I remember one occasion many years ago when my two children and I faced unusual bumper-to-bumper traffic. As we surveyed our predicament, there were cars stopped as far as we could see. We also noticed an invasion of blackbirds off to the side of the road where they seemed to be blanketing every surface.
Our conversation went something like this:
“Wow. This is crazy.”
“I’ve never seen so many!”
“I know, right. Do you think they’ll ever move?”
Just then the birds flew off, en masse.
My daughter said, “There they go!”
My son said, “The cars are still here … oh, wait … you were talking about the birds?!”
As a mom, I can tell you there is nothing funnier than having two parallel conversations, especially with kids. Two distinct topics with enough similar language that we didn’t understand the miscommunication at first.
But miscommunication isn’t always so amusing, especially when we’re talking with clients.
Many of your clients may be retired or planning to retire soon. This can be scary and exhilarating for them. This article looks at three primary retirement issues and how to communicate with clients and help them avoid making mistakes.
1. Retirement-savings deficits
The first retirement issue is not having enough money in retirement. Because baby boomers are the largest cohort to retire, let’s take a look at those statistics.
Although boomers possess more than half (54%) of all U.S. household wealth, they have an average $152,000 saved for retirement. In addition, 45% of boomers have no retirement savings and of those that do, 28% have less than $100,000 saved. About half of all retirees plan to live exclusively off their Social Security benefits.
These statistics paint a bleak picture of preparedness.
As we live longer, the notion of how to invest for retirement and during retirement continues to evolve. We are now investing for a retirement that might last for 20 or 30 years, which means the old retirement ratios may no longer work and money needs to be more aggressively invested. But our clients’ potential aversion to risk remains, as does their definition of risk.
If risk aversion or lack of understanding the long-term view hampers our clients, how do we help them avoid unintended consequences? They deserve straightforward and plain-English explanations.
Reframing their understanding of risk is a good first step.
I usually ask clients to tell me why they invest for retirement. It’s obvious from their reactions that they wonder how something so simple could be difficult for me to understand. I make them drill down and encourage them to think about maintaining purchasing power and lifestyle. Then I introduce taxes and inflation, and suddenly, they understand that their safe investments are less safe than they thought.
Compounding and the growth of investments over a long period of time is another simple, but misunderstood concept. Even with clients who are preparing to retire, these are valid discussions: 20 or 30 years of future inflation and taxation demands nothing less.
Families make so many choices without understanding the implications. Our job as advisors is to help guide clients — even, or especially, when their instinct is to do the opposite.
I once met a prospective client who was happy to tell me how she and her husband, both approaching 50, were earning close to $500,000 between the two of them. She wanted me to guide them in retirement planning. I asked how much they had put away already. Stunningly, it was almost zero. With the exception of a mostly forgotten $5,000 IRA, they had saved exactly nothing. Most importantly, they wanted to spend no time thinking about or budgeting to maintain their lifestyle.
I have had conversations with other people who understood the value of saving, but who were too fearful to invest and make their money work for them.
Whenever I field questions about the markets and the risk of losing money, I tell the story of a client who over many years invested small amounts, lived below his means, and had the patience to see his plan through. When he died several years ago, his widow inherited a portfolio of almost $10 million dollars. He was a government employee; she was a school teacher.
2. Distribution mishaps
If not having enough money in retirement is a huge unintended consequence, then distributions can become the next landmine. Guiding clients though the choices of when to take distributions, which accounts they come from, and how to manage the combination of taxable and tax-free money, is our next step.
Like so many of the choices surrounding retirement, income generation and the timing and strategy to liquidating a lifetime of accumulated assets requires a thoughtful and knowledgeable approach. The first year of taking required minimum distribution (RMDs) can be especially tricky if not planned for in advance.
Under Secure 2.0, retirees born in or before 1959 must take their first RMD from their pre-tax savings by the April after they turn 73. By failing to property plan, clients could find themselves taking two RMDs that calendar year, potentially increasing their tax liability. Not only will their tax liability increase, but because Medicare premiums (Parts B and D) are based on adjusted gross income, these costs could escalate, as well.
Don’t limit yourself
Having both taxable and tax-free income in retirement is an important aspect in both the planning and the subsequent distributions from invested assets. Even when tax-free contributions are beneficial for the individual client, I often suggest considering opening and funding a Roth. As long as it is open for a minimum of five years, the account is considered “qualified” and renders all distributions tax free.
Here too, communication is critical. Moving retirement funds, whether to initiate a Roth conversion or simply to consolidate retirement accounts, sets up a potential minefield. The larger the account, the more painful the unintended consequence.
I had a new client years ago who decided to initiate a transfer without any input from me. She came into my office after the 60-day rollover period with check in hand and tears streaming down her face. She was self-admittedly unaware of two key aspects of transferring her retirement funds. Her IRA, which had exceeded $200,000 before the transfer, was now worth 20% less after mandatory federal withholding. Because she was younger than 59 ½, I had to explain to her that her $200,000 IRA was now considered a taxable distribution and carried an early withdrawal penalty. One simple election created a lifetime of lost tax-deferred income. It was an excruciating conversation for both of us.
3. Estate-planning oversights
Finally, the last of unintended consequences is the lack of proper estate documents or use of beneficiary designations. After a lifetime of helping to grow their assets, this opportunity to lower a client’s taxable estate and potentially keep it out of probate is too important to overlook.
For assets that are titled in single name, you want to encourage the use of beneficiary designation for their financial and insurance holdings. Many states allow real and personal property (houses and cars) to transfer via a similar mechanism. Called the Transfer on Death Deed, this legal option can seriously reduce the taxable estate, since many times homes are our greatest asset. Using a TOD Deed still preserves a stepped-up basis for the designee while circumnavigating the court’s oversight.
Clients may ask about simply re-titling the property, by adding future heirs to the deed, but doing this carries several pitfalls. First, if the amount of the gift exceeds the annual threshold, the donor will have to report it to the IRS and possibly incur taxes, depending on previous gifts. Most states do not tax gifts, and those that do have high thresholds, but this could still be an issue for the beneficiary.
More impactful however, is that upon the death of the client, the beneficiary’s tax basis does not enjoy a step-up in value. For areas of the country where real estate values have surged, the difference can be striking.
A costly example
Imagine a home currently valued at $750,00 that carries a cost basis of $250,000 for the client. Adding a beneficiary to the deed as a co-owner equates to a gift of $125,000 (reportable to the IRS since well over the annual $17,000 limit). Upon the death of the client, assuming a then market value of $800,000, the beneficiary has a step-up in basis on the decedent’s half ($400,000) but no step-up in basis on their half. If the house sells for $800,000 (net of selling costs), the beneficiary pays taxes on $275,000 [$800,000 sales price minus ($125,000 gift basis plus the beneficiary’s inherited stepped-up basis of $400,000)].
Using the same example, if the donor had used a TOD Deed instead, the beneficiary would enjoy a stepped-up basis of $800,000 and owe no taxes on the sale.
Even celebrities have made the mistake of disregarding the importance of a written asset distribution plan. Helping clients to align their wishes in this final step is a great service.
Ultimately, regardless of the type of relationship and services we offer, our clients depend on us to see the lurking issues and help guide them around potential disasters. Education, clear communication, and a nuanced understanding of the issues are the best tools we have.
llene Slatko, CEO and founder of DSS Consulting, coaches clients on building strong financial decision-making skills. Her focus is most often women dealing with the long-tail of a divorce or the death of a loved one. Ilene’s new project, Metamorphosis, is an e-learning platform designed specifically to guide subscribers through pre-retirement and retirement issues. She spent over 25 years as a financial advisor and built her business through her seminar series, “Women and Their Money.” Ilene is also a subject-matter expert on the Federal Employees Retirement System (FERS) and speaks to audiences across the civil-service spectrum.