The 2017 tax cuts are set to expire, which means we may see a dramatically different tax landscape soon. But just because taxes are likely going up doesn’t mean yours can’t go down. This week, John explores how you can achieve tax savings through strategic planning. (31:09) Plus, he gives practical insights on life insurance considerations and shares lessons we can learn from the past 12 months. (8:04)
Episode Description
Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!
John Hagensen: Welcome to the Rethink Your Money podcast presented by Creative Planning. To request a meeting with one of our local advisors, visit creativeplanning.com/radio. I’m John Hagensen, now join me as I help you rethink your money.
Today I want to talk about something that affects all of us, and that’s money stress. Rich people have stress about how much they owe in taxes and their estate plan and how to protect their wealth. Believe it or not, even they have stress. Others are stressed about not having enough or the debt that they’ve accumulated. And then there’s a middle group who have a blend of both of those concerns. And the reality is you’re not your best self when you are stressed out financially. It reminds me of those Snickers commercials, you’re not you when you’re hungry. Yeah, you’re not you when you’re stressed out financially. I remember when my wife, Brittany and I, were first married. We were typical broke newlyweds and it was stressful. We didn’t have any money. My hair was falling out on my pillow. I wasn’t sleeping well. I was certainly not a patient spouse. And more importantly, I was not present, mentally, emotionally because the weight of that stress was difficult. I wanted to provide. I wanted to create a great life for us and we didn’t have any money.
So it’s really important that we address this because the greatest value for your money isn’t so that you can accumulate a large number in an account or take a nice vacation or live in a fancy house. None of those things are bad, but money’s ability to lower your stress, and increase your freedom is the ultimate potential that I want you to unlock, because that’s when it will really make a difference for you and for your family. And I know what you’re thinking. Who doesn’t have money stress? Is it even realistic for you to think that you can overcome something that seems inevitable? Well, I want to encourage you the answer is absolutely yes. Because I’ve seen it firsthand.
People with stress who then take actionable steps and some that I’ll share with you here in a moment, feel more peace when it comes to their finances. And I want that for you. I have solutions for how you can reduce anxiety through rethinking your approach. And this is heightened right now because you see the markets and the economy, they’ve always been unpredictable. That’s not anything new. That’s their nature, especially over the short term. But what is unique is what you’ve been facing recently. This particularly high degree of uncertainty, really since the pandemic in 2020. COVID, inflation, impending recessions, bank failures, there’s always something that seems to be drawing a concern around your money, isn’t there? It’s no wonder why a recent survey from bankrate found that money is often a significant cause of stress for most Americans. In fact, 52% say money has a negative impact on their mental health, which is up significantly, from 42% who said that pre-pandemic.
I don’t know about you, but those numbers get my attention and my experiences with investors just like you who are sharing their stress and their anxiety and their worrisome thoughts around their ability to, maybe it’s retire or provide for their kids to go to college, or support an aging parent. Whatever it is with their situation, that uncertainty can be a heavy burden. And it can even lead to depression in some cases, full on depression. And the primary driver is financial wellbeing. I want to say it again. There is nothing around your money that will be of more value for yourself and maybe even more importantly for your family, for those that you love and you care about, than you finding confidence around your financial situation. And ultimately that won’t happen without a plan. So how can you manage your financial stress during times of economic uncertainty?
Well, I have three tips that will make a real difference, I’ve seen this work firsthand. My first tip is focus on what you can control. Control what you can control. Direct your energy there. In the midst of a lot of external factors that are affecting your finances, it’s crucial to remember a lot of them you can’t control, I can’t control, so don’t spend time there. It’s only going to stress you out more. You can make smart choices with your spending, with your saving, with your investing habits, those are all within your control. It’s about you taking charge of what’s within your power. Perfect example, the banking crisis. Well, if you were someone who had bank balances under FDIC limits and the rest was invested or in treasuries or somewhere else, you weren’t that stressed out that Silicon Valley Bank and a few others were going under. Because you had controlled what you could control. You can’t control whether your bank goes broke, but you can control the balances in your account to ensure that they are insured.
See what I did, there wasn’t even trying to. One of the easiest things, you can control your costs. I find that a lot of folks don’t even actually know what they’re paying for their investments or for their advisor or in commissions or in that insurance policy or that annuity. A lot of those expenses are internal. They’re not line itemed on an invoice that they send you every month so that you can review them. Often, we are hemorrhaging costs unnecessarily within our investments. So focus on what you can, in fact, control. Next, develop a financial plan. You will have stress if you have no plan, period. Having a well-thought-out plan that takes into account your goals, your risk tolerance, your time horizon, your tax strategies, your family dynamic can provide the peace of mind you need.
It really is like having a roadmap to guide you through all the twists and turns of the financial landscape. Most people, and this is important for you to know, do not have a legitimate, detailed financial plan, which is crazy to me because it’s available. There are so many great certified financial planners out there who can build you this plan and help you understand where you’re at and where you’re headed and that will absolutely relieve stress. And my third tip for managing your anxiety around your money, spend less than you make. I know. I mean these are profound things that you hadn’t thought of, right? Control what you can control, have a financial plan and spend less than you make. But I’m telling you, that will allow you to build up savings, you’ll have an emergency fund so you have a cushion because you’re spending less than you make.
So when that surprise expense inevitably comes, as it does, I need to re-roof the house, we need new air conditioners, our car broke down, unexpected medical expense, you have a buffer. You have a cushion, which then allows you to stay out of debt, which is the ultimate killer of financial peace of mind. And so here’s the thing my friend, if you don’t have either the time or the expertise or the desire to truly give your money what it deserves, but you want to have less stress, you want to feel confidence in what you’re doing with your money, then you hire an advisor. Not everyone needs a financial planner, but everyone does need a financial plan. Go to creativeplanning.com/radio now to meet with us. Together we can overcome stress. We can help you make better financial moves and build toward a more secure future.
Well, I’m joined today by Chartered Financial Analyst and Creative Planning Investment Manager Kenny Gatliff. Kenny, welcome to Rethink Your Money.
Kenny Gatliff: Hey, thanks for having me, John. It’s good to be back.
John: I approach personal finance from a certified financial planner side of things, as a wealth manager. Looking more broadly at the entire plan, you’re specifically on the investment side as a CFA. So that’s where I want to go with today’s conversation. It seems to me that there is a lot of what would be considered outdated for many years when it comes to investment allocation and strategies that are coming back into favor now. From your perspective, what have we learned in 2023 as investors?
Kenny: You’re definitely right. These things are cyclical. There’s always whatever the hot trend of investing is that people gravitate toward and what they read in the news and there is a little bit of recency bias here. And whatever has been the norm in the last few months or few years, we tend to get this idea that that’s going to be the norm in the future forever. In this case, in 2023, this is really pronounced in that if you’re under the age of 60, this is the first time in your adult life that you’ve been in an environment with high interest rates spiking and with high inflation. And that is something that’s been out of vogue for so long that we just haven’t really had to worry about.
So it has required some adjustments and not all of those adjustments have been made and it’s been a little bit messy and we’ve seen the results of that all throughout the economy and the bank collapses and a whole number of things that have gone on in the last year. We can look at this in one of two ways. We can say, “Okay, well let’s just hunker down and say we don’t know anything, so why even make decisions or what can we learn from these things?” And that’s the biggest one is to not get caught in that recency bias, to not just say, “Whatever’s the norm right now is going to be the norm forever.” So this has certainly been one of those years where we’ve been able to learn a lot.
John: I want to transition over to rates. So for a decade, you’re not sitting around with friends at a bar talking about interest rates. I mean, that wasn’t something that anybody cared about. I mean, nobody even thought about rates other than occasionally they’d say, “Wow, I’m getting 10 cents on my $100,000 in the bank!” Or, “My bank said they’re going to offer me a high yield savings account at 35 basis points,” or something like that. I mean, it was so out of sight out of mind, and that obviously changed. So what did we learn about rates in 2023?
Kenny: We really hadn’t been exposed to this and then all of a sudden the Fed raised rates basically from 0 to 5% in just over a year. And in the last 40 years, that’s easily the highest and most aggressive rate raise that we’ve seen. Again, it is something that we didn’t necessarily plan for and there have been consequences. There’s been the bank failures, there’s been bond holders suffering. The housing market’s been all out of whack with all of a sudden mortgage rates going from 2.5 to 6.5 or 7%. So there’s a lot to deal with in that scenario. It is funny that all of a sudden that is what people are talking about and it’s not something I would’ve predicted that being locked into a low mortgage rate or having this old CD in your investment portfolio is going to be a topic of conversation. But that is worth having the conversation about because it does require us to do things differently.
John: Well, I think it taught us, again, recency bias was who cares if I cheat out a little bit longer on duration or lower credit quality bonds because I need to juice my return a little bit when rates were a lot lower. And we learned that not all bonds are created equal. Can you speak to that a little bit in terms of how bond investors fared and what we can learn?
Kenny: This is a huge one. This is probably the biggest takeaway for individual investors in that, John, you and I have had this conversation many, many times over the last 10, 15 years of we would have investors show us a portfolio and we would see these long maturity, long duration bonds and we would bring up and say, “Look, that might have a little bit more risk than you are understanding.” And we always got the same reframe because it hasn’t been risky in our lifetime as saying, “Eh, it’s a bond. A bond’s a bond. It’s fixed, it’s guaranteed, especially if it’s a government issue, there’s no real risk associated here.” But then we turn back the clock here and if we look at the start of 2023, you can look back at your one-year return of your portfolio and if you’re in long bonds, you’re down as much as 30%.
And this isn’t bonds that defaulted. This isn’t some 2008 scenario. This is just a government issued long-term bond was down a significant amount, whereas if you’re in a short term bond that T-bills at that same time, we’re up over a percent. So it’s not you’re getting great rates, but you’re not losing money either. And that just shows the stark difference that there is in these different bonds. And depending on what the environment is, if we’re in a high interest rate environment, if we’re in a low interest rate environment, that should absolutely dictate what your asset allocation is.
John: The difference of being down 30% or up 2% is obviously huge when that’s the portion of the portfolio that you need to be there when times are bad. So I think that speaks to risk. Risk suddenly mattered. People were saying, “Where am I banking?” What happened to that preferred stock that I owned? It went to zero. And can you speak a little bit maybe to risk and what your takeaways are?
Kenny: Yeah, and I think this has been a big highlight in that risk does matter and the bond one is great. When we talk about bonds, we talk about it as a risk mitigator. We know that there’s volatility in a stock portfolio, and so we buy bonds to reduce that volatility. And the reason they work and historically they’ve worked is that if stocks go down, bonds can generally not go down at the same time or at least not go down to the same degree. But when you buy the wrong bonds, you are taking a risk that you don’t understand. We’ve mentioned the bank crashes a couple of times, that’s more or less exactly what happened in these bank crashes. So they have these depositors come in, they need to make money on that deposit, so they go and invest it. And they had this same conversation that you and I were just talking about in that well, yields were really low everywhere. So what did they do? They went and bought long-term bonds so they could get just a little bit more yield. And then what happened?
The rates rose and somehow depositors at the same time realized, “Wait a minute. My deposit might not be safe.” And we saw a good old-fashioned bank run. These bank positions were down 10, 20, 30%. They weren’t able to get that liquidity to pay off depositors and that’s where we saw this risk reared ugly head. And these weren’t investors that just didn’t have knowledge. These banks have risk analysts, multiple on staff and their whole job is to try to look at every risk and make sure that they’re not exposing themselves and they totally got this wrong in a very easy and simple way. All that to say is risk does matter. And if we don’t learn from that, if we don’t look at what risks might be out there beyond the obvious, that’s where we can get hurt is those ones that happen once in a generation or once every decade, not easy to foresee.
John: I’m speaking with Creative Planning investment manager, Charter Financial analyst, Kenny Gatliff. So what you’re saying is we’ve seen the Fed and their 400 PhDs butcher inflation policy, and we’ve seen these banks with actual risk managers and analysts make that mistake as well, so individual investors don’t need to feel terrible if they’ve made a couple of mistakes with their own portfolio. We’re all subjected to that risk for sure. The other thing I was thinking about, Kenny, as you were saying that is so often people will just say, “Well, the risk of the stock market.” They understand there’s volatility in the market and returns and they’ll say, “That’s why I’m in cash. Wait a second. They were telling me this while inflation was at 8%. I don’t like risks, so I sit in cash.” You’re losing 8% right now on that million dollars that’s sitting in cash plus you’re over FDIC limits. There are other risks that are maybe just less at the forefront of our mind, to your point that are very real risks.
Kenny: Yeah. And I do think that is the big takeaway here is if you look at those bank collapses, what happened? In 2008 a bunch of banks collapsed and the regular years came in and they had these stress tests, they looked in the books and they broke up some different banking institutions. And all these regulations were put in place and then they washed their hands and said, “All right, well, we fixed it. The risk isn’t there anymore.” And of course those regulations work to stop the risk that happened last time. And of course in this time, there’s a new risk that came about and something that they didn’t prepare for.
And so that’s the takeaway here is not to say, “Okay, I got burned on long bonds. I’m never going to buy a long duration bond again. What I’m going to do is adjust for only that risk and then totally ignore what happens next.” And I think that’s where we really see investors get hurt is if they just get burned time and time again by something that’s slightly different than what burned them last time. And that’s where having a conversation with someone who does understand the financial planning side of things, the investment side of things to say, “Hey, where are my blind spots? What am I not seeing? What’s the risk that I don’t understand is out there that I can prepare for?”
John: What’s the saying? Risk is what’s left over after you think you’ve thought of everything? Something to that effect. It was almost by the way, like you were promoting a diversified approach, spreading out your risks, not having all your eggs in one basket, not having any big bets in any one spot. That is something that I talk about every single week because there just are too many risks for you to anticipate because some of them are new and you just won’t be able to identify those always in advance. So having risks that are dissimilar to one another is the best in and most efficient way to protect yourself.
Let’s talk about the 60/40 and its rebirth. For a while when interest rates were low and nobody could earn anything on bonds, even if you want to be 60/40, you just can’t afford to do it. You’re going to have to cheat out on the risk curve, have to have 80% stocks and 20% bonds. And I’m not even saying that was incorrect. I mean that actually may have been the right approach because you didn’t want 400,000 of your million dollar portfolio earning 1%. So we’ve seen a comeback though on the 60/40. What do you think we’ve learned about that?
Kenny: It goes back to what we were saying before in that you can’t just assume that the last 10 years of your investment strategy is going to work for the next 10 years. And a financial plan can never just be set it and forget it. A financial plan has to change based on changing regulations, changing laws, changing economic environments, interest rates, inflation rates. All of those are dynamic and ever-changing and there’s never just one specific coverall portfolio or coverall financial plan that says, “No matter what, this is in place and this is going to be right forever.” And that’s why we always say, “Look, talk to a wealth manager and figure out what works for you now and if something changes the next year, what needs to happen within your financial plan to change with that?”
And you’re right, this idea of the 60/40 portfolio, there’s been hundreds of articles over the last 10 years saying 60/40 is dead, and to some degree they were right. The 60/40 did very poor last year, but now we are on the other side of that where rates are higher. You do get more yield for your bond, so it might be time to consider an asset allocation change if you’ve spent the last 10 years trying to avoid those bonds.
John: So it was maybe like a bad horror movie like they were dead but their head wasn’t fully chopped off and then it rose back up.
Kenny: The reincarnation of the 60/40. I like that.
John: Yeah, basically. Well, I think that’s a good place to end, talking about zombies with their heads cut off. That’s what we learned from 2023. This is great insight and a great reminder that a dynamic financial plan, as you put it, is really important and the value is not really in building the plan, it’s in changing it as new information arises. And doing so within the context of a stated philosophy that you’re able to be grounded to while making adjustments on the peripheral. So thank you so much again, Kenny for joining me here on Rethink Your Money.
Kenny: Yeah, thanks for having me, John.
John: As a parent to seven kids, one of the things that is painfully obvious to my wife, Brittany and I, is that kids want attention and they will get it when they’re competing with their siblings for it by whatever means necessary. If I’m not careful, the kid who’s acting out the most doing the worst things ends up being the object of a lot of my attention where the child doing the right thing sometimes can be left behind a bit.
And so I’ve been working on ignoring negative behavior and just acknowledging, especially in front of the other kids, all of the positives when one of our children is doing the right thing. But I find the same is true more broadly in life. What bleeds leads. What catches our attention is the negative. I’m guilty of this even hosting the show. I’ll say, “Look, this scam happened,” or, “this person did this and it was not right and they lost a lot of money,” and we can learn from those and I think they’re helpful, but I also want to make sure I’m including some of the fantastic moves that I see on a regular basis as well.
And with taxes set to increase in 2026, here are a couple of great examples from recent visits I’ve had. Had a client making a high income was in a higher tax bracket. They regretted that they had purchased just this antiquated, garbage whole life policy that they’ve had for 30 years. Really wasn’t satisfying any financial objective, but there were tax implications of relinquishing it. So what they were able to do was a 10/35 exchange. It’s a tax-free exchange where the IRS says, “If you move from one type of insurance to a similar type of insurance, you can maintain the current tax status and it is not a taxable event.” They were able to transfer that money into a low cost tax deferred annuity. I know your ears perked up. Wait, John. Annuity? Are you sure an annuity? Is that a good thing? I’m not talking about an illiquid, high commission, high cost, lock your money up forever type of annuity, but rather one with no cost in, no cost out, low cost index funds as the investment vehicle but wrapped in this deferred annuity wrapper so that they can defer taxes until distribution.
And in this case most importantly, we’re able to go from something barely growing that served no strategic purpose into a portfolio that looks very similar to all of their other accounts, but because of the wrapper, and by the way, that wrapper costs about a quarter of a percent per year. And they were able to take six figures, a big chunk of money that in their mind was dead and now is serving a great purpose. Another great example from a tax planning standpoint, had a client with significant income. They were a business owner wanting to retire in the next 7 to 10 years. The way their business was structured, they didn’t have a lot of employees. The couple that they had were family members that frankly they’re going the transition the business to and want to support. They were able to establish a defined benefit plan, which is different than a defined contribution plan.
Most commonly like a 401k, where your contribution amounts are capped every year. With a defined benefit plan, you’re backing the math into a retirement benefit that you’re trying to achieve and so the closer you are to retirement, typically the older the business owner is, the more you can contribute and thus defer out of your current income. Well, this person’s making seven figures a year and we’re able to stuff over $500,000 a year into this defined benefit plan to be taken out after retirement, and although tax rates are likely to rise, this is the type of person where they won’t be in a lower tax bracket because their income’s going to drop significantly. Another great example of tax planning that I’ve seen recently was a client who took an early severance from their company chose in 2022 to not work, so essentially had no income in 2022 but planned to take a job again in 2023 and they were going to be making about $400,000 a year. So a high income earner that was going to fall back into a 32% tax bracket.
Well, they also had a lot of money deferred in their 401k from the old employer that they had left. Of course, this was a perfect opportunity to Roth convert. He was able to convert over $300,000 at an effective tax rate of only about 20%. It was a perfect example of someone recognizing that low income, temporarily, for a one-year period presented significant tax opportunities. My last positive example of someone making wise money moves in particular when it comes to their tax planning, was a person who had transitioned into retirement and focused much more heavily on dividend oriented positions rather than growth. Now, I’m not going to get into whether I agree with that or not because I think there’s a more efficient way to drive income in retirement, but regardless, this person was smart. They put their dividend oriented positions inside their IRA account, which allowed their positions that were less tax invasive to exist in their outside brokerage accounts.
This lowered their overall tax bill because they weren’t needing to reinvest unspent dividends after paying tax within that non-qualified account. So just a fantastic recognition of what we call asset location. It’s not just what you’re owning, it’s where you own them within the plan. Are you hearing these things and wondering what you might be missing out on? What tax opportunities exist right now and are there for the taking that you’re just not aware of? Maybe your advisor is not aware of? Does your advisor review your tax return on a regular basis? When’s the last time your CPA and your financial advisor met together? Not to review your filing but to plan and strategize for not only this year but the next several years. Contact us now by going to creative planning.com/radio. Our mission is simple, to help you find a richer way to wealth. And we’ve been helping families just like you in all 50 states and over 75 countries around the world since 1983. Lower your financial stress by gaining clarity and confidence around what you’ve worked your lifetime to save.
One more time, creative planning.com/radio to speak with one of our 300 local financial advisors just like myself. Why not give your wealth a second look? Well, it’s time for us to rethink some common wisdom to ensure that the advice is not only accurate but current and relevant for today’s environment. One thing I hear often is that to have financial success, I’m going to need superior investment returns. I’m going to need to achieve alpha. Well, let’s look at this together. Alpha, by the way, is a term used in investing to describe an investment strategy’s ability to beat the market. Let me just sift through the noise here for a moment and summarize. You are not going to be able to outperform broad markets. I know, it sounds harsh. Like, “Really? I mean, how do you know?” Because almost no one can. Over the last 10 years, according to a recent study, 89% of professionals ending in 2020 underperformed but here’s the silver lining.
Fortunately success won’t need to come down to superior investment returns. And the reason I say fortunately is because you’re almost certainly not going to be able to pull that off. So good thing there are other ways you can achieve “alpha”. And let me talk to you about two in particular, and these are very much within your control. The first and probably most important is to never be really wrong. Put another way. Your ability to avoid the big mistakes will be vital in you achieving success. Investing like any other endeavor comes with risks, but it’s the big mistakes that can truly derail your financial goals. And the second way you can achieve alpha is by strategic tax planning. Yep, that’s the theme of today’s show. It’s within your control and when you integrate your taxes and you pay the least amount possible, more stays in your portfolio to compound over decades.
Let’s unpack these two primary ways to achieve alpha. First off, talking about avoiding big mistakes. Creative Planning President, Peter Mallouk, who’s accumulated all sorts of different accolades, including a three time Barron’s Financial Advisor of the Year Award in 2013 through 2015, wrote an incredibly popular finance book that he titled, The Five Mistakes That Every Investor Makes and then How to Avoid Them. So I want to highlight these five mistakes that Peter outlines in his book for you. The first mistake, overconfidence. Many investors fall victim to overconfidence. Believing that they have superior stock picking abilities or can accurately time the market. This overconfidence can lead to excessive trading, chasing hot stocks, and ultimately underperforming the market. Look no further than the pandemic. The worst thing for many of those Robinhood Day trading investors was that they made a lot of money over a nine-month period. And it gave them a false bravado for what they thought they could accomplish year after year and decade after decade. Obviously, that reality check came in the form of 2022.
Second common mistake investors make is focusing on the short term. It’s really easy to get caught up in the short term market fluctuations and the breaking news, especially because we live in a 24-hour news cycle, we’re being notified on our watch in real time. Successful investing requires patience and a focus on long-term goals. The third common mistake is a lack of diversification. Concentrating investments in a few stocks or a few sectors exposes you to unnecessary risks. Diversification across asset classes, sectors and geographic regions helps reduce portfolio volatility and protects against significant losses. Our fourth of the five common mistakes that Peter outlines in his book is ignoring costs. One of the easiest things for you to control is not overpaying. And frankly, I find when I provide wealth path analysis for families who are looking for a second opinion, most do not know what their costs are.
If you don’t know what your costs are, that’s normal. Most of what you’re paying is internal, and unless you know where to look or have an independent advisor show you, you won’t know. And so often, those costs can be reduced and every dollar that you save remains in your portfolio to continue compounding for your benefit. For your future, rather than being siphoned out. My fifth and final common mistake that I want you to avoid is emotional decision making. Emotions often cloud investment decisions leading to irrational behavior. Money is emotional, it represents things that we care about. We are humans, we are emotional. It’s why in a recent behavioral finance study that is done on an annual basis by DALBAR, they once again outlined that over the last 30 years, the average American has earned only half of what the S&P 500 has delivered.
Successful investors stay disciplined and adhere to their financial plan, even and especially during periods of market volatility. Peter’s insights outlined in the book remind us of the importance of avoiding these common mistakes to achieve long-term investment success. So the first key to achieving alpha is not again, superior investment returns, but by avoiding big mistakes. And the second key is through tax strategies and great, proactive tax planning. As the saying goes, it’s not how much you make, it’s about how much you keep that matters. In summary, we need to rethink this idea, this notion that we should be spending significant energy and time focused on how to achieve the highest and best returns possible. No, we need to be focused on avoiding big mistakes through great planning and minimizing emotional moves with our money, and then having a fantastic, well-rounded tax strategy incorporated with our financial plan led by a CPA who is integrated with our financial planner so that we can pay Uncle Sam the least amount legally required. If you haven’t had your tax return reviewed recently by your financial advisor, visit creative planning.com/radio.
I want to ask you a question. Have you ever went to file your taxes? Maybe you’re on Turbo Tax or you’re at your CPA’s office and just holding your breath to find out at the end whether you’re going to owe money, if you do, how much are you going to owe? Is it going to be worse than I was expecting or how much am I going to get back in a refund, maybe? That would be great. I don’t know if it’s 2000 or 6,000 or $2, I just don’t have any idea. Well, if you felt like that before, you are not alone. That is the majority of American taxpayers, because they don’t have a tax plan. There’s no strategy throughout the year looking forward. There’s no projections being done. Even people with financial advisors, a lot of them are just looking at the investments, looking at some of the retirement planning.
They’re not a CPA, they’re not a tax practice. They’re not building mock tax returns during the year looking forward, and that’s a problem. Do you think taxes are likely to go down over the next 30 years? Now, you’re probably chuckling at that thought, aren’t you? I’ve spoken at hundreds of live events and whenever I ask that question, the audience laughs and no one raises their hand. And then when I say, “How many of you think taxes are going to increase over the coming decades,” everyone raises their hands. And by the way, it’s not because we have a crystal ball, it’s because we understand basic arithmetic. We have 32 trillion of national debt and counting. We run at a major deficit essentially every year with the exception of two years during the Clinton administration. So whether right, left, regardless of which side of the aisle we spend more than we make, I mean it’s like the most basic thing that I just mentioned when it comes to personal finances.
I mean, we don’t even adhere to that as a government. And on top of that, we are in the lowest tax environment we’ve seen in decades. For a 40-year period right around World War II on forward, our top tax bracket was never less than 70% at any, 70. I didn’t say 17. 70. Our top tax bracket right now is 37%. And so while we all wish that we were paying less in taxes and often think, “Ah, man, we’re getting hammered on taxes.” No, we’re not, historically speaking. We’re in a really low tax environment and because of that and the knowledge that the current tax environment sunsets at the end of 2025, we need to plan for taxes going up. And most importantly, what can you do about that? And I’ll post an article to the radio page of our website written by one of our 100 CPAs, Zach Cox, specifically on the sunsetting tax rates and what you need to know.
But before I jump into exactly what you can do about it, let me share, briefly, the major changes that are coming with the expiration of Trump’s Tax Cuts and Jobs Act. Individual tax rates are set to revert to their 2017 amounts. Again, at the radio page of our website, there is a chart that shows what they are today and what they will be after the sunset. The estate tax exemption is getting cut in half for each taxpayer and is estimated to be around 6.2 million in 2026 after adjusting for inflation. So this change will not only affect estates over the current exemption amount of 12.06 million, but also and probably more importantly because it’s a change, those that are between 6 and 12 million. And remember, that also does include any life insurance proceeds, any real estate, any valuations of businesses. It’s not just your liquid investments.
A lot of people think I’m well under that. Maybe not once everything is added up postmortem. Another change is that the standard deduction is going to lower by almost half adjusted for inflation. The $10,000 limitation on state and local taxes will be removed. Mortgage interest will be deductible on debt up to 1 million, which will be up from 750,000 and expands to include up to a hundred thousand dollars in home equity debt. Miscellaneous itemized deductions, most notably unreimbursed employee expenses will be allowed. Personal casualty and theft loss deductions will be reinstated. And a Pease limitation will be reinstated at certain income levels, which puts a cap on total deductible itemized deductions. Well, that’s a lot of information that frankly is only relevant if we discuss what you can do about it and how you can take advantage proactively and strategically in light of these changes.
First, don’t blindly defer income to a later date. Most notably, this happens inside of your retirement account at work. You fund a traditional 401k, feels really good, you max out that retirement account and you see those contributions come off your taxable income. But remember, and here’s the key, you’re not eliminating taxes. You’re simply going to the IRS and asking if you can pay them later. Well, we just talked about it. You don’t think tax rates are going down and neither do I, so why as a blanket strategy would we want to be asking to pay taxes later at what we assume to be higher? Consider this. If you are married filing jointly and you earn less than $360,000, which is a lot of money, or you’re single and you’re under 180,000, you probably shouldn’t be deferring. Now I’m painting with a broad brush. I don’t know your entire situation, but you are in a 24% bracket or lower.
If you’re asking to pay those taxes later, when do you expect to be in a less than 24% bracket down the road? Another consideration for you, charitable giving. That standard deduction is so high right now that many people are receiving zero tax benefit when they give money to their church or Habitat for Humanity or some other 501(c)(3). It doesn’t even help because they’re not able to itemize. So either bunch charitable contributions and itemize and take it all at once and then go back to the standard deduction in future years. You can utilize a donor advised fund if you still want to distribute those systematically rather than giving to your church at once and then not giving anything for five additional years. You can use a donor advised fund to facilitate those in the exact cadence that you’re used to while being tax efficient. Or if you don’t mind not giving in certain years, wait until you’re in a higher bracket and then backfill charitable giving that you hadn’t done the last year or two while you weren’t going to receive much of a tax break for it.
How about harvesting gains? I know this is another one that’s counterintuitive. Wait, I’m going to voluntarily trigger taxes, John? Yes. The lowest long-term capital gains rate right now is 0%. I’ve seen highly appreciated investments continuing to be deferred beyond December 31st in client accounts, when had they triggered that gain, they would’ve paid 0% in taxes. Then they could have either diversified those proceeds elsewhere or just repurchased the exact same stock or bond or mutual fund or ETF at a higher cost basis. Another consideration for lower rates today is strategic gifting. If you have a kid early in their career, maybe they’re working a job in college, they’re in a really low bracket because they’re not making a lot of money and because as we’ve already mentioned, rates are low. Get them money today by funding a Roth or offer to replace their salary. If they max out their Roth 401k, you’ll replace it for them. Help them get money in today at low rates that will then be tax-exempt like a Roth moving forward.
Also, inheritance distribution planning. Maybe you’ve inherited a retirement account from a parent and you have 10 years to distribute that money and you are planning on deferring it as long as possible. Well, maybe right now you take a bit more while rates are low. And my final tip of how to take advantage of these lower rates, one that you’re hearing everywhere, and that is Roth conversions. A Roth conversion is simply migrating money from a deferred account into a tax-exempt account and paying tax at ordinary income rates on that conversion amount. Why would you want to do that? Well, because unless you give it away between now and the day you die, it is going to be taxed at ordinary rates that, per the show’s theme, we expect to be higher. So for example, take a married couple with a taxable income of $83,550. They’re at the top of the 12% bracket.
If they complete a Roth conversion of $256,000, they could move from a deferred account to a Roth. It would only take them to around the top of the 24% bracket, and that would save them over $15,000 in federal taxes by performing the conversion in the next three years instead of waiting until after 2025. And obviously they might not convert that much and their income might change. I’m just sharing with you, apples to apples, it’s a $15,000 savings verse 2026. And that $15,000 now stays in their account and grows tax-exempt moving forward. Think about how much more they’ll have 20 years later on that compound growth. Here’s the key because I know I’ve thrown out a lot of different ideas. Have a tax plan. Not just a financial plan. That’s great too. You need that, but nothing will reduce stress more than controlling what you can control and nothing is more within your control than optimizing your tax efficiency.
You don’t have to wonder what the investment returns will be or what the economy’s going to do, or whether a company will continue to pay dividends or how much volatility will occur. None of that matters with taxes. It’s a calculation and one that is so often overlooked. I don’t want that for you. Just ask yourself, when’s the last time your financial advisor reviewed your tax return? Are they having these conversations with you this time of year in the summer saying, “Hey, I know you don’t need to file your taxes right now, but let’s discuss strategies so that when we file taxes in 2024, we’ve made some really strategic smart moves to reduce your taxes, especially in light of the fact that we’re in one of the lowest tax environments you’re probably ever going to see.”
Don’t wait any longer. Let’s make sure you’re not paying the IRS more than legally required. Visit right now creativeplanning.com/radio to speak with one of our local financial advisors just like myself. It’s complimentary and there’s no pressure to become a client. One more time. That’s creative planning.com/radio. Now, why not give your wealth a second look? Because after all, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode, you can subscribe to Rethink Your Money wherever you get your podcasts.
Disclaimer: The proceeding program is furnished by Creative Planning an SEC registered Investment Advisory firm that manages or advises on a combined 210 billion in assets as of December 31st, 2022. John Hagensen works for Creative Planning and all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning tax and legal are separate entities that must be engaged in independently.
sors, visit creativeplanning.com/radio. I’m John Hagensen, now join me as I help you rethink your money.
Today I want to talk about something that affects all of us, and that’s money stress. Rich people have stress about how much they owe in taxes and their estate plan and how to protect their wealth. Believe it or not, even they have stress. Others are stressed about not having enough or the debt that they’ve accumulated. And then there’s a middle group who have a blend of both of those concerns. And the reality is you’re not your best self when you are stressed out financially. It reminds me of those Snickers commercials, you’re not you when you’re hungry. Yeah, you’re not you when you’re stressed out financially. I remember when my wife, Brittany and I, were first married. We were typical broke newlyweds and it was stressful. We didn’t have any money. My hair was falling out on my pillow. I wasn’t sleeping well. I was certainly not a patient spouse. And more importantly, I was not present, mentally, emotionally because the weight of that stress was difficult. I wanted to provide. I wanted to create a great life for us and we didn’t have any money.
So it’s really important that we address this because the greatest value for your money isn’t so that you can accumulate a large number in an account or take a nice vacation or live in a fancy house. None of those things are bad, but money’s ability to lower your stress, and increase your freedom is the ultimate potential that I want you to unlock, because that’s when it will really make a difference for you and for your family. And I know what you’re thinking. Who doesn’t have money stress? Is it even realistic for you to think that you can overcome something that seems inevitable? Well, I want to encourage you the answer is absolutely yes. Because I’ve seen it firsthand.
People with stress who then take actionable steps and some that I’ll share with you here in a moment, feel more peace when it comes to their finances. And I want that for you. I have solutions for how you can reduce anxiety through rethinking your approach. And this is heightened right now because you see the markets and the economy, they’ve always been unpredictable. That’s not anything new. That’s their nature, especially over the short term. But what is unique is what you’ve been facing recently. This particularly high degree of uncertainty, really since the pandemic in 2020. COVID, inflation, impending recessions, bank failures, there’s always something that seems to be drawing a concern around your money, isn’t there? It’s no wonder why a recent survey from bankrate found that money is often a significant cause of stress for most Americans. In fact, 52% say money has a negative impact on their mental health, which is up significantly, from 42% who said that pre-pandemic.
I don’t know about you, but those numbers get my attention and my experiences with investors just like you who are sharing their stress and their anxiety and their worrisome thoughts around their ability to, maybe it’s retire or provide for their kids to go to college, or support an aging parent. Whatever it is with their situation, that uncertainty can be a heavy burden. And it can even lead to depression in some cases, full on depression. And the primary driver is financial wellbeing. I want to say it again. There is nothing around your money that will be of more value for yourself and maybe even more importantly for your family, for those that you love and you care about, than you finding confidence around your financial situation. And ultimately that won’t happen without a plan. So how can you manage your financial stress during times of economic uncertainty?
Well, I have three tips that will make a real difference, I’ve seen this work firsthand. My first tip is focus on what you can control. Control what you can control. Direct your energy there. In the midst of a lot of external factors that are affecting your finances, it’s crucial to remember a lot of them you can’t control, I can’t control, so don’t spend time there. It’s only going to stress you out more. You can make smart choices with your spending, with your saving, with your investing habits, those are all within your control. It’s about you taking charge of what’s within your power. Perfect example, the banking crisis. Well, if you were someone who had bank balances under FDIC limits and the rest was invested or in treasuries or somewhere else, you weren’t that stressed out that Silicon Valley Bank and a few others were going under. Because you had controlled what you could control. You can’t control whether your bank goes broke, but you can control the balances in your account to ensure that they are insured.
See what I did, there wasn’t even trying to. One of the easiest things, you can control your costs. I find that a lot of folks don’t even actually know what they’re paying for their investments or for their advisor or in commissions or in that insurance policy or that annuity. A lot of those expenses are internal. They’re not line itemed on an invoice that they send you every month so that you can review them. Often, we are hemorrhaging costs unnecessarily within our investments. So focus on what you can, in fact, control. Next, develop a financial plan. You will have stress if you have no plan, period. Having a well-thought-out plan that takes into account your goals, your risk tolerance, your time horizon, your tax strategies, your family dynamic can provide the peace of mind you need.
It really is like having a roadmap to guide you through all the twists and turns of the financial landscape. Most people, and this is important for you to know, do not have a legitimate, detailed financial plan, which is crazy to me because it’s available. There are so many great certified financial planners out there who can build you this plan and help you understand where you’re at and where you’re headed and that will absolutely relieve stress. And my third tip for managing your anxiety around your money, spend less than you make. I know. I mean these are profound things that you hadn’t thought of, right? Control what you can control, have a financial plan and spend less than you make. But I’m telling you, that will allow you to build up savings, you’ll have an emergency fund so you have a cushion because you’re spending less than you make.
So when that surprise expense inevitably comes, as it does, I need to re-roof the house, we need new air conditioners, our car broke down, unexpected medical expense, you have a buffer. You have a cushion, which then allows you to stay out of debt, which is the ultimate killer of financial peace of mind. And so here’s the thing my friend, if you don’t have either the time or the expertise or the desire to truly give your money what it deserves, but you want to have less stress, you want to feel confidence in what you’re doing with your money, then you hire an advisor. Not everyone needs a financial planner, but everyone does need a financial plan. Go to creativeplanning.com/radio now to meet with us. Together we can overcome stress. We can help you make better financial moves and build toward a more secure future.
Well, I’m joined today by Chartered Financial Analyst and Creative Planning Investment Manager Kenny Gatliff. Kenny, welcome to Rethink Your Money.
Kenny Gatliff: Hey, thanks for having me, John. It’s good to be back.
John: I approach personal finance from a certified financial planner side of things, as a wealth manager. Looking more broadly at the entire plan, you’re specifically on the investment side as a CFA. So that’s where I want to go with today’s conversation. It seems to me that there is a lot of what would be considered outdated for many years when it comes to investment allocation and strategies that are coming back into favor now. From your perspective, what have we learned in 2023 as investors?
Kenny: You’re definitely right. These things are cyclical. There’s always whatever the hot trend of investing is that people gravitate toward and what they read in the news and there is a little bit of recency bias here. And whatever has been the norm in the last few months or few years, we tend to get this idea that that’s going to be the norm in the future forever. In this case, in 2023, this is really pronounced in that if you’re under the age of 60, this is the first time in your adult life that you’ve been in an environment with high interest rates spiking and with high inflation. And that is something that’s been out of vogue for so long that we just haven’t really had to worry about.
So it has required some adjustments and not all of those adjustments have been made and it’s been a little bit messy and we’ve seen the results of that all throughout the economy and the bank collapses and a whole number of things that have gone on in the last year. We can look at this in one of two ways. We can say, “Okay, well let’s just hunker down and say we don’t know anything, so why even make decisions or what can we learn from these things?” And that’s the biggest one is to not get caught in that recency bias, to not just say, “Whatever’s the norm right now is going to be the norm forever.” So this has certainly been one of those years where we’ve been able to learn a lot.
John: I want to transition over to rates. So for a decade, you’re not sitting around with friends at a bar talking about interest rates. I mean, that wasn’t something that anybody cared about. I mean, nobody even thought about rates other than occasionally they’d say, “Wow, I’m getting 10 cents on my $100,000 in the bank!” Or, “My bank said they’re going to offer me a high yield savings account at 35 basis points,” or something like that. I mean, it was so out of sight out of mind, and that obviously changed. So what did we learn about rates in 2023?
Kenny: We really hadn’t been exposed to this and then all of a sudden the Fed raised rates basically from 0 to 5% in just over a year. And in the last 40 years, that’s easily the highest and most aggressive rate raise that we’ve seen. Again, it is something that we didn’t necessarily plan for and there have been consequences. There’s been the bank failures, there’s been bond holders suffering. The housing market’s been all out of whack with all of a sudden mortgage rates going from 2.5 to 6.5 or 7%. So there’s a lot to deal with in that scenario. It is funny that all of a sudden that is what people are talking about and it’s not something I would’ve predicted that being locked into a low mortgage rate or having this old CD in your investment portfolio is going to be a topic of conversation. But that is worth having the conversation about because it does require us to do things differently.
John: Well, I think it taught us, again, recency bias was who cares if I cheat out a little bit longer on duration or lower credit quality bonds because I need to juice my return a little bit when rates were a lot lower. And we learned that not all bonds are created equal. Can you speak to that a little bit in terms of how bond investors fared and what we can learn?
Kenny: This is a huge one. This is probably the biggest takeaway for individual investors in that, John, you and I have had this conversation many, many times over the last 10, 15 years of we would have investors show us a portfolio and we would see these long maturity, long duration bonds and we would bring up and say, “Look, that might have a little bit more risk than you are understanding.” And we always got the same reframe because it hasn’t been risky in our lifetime as saying, “Eh, it’s a bond. A bond’s a bond. It’s fixed, it’s guaranteed, especially if it’s a government issue, there’s no real risk associated here.” But then we turn back the clock here and if we look at the start of 2023, you can look back at your one-year return of your portfolio and if you’re in long bonds, you’re down as much as 30%.
And this isn’t bonds that defaulted. This isn’t some 2008 scenario. This is just a government issued long-term bond was down a significant amount, whereas if you’re in a short term bond that T-bills at that same time, we’re up over a percent. So it’s not you’re getting great rates, but you’re not losing money either. And that just shows the stark difference that there is in these different bonds. And depending on what the environment is, if we’re in a high interest rate environment, if we’re in a low interest rate environment, that should absolutely dictate what your asset allocation is.
John: The difference of being down 30% or up 2% is obviously huge when that’s the portion of the portfolio that you need to be there when times are bad. So I think that speaks to risk. Risk suddenly mattered. People were saying, “Where am I banking?” What happened to that preferred stock that I owned? It went to zero. And can you speak a little bit maybe to risk and what your takeaways are?
Kenny: Yeah, and I think this has been a big highlight in that risk does matter and the bond one is great. When we talk about bonds, we talk about it as a risk mitigator. We know that there’s volatility in a stock portfolio, and so we buy bonds to reduce that volatility. And the reason they work and historically they’ve worked is that if stocks go down, bonds can generally not go down at the same time or at least not go down to the same degree. But when you buy the wrong bonds, you are taking a risk that you don’t understand. We’ve mentioned the bank crashes a couple of times, that’s more or less exactly what happened in these bank crashes. So they have these depositors come in, they need to make money on that deposit, so they go and invest it. And they had this same conversation that you and I were just talking about in that well, yields were really low everywhere. So what did they do? They went and bought long-term bonds so they could get just a little bit more yield. And then what happened?
The rates rose and somehow depositors at the same time realized, “Wait a minute. My deposit might not be safe.” And we saw a good old-fashioned bank run. These bank positions were down 10, 20, 30%. They weren’t able to get that liquidity to pay off depositors and that’s where we saw this risk reared ugly head. And these weren’t investors that just didn’t have knowledge. These banks have risk analysts, multiple on staff and their whole job is to try to look at every risk and make sure that they’re not exposing themselves and they totally got this wrong in a very easy and simple way. All that to say is risk does matter. And if we don’t learn from that, if we don’t look at what risks might be out there beyond the obvious, that’s where we can get hurt is those ones that happen once in a generation or once every decade, not easy to foresee.
John: I’m speaking with Creative Planning investment manager, Charter Financial analyst, Kenny Gatliff. So what you’re saying is we’ve seen the Fed and their 400 PhDs butcher inflation policy, and we’ve seen these banks with actual risk managers and analysts make that mistake as well, so individual investors don’t need to feel terrible if they’ve made a couple of mistakes with their own portfolio. We’re all subjected to that risk for sure. The other thing I was thinking about, Kenny, as you were saying that is so often people will just say, “Well, the risk of the stock market.” They understand there’s volatility in the market and returns and they’ll say, “That’s why I’m in cash. Wait a second. They were telling me this while inflation was at 8%. I don’t like risks, so I sit in cash.” You’re losing 8% right now on that million dollars that’s sitting in cash plus you’re over FDIC limits. There are other risks that are maybe just less at the forefront of our mind, to your point that are very real risks.
Kenny: Yeah. And I do think that is the big takeaway here is if you look at those bank collapses, what happened? In 2008 a bunch of banks collapsed and the regular years came in and they had these stress tests, they looked in the books and they broke up some different banking institutions. And all these regulations were put in place and then they washed their hands and said, “All right, well, we fixed it. The risk isn’t there anymore.” And of course those regulations work to stop the risk that happened last time. And of course in this time, there’s a new risk that came about and something that they didn’t prepare for.
And so that’s the takeaway here is not to say, “Okay, I got burned on long bonds. I’m never going to buy a long duration bond again. What I’m going to do is adjust for only that risk and then totally ignore what happens next.” And I think that’s where we really see investors get hurt is if they just get burned time and time again by something that’s slightly different than what burned them last time. And that’s where having a conversation with someone who does understand the financial planning side of things, the investment side of things to say, “Hey, where are my blind spots? What am I not seeing? What’s the risk that I don’t understand is out there that I can prepare for?”
John: What’s the saying? Risk is what’s left over after you think you’ve thought of everything? Something to that effect. It was almost by the way, like you were promoting a diversified approach, spreading out your risks, not having all your eggs in one basket, not having any big bets in any one spot. That is something that I talk about every single week because there just are too many risks for you to anticipate because some of them are new and you just won’t be able to identify those always in advance. So having risks that are dissimilar to one another is the best in and most efficient way to protect yourself.
Let’s talk about the 60/40 and its rebirth. For a while when interest rates were low and nobody could earn anything on bonds, even if you want to be 60/40, you just can’t afford to do it. You’re going to have to cheat out on the risk curve, have to have 80% stocks and 20% bonds. And I’m not even saying that was incorrect. I mean that actually may have been the right approach because you didn’t want 400,000 of your million dollar portfolio earning 1%. So we’ve seen a comeback though on the 60/40. What do you think we’ve learned about that?
Kenny: It goes back to what we were saying before in that you can’t just assume that the last 10 years of your investment strategy is going to work for the next 10 years. And a financial plan can never just be set it and forget it. A financial plan has to change based on changing regulations, changing laws, changing economic environments, interest rates, inflation rates. All of those are dynamic and ever-changing and there’s never just one specific coverall portfolio or coverall financial plan that says, “No matter what, this is in place and this is going to be right forever.” And that’s why we always say, “Look, talk to a wealth manager and figure out what works for you now and if something changes the next year, what needs to happen within your financial plan to change with that?”
And you’re right, this idea of the 60/40 portfolio, there’s been hundreds of articles over the last 10 years saying 60/40 is dead, and to some degree they were right. The 60/40 did very poor last year, but now we are on the other side of that where rates are higher. You do get more yield for your bond, so it might be time to consider an asset allocation change if you’ve spent the last 10 years trying to avoid those bonds.
John: So it was maybe like a bad horror movie like they were dead but their head wasn’t fully chopped off and then it rose back up.
Kenny: The reincarnation of the 60/40. I like that.
John: Yeah, basically. Well, I think that’s a good place to end, talking about zombies with their heads cut off. That’s what we learned from 2023. This is great insight and a great reminder that a dynamic financial plan, as you put it, is really important and the value is not really in building the plan, it’s in changing it as new information arises. And doing so within the context of a stated philosophy that you’re able to be grounded to while making adjustments on the peripheral. So thank you so much again, Kenny for joining me here on Rethink Your Money.
Kenny: Yeah, thanks for having me, John.
John: As a parent to seven kids, one of the things that is painfully obvious to my wife, Brittany and I, is that kids want attention and they will get it when they’re competing with their siblings for it by whatever means necessary. If I’m not careful, the kid who’s acting out the most doing the worst things ends up being the object of a lot of my attention where the child doing the right thing sometimes can be left behind a bit.
And so I’ve been working on ignoring negative behavior and just acknowledging, especially in front of the other kids, all of the positives when one of our children is doing the right thing. But I find the same is true more broadly in life. What bleeds leads. What catches our attention is the negative. I’m guilty of this even hosting the show. I’ll say, “Look, this scam happened,” or, “this person did this and it was not right and they lost a lot of money,” and we can learn from those and I think they’re helpful, but I also want to make sure I’m including some of the fantastic moves that I see on a regular basis as well.
And with taxes set to increase in 2026, here are a couple of great examples from recent visits I’ve had. Had a client making a high income was in a higher tax bracket. They regretted that they had purchased just this antiquated, garbage whole life policy that they’ve had for 30 years. Really wasn’t satisfying any financial objective, but there were tax implications of relinquishing it. So what they were able to do was a 10/35 exchange. It’s a tax-free exchange where the IRS says, “If you move from one type of insurance to a similar type of insurance, you can maintain the current tax status and it is not a taxable event.” They were able to transfer that money into a low cost tax deferred annuity. I know your ears perked up. Wait, John. Annuity? Are you sure an annuity? Is that a good thing? I’m not talking about an illiquid, high commission, high cost, lock your money up forever type of annuity, but rather one with no cost in, no cost out, low cost index funds as the investment vehicle but wrapped in this deferred annuity wrapper so that they can defer taxes until distribution.
And in this case most importantly, we’re able to go from something barely growing that served no strategic purpose into a portfolio that looks very similar to all of their other accounts, but because of the wrapper, and by the way, that wrapper costs about a quarter of a percent per year. And they were able to take six figures, a big chunk of money that in their mind was dead and now is serving a great purpose. Another great example from a tax planning standpoint, had a client with significant income. They were a business owner wanting to retire in the next 7 to 10 years. The way their business was structured, they didn’t have a lot of employees. The couple that they had were family members that frankly they’re going the transition the business to and want to support. They were able to establish a defined benefit plan, which is different than a defined contribution plan.
Most commonly like a 401k, where your contribution amounts are capped every year. With a defined benefit plan, you’re backing the math into a retirement benefit that you’re trying to achieve and so the closer you are to retirement, typically the older the business owner is, the more you can contribute and thus defer out of your current income. Well, this person’s making seven figures a year and we’re able to stuff over $500,000 a year into this defined benefit plan to be taken out after retirement, and although tax rates are likely to rise, this is the type of person where they won’t be in a lower tax bracket because their income’s going to drop significantly. Another great example of tax planning that I’ve seen recently was a client who took an early severance from their company chose in 2022 to not work, so essentially had no income in 2022 but planned to take a job again in 2023 and they were going to be making about $400,000 a year. So a high income earner that was going to fall back into a 32% tax bracket.
Well, they also had a lot of money deferred in their 401k from the old employer that they had left. Of course, this was a perfect opportunity to Roth convert. He was able to convert over $300,000 at an effective tax rate of only about 20%. It was a perfect example of someone recognizing that low income, temporarily, for a one-year period presented significant tax opportunities. My last positive example of someone making wise money moves in particular when it comes to their tax planning, was a person who had transitioned into retirement and focused much more heavily on dividend oriented positions rather than growth. Now, I’m not going to get into whether I agree with that or not because I think there’s a more efficient way to drive income in retirement, but regardless, this person was smart. They put their dividend oriented positions inside their IRA account, which allowed their positions that were less tax invasive to exist in their outside brokerage accounts.
This lowered their overall tax bill because they weren’t needing to reinvest unspent dividends after paying tax within that non-qualified account. So just a fantastic recognition of what we call asset location. It’s not just what you’re owning, it’s where you own them within the plan. Are you hearing these things and wondering what you might be missing out on? What tax opportunities exist right now and are there for the taking that you’re just not aware of? Maybe your advisor is not aware of? Does your advisor review your tax return on a regular basis? When’s the last time your CPA and your financial advisor met together? Not to review your filing but to plan and strategize for not only this year but the next several years. Contact us now by going to creative planning.com/radio. Our mission is simple, to help you find a richer way to wealth. And we’ve been helping families just like you in all 50 states and over 75 countries around the world since 1983. Lower your financial stress by gaining clarity and confidence around what you’ve worked your lifetime to save.
One more time, creative planning.com/radio to speak with one of our 300 local financial advisors just like myself. Why not give your wealth a second look? Well, it’s time for us to rethink some common wisdom to ensure that the advice is not only accurate but current and relevant for today’s environment. One thing I hear often is that to have financial success, I’m going to need superior investment returns. I’m going to need to achieve alpha. Well, let’s look at this together. Alpha, by the way, is a term used in investing to describe an investment strategy’s ability to beat the market. Let me just sift through the noise here for a moment and summarize. You are not going to be able to outperform broad markets. I know, it sounds harsh. Like, “Really? I mean, how do you know?” Because almost no one can. Over the last 10 years, according to a recent study, 89% of professionals ending in 2020 underperformed but here’s the silver lining.
Fortunately success won’t need to come down to superior investment returns. And the reason I say fortunately is because you’re almost certainly not going to be able to pull that off. So good thing there are other ways you can achieve “alpha”. And let me talk to you about two in particular, and these are very much within your control. The first and probably most important is to never be really wrong. Put another way. Your ability to avoid the big mistakes will be vital in you achieving success. Investing like any other endeavor comes with risks, but it’s the big mistakes that can truly derail your financial goals. And the second way you can achieve alpha is by strategic tax planning. Yep, that’s the theme of today’s show. It’s within your control and when you integrate your taxes and you pay the least amount possible, more stays in your portfolio to compound over decades.
Let’s unpack these two primary ways to achieve alpha. First off, talking about avoiding big mistakes. Creative Planning President, Peter Mallouk, who’s accumulated all sorts of different accolades, including a three time Barron’s Financial Advisor of the Year Award in 2013 through 2015, wrote an incredibly popular finance book that he titled, The Five Mistakes That Every Investor Makes and then How to Avoid Them. So I want to highlight these five mistakes that Peter outlines in his book for you. The first mistake, overconfidence. Many investors fall victim to overconfidence. Believing that they have superior stock picking abilities or can accurately time the market. This overconfidence can lead to excessive trading, chasing hot stocks, and ultimately underperforming the market. Look no further than the pandemic. The worst thing for many of those Robinhood Day trading investors was that they made a lot of money over a nine-month period. And it gave them a false bravado for what they thought they could accomplish year after year and decade after decade. Obviously, that reality check came in the form of 2022.
Second common mistake investors make is focusing on the short term. It’s really easy to get caught up in the short term market fluctuations and the breaking news, especially because we live in a 24-hour news cycle, we’re being notified on our watch in real time. Successful investing requires patience and a focus on long-term goals. The third common mistake is a lack of diversification. Concentrating investments in a few stocks or a few sectors exposes you to unnecessary risks. Diversification across asset classes, sectors and geographic regions helps reduce portfolio volatility and protects against significant losses. Our fourth of the five common mistakes that Peter outlines in his book is ignoring costs. One of the easiest things for you to control is not overpaying. And frankly, I find when I provide wealth path analysis for families who are looking for a second opinion, most do not know what their costs are.
If you don’t know what your costs are, that’s normal. Most of what you’re paying is internal, and unless you know where to look or have an independent advisor show you, you won’t know. And so often, those costs can be reduced and every dollar that you save remains in your portfolio to continue compounding for your benefit. For your future, rather than being siphoned out. My fifth and final common mistake that I want you to avoid is emotional decision making. Emotions often cloud investment decisions leading to irrational behavior. Money is emotional, it represents things that we care about. We are humans, we are emotional. It’s why in a recent behavioral finance study that is done on an annual basis by DALBAR, they once again outlined that over the last 30 years, the average American has earned only half of what the S&P 500 has delivered.
Successful investors stay disciplined and adhere to their financial plan, even and especially during periods of market volatility. Peter’s insights outlined in the book remind us of the importance of avoiding these common mistakes to achieve long-term investment success. So the first key to achieving alpha is not again, superior investment returns, but by avoiding big mistakes. And the second key is through tax strategies and great, proactive tax planning. As the saying goes, it’s not how much you make, it’s about how much you keep that matters. In summary, we need to rethink this idea, this notion that we should be spending significant energy and time focused on how to achieve the highest and best returns possible. No, we need to be focused on avoiding big mistakes through great planning and minimizing emotional moves with our money, and then having a fantastic, well-rounded tax strategy incorporated with our financial plan led by a CPA who is integrated with our financial planner so that we can pay Uncle Sam the least amount legally required. If you haven’t had your tax return reviewed recently by your financial advisor, visit creative planning.com/radio.
I want to ask you a question. Have you ever went to file your taxes? Maybe you’re on Turbo Tax or you’re at your CPA’s office and just holding your breath to find out at the end whether you’re going to owe money, if you do, how much are you going to owe? Is it going to be worse than I was expecting or how much am I going to get back in a refund, maybe? That would be great. I don’t know if it’s 2000 or 6,000 or $2, I just don’t have any idea. Well, if you felt like that before, you are not alone. That is the majority of American taxpayers, because they don’t have a tax plan. There’s no strategy throughout the year looking forward. There’s no projections being done. Even people with financial advisors, a lot of them are just looking at the investments, looking at some of the retirement planning.
They’re not a CPA, they’re not a tax practice. They’re not building mock tax returns during the year looking forward, and that’s a problem. Do you think taxes are likely to go down over the next 30 years? Now, you’re probably chuckling at that thought, aren’t you? I’ve spoken at hundreds of live events and whenever I ask that question, the audience laughs and no one raises their hand. And then when I say, “How many of you think taxes are going to increase over the coming decades,” everyone raises their hands. And by the way, it’s not because we have a crystal ball, it’s because we understand basic arithmetic. We have 32 trillion of national debt and counting. We run at a major deficit essentially every year with the exception of two years during the Clinton administration. So whether right, left, regardless of which side of the aisle we spend more than we make, I mean it’s like the most basic thing that I just mentioned when it comes to personal finances.
I mean, we don’t even adhere to that as a government. And on top of that, we are in the lowest tax environment we’ve seen in decades. For a 40-year period right around World War II on forward, our top tax bracket was never less than 70% at any, 70. I didn’t say 17. 70. Our top tax bracket right now is 37%. And so while we all wish that we were paying less in taxes and often think, “Ah, man, we’re getting hammered on taxes.” No, we’re not, historically speaking. We’re in a really low tax environment and because of that and the knowledge that the current tax environment sunsets at the end of 2025, we need to plan for taxes going up. And most importantly, what can you do about that? And I’ll post an article to the radio page of our website written by one of our 100 CPAs, Zach Cox, specifically on the sunsetting tax rates and what you need to know.
But before I jump into exactly what you can do about it, let me share, briefly, the major changes that are coming with the expiration of Trump’s Tax Cuts and Jobs Act. Individual tax rates are set to revert to their 2017 amounts. Again, at the radio page of our website, there is a chart that shows what they are today and what they will be after the sunset. The estate tax exemption is getting cut in half for each taxpayer and is estimated to be around 6.2 million in 2026 after adjusting for inflation. So this change will not only affect estates over the current exemption amount of 12.06 million, but also and probably more importantly because it’s a change, those that are between 6 and 12 million. And remember, that also does include any life insurance proceeds, any real estate, any valuations of businesses. It’s not just your liquid investments.
A lot of people think I’m well under that. Maybe not once everything is added up postmortem. Another change is that the standard deduction is going to lower by almost half adjusted for inflation. The $10,000 limitation on state and local taxes will be removed. Mortgage interest will be deductible on debt up to 1 million, which will be up from 750,000 and expands to include up to a hundred thousand dollars in home equity debt. Miscellaneous itemized deductions, most notably unreimbursed employee expenses will be allowed. Personal casualty and theft loss deductions will be reinstated. And a Pease limitation will be reinstated at certain income levels, which puts a cap on total deductible itemized deductions. Well, that’s a lot of information that frankly is only relevant if we discuss what you can do about it and how you can take advantage proactively and strategically in light of these changes.
First, don’t blindly defer income to a later date. Most notably, this happens inside of your retirement account at work. You fund a traditional 401k, feels really good, you max out that retirement account and you see those contributions come off your taxable income. But remember, and here’s the key, you’re not eliminating taxes. You’re simply going to the IRS and asking if you can pay them later. Well, we just talked about it. You don’t think tax rates are going down and neither do I, so why as a blanket strategy would we want to be asking to pay taxes later at what we assume to be higher? Consider this. If you are married filing jointly and you earn less than $360,000, which is a lot of money, or you’re single and you’re under 180,000, you probably shouldn’t be deferring. Now I’m painting with a broad brush. I don’t know your entire situation, but you are in a 24% bracket or lower.
If you’re asking to pay those taxes later, when do you expect to be in a less than 24% bracket down the road? Another consideration for you, charitable giving. That standard deduction is so high right now that many people are receiving zero tax benefit when they give money to their church or Habitat for Humanity or some other 501(c)(3). It doesn’t even help because they’re not able to itemize. So either bunch charitable contributions and itemize and take it all at once and then go back to the standard deduction in future years. You can utilize a donor advised fund if you still want to distribute those systematically rather than giving to your church at once and then not giving anything for five additional years. You can use a donor advised fund to facilitate those in the exact cadence that you’re used to while being tax efficient. Or if you don’t mind not giving in certain years, wait until you’re in a higher bracket and then backfill charitable giving that you hadn’t done the last year or two while you weren’t going to receive much of a tax break for it.
How about harvesting gains? I know this is another one that’s counterintuitive. Wait, I’m going to voluntarily trigger taxes, John? Yes. The lowest long-term capital gains rate right now is 0%. I’ve seen highly appreciated investments continuing to be deferred beyond December 31st in client accounts, when had they triggered that gain, they would’ve paid 0% in taxes. Then they could have either diversified those proceeds elsewhere or just repurchased the exact same stock or bond or mutual fund or ETF at a higher cost basis. Another consideration for lower rates today is strategic gifting. If you have a kid early in their career, maybe they’re working a job in college, they’re in a really low bracket because they’re not making a lot of money and because as we’ve already mentioned, rates are low. Get them money today by funding a Roth or offer to replace their salary. If they max out their Roth 401k, you’ll replace it for them. Help them get money in today at low rates that will then be tax-exempt like a Roth moving forward.
Also, inheritance distribution planning. Maybe you’ve inherited a retirement account from a parent and you have 10 years to distribute that money and you are planning on deferring it as long as possible. Well, maybe right now you take a bit more while rates are low. And my final tip of how to take advantage of these lower rates, one that you’re hearing everywhere, and that is Roth conversions. A Roth conversion is simply migrating money from a deferred account into a tax-exempt account and paying tax at ordinary income rates on that conversion amount. Why would you want to do that? Well, because unless you give it away between now and the day you die, it is going to be taxed at ordinary rates that, per the show’s theme, we expect to be higher. So for example, take a married couple with a taxable income of $83,550. They’re at the top of the 12% bracket.
If they complete a Roth conversion of $256,000, they could move from a deferred account to a Roth. It would only take them to around the top of the 24% bracket, and that would save them over $15,000 in federal taxes by performing the conversion in the next three years instead of waiting until after 2025. And obviously they might not convert that much and their income might change. I’m just sharing with you, apples to apples, it’s a $15,000 savings verse 2026. And that $15,000 now stays in their account and grows tax-exempt moving forward. Think about how much more they’ll have 20 years later on that compound growth. Here’s the key because I know I’ve thrown out a lot of different ideas. Have a tax plan. Not just a financial plan. That’s great too. You need that, but nothing will reduce stress more than controlling what you can control and nothing is more within your control than optimizing your tax efficiency.
You don’t have to wonder what the investment returns will be or what the economy’s going to do, or whether a company will continue to pay dividends or how much volatility will occur. None of that matters with taxes. It’s a calculation and one that is so often overlooked. I don’t want that for you. Just ask yourself, when’s the last time your financial advisor reviewed your tax return? Are they having these conversations with you this time of year in the summer saying, “Hey, I know you don’t need to file your taxes right now, but let’s discuss strategies so that when we file taxes in 2024, we’ve made some really strategic smart moves to reduce your taxes, especially in light of the fact that we’re in one of the lowest tax environments you’re probably ever going to see.”
Don’t wait any longer. Let’s make sure you’re not paying the IRS more than legally required. Visit right now creativeplanning.com/radio to speak with one of our local financial advisors just like myself. It’s complimentary and there’s no pressure to become a client. One more time. That’s creative planning.com/radio. Now, why not give your wealth a second look? Because after all, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode, you can subscribe to Rethink Your Money wherever you get your podcasts.
Disclaimer: The proceeding program is furnished by Creative Planning an SEC registered Investment Advisory firm that manages or advises on a combined 210 billion in assets as of December 31st, 2022. John Higginson works for Creative Planning and all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or this station. This commentary is provided for general information purposes only. Should not be construed as investment, tax or legal advice and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning tax and legal are separate entities that must be engaged in independently.
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