4 Tough Retirement Planning Questions I Asked Wade Pfau

Question #1: What Is the Best Way to Turn Your Retirement Savings Into Income?

Accumulating money is relatively straightforward.

For 30 or 40 years, you work, save into a 401(k), IRA or other retirement account, invest the money, and hopefully allow compounding to do its job.

Then retirement arrives.

Suddenly the question changes.

Instead of asking:

“How much can I accumulate?”

you are asking:

“How much can I safely spend?”

That is a much harder question.

There are several basic ways retirees can approach retirement income planning.

One is a withdrawal-rate strategy, such as the traditional 4% rule.

Another is a more flexible or “guardrails” approach where spending changes depending upon investment performance.

And another is an income-flooring strategy, where reliable or guaranteed income is used to cover essential expenses while investment assets are available for discretionary spending and longer-term growth.

Wade was careful to point out that there is no single strategy that is appropriate for everyone. Different retirees have different preferences, goals and tolerances for uncertainty.

But his research has repeatedly found advantages to creating a reliable income floor.

In his words, once essential expenses are covered with reliable lifetime income, the remaining portfolio can potentially be used more flexibly for discretionary goals and long-term growth.

That concept matters because retirement risk is different from working-life investment risk.

At age 45, a market decline is uncomfortable.

At age 65, a market decline may occur at the exact same time you are withdrawing money to pay your bills.

You also have another unknown:

You do not know how long retirement will last.

That uncertainty can cause some retirees to dramatically underspend.

They have accumulated $1 million, $2 million or more, yet they remain afraid to enjoy the money because they are constantly wondering:

“What if I live to 95?”

“What if the market crashes?”

“What if inflation stays high?”

“What if I run out?”

Wade pointed out that reliable lifetime income can help reduce some of that uncertainty because certain risks can be pooled through an insurance company rather than borne entirely by the retiree.

I sometimes refer to dependable retirement income as Mailbox Money.

The objective is not to put every dollar into an insurance product.

It is to determine how much income you need to reliably support your lifestyle, and then decide how the rest of your assets should be invested.

That is retirement income planning.

Not simply picking investments.

Question #2: Should Retirees Assume Today’s Tax Rates Will Last Forever?

This may have been my favorite part of the conversation.

I asked Wade a question nobody can answer precisely:

How much are taxes going to go up?

His answer was appropriately cautious.

Nobody knows exactly what Congress will do.

But he also made an important planning point: assuming today’s tax environment continues indefinitely may not be a prudent base case.

More importantly, Wade explained that proactive tax planning can make sense even if future tax rates do not increase.

That is a critical distinction.

Many people still approach taxes in retirement one year at a time.

They go to their CPA and ask:

“How do I pay the least possible tax this year?”

That is a perfectly reasonable question when preparing a tax return.

But it is not necessarily the right question when designing a 25- or 30-year retirement tax strategy.

Wade described the difference as lifetime tax planning.

Instead of simply minimizing this year’s taxes, you are looking for opportunities to pay taxes when your overall rates may be lower and avoid being forced to recognize income later under less favorable circumstances.

For many 7-figure retirement savers, that is where the planning becomes much more complicated.

A married couple might retire in their early 60s with substantial balances in a 401(k), rollover IRA or other tax-deferred accounts.

Initially, their taxable income may look relatively low.

Then several things begin to happen.

Social Security starts.

Required minimum distributions begin.

Investment income continues.

One spouse eventually dies and the surviving spouse may move from married filing jointly to single tax brackets.

Medicare IRMAA surcharges may enter the picture.

And IRA assets that eventually pass to adult children can create another income-tax issue for the next generation.

Wade referred to the impact of future required distributions as an “RMD tax cliff.”

This is why RMD planning, Social Security taxation and Roth conversion strategy should not be treated as separate decisions.

They interact.

Question #3: Is the Roth Conversion “Break-Even” Date the Wrong Question?

This is where I became a little contrarian.

There is an enormous amount of discussion about the Roth conversion break-even date.

The idea is simple:

If I pay taxes today to convert IRA money into a Roth IRA, how many years does it take before I “make my money back”?

For certain retirees, that may be a useful calculation.

But for many of the families we work with, I believe it misses the bigger picture.

Imagine a married couple with significant IRA and 401(k) assets.

They are reasonable spenders.

They have children.

And there is a high probability they will die with significant assets remaining.

In that situation, the retirement tax-planning story does not necessarily end when the husband and wife die.

There is still an embedded income-tax liability inside the IRA.

Their children may eventually inherit that account and be required to distribute it over the applicable inherited-IRA period.

And those children may inherit the money while they are still working and potentially in some of the highest tax brackets of their careers.

So I asked Wade:

Does the traditional Roth conversion break-even concept even make sense for this family?

His response was important.

He said he does not believe the traditional break-even concept really works for Roth conversions.

The more important question is often:

At what tax rate can the family pay the tax?

If the parents can convert IRA dollars at a lower tax rate than their beneficiaries could eventually pay on those inherited dollars, Wade explained that the family’s after-tax legacy value can improve immediately.

That is a completely different mindset.

Instead of asking:

“When do I personally break even?”

you begin asking:

“How much of our family’s wealth ultimately stays with our family after taxes?”

That is much closer to how I believe Roth conversions in retirement should be evaluated.

But there is an equally important warning.

A Roth conversion strategy should not simply mean:

“Fill the 22% bracket.”

Or:

“Convert everything up to the top of this tax bracket every year.”

Wade was particularly critical of overly simplistic Roth conversion software that takes this approach.

Why?

Because Roth conversions can affect much more than your federal income-tax bracket.

They can influence:

• Medicare IRMAA surcharges
• Social Security taxation
• required minimum distributions
• deductions and phaseouts
• capital-gain taxation
• future withdrawal strategies
• the surviving spouse’s tax situation
• estate and beneficiary planning

Wade emphasized that these variables are interconnected and that sophisticated retirement tax planning requires modeling more than one isolated tax bracket.

This is one reason I believe retirement tax planning falls into a gap between two traditional professions.

Your CPA may be excellent at preparing your tax return.

Your financial advisor may be excellent at managing your investments.

But who is coordinating the next 20 or 30 years?

That is the question.

The Difference Between Tax Preparation and Retirement Tax Planning

I started my career as a CPA.

And I understand this problem from both sides.

During tax season, a CPA may be working 60, 70 or 80 hours a week.

The immediate job is to accurately prepare the return, comply with the Internal Revenue Code and identify appropriate opportunities for the current year.

That is very different from modeling:

“What happens if this client converts $100,000 a year for the next six years?”

“What happens to future RMDs?”

“What happens to Medicare premiums?”

“What happens when one spouse dies?”

“What happens if future tax rates change?”

“What happens to the children’s inherited IRA?”

“What happens to the family’s total after-tax net worth?”

At the same time, many financial advisors do not consider themselves tax specialists.

Wade agreed that there is a genuine planning gap between the traditional tax world and financial planning world, particularly when dealing with lifetime Roth conversion and withdrawal strategies.

For retirees with $1 million or more, that gap can become increasingly important.

Because the larger your tax-deferred accounts become, the more consequential the eventual decisions surrounding those accounts may be.

Your 401(k) balance is not the same thing as your after-tax net worth.

Neither is your IRA.

What ultimately matters is what you and your family are able to keep after taxes.

Question #4: What Is the Right Way to Think About Long-Term Care?

We finished by talking about another difficult retirement-planning subject:

Long-term care.

The typical conversation begins with a frightening number.

“What if nursing-home care costs $X per year?”

But Wade raised an important point that is sometimes missed.

If someone enters a nursing facility, you generally should not simply add the entire cost of the facility on top of the family’s existing lifestyle expenses.

Some existing expenses may decline.

If one spouse has already died and the surviving spouse enters a nursing facility, much of the previous household spending may no longer exist.

That does not make long-term care inexpensive.

Far from it.

But it means comprehensive retirement planning should evaluate the net additional cost, rather than simply stacking a nursing-home expense on top of an unchanged household budget.

From there, retirees generally have several ways to address the risk.

They may self-fund it.

They may purchase insurance.

They may use certain hybrid life insurance and long-term-care products.

Or they may combine several strategies.

Wade noted that the insurance marketplace has shifted substantially toward hybrid solutions, while also emphasizing that no one product is automatically appropriate for every retiree.

Again, the answer comes back to coordinated planning.

Long-term care cannot be evaluated only as an insurance decision.

It affects the retirement income plan.

The investment plan.

The estate plan.

And potentially the tax plan.

Retirement Planning Should Be One Coordinated System

This conversation with Wade reinforced something I have come to believe more strongly every year.

Retirement is too interconnected to plan one piece at a time.

Your Roth conversion strategy affects your taxes.

Your taxes can affect Medicare.

Your Social Security decision affects income and taxes.

Your retirement income strategy affects how much investment risk you may need to take.

Your estate plan affects how we should think about the taxes embedded in your IRA.

And your long-term-care strategy can change how much wealth needs to remain available later in retirement.

That is why our approach at Cyr Financial is built around the AIM Retirement System™: Assess, Implement and Monitor.

We believe comprehensive retirement planning should integrate:

retirement tax planning,

retirement income planning,

investment management,

Social Security,

Medicare and healthcare considerations,

RMD planning,

Roth conversions,

and estate coordination.

As a CPA and CFP®, I increasingly think of my role as a Retirement Tax Architect.

Not because taxes are the only thing that matters.

They aren’t.

But taxes touch almost everything else in retirement.

And for retirees who have spent decades building a seven-figure nest egg, the goal should not simply be to see the largest possible number on an IRA statement.

The better question is:

How much of your wealth will you and your family actually get to keep?

If you are approaching retirement and want to identify areas of your plan that may deserve a closer look, you can learn more about our AIM Assessment here:

https://cyrfinancial.net/aimassessment/

And you can watch my entire conversation with Dr. Wade Pfau here:

https://youtu.be/Q8MAGj_9olY

Investment advisory services provided by Cyr Financial Wealth Advisors, an SEC-registered investment adviser. This article is for educational and informational purposes only and should not be considered individualized investment, tax or legal advice.