• Roger Whitney:
  • Retirement Answer Man Podcast
  • Episode #549: Answering Listener Questions
  • Rock Retirement Club
• Roth Conversions:
  • Roth Conversions Part 1: What, How, and Why
  • Roth Conversions Part 2: A 5-Step Process to Determine if a Roth Conversion Makes Sense for You
• Q&A Resources:
  • Closed-End Funds vs. Open-End Mutual Funds
  • New Rules for Inherited IRAs
  • Pension vs. Lump-Sum Strategy Decisions
  • What Every Retirement Saver Needs to Know About Annuities

Roth Conversions for Kids, Home Equity in Retirement, Pension vs. Lump-Sum (And More!)

Taylor Schulte: Are you ready to get answers to some big retirement questions?

Question such as:

What role does the equity in my home play in my retirement plan?

Why on earth would I do Roth conversions just to help mitigate taxes for my kids when they inherit my retirement accounts?

Are closed end funds a good investment?

How do I properly evaluate pension vs. lump-sum decisions? 

Welcome to the Stay Wealthy podcast, I’m your host, Taylor Schulte, and today, I’m these questions (and more) with my good friend, Roger Whitney. 

I’m also providing an update on the Retirement Podcast Network and what we’ve done with the feedback provided by listeners.

To view the research and articles supporting today’s episode, just head over to youstaywealthy.com/222. 

Roger Whitney: Things before we get started answering questions. Number one is a warning to you and number two is I want to hear what’s going on with our retirement podcast network. 

So number one, the warning is I started golf lessons again for our trip in November. Oh boy. And they’re going to stick this time. I’m committed to doing the work, although I really showed up last year, so just FYI on that. 

And number two, what’s going on at our retirement podcast network that we’ve been iterating on? You’re the mastermind of a lot of things there.

Taylor Schulte: Yeah, I’m glad you brought it up actually. Yeah, I think we touched on it briefly here on the show, I don’t know what it was a couple months ago, and kind of talked about the genesis of the Retirement Podcast Network and our vision for it. And interestingly enough, and I think this happens a lot in the business world, you pivot based on feedback that you get from your customers or your people or your followers, your audience. 

What we learned really quickly is that all of you guys, all of our listeners, my respective show and yours are really enjoying our weekly email that we’re sending out. So as part of the Retirement Podcast Network, we send out a weekly email called RPN Weekly. Every single week on Fridays, we send this email out. It includes five of our favorite articles that we read that week that have something to do with retirement planning, investing, tax planning.

We’re scouring the internet, we’re reading all these articles all week long and we’re choosing the best five and we’re including them in this email as well as our favorite chart of the week. 

Again, that chart is related back to investing, retirement, financial planning, tax planning, something that makes sense for our target listener, and then also a summary of the episodes that we have all individually produced for that week. 

So it’s a really nice concise email. Almost a thousand people are subscribed to that email right now, and the feedback that we’re getting is phenomenal. So we’ve been pouring a lot more of our time and attention and resources into making that email even better as a way to add more value to the Retirement Podcast Network and then the people that are following us there.

Roger Whitney: So much to listen to and we have five shows in the network currently. So you can go to Retirement Podcast Network and sign up for that email and hopefully save yourself some time. Alright, we have our first question. Taylor, you ready?

Taylor Schulte: I’m ready.

Roger Whitney: Yeah. We’ll put a link to this in Six Shot Saturday, by the way, our weekly email summary of this show only. Alright, this comes from Jeff related to tapping home equity and retirement. 

Taylor, I am still in the accumulation phase and on track relative to my bespoke plan. Nice fancy word there. My wife and I find ourselves headed to a place where it’s at a point where I want to retire. We will have one substantial 401k asset non Roth and two substantial amount of home equity, probably two to 3 million. 

It’s clear that one option is to consider downsizing to a less expensive home and turn some of that home equity or use asset into a productive asset, but if we decide to stay in our home, my research is telling me that we should convert some home equity to cash vis-a-vis a home equity line of credit, a HELOC or verse mortgage. 

I’d love to hear your perspective on how do you go about using home equity as a resource in retirement and you live in California, San Diego, where you deal with it seems always rising, real estate prices. How do people access their home equity if they don’t want to move?

Taylor Schulte: Yeah, there is a lot to unpack here. Yeah, we do run into some interesting scenarios out here where there are people in California with most of their money tied up in their home, which is an illiquid asset. So they are faced with some decisions in many cases where they do need to either sell the house and downsize or find a way to get cash out. 

This is a really huge topic, Roger, and we don’t have all the relevant information here. This person is asking some really good questions about order of operations and what to think about here. Maybe just a start here. Maybe we start with that order of operations just in general and then try to get to the root of his question and try to answer it as best as we can with the limited information. 

So for me, unless you have plans to sell the house in the future and downsize within the next 10 years or 10 years from now, we want to sell this house and we want to downsize.

We want to move closer to our kids or we want to just move to a lower-cost area, or we’ve always wanted to live in Arizona. If you have the intention to sell that house in the future and downsize, then the house sales scenario to me is usually the last asset to sell in the order of operations. 

In other words, if you have no plans to sell the house, if you just want to live in it for as long as possible, then typically the order of operations is we’re going to take money from our traditional IRAs first to ensure that we’re maxing out favorable tax brackets, so we’ll withdraw up to those favorable tax brackets from our traditional IRA. You might be doing that through Roth conversions. If not, you can do it through straight withdrawals. 

Then from there, I want to look at our taxable brokerage accounts where those more friendly capital gains exist, and then third, that Roth ira, if we have a Roth IRA bucket, we want that to grow as long as possible.

So that would be third on the list and then to me, fourth would be these other items like your home. If there’s no plan, if you don’t intentionally plan to sell the home in the future, then to me that’s kind of like the last thing on the list. If I have to sell this home, then that’ll be the last asset I sell. 

Now that’s just your strict order of operations. That’s not necessarily, well, how do I get some cash out now or set ourselves up now in case we do want to tap into some of that cash, but just in terms of straight order of operations, if there’s no intention to sell the house, then yeah, I’m going to put that at the very bottom of my list and when if I ever have to sell the house, I know that that asset is there and I’ll sell it.

Roger Whitney: Yeah. I like this idea of order of operations of how do I think through it in an organized way. Our order of operations would be first establish a feasible plan of record to determine whether it’s feasible to live the life that you want without selling the house. 

Let’s say that’s version one to see if it’s even feasible and it may not be right. It would probably be good to know that. And then creating, if it’s not, then it’s, well, how long can we stay in this house? Right? 

What if version number one might be, and I’ve done this numerous times, Taylor, where it wasn’t feasible to keep the house or the second house forever, but it’s feasible if you agree that you were going to sell it at some point in the future and recapture some of those assets so you can get an idea of what the roadmap looks like.

One thing I find interesting about this, Taylor, is someone told me, and I haven’t Googled this to see if the study is actually correct, but it said if you are on a perfectly flat surface and you are six feet high, that you can only see 2.9 miles before the curvature of the earth takes over. 

And I think of this like that in that we’re sitting here making assumptions about ourselves 20 years in the future or 15 years in the future. Nobody really has a forever house. Very few people actually do. So I think knowing whether it’s feasible not to be able to do it or if it’s a lever that you can pull later on, do you have any specific thoughts on now the heloc, that seems a little bit more problematic to me because it’s really just a line of credit and you’re going to have payments on it, etc. 

Have you ever walked the journey of a reverse mortgage in your practice?

Taylor Schulte: Yeah, I think the reverse mortgage here, the comment about that it truly is. I know there’s some part of the question about risks and considerations, and I think that’s truly the biggest risk or consideration to factor in. 

Maybe before we go there, I just want to share that if you have an intention to sell your house or you realize, hey, we do need to sell this house 10 years from now to help fund retirement expenses. I know part of his question is what assumptions should I be using? And I’m not sure exactly where he was coming from with saying, what assumptions should I use? 

But just for whatever it’s worth, we typically use a 4% growth rate for residential real estate, which is the long-term, historical average at least before the last couple of years where real estate went crazy. So if you are going to model something out, Hey, in 10 years we’re going to sell the house, I might use a conservative growth rate like three or 4% on that asset.

Then I’d want to figure out my cost basis and ultimately end up with what’s my tax bill going to be after the sale of this house factor in real estate agent fees as well, but essentially, what am I going to walk away with 10 years from now if I sold this house? 

You can use financial planning software, talk to your financial advisor or model something out in Excel, but those are really the basic assumptions is just the growth rate of this asset for the next 10 years. My cost basis, if you made any improvements to the home, you’re going to factor those in because that’ll increase your cost basis, the exclusion that you get when you sell a home, and then real estate agent fees. 

And so what do I walk away with at the end of the day? That’s a really important piece of information to know what am I going to do with those proceeds? I need to go buy another house and then also use some of those proceeds to fund retirement. So that’s the exercise there.

Roger Whitney: I think another assumption there, Taylor, that in working through this exercise is if I were to do it today, what would be the cost of the place I want to go to? Because many times it’s not near as downsizing as you think it is, just depending on your local real estate market. So getting an idea of what the cost of the place that you want to go to today because the delta might not be as large as you think.

Taylor Schulte: Yeah, that’s a really good point, and especially if you’ve owned your home for a long time and there’s a lot of capital gains in there, you might have a much larger tax bill than you thought and what you walk away with at the end of the day might not be as much as you had initially hoped. 

So I think that’s a really important piece of information. I think what he’s really getting at is I don’t necessarily want to model the sale of my home, but I just want to be prepared in case I ever do want to tap into that equity, which has led him to this reverse mortgage question or some sort of a loan that I can tap into. 

In short for us, and I know there’s some academics out there that talk about using reverse mortgages to create retirement income for us, reverse mortgages are typically your last-ditch option.

I’ve tapped everything in my last option because I want to stay in my house. I do not want to leave my house. The last option is reverse mortgage the house. Now most of our clients, all of our clients do not proactively go and get a reverse mortgage now for a few reasons. 

One, the application process is long and painful. You now have to go through counseling to ensure that a reverse mortgage makes sense for you. And then the big kicker is the origination fees for these reverse mortgages can be as high as like $40,000, somewhere between 20 and $40,000. 

This could change a little bit state by state, but it’s expensive to set these things up. So unless you absolutely need this thing, most people don’t want to go through all those hoops and then write a check for 20, 30, $40,000 on something that they may or may not need.

I like to highlight that this is a loan, don’t kid yourself. Here you are getting a loan, A reverse mortgage is a loan, and so unless you need to go and establish a loan to borrow from yourself or borrow from the bank, it’s not really the most prudent option. 

Maybe the last thing that steers people away from reverse mortgage, and again, he asked about risks and considerations. Your reverse mortgage will mature if you’re away from the property for more than six months for non-medical reasons, and then more than 12 months if you’re in a medical facility. 

So if you have a medical event that requires you to be in assisted living for a year, well then say goodbye to your reverse mortgage and then hope that you still have enough equity in the house to avoid a foreclosure situation. So there’s a lot of little nuances there that typically spook people away, especially those who are in really good financial positions, really scares them away from doing a reverse mortgage. 

So I’m not sure that that’s the solution here, especially since this person said, I have a substantial amount of money in 401k assets and a substantial amount of money in my home. It doesn’t sound like there’s a huge income need here from these assets.

Roger Whitney: And I think that’s built that feasible plan of record first to know if it’s even something you need to think about pulling. We’ll get into reverse mortgages. We’ll have to do a whole episode on it because there are a lot of nuances. I’ve walked this journey with one client and to almost do the traditional mortgage or a reverse mortgage of sorts, and we chose not to do the mortgage. 

So there’s some places for innovation here. That was a long one. Now I got a short one, and this comes from Thaddeus Roger, looking for clarification. My mother passed away in December, 2019, but we did not inherit her IRA until March of 2020. Do we follow the pre 2020 IRA withdrawal rules or the current 10 year rule for IRAs? Which one?

Taylor Schulte: This is like a CFP test question here.

Roger Whitney: It does sound like this, doesn’t it?

Taylor Schulte: Yeah, so the rules just tie back to date of death. So date of death of that person would be December of 2019. So you’d use the pre-2020 IRA rules for this situation. So everything ties back to date of death, whatever’s on the death certificate.

Roger Whitney: And we just recently got some more clarification from the IRS related to this because the next question now that we know that is in your case, it’s prior to Secure Act, so you’re just going to follow the normal stretch rules. Okay. 

So actually all the secure ACT stuff doesn’t apply to you. So I just answered my own question. I was going down the secure act because I’ve been reading that lately, and so that’s where my mind is. So you got it pretty easy there, Thaddeus, from this perspective, you just can stretch it out over normal life expectancy. 

Alright, next one is from Anthony related to Roth conversions. Yo, Roger, my question, he didn’t actually say yo Roger, but I like that. I think that’s how Anthony talks. I know an Anthony who talks that way. I know the advantage of Roth conversions that you recommend doing as much conversions as you can in paying the taxes, preferably from our savings.

My question is why should I do a Roth conversion, even though I know when I pass, my two kids can easily pay the taxes themselves when they inherit my traditional IRAs. I don’t want to do Roth conversion paying taxes from my IRA distribution itself. I think as long as I am alive, I pay taxes on whatever RMDs I have and he goes on to say, my wife and I are 60, 67 and receive monthly pensions. 

Well, one I would argue before I throw this back to you Taylor, is I don’t say yes, you must and should really do Roth conversions. I think it’s a tool that you should evaluate, but it sounds like from Anthony’s perspective, it’s like, I don’t want to pay all these taxes. My kids can handle it. How do you approach this subject?

Taylor Schulte: Yeah, I think last time I was on, we had a Roth conversion question. We’re assured to emphasize that look, Roth conversions can be great. It’s a way for you to optimize your plan. It’s not going to make or break your plan. 

So if you skip Roth conversions fine. I’m sure you’ll be just fine. If you do some Roth conversions where it makes sense, it could put you in a better position at the end of the day. To me, just like let’s set the kids aside for a moment. A Roth conversion is paying taxes on your terms versus the IRS’s terms. 

So is it cheaper to start to pay some of the taxes? Now, by the way, I don’t think you mentioned it, but I know Anthony has, he mentioned a $1 million IRA and he’s 70 years old. His wife I think is 67 $1 million IRA.

Is it better? Is it cheaper to start to pay some taxes now on that money, convert it to Roth or do nothing, wait and pay some of the taxes at age 73 when Anthony is forced to start to take required minimum distributions, IE, will your effective tax rate be higher at age 73 and beyond than it is today? 

To a certain extent, you have to make some assumptions here, right? We don’t know exactly what things are going to look like in the future. There’s no guarantee, but that’s the question to ask yourself is am I in a better tax situation today or can I get some money out at a lower rate today than where I’ll be in the future? 

So that’s just an exercise that I think everybody should go through to determine if there’s an opportunity there. Now, going back to the kids, I think he’s asking a really good question.

This comes up a lot. First off, with Anthony, with your pensions and social security and the fact that you only have three more years before your RMDs begin, it’s highly unlikely that you’ll be able to convert all $1 million, at least I think I don’t have all the information here, but that’s a lot of money to convert in a short period of time when you have other income sources. So maybe push that to the side that you’re not going to convert all $1 million. 

Again, it might still make sense to do a Roth conversion analysis and determine maybe you can get a little bit of money out. Maybe it’s just $50,000 per year for the next three years. That could still be a win back to the kids. Yes, your kids can likely easily pay the taxes themselves when and if they inherit this IRA, the inability to pay the tax bill is not usually the primary driver of this approach.

The reason that at least our clients, the reason that they consider their kids when doing a Roth conversion is for two reasons. One, their kids will likely be in their peak earning years when that IRA is inherited, and two, the client, again, we’re not going to make this prediction, but the client believes has a strong opinion that taxes will be higher in the future than they are today. 

So if my kids are going to be in their peak earning years and taxes are going to be higher in the future, the parents are saying to themselves, well, I can pay 22% or 24% of the IRS today, or my kids might have to pay 37% or higher on a potentially larger balance in the future. So that’s really what I hear from clients. It’s not like I’m worried they won’t be able to pay the tax bill, so I’ll pay it for them.

It’s like, no, I don’t want the IRS to get a bigger chunk of this money than they really deserve. Lastly here also, it’s rare in my experience, for someone to do Roth conversions just for their benefit of their kids. It’s usually a mix of a few different things.

 One, clients wants to pay tax rates on their terms at favorable rates. Two, getting money into a Roth provides some flexibility and tax diversity in retirement. And then finally it might be something like, yeah, I don’t want my kids to inherit a tax burden or I don’t want the IRS to collect a bigger check in the future, so I want to get some money out of there today. 

I want to pay it at more favorable rates today so my kids don’t get stuck with this giant tax bill and the IRS collects a bunch of money. So it’s usually a mix of these things. It’s not just, I’m going to do this for my kids.

Roger Whitney: Yeah, our good friend Michael Kitsis says, and I think it’s the best way to think about taxes is it’s never a question of avoidance. It’s always just a question of timing. You’re going to pay the tax, whether it’s this year or next year or your children pay it, taxes will be paid. It’s just really a matter of timing. 

And so if you think of a couple quick steps, you could go through Thaddeus. It’s number one, create a, let’s just call it a three-year cashflow estimate for you and your wife. What is your income going to be by source over the next three years? That’s step one. 

Step two, you say you’re not taking money from your IRA. If you don’t take money from your IRA, just throw a 5% growth rate on it, what will that grow to your required minimum distributions? You go onto an online calculator and figure out what your first year and beyond RMD estimates are.

Now that’s going to be income that you’re going to be forced to take out. That will be added to your other income sources. And C as Taylor was saying, does this move me from the 12% to the 22% or from the 22 to the 24 or whatever they are after 2026. And like you were saying, Taylor, do I have the opportunity of taking 20,000 and paying 12% this year rather than waiting and paying 23 or 24 or whatever it is? 

That’s really the low hanging fruit on all of this is give me a burger today rather than two tomorrow. I know I can pay 12% on some portion of it and maybe there isn’t any opportunity. So that’s usually a more healthy way to approach this.

Taylor Schulte: That’s well said. It is a timing decision. Another one of our mutual friends says, Hey, we want to pay the IRS, their fair share. We just don’t want to leave them a tip, right? So let’s not just be lazy here and do nothing, or I don’t want to pay this tax bill for my kids, right, and just not do anything. And then all of a sudden you are leaving the IRSA tip. The IRS is winning in this situation. 

So be proactive, crunch the numbers, make an educated and informed decision. And yes, we don’t know the future. So to a large extent, we are making educated assumptions here to try and make the best decision possible for us in our financial plan.

Roger Whitney: Okay. You said other mutual friend. I don’t know who this person is. I want to confirm that I’m actually friends with them. Who is this?

Taylor Schulte: I’ll tell you all fine. Okay.

Roger Whitney: I’m assuming my friend. Okay, our last question, Taylor, is from Brent. My question is as follows, my wife has been a teacher for 31 years. She plans to retire in three years. At age 58 when she started teaching all these years ago, we fell for the sales pitch and opened a variable annuity for her. 

When I came to my senses, I stopped contributing money to the annuity and opened up a Roth IRA, which has a balance of 250,000. The annuity has a balance of $14,000. What can I do with the annuity? Can I somehow get the money into a Roth? Can I plan on retiring in December? 

And I have Roth in my name also. I think the good thing here is it’s $14,000. It’s not the majority of your nest egg. So how you manage out of this annuity is really just looking at the fact set of what are my options? How would you approach this, Taylor?

Taylor Schulte: Yeah, I was almost wondering if there was a typo in the question. It’s a really good question about the annuity and what do I do with this thing, but it’s only $14,000. I don’t want to make assumptions here about what that 14,000 means to this person, this couple. But yeah, the balance, at least compared to the other 250 that’s been saved, it’s relatively small. 

So even if you paid the taxes and paid whatever penalty, you’re still walking away with some money there that maybe it doesn’t require a large analysis. However, let’s say that that 14 grand means a lot to you. You want to make the smartest decision you can with that $14,000. 

One is just understanding if there’s any surrender fees on this annuity. So most annuities have some sort of surrender period. You need to wait seven years or 10 years before you can liquidate it without penalty or move it without penalty.

So you might just want to understand what those surrender fees are when that schedule ends. Maybe it’s already ended. It sounds like you did this quite a while ago. And then from there it is pretty simple. He didn’t share what type of account the annuity is held in. Annuities can be held in retirement accounts, IRAs, they can be held outside of retirement accounts and just your traditional brokerage accounts or in the name of a trust. 

But let’s just assume that it’s a pre-tax. IRA account type. So if the annuity is out of surrender, there’s no more fees. That $14,000 is yours to do something with. Well, you can just move it to another pre-tax traditional IRA and invest how you see fit. Maybe do some Roth conversion since he mentioned trying to get it into a Roth. 

You could also move it to another annuity if annuity seems to be fitting for you. But once you’re out of surrender, you can kind of do whatever you want with it. You could just treat it like any other account type, any other traditional IRA that you might have. So there’s a few things maybe understand there to ensure that you’re not surprised by fees or penalties, but it is pretty simple once the annuity is out of surrender.

Roger Whitney: And I think a key to this is thinking through it in an organized way rather than, obviously you’re not an annuity fan from your experience just with the verbiage that you used in your question. 

Taylor Schulte: No, him. Oh, him.

Roger Whitney: Yeah, the gentleman. Yes. But you also want to make sure that you’re not giving up a valuable benefit that you’re not even aware of, that you might not recreate. So similar to Taylor, have a feasible plan and just think about this as a financial asset. Table stakes is have a feasible plan.

This is a tactical decision of what do I do with this one piece of my financial assets in the context of the bigger plan of what’s important to you. And then when you’re looking at this new, is it in a surrender charge? What are the costs? What are potential benefits that were in there that you may not even realize we’re in there because you’ve had it for so long? 

That could be a long-term care benefit. It could be an accelerated death benefit. It could be you just know it doesn’t matter whether you like it or not, just know what they are. And then once you have that information, what are the options? I could buy another annuity and maybe there are better annuities that have things that you care about now, long-term care with limited underwriting perhaps, or you could turn it into cash. 

If you turn it into cash. Is it an IRA? So just think through it like a decision tree will help you get to your best judgment because there’s likely not going to be a slam-dunk answer. And that’s true for most things.

Taylor Schulte: Yeah, I that’s really well said. I should have mentioned that every annuity is different. So it might be called a, let’s say variable annuity, but every variable annuity is different. Even variable annuities at these insurance companies that have the same name actually are different. They roll out different variable annuities under the same name all year long with different ID numbers. 

So anytime we’re dealing with an annuity, new client comes on board, we call the insurance company directly and we’re on the phone with that annuity company for at least 30 minutes asking them a lot of questions about that specific product and learning as much as possible about that specific product to then decide how are we going to move forward with this annuity. 

So not all annuities are the same. Be very careful, and I think you listed out some great questions and things to understand, to know how you want to move forward with this bucket of money.

Roger Whitney: Yeah, it’s like wine that way. It could be the exact same name, but a different vintage year to year.

Taylor Schulte: Right. That’s a really good analogy actually. Thank you.

Roger Whitney: Alright, I’m going to throw a curve ball at you. Here’s another one actually. This was asked in the Rock Retirement Club and I promised I would ask it on the show. A good friend asked me to read a book and I don’t really want to mention the new title book by a former financial advisor promoting actively trading in closed end funds to enjoy large and growing distributions during retirement. 

And then do you have any thoughts on a few closed-end funds? And they gave me a couple of symbols. So the symbols they gave me were essentially equity, dividend equity portfolio in the structure of a closed end fund, not the traditional fixed income closed end funds that we talked about. 

But I think the two key questions here are, one, closed-end funds, good or worthwhile investments, and two, really what the guy was promoting, which is actively trading closed-end funds to capture dividends and be protected in all markets. Which somewhat of the pitch when I went and checked out the book, and I don’t want to recommend it, I think it’s hoo-ha. 

But I wanted to talk about one, let’s talk about actively trading in terms of getting growing distributions in retirement. Is that a good strategy and what are some of the maybe advantages or disadvantages in your mind?

Taylor Schulte: Well, it’s timely. I just did a whole four part series on dividend investing on the state Wealthy Retirement show this last month. I cover everything you could possibly imagine on dividends and dividend investing and exploring a lot of these concepts and what I would call myths that are out there about chasing yield or chasing investments that promise these distributions. 

So if you want to learn more, go there and listen, pushing aside the investment product closed-end fund versus ETF versus mutual fund versus separately managed account, whatever, push the product, type aside your retirement needs and goals, your income needs, your retirement timing, your needs and goals should drive how you invest your money based on what I need, based on what I’m going for, what my goals are, here’s how I need to invest my money. 

From there then determine, okay, what’s the best way to go and implement this investment portfolio?

It might be closed-end funds, it might be mutual funds, it might be ETFs, it might be a mix of all these things. At the end of the day when it comes to choosing investments for yield, you get in a situation where you end up taking a lot more risk than you probably think. And I think the simplest way to frame this is the global stock market.

So US stocks and international stocks, the global stock market, the current yield of the entire global stock market right now is about 3%. So if the global stock market, the yield of the global stock market is 3% and there’s an investment out there. 

Again, I don’t care if it’s a closed-end fund, if it’s a mutual fund or an ETF, there’s an investment out there that says we’re spitting out a 6% yield, double that of the global stock market.

All you need to tell yourself is I’m taking more risk than the global stock market to go and get that 6% yield. That 6% yield doesn’t come out of nowhere. You don’t just get more yield for the same amount of risk. There’s more yield there for a reason that that portfolio, that closed-end fund contains junkier companies that are paying higher yields.

So you need to accept more risk by getting that higher yield. I don’t really care so much that it’s a closed-end fund, although closed-end funds certainly have some issues. I just care about the luring of investors into these products that on the surface appear like they’re great solutions, but these investors not really realizing how much risk they’re taking by buying these investments. 

So I would just be very, very, very careful and hopefully that illustrates just really simply how to think about the risk when buying some of these funds.

Roger Whitney: Yeah. One thought on how we think about dividends, but I want to question and perhaps a pushback on something you said is thinking about the dividend yield. I mean, dividends are nice, right? It’s nice to get paid, the price will go down by the amount of the dividend, but behind income strategies is that we think of retirement planning like our parents did, that we’re going to live off interest rather than thinking in a total return strategy. 

So I think the idea of just living off the income a portfolio throws off for 99% of us, that’s not going to work. And it can lead you down some of these strategies where a more thoughtful retirement process can help you. 

But I wanted to question you on the junkie company comment. I think of companies have free cashflow, they have to decide what to do with it, they can reinvest it in the company, they can buy back stock, which is more popular than ever, or they can distribute to the owners and there’s obviously more options, but those are the main three. 

Not all companies that decide to pay back a portion of their free cashflow or profits to the owners are junkie. The ones that the higher the yields, the more aggressive they might be, but I don’t know if it’s always.

Taylor Schulte: Absolutely. It’s certainly not always. Maybe we’ll back up and we’ll say one of the common reasons that companies pay a dividend is to show potential investors that they’re healthy, they’re so healthy that they have some excess profits that they can share with you. They don’t need that money to fuel the future growth of the business. 

We’re doing so well that we can share some of these profits with you, our investors. Now, it’s not necessarily true, just because they pay a dividend doesn’t mean they’re healthy, but that’s kind of what they’re signaling to investors is that they have some excess cash, they’re healthy, therefore you should invest in them. 

The other thing to note is most companies pay a dividend. I think it’s like 75% of all US companies, they pay some sort of a dividend. It may not be 6%, it might be 1%, it might be 3% or 2%, but most companies do pay a dividend. So yes, there are great companies that pay dividends. To your point about looking at the total return of your investment versus just the yield. 

That’s the important part. You’ve got a great company, I’ll pick on at t for example. At t is long paid a nice dividend, but if you look at the total return, and I haven’t looked at T specifically, but most of these great dividend paying kind of blue chip stocks.

Roger Whitney: AT&T’s about 6%, they’re in my doghouse because they’ve released all my information, but they’re about 6% right now.

Taylor Schulte: If you look, oh, I haven’t looked at the total return chart, but most of these like blue chip, stable dividend paying stocks, you look at the total return compared to just the S&P 500, and they significantly outperform even with the dividends included. 

So yeah, it’s a stable company that spits out a nice dividend, but on a total return basis, your investment returns are significantly lower than just owning the global stock market. And so no, not a junkie company, but you should expect lower returns from these dividend-yielding or high-dividend-yielding securities. 

My comment about junkie companies is when you go chase a portfolio that has 6% yield, you are owning some junkie companies that are going to drag down the future returns of that company. You are increasing the risk in the portfolio and you’ll likely have lower future expected returns. So no, they’re not all junky companies that are great companies that pay dividends, but just very simply, there’s no free lunch you’re giving up.

Roger Whitney: Yeah, I’ll check out your series. I didn’t realize you did that. 

The other part of this question, Taylor, which I have a big issue with, is this idea that there’s a trading strategy that’s active in trading these instruments or any instruments that can somehow participate in the upside and protect you in the downside, which is what this book is arguing and well, I’ll say promoting. 

I think that is a recipe for disaster in that it’s all about the execution, not just now, but consistently. I think that’s a recipe for disaster for someone to try to go into retirement thinking they’re going to have a trading strategy to pay for their life for the next 20, 30 years.

Taylor Schulte: Yeah, I think we’re in agreement there. Actively trading, I mean, again, all the data is out there, all the research is out there that actively traded investment products largely underperform just your passive low-cost simple solutions. So it all sounds good. 

The marketing sounds great, but you should expect lower future returns from that product that’s actively trading things. Now you might get lucky and choose the right manager at the right time and it happens to work out. But on average, over long periods of time, these actively traded strategies typically underperformed. 

Now, I will say some of these, they’re very good strategies run by incredibly smart people. And it’s not that the strategy is bad, but these actively traded strategies cost more money than your low-cost kind of passive plain vanilla solutions. And those additional fees reduce the rate of return. 

So it’s not that the manager doesn’t know what he’s doing or she’s doing or it’s a bad strategy, it’s just like the fees that are embedded. They take away all the excess return that that manager generated. So just on average over a long period of time, 85, 90% of these active strategies underperform. And maybe you get lucky and you choose the 10%, but that’s a really hard thing to do.

Roger Whitney: Yeah, Charles Ellis winning the losers game investment classic, and if you’re going to learn the investment strategy and take it on yourself, then yes, you’re saving this quote, the cost of paying someone else to do it, but now you’re paying in a lot of other costs. 

You’re paying in taxes, you’re paying in time, you’re paying and execution risk goes up through the roof in terms of you’ve got to do it exactly the same way every single time and not outthink it. And even then it might not work. And even if it has a bad period, you have to stick with it even if it was a valid strategy in the first place. So it sort of sets you up for a lot of future difficult decisions.

Taylor Schulte: I agree. I always say the best investment strategy is the one that you can stick with. And what I find when people come across these too good to be true type investments that they want to go and implement themselves, they go and they try it for a year or two. It doesn’t work out how they had thought. 

So then they jump to something else and they never really give this thing the long-term hold that it deserves to be successful. It’s really hard to stick with things no matter what strategy you choose, you’re going to go through a period of underperformance. You’re going to go through a period where you hate this strategy that you have. It could be dividend investing, it could be small-cap value investing. 

It could be this closed-end fund actively managed strategy. It’s going to go through difficult time periods, but you have to stick with it. You need to own it for a long period of time, and that’s really challenging to do on your own. 

And I think you brought up the real point, which is like, is that really how you want to spend your time in retirement day trading actively managed closed-end funds? Like most people would say, no I don’t.

Roger Whitney: So I’m going to check out your dividend series on Stay Wealthy Retirement Podcast. Didn’t realize that you did that. That’s awesome. Thanks for hanging out with me, buddy.

Taylor Schulte: For what it’s worth, I did see one other question come through.

Roger Whitney: Did I miss one? Okay, you read the question since I don’t show it on board.

Taylor Schulte: I’ll play Roger. I’ll play Roger Day. All right, question bit of a background. I retired last year at 52 from the corporate world in order to scratch my entrepreneurial itch. It’s been a goal of mine for years, but the golden handcuffs and multiple college bills for kids prevented me from doing so. 

After doing some calculations, I determined that I was financially independent and I pulled the plug. This person has $6 million net worth, not including their home equity, and they have an option to take their pension from their company as a lump sum or in monthly payments. 

So the monthly payments would be about $3,500 per month starting in 2032, so six years from now. So he’s 52 today, six years from now, he’ll be 58, and that’s when he could start to take $3,500 per month from his pension. That’s one option. Or he could take the cash value.

Now he could take the $400,000 lump sum, roll it into an IRA and invest it how he sees fit. He mentioned that he also has another pension that will be paying $1,100 per month starting in 2028. That one cannot be taken as a lump sum. So he’s just accepted that. And then also, both of these do not have cost of living adjustment increases. 

So no cola on either of these pensions. In other words, it’s $3,500 per month and that’s it. It’s not changing in the future. So inflation will slowly erode or eat away at the purchasing power of that $3,500 per month. 

Lastly, he said he’s leaning towards taking the lump sum after doing some calculations, but wanted to see if he was missing anything. He just figures he could invest the $400,000 now and have more flexibility down the road than this fixed monthly payment that does not grow with inflation. So what should he do?

Roger Whitney: Okay, so it actually starts in eight years, not four years. I think he said four or six years, right? Starts in 2032, so that’d be eight years from.

Taylor Schulte: I’m sorry, eight years. Yeah. 

Roger Whitney: So age 60. Okay, so you’re asking me that question. I’m going to answer this first. Alright, so one, it sounds like we have a feasible plan. You are likely overfunded. I’m going to make that assumption based on the numbers you gave, right, Taylor. Right? 

Okay, so you’re overfunded. So this is an optimization question. Do you take the $400,000 today or $3,500 a month starting in 2032? We can make some assumptions on what the 400 would grow to. One question is do you have to make the decision? 

Now some pensions will allow you to defer that decision and sometimes the pension amount in terms of the monthly income could grow by deferring it. So we would want to know that because perhaps you could not choose one or the other and then choose $4,000 a month, four years from now, you have to check with your pension on that.

Just using the $400,000 in today’s dollars. That’s about a 10% payout, which is attractive, but we have the foregone growth on that $400,000 if the pension is locked in the way we talked about it. 

So we do want to know that. I think this is a little bit of dealer’s choice in what do you want. The advantage of taking the money is going to be that you can hopefully grow that longer and you’re so overfunded that you’re building a bigger pie for family later on. The disadvantage is that you’re going to have a higher need from your financial assets because you don’t have this guaranteed income source, not with the facts presented. I would likely take the pension.

Taylor Schulte: Interesting.

Roger Whitney: We’d need to know whether that what might grow later between now and 2032. That’s really the wrinkle for me. I think Taylor, but assuming you got that $40,000 a year today, I would rather get the social capital as guaranteed payments and that will allow you to be one more aggressive potentially with the rest of your assets because there’s less of a demand for them and it’ll also be make your future self, their life a lot easier potentially. 

The other factor is if you take the pension, you may have a bigger window to do Roth conversions and things like that because we have the time. I would say 80 90% of the time, this is one of the most answered questions, Taylor that we get. 

The pension is usually a really good option. So this is not a recommendation to you, but this is as I think through it, you’re never going to recreate that pension if you were to try to buy annuity later on. What do you think, Taylor?

Taylor Schulte: So it’s interesting where you landed with that. There’s a few other things that came to mind for me here. So one is, yeah, so this $400,000, well, the way I took it in his question was the $3,500 per month in 2032. To me, I took it as he already has that number from the company that if he waits until 2032, that’s going to be the amount. 

So that’s the way I read it. So I can take the $400,000 now or wait and get $3,500 per month, eight years from now. So the first part for me is, okay, I take the $400,000 now and I invest it. So what’s that going to grow to eight years from now, I’m just going to make a number up and say it’s $550,000.

Roger Whitney: 590, pretty good. 590. Yes.

Taylor Schulte: So conservatively again, let’s just say $400,000 turns into $450,000 conservatively at the end of eight years, $3,500 per month divided by that $550,000. It’s getting close to like a seven, 8% distribution rate on the surface. That sounds pretty darn good. We all know the 4% rule. 

So this pension company is basically saying, we’ll pay you seven or 8%. I don’t calculate the numbers in front of me here, but we’re paying you 78%. That sounds pretty enticing. However, there’s no cola increases. So it sounds good today, and this is pretty typical with pensions that don’t have colas. 

It sounds good today, but inflation is going to start eroding at your purchasing power. $3,500 a month, 10 years from now is not the same as it is today. The math is all making sense to me. The other thing, the cola is a big one for me. If there’s no cola, I’d say 99% of the time the client’s not taking the pension, they’re going to roll the over. Interesting.

Roger Whitney: We’re very different on that one.

Taylor Schulte: Yeah. Well, here’s the bigger kicker for me, and we don’t know this information. He did mention kids college bills. I know he has kids, so he seems like he’s very well taken care of financially, that he’s over safe for retirement. 

So what are his intentions and goals for his heirs, his kids, if he takes the pension and he passes away, that money is gone, right? The kids don’t inherit that pension. If he takes the 400 K and invests at how he sees fit and grows that $400,000 to a million dollars by the end of life, his kids now inherit a million dollars. 

So I think that’s an important consideration here is what does this bucket of money mean to you and your legacy goals? And then second to that, again, there’s a lot more to understand here, but I’m not sure if he’s married, I know he has kids, but I dunno if he’s still married or not and how his wife plays into all this as well.

There’s some different pension options, spousal benefits also. Sometimes you run into, let’s say he plans on taking the pension eight years from now. In some cases, if he passes away before that pension begins, it’s gone. If he doesn’t make his election and start that pension and he passes away, that whole bucket of money is gone. 

She doesn’t get the $400,000, she doesn’t get the pension. So it’s not until he starts to take that pension income and if he elects an option that includes a spousal benefit, that she would be entitled to it. So that’s something to factor in as well, is how does my spouse and the benefits from my spouse play into this decision? And we just don’t have enough information there. 

So a few more things to consider, but the lack of a cola is a real big one for me, especially since he doesn’t really sound like he doesn’t really need this income. Is it better to take the money and grow it yourself?

Roger Whitney: Yeah, I think the key thing is $6 million net worth likely doesn’t need the income. Lack of cola doesn’t bother me near as much as it does you now, this is interesting. 

I think Taylor is one of the smartest retirement planners I know, and I try to be, and we have some differing views on approaching this, and it goes back to sort of that annuity question is, and this is frustrating for you, it’s frustrating for us is almost all of these questions become our judgment calls based on financial numbers, but also personal preference, and that’s okay, although that is frustrating.

It’d be great to have clarity. So when you’re dealing with judgment calls is have all the information so we understand exactly how the pension works, what your feasible plan of record is, so you can work through it in an organized way to make a judgment call that you can at least feel confident that you didn’t wing it. Thanks for grabbing that question, Taylor.

Taylor Schulte: Sorry, there’s one more thing that we totally glossed over here. What’s that? Taxes. So if he takes a pension at age 60, he’s essentially triggering a tax bill. And again, we’re making an assumption that his financial situation, he’s over-safe for retirement. He doesn’t need this money, he doesn’t need this income yet he’s taking this income and creating a tax bill that he doesn’t really need. 

Now, I don’t know enough about his situation. Maybe that tax bill is not a big deal, but if you take the pension, you’re also accepting a tax bill on income that sounds like you don’t need at that time. If you instead rolled that money over to an IRA at age 60, well, you would do it today, but you would have from today until age 75 to deal with the tax bill. 

So you would have more control over the timing of your taxes by rolling it into the IRA and dealing with it either through Roth conversions on your terms between now and age 75, or maybe RMDs at age 75 and beyond are more tax efficient for you than clipping $3,500 per month today, or starting at age 60, 15 years ahead of RMDs.

So 15 years of income that you don’t need. Again, I don’t know what that does to his tax situation, but that’s a really important piece of this puzzle.

Roger Whitney: So we could banter around this all day then I’m thinking, yeah, qualified charitable distributions. When you at age 70, this is what we do for a living. Taylor, thanks for hanging out with me today and thinking thoughtfully on. My words are funny today, thinking with me on helping people take little baby steps to get the judgments they’re comfortable with. I appreciate it.

Once again, to grab the links and resources mentioned in today’s episode, just head over to youstaywealthy.com/222.

Thank you, as always, for listening and I will see you back here next week.

Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.