00:00:00
Karmi Gutman: So, good afternoon everyone. It’s 11:55 for those who are here. Can anyone hear me and see the screen okay? Give me a thumbs up if you can hear me. I see one thumb. I see a hand raised; that’s a good sign.
The presentation is scheduled for 12:00, so we’re going to give it five minutes and then we’re going to begin promptly. I will be right back and we’ll rock and roll at 12:00 on the dot.
Just want to make sure everyone can still hear me. If you can give me a thumbs up or raise your hand using the function… I see thumbs up. Excellent. Great news. Everyone can see the screen; still seeing some thumbs up. Love it. Perfect.
Okay. So, my name is Karmi Gutman. I am the financial planner over on the Keystone and Lifestyle Planning side.
00:09:22
Karmi Gutman: That is part of the brand—the Retirement Management Office that you see below—which is the partnership of the two organizations to be your one-stop shop for planning, investments, taxes, and estate planning all in one go.
Today we have an exciting topic regarding why your “perfect” asset allocation is still leaking money to the IRS. We’re going to have a fun conversation today about taxes, planning, allocations, and such. I hope that’ll get across today. The goal is to take around 30, 35, or 40 minutes to go through the material and then leave the last 15 to 20 minutes to answer any questions that you may have.
If you’d like to ask questions throughout the presentation, I will ask that you hold them until the end. However, if you are afraid you will forget your question, there is an option on the bottom of your screen right next to the red button where there’s a phone.
00:10:28
Karmi Gutman: You’ll see there will be a chat icon that will essentially allow you to type in your questions, and I’ll make sure to address those in the chat.
On top of it, just so everyone knows, this meeting is being recorded and will be uploaded to our YouTube site so that you can review it at a later time if you’d like to. So, let’s get going.
I know Francisco made a point about our upcoming webinars; we’ll also make a formal announcement about that at the end. With that in mind, because I need to make the lawyers happy, anything that we discuss today is purely educational and does not constitute investment advice or tax advice. Please keep in mind that anything we discuss today is not enough to make an informed decision. Please, please, please make sure you talk to your trusted professional before acting on anything we discussed today. I have to share these notices with you just to make the lawyers happy.
Asset Allocation vs. Asset Location
00:11:35
Karmi Gutman: So, let’s get into it. As you guys probably already know: asset allocation. This is probably what everyone knows about. What is the actual mix that you’re going to be dividing your monies into? What percentage goes into stocks? What percentage goes into bonds? What amounts into commodities, cash, etc.? This is essentially the what.
Hypothetically speaking, you decide that a 60/40 mix is the right mix—that would be 60% stock and 40% safe assets. That would be considered your asset allocation. That answers the what of the plan you’re trying to accomplish.
Asset location is different. This is the where or the how. How am I going to achieve that 60/40 mix we just talked about? Meaning, if I have decided that a mix of 60% stock and 40% bonds is the right mix for me, how do I ensure they’re in the right place?
00:12:44
Karmi Gutman: That’s what asset location is referring to. And that can be dependent on your goal. It doesn’t necessarily have to be for tax reasons; it can be specifically because you need X amount of money to be ready if you’re going to be funding a business property, a wedding, a house purchase, or you want to spoil your kids and grandkids (or great-grandkids, God willing).
Specifically for this topic, we’re going to be focusing on making sure we’re not leaving any tips to the IRS. We pay enough in taxes; let’s make sure we’re not giving them an extra tip if we can legally avoid it.
Now, before we go into it, I always want to make sure we do a quick recap of the types of accounts most people have. You guys probably already know this, but we want to make sure we go through a set base so we’re all on the same page.
Understanding the “Big Three” Account Types
00:13:41
Karmi Gutman: You have traditional IRAs or your 401(k)s. These are essentially your pre-tax accounts. These are tax-deferred, meaning you put money in and you don’t have to pay taxes until you take it out.
Now, I put “specific circumstances” under the characteristics side because they are not always tax-deductible. It depends on your income, it depends if you’re participating in a 401(k)—it just depends. So, I always say that under specific circumstances, you can get a deduction.
The one iron-clad rule is that as long as you take physical possession of the monies—say you put them in 10 years ago and you take them out now—that is going to be ordinary income. If you do charitable giving out of that, that’s a different ballgame. But for our simple purposes, if you’re telling Vanguard, “Send me a check for $5,000 from my IRA,” if that’s traditional, it’s going to be ordinary income. It’s going to be as if you got a bonus of five grand that’s going to be reported to Uncle Sam.
00:14:48
Karmi Gutman: Taxable accounts: yes and no on tax deferral. Gotta love finance; there’s always a “yes and no.” What I mean by that is if you’re going to be putting investments in there—let’s say you put in $100 and you buy Apple—you do not have to pay the tax on Apple until you sell the stock. So yes, there is a tax-deferred element to a typical taxable brokerage account that you can open anywhere.
The “no” part is the income. The dividends that you get before you sell will be taxable as ordinary income to you, or they would be Qualified Dividend Income (QDIs).
What that is in English is essentially that if it’s held within 60 days before the ex-date of the dividend and held for a certain period, instead of it being taxed as ordinary income, it’ll be taxed at capital gains rates. Those are more favorable than ordinary income because they could be at 0%, 15%, or 20%, relative to ordinary income which can go as high as 37%.
00:16:09
Karmi Gutman: So that’s why I say “yes and no” on that. Now, tax-free? Maybe; it depends. Your interest, like we talked about, will be taxable in a brokerage account, so that is a “no.” Your interest is not tax-free. Your capital gains can be, but only under specific circumstances if you keep your income below a certain threshold. Typically, if you’re filing jointly, that’s below $98,000, if I remember correctly on my IRS table. Don’t quote me on that because they keep changing it, but the last time I remember, it was around $98,000 Adjusted Gross Income.
Gotta love finance. Taxable accounts can be very, very favorable if you use them correctly.
Excuse me—my kids decided to gift me with a fun cold, so I’ve been dealing with that. I apologize if I’m coughing throughout the presentation today; I will do my best not to cough in everybody’s ear.
00:17:16
Karmi Gutman: Roth IRAs, as we all know: no tax deferral. However, if you follow specific criteria, all earnings will be tax-free. Now, there are a couple of catches with that. A Roth IRA has to have been opened with a balance for at least five years, and you have to be over 59½ in order to claim the tax-free notion of it without any penalties.
There are some loopholes within the Roth IRA to get money out if you’re before 59½, and there are some nuances regarding the five-year rule. For simple purposes today: as long as you’ve held it for five years and you’re over 59½, you can walk away scot-free without paying taxes on the earnings.
The only catch with Roths, as you may be familiar, is that not everyone can contribute to them if your income is above a certain threshold. I believe right now, filing jointly, it’s around $250,000 before the phase-out kicks in. If you’re filing single, cut that in half. But like I said, make sure you double-check the tables or talk to someone you trust.
Strategies for Minimizing Taxes
00:18:26
Karmi Gutman: The reason why we go over this is that these are usually the “Big Three” horsemen most people have when they are planning for their investments: pre-tax monies, after-tax monies, and tax-free. Pre-tax is your traditional IRAs or 401(k)s. After-tax is your brokerage accounts. Tax-free is your Roth accounts.
So, what should I do if my goal is to minimize taxes? If we know that certain accounts are the most tax-advantageous to us, in theory, we should allocate investments that provide the most growth to those accounts. They should provide us the best chance for growth while paying the minimal taxes possible.
00:19:46
Karmi Gutman: How do you do that? Hypothetically speaking, if we’re utilizing that 60/40 mix (60% in stocks and 40% in bonds), we would allocate as much “shelf space” as possible to the Roth. Meaning, if we have enough space in the Roth to meet the full 60% of the intended stock mix, we should allocate as much as possible to the Roth accounts.
The reason why is that all that growth—as long as you follow the rules—will be tax-free. Typically, Roth IRAs are also the last accounts that most people touch. So, there is a tax-sheltering element as well as a time-horizon element.
00:21:05
Karmi Gutman: Traditional IRAs: if you’re over 59½, most people will decide to start pulling from these if they are retiring around that time frame.
I will put in a caveat in just a second, but typically, if you’re going to be drawing down from a traditional IRA in the near future, it is extremely important to maximize your available shelf space for preserving capital assets. I’m going to explain why.
One: if you’re over 73, that’s typically when you need to start taking money out because Uncle Sam forces you. Now, some of you born after 1959 have the luxury of waiting until 75. But the reason this is something to consider—and we’re going to show you the math behind it—is that if you have aggressive investments in your traditional IRA and they do really well, what you’re essentially doing is giving Uncle Sam more money to tax.
Each year as you get older, the amount you need to take out grows because of the life expectancy table. They take your balance at the end of the tax year and divide it by your life expectancy, which, according to the IRS, grows shorter.
00:22:25
Karmi Gutman: You’re essentially giving them a bigger chunk of your pie to pay taxes on. So, if you were to change that by having lower expected return assets, it’s a nice way to shield some of that. Bonds, cash, CDs—those have lower expected returns but can give you some recapture through dividends and interest. That could be a nice way to lower your tax bill.
Now, you might say, “Karmi, what if I only have traditional IRAs?” That’s a different ballgame. Most people only have access to traditional IRAs or traditional 401(k)s. When you’re younger, it makes sense to pick the right mix. In that situation, it’s okay, in our opinion, to have aggressive assets because you’re not in the drawdown phase yet. It’s when you are drawing down where we would make an argument to maybe start making a change.
00:23:44
Karmi Gutman: Your taxable accounts are going to be a wildcard. This is your brokerage account or trust account at Fidelity, Vanguard, Schwab, etc. It all depends on your goals.
But hypothetically speaking, if you can achieve most of your available shelf space through the IRAs, then the taxable account should be more stock-heavy, specifically on the US side, for one reason: the Qualified Dividend Income (QDI) element. If you own ETFs, which are essentially like mutual funds that trade on the stock exchange, you can look up what percentage of their dividends will be distributed as qualified.
I’m going to throw one out there as an example—not as a specific recommendation. You can go to Vanguard and type in “VTI,” and you’ll be able to see from the distributions tab how much the QDI percentage is.
00:25:03
Karmi Gutman: It’s typically around 90% or higher. What that means is whatever dividends they pay, 90% of that’s going to be at much more favorable rates. We’re okay with potentially taxable things as long as they are tax-efficient.
Now, let’s say you don’t have enough shelf space in your traditional IRA, but you want some liquidity; then maybe it makes sense to include some tax-free bonds so you can save yourself a little bit on taxes. But it will really depend on your goal, which is why your taxable account is the wildcard.
In theory, we want to essentially draw down our least tax-efficient accounts first to allow our more tax-efficient accounts to grow over time. For most people, that will be IRAs first, then your taxable, and then your Roth last. We’re going to show some numbers behind that in just a second.
00:26:06
Karmi Gutman: But you want to go through the process and the theory first. Now, if you’re under 59½ or you’re not on Medicare yet and you’re going to be on an ACA plan, that might change. You may have to draw from your taxable accounts first to ensure you can qualify for premium tax credits so you don’t get a surprise recapture bill at the end of the year.
So, this isn’t the gospel, but in generalities, this is the order we prefer. Or, if you’re under 59½, it might be taxable first, then IRAs, then Roth, because you can’t easily access traditional IRA money before 59½.
Case Study: Homer and Marge Simpson
00:27:15
Karmi Gutman: Let’s go through an example together. We have Homer and Marge Simpson. I’m a big Simpsons fan.
Homer is 68 years old; Marge is 67. They file a joint tax return. They’re collecting Social Security: $2,500 for Homer and $1,800 for Marge. Homer, believe it or not, was able to get a nice pension from the Springfield Nuclear Plant at $70,000 a year.
While working with their financial planner, they decided the most suitable mix for them is 60% stock and 40% safe (bonds) to reach their goals. They also have monthly expenses of $8,500.
Their investment profile:
A trust account with $400,000.
Homer has an IRA he rolled over from the plant with $500,000.
Marge has a Roth IRA she stacked up over time with $300,000.
We’re talking about a $1.2 million portfolio.
00:28:41
Karmi Gutman: We’re going to walk through what their lifetime tax bill would be if they just did a proportional mix in all accounts versus using our strategy.
But first, let’s talk about assumptions. Any model is only as good as its inputs.
We assume they live until age 100. We’d rather plan for 100 and not be surprised.
We assume the 60/40 mix will follow historical average returns from 1923 until now.
We assume they are comfortable holding that same mix for the next 32 years.
We assume current tax laws stay active, and items set to expire in 2029 (like certain deductions) will actually expire.
00:31:07
Karmi Gutman: For example, the senior deduction and SALT deductions—we assume those will revert to normal rulings after 2029.
I’m going to change my screen now so we can run the numbers. I’m using a software called Right Capital. We’re not promoting it, but we like to use it because it’s clear for demonstrating these concepts.
Running the Numbers: Proportional vs. Strategic Location
00:32:19
Karmi Gutman: Let’s start with the base case: Homer and Marge do 60% stock and 40% bond across all their portfolios and take distributions proportionally. When we total that up until age 100, Marge and Homer are going to pay $888,409 in taxes.
How does that happen? Because if your traditional IRA is stock-heavy and returns outpace your fees and RMDs, the balance continues to grow. As it grows and you age, Uncle Sam forces you to take more and more money each year, meaning you pay more taxes.
00:35:03
Karmi Gutman: Now, what if we use the strategy we talked about? We maximize the stock allocation in the Roth first and put as much as we can of the “safe” side in the traditional IRA.
We tell the software to make that $300,000 Roth fully equities because that’s likely the money they touch last. When we rerun the numbers, the lifetime tax bill goes from $888,000 down to $643,000.
00:36:31
Karmi Gutman: Why is that? Very simply, you are removing the higher-growth elements (stocks) from the traditional IRA and replacing them with bonds. Bonds historically return 2% to 4%, while stocks can be 8% to 10%. If the traditional IRA grows more slowly, there is less tax coming out of that account over time because there are fewer investments “going to the moon.”
Meanwhile, in your Roth, you are maximizing the investments that exceed growth expectations. When you change your portfolios to be more tax-efficient, you achieve better risk-adjusted and tax-adjusted returns.
00:37:52
Karmi Gutman: Now, what if we also change the withdrawal order? Instead of taking money proportionally, we draw down the IRAs first, then the taxable accounts, and the tax-free Roth accounts last. Over time, we save an extra $30,000 to $40,000 in taxes.
By drawing down the pre-tax accounts earlier, you are putting yourself more in control of your tax bracket compared to letting the balance grow and being forced to follow IRS mandates later.
Summary and Q&A
00:40:46
Karmi Gutman: To summarize:
Roth: High-growth/aggressive investments.
IRA: Safe/lower-growth monies.
Brokerage/Taxable: The wildcard, depending on specific goals and remaining shelf space.
On paper, an individual account might look “too aggressive” or “too conservative” if you don’t look at it holistically. But that is the point of asset location.
Determining your right mix of stocks and bonds is a great first step. But if you’re not ensuring your accounts are being used to their best capabilities, you could be giving a “tip” to the IRS.
00:42:17
Karmi Gutman: With that in mind, I want to open it up for questions. You can go to the chat box to the right of the red button. I see a couple of people with raised hands. Alexis, if you’re there, can you help me unmute them?
Alexis Rico Cortes: It doesn’t look like I can, but I did allow everybody to turn on their mics.
Karmi Gutman: If you’d like to ask a question verbally, you’ll see a little microphone option on the left-hand side. Oh, okay—no worries. Someone said they raised their hand by accident.
Michelle Dexter: Karmi, I don’t know if you answered this, but for anyone still in the phase of investing, do you have recommendations on how they balance that? Is it just “put as much into Roth as you can”?
00:45:24
Karmi Gutman: Great question. If you’re still working, it depends on what accounts are available to you. First, figure out the right mix for your allocation. If you’ve been very aggressive in a traditional IRA, don’t panic; you haven’t necessarily done anything wrong. You’re playing on the monopoly board given to you.
We find there’s a “golden” period from age 60 to 70 where we can make proper adjustments. If you want more risk but don’t want it in your 401(k), a brokerage account is a nice place for that. It provides great tax-efficiency options (like ETFs with high QDI) and has no contribution limits or withdrawal age restrictions.
00:49:02
Karmi Gutman: And just a quick note: because this is also an estate planning firm, if you have a trust, we would prefer that brokerage account to be in your trust. Michelle, don’t get mad at me; I made sure to say it!
Any other questions? Either I did a really good job or I went too fast! If something pops up later, you can email me at the link listed. There is also a book on Amazon called Tax Planning To and Through Early Retirement. It’s about $20 or $30, and if you’re a DIY investor, it’s an excellent resource.
Alright, Alexis, are there any upcoming webinars?
Alexis Rico Cortes: Yes!
May 13th (Noon): “How to Document Your Specific Healthcare Wishes” with Michelle.
May 20th (Noon): “How to Transfer an Operating Business Without Chaos” with Francisco.
May 27th: “Intro to Wills and Trust” with Francisco.
I’ll drop the registration links and our YouTube channel link in the chat.
Karmi Gutman: Awesome. Thanks, Alexis. Thank you everyone for your time this afternoon. I hope it was enlightening or at least thought-provoking. Have a great rest of the week and a great weekend!
