simply have to happen, and they will force you into a higher tax bracket no matter what. Could be because maybe there is a point in the future where you expect a higher income year. Could be before you hit what's called the widow's penalty, which is at the point the year after somebody dies and thereafter, where you go from married filing jointly rates to single rates, and those thresholds for tax rates come down. It might be avoiding taxes on beneficiaries who maybe are in higher tax brackets, and it could be avoiding policy changes where tax rates go up. Typically, that's what people are worried about. They're not as concerned about tax rates going down, of course. Okay, so let's go over again the basics of what's the concept behind tax arbitrage. If tax rates stay the same for you, so this isn't about policy, although the policy can have a part in this. But if somebody's actual taxes paid are the same now as they are at some point in the future, doing a Roth conversion or not does not make a difference. It's the same. So here's an example. I have a million bucks. I pay 20% in tax. It's $800,000. Over some period of time, it grows 50%, I have $1.2 million. If instead I deferred my taxation and it grew 50%, I'd have $1.5 million. I pay 20% tax, I'm at $1.2 million. Same thing, no big deal. If the tax rate in the future is higher, suddenly it's a bad idea to defer. I think I put this the wrong way. It should say don't defer. So it should say convert here. So taking the money out now, paying the taxes, and then having tax-free growth would be the way to go. On the other hand, if the tax rate in the future is lower, again, and I don't mean our tax rates lower. They might be. That might be why the tax rate went from 20% to 10% here, but it's really is the particular amount of tax paid on this distribution. If it's less in the future, then I'm better off deferring. So again, flip in your head. We'll fix it before we send out the slides here, but the don't convert, convert in the top should be flipped. All the rest looks correct. Okay. Here's the problem with this. There's no problem with that conceptually. All that works perfectly fine conceptually. The main problem is what I was trying to highlight, which is that it's not about tax rates, it's not about the tax regime, it's not about laws, although those have a role to play, and an important role to play. It's the fact that we need to know the amount of tax you would pay today and in the future with every part of the tax system coming into play. That means ordinary long-term cap gains rates, Social Security taxability, interactions of ordinary and long-term cap gains rate that can lead to higher cap gains taxes, even if you just have more ordinary income. Medicare, IRMAA, deduction and credit phase outs, all of these things. So, the main problem with applying this basic concept of arbitrage, which is sound, is just the complexity of it all. So, here's an example of this. On the right, we have Roth conversions up to, it says 24, but it should be the 10% ordinary income tax bracket. But when we do that, we also need to take into account long-term cap gains income, or really you could think of it as just a preferential rate income, so it's also qualified dividends. That yellow stuff, these are screenshots from Income Lab's Tax Lab. That yellow stuff on the right is floating there. Why is it floating? There's nothing underneath it. Well, technically there is. All of your ordinary income pushes that cap gains income up into higher brackets. So if I look on the left where we're doing Roth conversions, which is the purple stuff here, up to the 24% bracket, we've also pushed the yellow into a higher tax bracket here. So this is what I mean by interactions between things. So it's not just about knowing ordinary tax rates. It's not just about knowing long-term cap gains tax rates. It's about handling all of the interactions of these things. So as much as it's really as humans, we do best when focusing on one little thing, and I think in talking with clients, that's perfectly reasonable. But in the full analysis, we actually need to take all of the interactions into account. Another one that's especially important at kind of income levels that are really common for sort of middle market, mass affluent clients is taxation of Social Security, or what's sometimes called the Social Security tax torpedo. Now you can't pin down exactly the range of income where this applies, because taxation of Social Security is, of course, based on a fairly complex calculation. Here you're seeing a little bit of the shape of the increase in taxability as your income goes up. But the thing to note here is that originally, Social Security was not taxed, Social Security benefits were not taxed. But then starting in 1983, the 50% taxability came in, and then I forget the exact year in the '90s, we got the 85% taxability. So what you're seeing here is how taxability of benefits goes up as income goes up. I'll do some examples so that we understand why it's important to include taxability of Social Security in the analysis, not just view it on its own. So, for example, here we have a couple with $70,000 in total income. They have $10,000, and they actually might have a little more than that because this is taxable income and Social Security benefits. So maybe they've got another 40,000 in deductions or something. Right, so these are people who are spending in the $100,000-plus range each year. So the calculation goes that we take half the Social Security benefits, and we add them to that other taxable income, which in this case gets us $40,000. The IRS calls that combined income. And for this particular situation, they would be paying tax on $4,000 of their Social Security. So you'll already notice that although the headline is, well, 0%, 50%, or 85% of your Social Security can be taxable, it's not actually true. Instead, like you see here, it's a range. So yes, you max out at 85%. Yes, the minimum is 0%, and yes, there are times when it's exactly 50%, but actually it's typically a range. What's important here is to note that we're not just dealing with ordinary income tax. So if you're in this range, in this case you're in the 50% taxability range, you're not paying 12% on each dollar of income that you get, each marginal dollar, you're paying 18%. So with each dollar that you add, you're paying 12% plus you're bringing half a dollar of Social Security into taxability. So that's why it's called the torpedo. It's basically expanding your 12% bracket to 18% or to 22.2%. So if I go to a little bit higher income, now I'm in the 85% marginal taxability range. So now instead of $10,000 in other taxable income, I've got 40. So in total, we're looking at 100, probably around 140 in total gross income for this couple. So again, very middle class range here. And now we can see almost half of their Social Security is taxable, and they're paying a marginal rate of 22.2%. I go a little higher, now 61% of my benefits are taxable, and I can max it out. Here again, we're maxing out probably in the range of $170,000 in gross income for this couple. So, I show this not because you should memorize the way to create this graph or anything like that. It's nice to know some of the details, but mostly to understand another place where parts of the tax code interact. So we just saw how long-term cap gains floats, and so there's a relationship between long-term cap gains and ordinary income. And now we're seeing how there's a relationship between Social Security taxability and other taxable income that has this effect of increasing the actual tax rate on a new dollar of income. Now, the takeaway from the Social Security angle is that if you are doing tax-smart distribution planning, it can be a very good idea to try to do Roth conversions before Social Security starts. That could be because you're doing it before age 62, or it could be you're doing it before the clients happen to start taking Social Security. So here we see just an example from Income Lab, where we have Roth conversions for five years. And during those five years, Social Security is happening in the last three of them, and you can see that the non-taxable portion is quite small compared to the taxable portion. Right? And then, basically a couple of years later, we've sort of flipped that around. So, even people who have quite high income, so in this situation you say, "Well, we're going to be in trouble no matter what. These folks are going to be in the $170,000 range of gross income every year." Well, in this situation, if you could simply get the other taxable income down by taking money out of Roth accounts or maybe taking money out of taxable accounts instead of IRAs, you can see how you can actually bring that marginal rate down. Just as a sidebar, it's not just a matter of understanding how all of these things interact, it's also a matter of understanding how things are projected to change through time. So, there are many parts of the tax code that are adjusted for inflation over time, but there are some that are not. Examples are those Social Security taxability thresholds. So those have been at, in the case of married filing jointly, 32,000 for 50%, 44,000 for 85%. Those have been like that from the beginning. They do not adjust every year. And so over time, more and more people, because of inflation, will pay higher and higher amounts of tax on Social Security. More and more of their Social Security will be taxable. Another one where this is true is the 3.8% Net Investment Income Tax. I mentioned that's not for IRA distributions and things, but it is for other kinds of investment income. In fact, if inflation averages 3%, then in about 20 years, Net Investment Income Tax, if we still have it, will actually hit below the 15% cap gains bracket. So if we go back to what the cap gains brackets are, you'll see around the left here, there's a 0% bracket, there's a 15, and currently there's an effective 18.8, which is 15 plus 3.8 Net Investment Income Tax. Over the next 20 years, that's going to come down, so that it'll go 0, 3.8, 18.8. There no longer will be a real 15% effective rate. And that's just because of bracket creep based on not adjusting by statute for inflation. We have seen a few things over the past years that didn't used to be adjusted for inflation that now are. So one that I remember is the limit on qualified charitable distributions, I believe used to be 100,000. And now it goes up with inflation. So sometimes these things change. But IRMAA brackets are another. The very top bracket for Medicare IRMAA didn't used to adjust for inflation. That'll begin adjusting in 2028. But a lot of times it's thresholds and things. Another one, the home sale gain exclusion amount. So selling your own home, tax-free gains, has been 250 and 500 for single and married filing jointly for a long time, and that remains unadjusted for inflation. So when we're doing this analysis of, okay, in each year, how much do we think we should take out of which kinds of accounts, we also need to handle this. That we need to project future years, not by assuming thresholds sort of stay the same in today's dollars, but by applying different amounts of inflation to different parts of the tax code. Another part of the tax code we need to handle, I know I'm just going to be just piling on all of the challenges here before we kind of get to a solution, but it's Medicare. So there's been a lot more talk about this lately, I think as people have become aware of this quirk to the tax code because it's not really seen as a tax. It's presented as simply an increase in your Medicare premiums. But it's based on MAGI, Modified Adjusted Gross Income. The higher that is, the higher the premium, so it sure smells like a tax. There's a couple of gotchas here. One is it's actually based on your Modified Adjusted Gross Income from two years ago. And that's not just a way of being mean. That's because you're paying those premiums this year right now. You're paying them in January, February, March. Well, at the beginning of this year, nobody had filed taxes for 2025. So the 2025 MAGI was not available. In fact, the most recent that would've been available at the beginning of this year was 2024's MAGI. So it's simply a matter of practicality that they have to use MAGI from two years ago. That does mean, though, that starting at age 63, your MAGI matters for this purpose. The other thing is that it's a cliff tax. So it's not a percentage, it's a dollar amount. And you can see here the per person, married filing jointly surcharge, and the brackets. So as soon as you hit 218,000 in MAGI, you're paying another almost 2,300 for a single dollar over that threshold. So the marginal rate on that dollar is incredible. And so again, this is an interaction that we need to keep our eyes on. And that's why in that first chart I was noting which things are AGI, or which is part of MAGI. And we need to be on the watch out for them. There are, of course, other things. They're a little less spectacular because they're not cliffs like IRMAA. But things like QBI deductions, so that's Qualified Business Income deductions, senior bonus, child tax credit, other dependents, premium tax credits And so on. All of these are related to AGI, MAGI. Sometimes MAGI, by the way, it has many different definitions. We won't go over those today, but for example, for ACA premium tax credits, it's not the same as for IRMAA. But the point is, in a full analysis of a tax-smart distribution plan, we need every single one of these things to be taken into account. The solution is no, we're not going to come up with a easy rule of thumb. We're not going to be able to just focus on one number, one tax rate. We're going to have to do the hard work of having an entire plan, including anything lumpy, any changes over time, and we are simply going to have to run all of our numbers, all the interactions of all of these things, and see how things shake out. So there's just too many dimensions here in order to really be able to kind of use your gut or use a rule of thumb on these things. And so that's what people should be doing is really running the full plan. And then looking at what's the overall life impact of these different choices, what's the impact on total net income, on net legacy, the combination of those two things over time. However, there's another problem, which is, okay, maybe we've done this analysis and you get a nice grid here, even with some nice heat map, so you can sort of look at it and say, "Okay, looks like for me, Roth conversions to the 24% bracket, maybe IRMAA level four. Okay, those are looking pretty good here." But there's a few more problems. So the first problem was complexity, right? The interaction of all those things. The second problem is uncertainty. So yes, we can do a full analysis, and of course, that's part of what we do at Income Lab. Down to the penny if you need it, absolute detail. But we do not know what the tax system will be 20 years from now, 10 years from now, maybe five years from now, right? So this is, you've probably seen a graph like this before. This is just top tax brackets over time. Of course, it was much more complex than this, but it shows you, of course, taxes do change over time. A third problem, which is a little bit related to the last one, is just the reluctance of a client to accept a certain loss today, which is paying taxes, doing Roth conversions, in exchange for an uncertain gain in the future. Uncertain because tax rates might change, uncertain because we don't really know what returns will be between now and then. Even uncertain in the sense that we don't know if we'll be alive then. Right? So it is a trade-off between something relatively certain, which is a tax bill today, and that uncertain payoff in the future. So problems two and three, the uncertainty about the future and the reluctance to make that exchange, lead us to a position where it's not so much a matter of simply looking at the numbers, picking the best one, and going forward. I love that analysis. It's great. There's lots of great articles out there, kind of fine-tuning things and so on. One way to address this sort of reluctance and pain thing is not to present the gain from your tax-smart distribution plan as a gain, but rather as a loss you're not taking. So here, if I'm looking at and comparing Roth conversions to the 24% bracket to not doing those Roth conversions, I could say, "Well, it looks like, in real dollars, we're looking at maybe $800,000 in savings to you and $300,000 to your heirs." So over a million dollars total. Great. Well, often it's actually a bigger deal for humans to avoid loss than to get gain. So if we simply look at it as, hey, failing to do Roth conversions costs us a little over a million dollars. But regardless, what the key here is... I don't know if I have a... Yeah, the key here is that we don't want to fixate on pure precision and finding a single answer. There's simply too much uncertainty. There's too much of a psychological barrier for us to be fixated on a single, hey, this answer is one basis point better than another answer. That is far too... It's mistaking our ability to be precise with accuracy. We don't know for sure what the future's like. And so typically what we want to do is kind of find an area where it looks like there's probably going to be some value, and we don't need to obsess about a few basis points or a few tenths of a percent, or even a percentage point or two. It may not be that big of a deal. So instead, look for patterns and trends and reasonable ways forward that work for the client within their capacity and desire to spend on being more tax efficient. Also, this is not a single answer, it's a process. So this full long-term planning process that leads us to these Tax Lab like outputs, these outputs, this kind of output, it's not a one time thing. We're going to do it at least every year, maybe more than that. We're going to choose an approach for that year based on the client's appetite and based on what looks best, and then we're going to repeat that process. And helping clients understand that's the process, that's how we kind of iteratively move through the world, will really help not say, "Well, last year we said we were going to the 24. Why are we doing 22 now?" Well, it's because we reanalyzed, right? We're always doing the best we can with the information we have, but you cannot know the future, and it is okay to change year by year. So where is the tax value in making tax-smart distribution long-term strategic plans? The first place is typically with Roth conversions. So finding a reasonable Roth conversion threshold to shoot for, it provides a lot of the tax value. The next step is figuring out how much typically is going to be in the future, but at what point to stop converting to Roths. How much do you want to leave in your tax-deferred accounts? Because if I convert everything to Roths, in some plans that don't have other taxable income sources, you'll be at a 0% tax rate and maybe not even using your deductions every year, which is a waste. So we typically are going to want to leave at least some money in a tax-deferred account. If the client is charitably inclined, we want to make sure we're leaving money in an IRA, rather, so that starting at age 70 and a half, they can start doing qualified charitable distributions, which are basically a way of moving tax-deferred money out of it tax-free. So it's like it turned into a charitable Roth. So these are the three main places where we see the value accruing, where two and three are kind of, they're very secondary to number one, but they all add value. Another way to kind of wrap up with this on the strategic side is simply to think about and teach clients about these kind of life phases. So first we're in the pre-Social Security time, when Roth conversions are often a good idea if you're in lower tax years. Then we hit Social Security and Medicare at 62 and 63. 63, notice, not 65, because we're doing a two year look back for Medicare. We hit QCDs at age 70 and a half, RMDs at 73 or 75, and then there's a survivor period where again, we have those considerations of new tax rates. So kind of thinking through the plan in terms of life phases really helps. And of course, a full analysis like the one I just showed you, that already takes all that into account. Okay. To wrap up today, I want to talk about the other side, which is, okay, we've done all this work. We're doing an annual review. We're doing full analysis that takes into account every interaction of tax rates and AGI and so on. And then the client calls up and says, "I need $50,000. I can afford it. I'm buying a car, I'm buying a boat," whatever it is. "Sell some things and send me a check." This sounds simple to the client, right? I mean, I have the money. It's my money. Send me a check. But to an advisor, it's a tax-smart distribution problem. So are you going to go back and change the plan and make sure that this is addressed? Of course you are, right? You're going to figure out long term what the right thing to do is. But you also have this short term need that you do need to respond to. And instead of just, "Well, I'll make $50,000 and send it to him," it's which account should I tap? Which holdings should I tap? Should I be grossing up for taxes? Typically, yes. Should I sell high basis stock? Should I harvest losses? Should I harvest 0% cap gains? How do I avoid losing deductions and credits? Should I take some money from Roth accounts? I said at the beginning, we often avoid that, but there can be good reasons in these situations in order to avoid maybe tripping a new IRMAA bracket or losing an ACA credit, something like that. Maybe I'm a little older. Are there RMDs I still need to take this year? So I might as well take them from IRAs and 401(k)s. How much should I withhold? I want to make sure that we're meeting safe harbor positions. I don't want this withdrawal to cause tax penalties and interest. There's a huge number of things that come up that I think clients certainly don't appreciate, and often advisors are not even aware of. How do I get this right? There's three things that we need to do in these kinds of decisions. Of course, we're taking money out of our investments, so we need to be investment smart. If there are things in an investment policy statement or something to follow, of course, we need to follow that, but we also need to be tax smart and plan smart. So this is a place where all of that great work that we do in asset allocation or in stock selection can easily be lost. So it's the place where we turn gross of tax returns into net of tax returns. And as I've heard people say, gross of tax returns are a vanity metric. So all of those things I just talked about as being important for determining your long-term tax-smart distribution plan, and you basically need software to do that, right? That's why I was showing you that big table of results, because there's just too many interactions to handle as a rule of thumb or even in a homegrown Excel spreadsheet or something. The same is true for a one-off ad hoc distribution. And again, these numbers, just any kind of tax-smart distribution planning, often the researchers say this is somewhere between tens of basis points to over 100 basis points in potential impact. Probably the biggest takeaway from this section, the tactical planning section is even if you are not an in-depth financial planner, and some people aren't, right? They don't do long-term financial plans. Having at least the structure of a plan in place, which just means, hey, what's happening this year? What's happening next year? What's happening the year after? When do different things start? How much do I have coming out of my pension, my rental, my Social Security, different accounts and things, is crucial if you want to be able to react quickly to that request for a distribution. So at Income Lab, we've thought a lot about, okay, what sorts of things, given that we have a detailed financial plan for someone, what sort of pain can we alleviate for you as an advisor or for a client? And this is one of them. So because we know all about the structure of the plan, what all is happening this year? Ideally, we know your holdings, your basis, everything as you see here. We're able to kind of like running the full plan over 10, 20, 30 years and having statistics on where it looks like Roth conversions might help. Doing a one-off withdrawal, knowing what's happening this year, is incredibly easy for us. It's not at all easy unless you reproduce the plan entirely in your spreadsheet. But so for example here, we have a $100,000 withdrawal from a family I think they have $3 million mixed between different account types. And you're seeing here the solution is to take a certain amount. In this case, they're taking some money out of their inherited IRA because they have to take it out anyway. Taking some from a taxable account, but minimizing that tax by taking a loss to counteract some of the gain. They're going to be able to use some of that loss. It's under $3,000, so they're going to be able to offset some of their other income because of it. There's a bit of withholding that's happening here from their standing order on their IRA, and we also see new estimated tax payments that we need to make and by when. So all of this is the kind of thing, again, that you need to have a good system for taking into account all of these different complex interactions between the plan and between different parts of the tax code. Another thing that's really helpful if you have a system like this is you can memorialize it, right? You can share it with a CPA, make sure we're doing things right. This is an area that is a little bit of a risk, even though it feels very normal to a client. But getting this kind of thing wrong, I would highly advise working with a CPA and making sure these numbers are checked out. All right. The other thing I would say here is, it's typically a good idea to leave some margin of error. Margin for error, rather. So, for example, not in this case, but I've seen cases where maybe we're trying to stay under an IRMAA bracket. Great, 218,000 in MAGI. But do we want to tiptoe right up to that line? Probably not. So IRMAA brackets are adjusted for inflation every year, but we don't know exactly what those are going to be. So often it's a good idea to leave a little bit of space, just, hey, leave a... Maybe it means, in retrospect, we'll have paid slightly too high of tax, but it can be a really good way to go to just make sure you're not tripping over some of those, especially IRMAA brackets, which are cliffs. Who does this kind of withdrawal optimization help? The person who withdrawal optimization for that ad hoc this year, this today, this week, kind of withdrawal. Anybody who has multiple account types, anybody who has embedded unrealized capital gains or losses, somebody who has RMDs, somebody who's within that progressive marginal rate zone, which is most people. Certainly people who have ACA credits or Medicare, people who are taking Social Security and are in that range under 85% taxability. People who are charitably inclined. We didn't talk about that, but you can sometimes pair a charitable gift with one of these withdrawals in order to minimize the taxes. And who does it not help? Typically, people who only have IRAs or only have Roths. There's not really much to do in that case. Or people who have extremely low income, so they're not really in the tax zone, even with the extra withdrawal. So in other words, most people need this kind of smart help with those tactical distributions. All right. To wrap up, and then we'll take a few questions. We went over the taxable, tax-deferred, tax-free rule of thumb, why it exists. It's not crazy, but where it came from. But we went over why it's typically a bad idea. Basically because the world's much more complicated than that. We went over the idea that maybe keeping a tax bill as low as possible might not be the best planning option. So a low tax bill today might be a sign of a missed planning opportunity. We talked about several examples of interactions between parts of the tax code and the idea of a tax life phase to kind of trigger in your own mind things that might be important to look at. And we talked about a solution being, we need a system that looks at everything all at once, but we also need to not get bogged down in looking for the one right answer instead, because we can't possibly hope that our projections are exactly correct. Don't sweat the precision, and instead do an iterative process where at least once a year you are reevaluating, looking at client preferences and abilities to pay, and figuring out what's the best choice for that year. For tactical planning, ad hoc withdrawals, these outside of plan withdrawals are a key place where after-tax returns are locked in. So it is really an incredibly valuable place to spend some time. Super common as well, but very few people actually have a good process for making sure that it's done right with investments, taxes, and the plan in mind, and in a way that you can memorialize it, share it with other advisors, and so on. It does require at least a detailed plan of the current year's income, ideally the next couple years. So even if you're not a kind of a long-term planning person, at least having something in place that you can go to to do this kind of analysis, because if you're managing someone's money, eventually they're going to ask for it. Is super important. And of course, because this is actually a place where we do want to get into precision, but leaving a little margin for error is always a prudent thing to do. All right, so that was a mouthful, but let's get to some questions in the last couple minutes here. I don't know if we have a transcript, Chris, but we will send out the recording. Maybe Zoom does transcripts. They might. I wouldn't be surprised if that's a thing. Let's see. Jeff was asking about in the software, so we have a lot of integrations, and they pull in account balances and things like that. And he was asking about Redtail. I believe we're actually launching an upgraded integration with Redtail. It might be tomorrow, actually. So, yeah, I do not know the answer to your question, but I know that there's some Redtail stuff happening right now. Can we get the slides? I believe yes. We will send out the slides to everybody where we have your email. Is the legacy figure pre or post-tax? Good question. Let me pull up what you're talking about there. Okay, so, this slide, you don't see it, but the far right is the net legacy. You can also see it here. So what we're doing here is we're looking at net legacy. So we're taking all the final balances. Roths go net of tax, of course. Taxable accounts go net of tax because of the step-up in basis, and then we're netting out tax from tax-deferred accounts in order to get you the net legacy number here. So this is basically if someone were to inherit at the end of the plan, what would that look like to them? These are all really helpful little snapshots, little numbers to look at. But going into my theme of, hey, let's not get bogged down in the exact number. Is this person going to inherit at the end of this plan? Unlikely, right? Or did we nail the longevity assumption exactly right? Unlikely, right? So a real analysis of the beneficiary impact of the tax-smart plan would look more at, okay, along the way, where are they? And are they surgeons? Are they school teachers? How much do we care about the net legacy? How would the tax rate be determined? Right now, we cash it out completely. Actually, somebody asked this recently, like, "Hey, well, what if you stretched the amounts that can be stretched? Would that make a Roth conversion more or less attractive?" And it might seem to you that you'd think it would make it less attractive because stretching an IRA might mean you could pay a lower tax rate along the way. But we've done the analysis and let's just say at least that's not always true. It might never be true because you can also stretch a Roth. So if you're going to stretch IRAs and 401(k)s, you also have to stretch the Roth and to do apples to apples. And actually, what we see is a larger net legacy difference if we allow the stretch. So, I didn't know which way it would go, but we did the analysis and that is true, so. Let's see. Tax charts are not making sense. Thank you for asking that question. That is often a question we get. Let me grab this for you. I suspect it's this one. A key thing to note here is on the left is total income. It's not taxable income. It's not AGI. It's not MAGI. So this plan happened to have a certain amount of return on principal on the tax on withdrawals from a taxable account. We're calling that income here because here income is meant to be money I could spend, or money that I'm seeing every year. It is a common question, Robert. So honestly, we probably should adjust or at least give you the option to view this as taxable income, because that often confuses people. That light blue is non-taxable income. One way to note that is there is no such thing as a 0% ordinary income tax bracket. Instead, what we're putting in there is everything that's not taxed. So it's your standard deduction or itemized deductions. It's return of basis. We don't have them here, but if you had a Roth distribution or QCD, that would be in there as well. So totally reasonable to be a little shocked to see the 10% bracket at $275,000, but that's what's going on there. On the Medicare, right here, it's the same thing. So although this is actually an MAGI concept, we show it with the non-taxable income in there. But very good question. Why was I saying 170, Robert? Another good question. The reason I was saying that was... Oh, you know what? I may have misspoken, actually. Yeah, maybe I was. So maybe my numbers were correct, 130,000. I was adding back in the standard deduction. But now that you mention it, I think this is above the line stuff. So yeah, I think you're right. I stand corrected on that, Robert. Thank you for that. So I think my total is actually a good number. We're at 130. Okay. All right. I think some of these other questions, there are tons of questions. I'm really sorry we weren't able to get to them. But if you come back on Thursday, we're doing a deeper dive with more of the software. And we can try to hit some of these questions as well, especially the ones about, hey, are there ways to use the software to do certain things? But thank you all for joining us. If you have other questions, please put them in the survey that you will get right now, and hope to see you all on Thursday. Thanks a lot.