Are we in a bear market? John answers this million-dollar question following the market turmoil that’s consumed news headlines these past several weeks. He also sends a strong warning when it comes to annuities before his interview with Private Wealth Manager Jessica Culpepper (who has appeared on Barron’s list of Top Women Financial Advisors six years in a row!) on why it could be beneficial to treat your kids uniquely when establishing an estate plan.
Episode Notes
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. I’m your host, John Hagensen, and on this week’s episode, I’m addressing really bad advice, more importantly, the lessons learned from a highly successful person who was sold a high commission investment/insurance vehicle that he didn’t need. Also, a sneak peek into how a wealth manager and also a CPA working with ultra-affluent families applies the concept of loving your kids equally by treating them uniquely to her advice. A great interview with six-time Barron’s, Top 100 Women Advisors in America, Jessica Culpepper. And finally, why getting what you pay for may not hold up when it comes to your investments. Now, join me as I help you rethink your money.
I need to rant. Now, I need to rant for one simple reason, to ensure that you don’t miss this. Let me set the stage. I met with a prospective client last week; super smart guy, great guy, easy to talk to, thoughtful in his decisions, and he’s overall just crushed it financially. Nearly a $10 million net worth, way more than he’ll ever need, so completely financially independent and almost all these assets will ultimately go to his four kids plus a lot more growth over the coming decades hopefully.
Now I get it. You might be thinking, “Well, I have $750,000” or “I have $2 million. What lessons can I learn?” The answer is a lot. I just saw this almost the same situation with a client in the upper Midwest recently as well, and I can’t take it anymore; people being sold random insurance products for high commissions that do not serve a strategic purpose of note within the plan.
Now it’s important that I point out a detail. An insurance agent is held to a suitability standard of care. So they’re regulated, it’s not the complete Wild West. But if you have a financial advisor, they are held to a fiduciary standard of care. But when they sell you an insurance product, permanent life insurance, long-term care insurance, or in this case an annuity, they’re held to what’s called a suitability standard of care. And what that means is they switch, it could be within the same meeting that you’re sitting there with them, between being legally required to put your best interests ahead of their own, to simply needing to sell you things that are suitable. These are very different standards from one another.
So this client in particular had multiple annuities, from nearly $3 million in one contract to one recently sold for less than $50,000. Now, I’m probably going to jump around a little bit as I explain this, but I’ll try to organize my thoughts as best I can so that you can follow. But I’m on a roll. I’m all worked up right now. $10 million and they’re tying up $50,000, less than 1% of their portfolio for a decade? Why? It’s not even worth doing the paperwork. It doesn’t create any strategic advantage that’s meaningful for the plan.
When looking at annuities, you have fixed annuities, indexed annuities, variable annuities, immediate annuities. Each have different features and risks and use cases. And I don’t have time to go through all of these, but in general, annuities offer two primary benefits: tax deferral and a potential for a lifetime income payment, essentially creating your own individual pension. And I’m not suggesting they serve no purpose, they have no reasonable use case ever. They do.
But this person was so overfunded, spending less than 1% of their portfolio each year. So running out of money wasn’t an issue that needed to be solved with a guaranteed income feature.
And since these assets are not going to be spent and he’s not in a high tax bracket temporarily because he’s in retirement, the idea of deferring taxes is actually a really, really bad strategy from the insurance agent. These monies are going to his children. Inside of this annuity, all the growth is deferred, it’s off of his tax return. Well, that sounds great, except for the fact that when either he takes withdrawals or he dies and passes to his children, that deferred growth is taxed at ordinary income rates. And it’s stacks on top of all the rest of the income, and it’s last in, first out, meaning the growth is what is first withdrawn and taxed.
So here is why I tell you this. It’s not to demean this specific individual’s decisions. He’s smart, he’s golden financially. He didn’t put half his money in one stock that went broke. I told him, “Live and learn.” So this isn’t to knock him in his decision-making. I personally have made plenty of financial decisions that I have looked back on and would do differently. I think of myself as a young financial advisor. I recommended things that I wouldn’t today, now that I have more knowledge and experience.
But there are three key lessons for you to take away. Number one, who are you listening to for advice when it comes to your money? This guy was basically sold hurricane insurance in Arizona. If you’re going to ask for financial guidance, the firm that you choose is the most important financial decision that you’ll make, because it’s off of that decision that leads to hundreds of other decisions over the years. This was just egregiously bad, but what are the conflicts of interest?
By the way, on a million-dollar variable annuity, depending on several factors of the specific contract, the commission is generally around $70,000 paid shortly after the money is invested. So they can either sell you that or provide advice and planning and charge you say 1% per year, and it’ll take nearly a decade for them to make that same $70,000 that was earned by one sale. So number one, who are you listening to?
Number two, do you currently own an annuity or permanent life insurance? If so, I encourage you, go seek a second opinion from someone who didn’t earn that big fat commission and say, “How does this strategically fit within my plan?” Go find a credentialed fiduciary that’s not going to sell you something. “Can you have a second look at this?” Because in my experience, most people who own an annuity are not fully aware of the contract provisions, the costs, the way it works. So I encourage you to do that.
Number three, understand the tax implications of your investments, obviously including annuities. Right now, per the current laws, if you own a mutual fund or you own an ETF or a stock or a bond even that’s appreciated, I don’t know if that exists, but let’s say you own one that’s appreciated, it will step up in cost basis at your death; meaning the taxable obligation that was unrealized goes away when it passes to your beneficiaries. An annuity does not do that, making them arguably the worst legacy vehicle, as it’s received with ordinary income tax stacked on top of everything else your beneficiaries own.
Yeah, I’m fired up. I know you’re like, “Geez, John. Settle down, man.” But nothing makes me more fired up in wealth management than seeing people shoehorned into inappropriate vehicles that are just suitable enough to be approved, but make virtually no sense strategically. I’m sharing this specific story with you. I see similar things all the time.
So what can this gentleman do? Obviously, he’s still in a good spot, but he doesn’t want to stay in this thing and compound the tax burden for his beneficiaries the next 20 years. He also doesn’t want to keep paying high fees for features that he has no use for inside of this annuity. But he’s had it in there a long time, and it was invested in the market, so it wasn’t as efficient as it should have been. It would’ve grown way more if it were just in low-cost index funds. But he still has nearly a million dollars of deferred growth due to the long-term appreciation of the stock market. And if he rips the Band-Aid off and says, “I don’t like this thing,” he’s going to add a million dollars of taxable income to his return this year.
Well, he can do what’s called a 1035 exchange. This allows him to move from one annuity to another and continue to defer taxes temporarily. If I’m you, I’m thinking right now, “Wait a second, John. Are you trying to make a 70,000 commission? Wait a second. You just told me all the reasons he doesn’t need an annuity and you’re saying go from one to another.” Nope, no commission, first of all. Registered investment advisory firms like us have access to non-commissionable annuities. We’re a fee-based, credentialed fiduciary that’s not going to sell you something.
So he moves his money from a higher cost vehicle to a much lower cost vehicle invested in index funds that still has that variable annuity wrapper. In addition to no commission, there’s also no surrender schedule or lockup because the insurance company isn’t paying a big fat commission that they need to recoup if you get out of the contract. So it’s fully liquid, it lowers the cost, and in my opinion, significantly the efficiency of the investments.
But you see, that still doesn’t solve the tax issue of all of this tax-deferred growth, and this is where that portion comes in. Now on an annual basis, he can withdraw a strategic partial amount, keeping him below certain tax bracket thresholds, with the goal to be fully out of it over the next few years while controlling the tax. So if you have an annuity, this isn’t hopeless. I share this with you to say you’ve got options, just as this gentleman does.
My favorite part of the story, and this applies to you, is that he’s the hero in this story. A lot of financial advisors, it’s like, “We’re the heroes. Let us swoop in and save the day with this recommendation.” He called us having listened to this very show, Rethink Your Money, for years. Because all of a sudden he heard something about annuities and thought, “I wonder if that applies to some of my accounts.” So he took the first step to get answers. He didn’t let apathy get in the way, which would’ve been very easy to do.
He’ll be fine regardless. His kids will be fine regardless. No, he thought to himself, “I’m pretty sure I can do better. There may be some unnecessary taxes here. I might be paying higher fees.” And he didn’t let sunk cost bias get in the way or his pride, because I know personally making a change or asking for advice when you sense something might be off here, it takes a lot of humility. And I sure hope in no way did I make him feel ashamed, because he’s done a marvelous job overall and continues. Really, here’s the key to exhibiting the curiosity and the commitment to improvement that helped him achieve this $10 million net worth. So kudos to him for not trying to be right, but rather wanting to get it right. May that be a lesson for both you and I as we move forward with our financial decisions as well.
My guest today is one of those people who make you smarter, and they do so in a humble way. Where to even begin when introducing Creative Planning partner Jessica Culpepper, she serves as a Wealth Manager on our Ultra-Affluent Team helping some of the highest net-worth families in the firm. She’s a CPA. She’s a CFP. She has her MBA. She’s been featured in Barron’s as one of the Top 100 women advisors in America six straight years from 2019 through 2024. She’s also been named to Barron’s Top 100 Independent Wealth Advisors in America in 2019, ’21, ’22 and ’23. Jessica has two daughters, and along with her husband, she loves running them around just as I do with my kids to their sports. And maybe that’s in part why she was named by Working Mother’s Magazine on their list of Top Wealth Advisor Moms in 2020. She’s active at her church and with the Give Back high school mentor program. Jessica, I appreciate you joining me.
Jessica Culpepper: Oh, thanks for having me, John.
John: As someone who has a front row seat to a lot of very successful people, is there a common attribute or two that a lot of these people share and maybe have contributed to their financial success?
Jessica: A lot of it has to do with a strong work ethic. They’ve put in the time, they’ve earned the money, and now they’ve come to us with help, whether it’s preserve it over time or continue to grow it for future generations. But they have a great work ethic. And then, they take financial responsibility, personal responsibility for the decisions that they’ve made, whether they’ve turned out poor.
John: I like that.
Jessica: Or they’ve turned out really good. And then, if they do make mistakes along the way, they take the opportunity to learn from them.
John: I’m thinking about that with my kids just in terms of trying to teach your kids responsibility and, “No, it’s not the teacher’s fault that you got in trouble for talking.” Those are great lessons to learn along the way from the time you’re a child all the way through into adulthood. I think the perception, Jessica, is if somebody has a lot of money, that must basically solve all their problems, things just must be all rainbows and unicorns. But there is a reason for the expression, “Mo money, mo problems.” What are some of the common worries or concerns that maybe would surprise people? And how do you help clients with high net-worths navigate those sorts of challenges?
Jessica: You touched on one initially, being more the emotional side of things, per se; people knowing you’ve come into money or that you have money and how to deal with that. And I think it’s important to set expectations there or even have a mission statement when it comes to money and what it’s working for and what its purpose is.
I’ve got a lot of clients who’ve come into money, and it’s a public transaction so people know they have money. We have advised them that, “You need a mission statement. You need a reason to be able to navigate the deals. People are going to be coming to you asking for money for a variety of things, whether it’s to invest in this next business or this next cause or give money to a charity. And it’s really hard to say no. You don’t want to disappoint people, especially when they know you have the resources to help them out.” So developing a mission statement for their money and working with an advisor to help you put that together to help give you a backdrop to, “Look, I’ve developed a plan. These are the things that are important to me. And while I really love this company or this cause that you’re helping with, it’s not part of my plan. But I’m confident that you’re going to be able to find someone to help you out.”
John: I think that’s really hard, because let’s say you have $100 million dollar net worth, helping someone pay off some medical bills that are $40,000. You don’t even notice it necessarily from a financial perspective and it really changes their life, but they’re a second cousin. It becomes very nuanced. Create a set of rules in advance, that’s what I hear you saying, so that then you’re not trying to react in the moment and decide. You’re able to run it through this matrix that you’ve already built. Do you suggest that people, if they have a family foundation, there’s a gatekeeper? I know that can work for some families, so there’s a little separation.
Jessica: Absolutely. That’s a great way to take it off of yourself and do have that gatekeeper. Whether it’s for decisions like charitable giving or things like you mentioned, the medical bills, being intentional in having a plan and a process and that gatekeeper role is certainly something to put a barrier between you and particularly family where that can be a difficult decision.
John: With wealthy families, it’s not the concern of, “Do we have enough to get by or do we have to help our family?” It’s, “How much is the right amount to give our children or our grandchildren? When do we give it?” How do you help clients navigate using this money in a way to foster family relationships and grow those rather than, as we’ve all seen, often it goes the other direction.
Jessica: Ultimately, the sooner you can start with some level of education on wealth and what it means and what it doesn’t mean, because the potential negatives to family wealth, which is the sense of entitlement that you’re speaking about and sibling rivalry and things like that, a loss of incentive if you give someone a lot of money and now they don’t have to work hard for what you would hope that they would develop ambitions and pursue meaningful work.
There’s a careful balance, and so the earlier you can start to educate family, whether it’s your children or your grandchildren, “What is wealth?” For some it’s a tool, a means to accomplish things for retirement, for giving, building a business. And for others, wealth is just a status symbol. It’s who they are, and they want more to have more. That’s where you really have to be careful is if you’re growing up and you’re used to getting everything you want and having everything, it can be very difficult to flip that switch and now be expected to do something meaningful. So setting that example, “What is money? What do we use it for?” Educating them and communicating about wealth.
Having young children, one thing that my husband and I try to do is communicate value of money and the value of working hard. And so, maybe they’ve set up a lemonade stand and they’ve earned some money, they’ve earned $20. “This is great, but by the way, mom and dad spent $40 for you to make that $20.” Walking into those money topics as early as you can to help them develop not only to understand the value of money, but what it takes to earn money. “And that $20 by the way you think you just made, let’s go to the movies and we just spent $100 to buy the popcorn and all the things.” Well, ultimately it takes a lot of money to make the world work. So the sooner you can have those conversations, the easier it will make hopefully to instill values that over time as you want to give them money and transition money or transition responsibilities to them, it will make it easier.
With a lot of my clients who have stepped into that phase of wanting to now help their children out versus them passing away and them not helping their children when they really needed it, we try to start small.
So I have a client who has wealth in excess of $50 million and has the capability to give probably half of that away. They have younger children. They’re adults, but they’re young in their careers, they’re just getting started. And it’s important that their children be allowed to continue to develop in their careers, but also help them out so they’re pursuing their dreams and not making decisions based upon, “Well, I can’t move to that part of the country because it costs too much.” “No, I’m going to help you move to that part of the country. So rather than watch you struggle, I’m going to give you some money in a trust, and it’s going to be enough to help you afford that apartment that you couldn’t otherwise or buy that first house that maybe you couldn’t otherwise because of where you’re living.” So let’s start small. They are the trustees of their trust. So again, that trustee role puts their child in a position to be able to make their own decisions.
Now, my client has put their kids in a situation where they can learn and grow and they can see what they do with the money. So if in a year or two years or five years, things are going great, they’re making great decisions, we can see, “Wow, I can trust them with a little, so I can probably trust them with more.”
John: You reminded me of a conversation I had with a friend of mine. And same thing, public company, multi-billionaire, and has two adult children that are just awesome people and are hard workers and very successful in their own right. And I asked him, “What did you and your wife do to instill this type of work ethic in your children, knowing that you have billions of dollars of net worth?” And he said, “Well, we sat them down at one point when they were still younger.” It’s basically echoing what you said. “We let them know, ‘We’ll use this to support you, we’ll help you here and there, but by the time you get this money, you’re not going to need it.'” So they essentially took the approach of saying, “Outside of paying for your college and wedding and helping you out here and there with a down payment for a house, we’re not going to just drop $10 million in your accounts because you hit 25 years old.”
But I thought, “Yeah, that’s hard. Because as a parent, you want to help your children out, and you completely have the means to do it.” It’s also almost training the parent. It’s like when you go to dog training, they say, “We’re not training your dog, we’re training you, the owner.” You almost have to train yourself to say, “It’s okay if my kids struggle.”
Jessica: Yeah. I know.
John: “It’s okay. I don’t need to swoop in and immediately help them out because that’s part of the journey.”
Jessica: Yeah. Absolutely. And sometimes by doing those things, which in today’s culture, there are so many reasons why it’s hard to see your child struggle and fail, but that’s how they learn. And if you can watch them struggle and fail in the small things, it’ll make the big things easier for them to navigate. So it’s very important to do that, because if you don’t educate your children and you don’t let them make the small mistakes, they’re going to make the big mistakes, and those ramifications can be very detrimental.
John: Let’s keep this conversation going about wealth transfer and estate planning and how to handle that with children. I love the quote from Ron Blue, “Love your kids equally by treating them uniquely.” That can be challenging when there’s a family business involved, and one child should be the CEO because they have the talents and have put in the time, but the other two kids are like, “This business is worth $600 million. We either want to be involved but probably shouldn’t be, or we don’t want to have anything to do with this business, but that’s where most of our family’s net worth is.” Well, this other kid’s going to be working it every day. Should they make more money? How do you help clients navigate that conversation of keeping family harmony, everyone feeling like they’re loved? Ultimately, that’s the reflection. They want to feel like, “Mom and dad or grandma and grandpa love me just as much as the other kids or grandkids.” How do you do that when sometimes there’s illiquid investments in businesses and certain kids’ capabilities that are different than others? What do you advise clients in terms of how to navigate that?
Jessica: That’s a great question. Having an open line of communication and just honest conversations, first of all with mom and dad, “What do we truly see?” Because it’s their money. They’ve worked for it, so they should be the ones to make these decisions.
John: Sure.
Jessica: And then, what do they see for their family? Do they feel that one of the children or some of the children are in the business and should remain in the business, and should they be rewarded more so than the others? Also to promote family harmony, having open conversations with those involved in the company and those that aren’t.
I have clients who have a situation just like you’ve described. We have several siblings and cousins, and only a few of them work in the business. They have equity in the business and they have voting rights in the business and they have salaries. The ones who aren’t involved, they still have shares of the business that have been gifted to them, but maybe they’re non-voting rights and they don’t get to participate in the decision-making. But there’s still some equity there because ultimately they have a share of the company, but their rights are more restricted.
So if you begin to treat children unfairly without a reasonable excuse, it’s going to be very hard to have family harmony over time. So if you choose to take that path, you have to be very transparent about why you’re doing it. But if it’s at death, a letter as to why you’ve made those decisions; so it’s trying to promote as much harmony as you can, but really accomplishing your goals and what’s best for the company.
John: If you’re passing $300,000 onto kids or $100,000 or $100 million, you don’t want your beneficiaries surprised by whatever happened.
Jessica: Yeah, I’ve got a client who has essentially disinherited some children because he knows they don’t need the money. And if there’s not communication about that, that is a very difficult post-death feeling and one that will not go over well.
John: You’ll also potentially avoid any sort of litigation after the fact of somebody saying, “This was left out by mistake. This was an issue.” Right?
Jessica: Yep.
John: So no, really good points. Jessica, this is a great conversation. We could talk for another 30 minutes, but I’m thankful you joined me here and shared some of your wisdom on Rethink your Money.
Jessica: You’re most welcome, happy to be here.
John: Common wisdoms, as you know, exist for a reason. They often hold truths or at least partial truths. And much of the conventional wisdom when it comes to your investments, your taxes, your estate planning, they’re no different. And I have two for you today. The first, pretty sure you’ve heard this old saying, “Age is just a number.” Now, it’s usually tossed around when someone’s trying to justify jumping out of an airplane at 70 years old for their birthday or dancing like they’re 20 years old at a wedding reception. But when it comes to personal finances, this saying holds a lot of truth, too. So this is an idea I want to rethink with you, but it’s not because it’s wrong, because it’s dead on, totally right. Your financial strategies should not be dictated by how many candles were on your birthday cake. Rather, it should be driven by where you are in life and what you need to reach your goals.
Money is just a tool. You only invest money, try to protect it or grow it or transfer it, for a purpose. In and of itself, there’s no inherent value to money. Let me share with you a few practical examples. I recently had a visit with a client in her sixties, let’s call her Susie. Now, Susie was very worried that she was too old to start investing because she felt late in the game and she was underfunded a little bit from a retirement perspective when just looking at her liquid assets. But here’s the thing. When I ran through Susie’s plan, it was pretty unique. She had a solid pension, had been a government worker for decades receiving 100% of her working pay through an indexed for inflation pension.
So it’s like you just stop right there and go, “If you don’t need a whole lot more than what you lived on the whole time you were working, you’re in phenomenal shape.” Her mortgage was paid off, her kids were already through college and doing well on their own. So for Susie, yeah, age was just a number. She’s in a great position and can be a lot more aggressive for growth if she desires to do so with her money than maybe stereotypically you would think someone in retirement should be positioned with their investments. “Oh, shouldn’t she have 60% in bonds because she’s in her sixties, and 40% in stocks?” Well, no, she had a safety net, a good emergency fund, the pension that I referenced, very low expenses, and her desire was to help her kids and grandkids from an inheritance standpoint with her liquid assets.
So while she was looking at it thinking, “I’m not in that great a spot. Is it really worth even focusing on this? I’m kind of small potatoes.” “No. If you live till 95 or a hundred years old, you have three or four decades to let this compound. You could create an incredible inheritance, especially considering the fact that your expenses are so low.”
On the flip side, one of my longstanding clients’ children came in, just finished medical school and now a newlywed, and she felt like… She’s in residency. She has all these student loans. She’s way behind her peers who went right into business, and partly was thinking like, “Am I too young? My income is not going to ramp up here for a couple of years to even focus on this. For right now, I think my student loans is probably the most important, most imperative, critical thing that I should be prioritizing.” But actually, she may have the opportunity to have some of those forgiven depending upon what state she works in and what type of hospital or clinic she gets hired at. So there were actually a lot of planning opportunities to be considering, even if that didn’t mean her investable assets at this point were substantial. It was beginning to lay the foundation with some really important critical moves to set her family up for success.
And to extend the analogy further, I’ve had two 45-year olds with similar situations on paper, but one’s going to care for an aging parent, that’s a big priority to them, and the other is going to inherit $5 million from theirs. They have different lifestyles, different priorities, different living expenses. Their plans don’t look anything alike because age is just a number. That is a concept to rethink and actually reaffirm.
Which leads me to our next piece of common wisdom that we’ve all heard that needs to be rethought and that is that “You get what you pay for.” Now, this one’s tricky because it seems so logical. It applies to almost every other aspect of life. You pay more for a premium product. A Ferrari costs more than a Kia. But in the world of investing, higher fees often don’t correlate with better performance. And it trips us up, it confuses us, it just doesn’t make sense.
But you take a look at the data, Morningstar’s research consistently shows that expense ratios are one of the most reliable predictors of future fund performance. So to paraphrase a study that Morningstar completed, you grab a hundred mutual funds, and you try to assess the correlation of a manager’s past performance with what they might do in the future and a hundred other variables. The conclusion was if you find the lowest cost funds, that was the highest predictor of which funds would tend to be in the top quintile over the coming years. Of course, past performance is no guarantee of future results.
This isn’t predictive. It doesn’t mean that the best fund is the lowest cost. It just means when looking at all the variables and everything to consider, the lowest cost is a good starting place.
In a study covering a 10-year period, the lowest cost funds had a success rate of 62% compared to just 20% for the highest cost funds. Here’s another example. The S&P Indices Versus Active Report compared the performance of actively managed funds against their benchmark. So you have these money managers, let’s say it’s large-cap growth, that are buying and selling large-cap US stocks, hand selecting which companies they think will do best, excluding companies that they believe will underperform. And the data was overwhelming. They took a 15-year period, and over that time, 80% of large-cap active managers underperformed the S&P 500. So one out of five if you hit on the right one, did outperform the broad index, but good luck finding that manager in advance. And the higher fees charged by these active managers didn’t translate into better performance. Instead, they actually just ate into returns like little termites.
I like to jog. I’ve done a couple of marathons. Times aren’t anything to write home about, but I did complete them. And for me, running is a way for me to be mentally and emotionally stable even far more than physically. It’s my time to decompress. I get back from a jog, my wife thinks I’m crazy. Sometimes it’s when it’s over a hundred degrees in Arizona, I’m dripping in sweat. I can’t even think about sitting on furniture, gross. Man, my endorphins are flowing. I’m feeling good.
And if you run, you know how important your shoes are. But the most expensive running shoes that I’ve ever bought were the worst. That brand will remain nameless, but instead I buy some middle of the road Brooks that fit my feet perfectly. They don’t look the best. They’re not super on-trend. My kids who are sneaker heads are like, “Oh, dad, Brooks. Are you that old?” It’s like, “These are really good for running. Yeah, they’re not the most expensive, but they’re really good and my arches don’t hurt.”
And that’s just a loose kind of a weak analogy actually now that I think about it. But the point is that it’s not always like the most expensive signals the best, as we often think. So the next time that you are choosing your investments or you’re talking with your advisor about your investments, consider the internal costs. They don’t show up on your statement, but you can find them. They’re publicly disclosed. And I don’t want you to fall into the trap of thinking you need to pay more to get more. Look for low-cost stuff and let compound interest work its magic.
If you have questions about what your costs currently are, especially if you have a variable annuity or you’re working with a broker, and you’re not sure if there are proprietary funds in there. Or if there are funds that have revenue-sharing agreements with that company that of course ultimately you’d be paying for, and you want to get a clear understanding of what you are paying, call us.
It is time for this week’s One Simple Task, where I help you incrementally improve your financial situation one week at a time. If you’ve missed any of our previous One Simple Tasks, those are located on the radio page of our website at creativeplanning.com/radio. I want you to picture this. You are building a house. Maybe you’ve built a custom home before. You had to hire an architect. Well, you wouldn’t start but just building a house without house plans. You obviously need some blueprints.
And your financial life is no different. A financial mission statement is this week’s One Simple Task. You need that personal blueprint, a plumb line if you will, that keeps everything on track when it comes to your spending and saving and giving decisions. It’ll hopefully help guide you and keep you focused back on where your priorities ultimately lie.
The beautiful thing about your mission statement is it’s your financial foundation. And if the option you’re confronted with doesn’t align, it’s a hard pass. But beyond just guiding decisions, a financial mission statement helps you find meaning with your money, which is also really important. Because it’s very easy to get caught up in numbers, net worth, retirement goals, investment returns, tax obligation. By the way, all important stuff, I’m a certified financial planner. This is a show on personal finances, but what’s it all even for?
So you are tax efficient, you do get efficient investment returns, then you just die with more money in your account. What did that accomplish? Absolutely nothing, in and of itself. A financial mission statement turns financial success, which can actually be pretty superficial and unfulfilling into something deeply personal and deeply meaningful. So whether your mission is to secure your family’s future or support your community or travel the world without financial stress, having that statement in place is crucial.
And you know what I love about it? It gives you a reason to be excited about your money, because it’s not about the money anymore. It’s about what your money allows you to do, and to achieve and to become. So again, this week’s One Simple Task is to create a mission statement for your money. And I’ll provide you with some tools on the radio page of our website to help you complete it.
Well, we’ve made it to listener questions, one of my favorite parts of the show. And one of my producers, Britt is here to help me out. Hey, Britt, how about we start with Andrew’s question?
Britt Von Roden: Sure thing. Andrew was out of Missouri and was recently let go from his job. He and his wife are in their early fifties with $2 million in their 401ks, which John he shares is where all of their savings is. He’s wondering, “Is it okay to tap into that if necessary?”
John: Well, I’m sorry Andrew, to hear about you losing your job. I know that can be very stressful and certainly change some of the expectations you had for your year or your financial future, but it sounds like you’ve done a heck of a job. You’ve already got $2 million saved, so you’ve put yourself with a nice cushion. And I think what you’re asking is pretty typical, which is, “Yes, I’m in a good position. But I have liquidity constraints because the money is sitting in a tax-deferred retirement account with age restrictions.” So fortunately, there are new rules that allow you to get $1,000 out without any penalties, but that’s only going to solve for $1,000. If it’s just a one-time emergency, kind of a one-off, that may be helpful. But my guess is you have some money sitting in checking and savings, $10,000 or $20,000, something like that. In reading between the lines, I’m assuming what you mean is you don’t have substantial money outside of your 401ks.
And this is a challenge with deferred retirement accounts. You’re not alone. I regularly see people with almost all their money saved in tax-deferred accounts. And in fact, financial surveys show that the vast majority of Americans have the vast majority of retirement dollars saved inside of retirement accounts. Beyond the early withdrawal penalty of 10% if you’re too young, the other challenge is that everything comes out taxable. So you’re very beholden to whatever future tax rates might be, and if you want to spend more for a vacation or renovation on your home, it’s all coming out at ordinary income rates and can potentially escalate your brackets. It takes a lot of tax planning.
So again, you’ve done a really good job saving up to $2 million, but here’s what I suggest you do. First off, typical certified financial planner answer, build a financial plan that’s detailed, that’s written, that’s documented with the new set of base facts. You didn’t mention whether your spouse’s income can support most of your income needs. What was the difference in your salary versus hers? It sounds like she still has her job, I think. But you need to build a plan and figure out, “How short are we every month, and how long do we expect that to persist?”
I would then consider using home equity. It’s not for sure the best bucket to pull from, but it’s an alternative. It might be more effective than pulling from retirement accounts. Do you have the ability to grab a HELOC? Go pull from that home equity line of credit and use it while you search for a new job. That would be a reasonable solution to consider if you think this is temporary.
Now, if you think it’s likely you’re never going to go back to work, you run your financial plan and you realize, “I think we can spend what we want by pulling from some of our investments to supplement my spouse’s income and then bridge it to Social Security and we’re going to be okay.” Well then, the HELOC may not be as good of an option as exploring what’s called a 72t. Now, that’s an agreement you make with the IRS that allows for systematic withdrawals from your retirement accounts, pre-59.5, without any penalties.
Before you think that’s a magical unicorn, “Wait. In my early fifties, I can pull from retirement accounts and I don’t have to pay the 10% penalty?” By the way, of course you have to pay income tax on those withdrawals. But the reason for that is because you say, “I am going to do this continually and systematically.”
And the rules are extraordinarily rigid. I would definitely do this with the help of an experienced financial advisor, because if you mess it up, the 72t comes with retroactive penalties. So it’s a long-term commitment. It’s not flexible, which is why yes, it’s an option, but it’s really more viable if you’re not intending to find another job and dipping into your investments for income is a long-term play.
Andrew, there’s so much more to unpack. We have offices in St. Louis, our headquarters are in Overland Park. Feel free to visit the radio page of our website to request a one-on-one meeting if you’d like more specific planning around this adjustment to your life. Hang in there, because you’ve got a nice base built up. You’ve obviously made a lot of really good decisions, and I’m sure you will here as well. All right, Britt, who’s next?
Britt: Our next question is from Dave out of Minnesota. Dave says that his parents are getting older and that they are planning for the inevitable. One area that came up during their planning recently was taxes. He’s wondering what will happen to their taxes after one of them passes.
John: All right, Dave. Well, this is a loaded question and one that we are happy, either myself or one of my colleagues, can work through with your parents specifically. We have a couple of offices there in Minnesota.
I’ll give you some general rules of thumb. So when the first of your two parents passes away, the taxation depends on the type of account more than anything else. So if it’s a joint tenant with rights of survivorship, which is a very common account registration between a married couple, you’ll see JTWROS, all capitals. In that scenario, the surviving spouse typically inherits the account without any tax consequences at the time of the transfer. However, there might be a step-up in basis for half of the account’s value. Again, I’m not going to get too far into the weeds.
There’s also tenants in common. It may be held in trust. It really depends upon the type of account. A common type would be an IRA or a 401k. And in that scenario, the surviving spouse can roll over the account into their own IRA, continuing tax deferred growth. And distributions of course will be taxed as ordinary income when taken out. If it’s a Roth IRA, the surviving spouse can also roll it into a Roth IRA for themselves without any tax consequences and qualified distributions remain tax-exempt.
With real estate, the surviving spouse typically receives a step-up in basis, again, depending upon how the account is registered. I can’t stress that enough. And then, also worth considering is this an insurance vehicle? Is it an annuity or is it life insurance? Life insurance generally is received, if it’s a death benefit, tax-exempt. If it’s an annuity, it’s generally taxed at ordinary income on any deferred growth. Again, there may be some spousal continuation rules associated with that annuity, but very specific to each individual situation.
These are great questions though, because I find often that people are surprised, either the surviving spouse or the children, by the taxation that occurs when inheriting an account. And this is where great planning and solid communication can not only make things smoother and easier and less stressful, but also save a lot of money. I’ve seen people say, “Roth conversions, those are going to be so smart because my kids are in a higher bracket than me.” And by the way, that in and of itself, if they’re inheriting the money, may be a good strategy, like pay tax on the conversion amount as the retiree at maybe 12 or 22%, and then avoid your kid in California who’s in a 37% bracket and well over 10% state tax the difference. Because they’ll receive it tax-exempt, assuming it’s a qualified distribution.
But I’ve seen other people do that same thing with that same logic, yet they want to give away half of their estate to 501c3s. Well, why not just give away the 50% of your net worth that’s going to be taxed at ordinary income in retirement accounts, give those assets to the charity. Disinherit the IRS there, and then give your child in California in that example, that’s the high income earner, the other accounts that will be stepped up in basis regardless. Oh, wow. Now you don’t have to pay any tax in that hypothetical scenario. That would be smarter than even a Roth conversion that on the surface makes sense. So Dave, I hate to not answer this question better, but when speaking big picture, this is an hour or two conversation, and isn’t even that relevant until we see exactly what the account registration and account types are for your parents. Thank you for that question. Britt, let’s go to the last question for the day.
Britt:
Our last question for the day is from Christina in Nebraska. She is wondering what your take is on if we are in a bear market? She also asks if there are any tips on things she needs to be doing immediately, if so.
John: Well, there’s certainly been some ups and downs, no question about that, more volatility. But a bear market is defined, Christina, as a drop of 20% or more from the top. So no, we’re not in a bear market at this point. A correction now is 10% or more. The NASDAQ recently had that. The S&P got real close and then bounced back. And it feels violent and dramatic and volatile, right? We use that word volatility. But remember historically, it’s normal for the market to drop about 14% in a calendar year, peak to trough.
Now of course, whenever it happens, it’s not in a vacuum. There’s either a slowing labor market or a hot labor market or inflation or deflation or political unrest or global conflict or the market’s in a drawdown or it’s coming off of an all-time high, so maybe that was a bubble and now I should be making changes, et cetera, et cetera. But how you’re thinking is normal.
But if you have a written documented plan that’s solid, which by the way is a big assumption, but let’s say you have that, then no, you don’t need to make any immediate changes. You don’t need to be making any big directional moves. You should work the plan per your stated objectives. And assuming that nothing’s changed there in your life and it’s just the account balance is down due to market volatility, then you want to make strategic tax trades and timely rebalancing in asset categories that have deviated enough to present some opportunities or to distort your risk return profile. That’s totally acceptable.
And remember, Christina, I don’t know your situation, but one of the most important things to consider when the market is down is to increase your savings rate. Everything’s on sale, everything’s discounted. Now, if you’re overly concentrated in the Japanese stock market, then yeah, I don’t know what to tell you, other than heck of a wild ride. And that was extremely risky from the beginning, just as any concentrated position is.
But assuming that that’s not the case, which I’ll assume it is, crack a coconut LaCroix, by the way, best flavor, I will battle anyone on that. Lemoncello is close, but it’s not quite there, and hang out with some friends and family and enjoy the end of summer. Don’t worry about this. Volatility is something that should be scary only if you don’t have confidence in your plan or certainly if you have no plan at all, then it’s very unnerving.
And remember, the times to make changes are when your situation or objectives have evolved. “Oh, now we’re pregnant with our first child. We might need to now buy a house. One of us may take some time off work. Our income may be adjusted. Our expenses will be higher because kids are expensive.” Those are the times where you look at your plan and say, “What needs to adapt?” But if you have a good plan, and the market drops 10% or shoot even 30%, your best course of action is execute what was established prior to the storm, which is inevitably accompanied by heightened emotions, and therefore a risk of reacting inappropriately to those when it comes to your investments.
If you’re like me, you’ve probably gotten really good at lying to yourself as a way to feel better. Sometimes that expression, “The truth hurts” is true, it’s right on. It does hurt. And as I wrap up today’s show, I want to leave you with a little challenge. And it might be uncomfortable, it can be for me, but it’s also revealing. Take a hard look at two things, your bank account and your calendar. These two are ultimately the true serum when it comes to your priorities.
Let’s start with your bank account. You might say you value generosity. “I really want to give back and help those in need.” Does your spending/giving reflect that? If you’re spending more on takeout subscriptions and DoorDash or your morning coffee than causes that you say you care about, then maybe your priorities aren’t actually what you say they’re or you think they are.
And I’m not telling you this out of guilt. I have wrestled with this personally for my entire adult life, like aligning my actions with my beliefs. But the reality is your bank account tells the story of what actually matters. So if giving is important, but the numbers don’t back it up, maybe it’s time for a change.
Now take a look at your calendar. We all have the same 24 hours in a day, but how we spend time also says a lot about what we value. I know I’ve said before, family comes first, and my calendar is packed with a bunch of things that aren’t that important and are taking away from my family. Or maybe you say self-care is important. “I know I need to maintain my health.” But you don’t even carve out enough time in your day to get a jog in or a quick workout or getting adequate sleep.
So your calendar reveals the truth about your priorities just like your bank account does. And it’s very easy to get caught up in the day-to-day, and for all of us to lose sight of what’s important. We spend on convenience. We book our time out of obligation. And before we know it, we can be living a life that doesn’t match up with our values.
But here is the good news, and I’ll end with this. Once you know where you stand, then you can make a change. And so, I challenge you. Take a look, really look at your bank account and your calendar. They’ll tell you everything you need to know about where your priorities are right now. And if you don’t like what you see, remember it’s never too late to start living a life that reflects what’s truly important to you. And I’m cheering you on, and I’m hoping you are for me as well because Lord knows I need it, too. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.
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Disclaimer:
The preceding program is furnished by Creative Planning, an SEC registered investment advisory firm. Creative Planning, along with its affiliate, United Capital Financial Advisors, currently manages or advises on a combined $300 billion in assets as of December 31st, 2023. John Hagensen works for Creative Planning, and all opinions expressed by John or his guests are solely their own and do not necessarily represent the opinion of Creative Planning.
This show is designed to be informational in nature and does not constitute investment, tax, or legal advice. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels. 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 independently.
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