Prepare for Tax Law Changes by Having a Tax Plan with JoAnn Huber

[00:03:17] JoAnn Huber: Alright. In my mind, those two plans, neither one can exist without the other one. And it’s really important to realize that. And we always start with the financial plan because that’s going to let us know what does somebody have because we can make a really efficient tax plan if you don’t need any money. But that’s not going to work for me what you want in your life. So, we always start with the financial plan. We start with what assets do you have and what do those assets need to do for you?

What income sources do you have? What expenses, and go from there? And what is it that you want to do? Because nobody has a life or they just want to stay home. If COVID taught us anything, it’s like even the introverts were ready to get out. So, let’s look at that, but once we have that financial plan, then we have to look at it from a tax perspective. And if we don’t have that tax perspective, then that plan isn’t going to be as robust as it needs to be, and we’re going to be missing something crucial.

[00:04:10] Dean Barber: So, let’s talk really quickly about the difference between a goals-based plan and a robust financial plan that is really more of an outcome-based plan. And that goals-based plan is simply saying I have a goal to generate X amount of dollars at a certain time in the future. You use a 4% income right off of it. You can say, well, this is how much money you need have accumulated and you can use a simple time value of money calculator to say how much do you need to save and what rate of return. And that’s the goals-based plan. Or I want to purchase a new car that’s going to cost $60,000 and I need to do that in five years. How much money do I need to save in order to get there? That’s not what we’re talking about. That’s not financial planning.

[00:05:00] JoAnn Huber: Now, we want to look at all– I mean, those are both a piece of it, but it’s not financial planning. We’re really looking at the whole picture. What are those goals you want to do and what are your expenses? What do you have in putting all of it together? But then a crucial part of that is what is your distribution strategy? And that’s where the big magic comes in because we start looking at things from a tax perspective. If you’re not paying that money for taxes, you can get a lower rate of return and you’re better off. And maybe you won’t need to take so much out for spending because you’re not sending it off to the government.

[00:05:32] Dean Barber: In order to illustrate what you’re talking about, we actually created a video that we’ll put a link in the show notes to watch this video. The video shows the power of good tax allocation. We already talked about asset allocation. We want to talk about tax allocation, and just a quick teaser on what’s in the video, and I’m going to encourage everybody listening here to go watch that video. And if you’re watching us on YouTube, watch this next video as well. It’s about 20 minutes, so it’ll be a good use of your time. But what we did is we took four couples and assume that they all had a million dollars, that they all had the exact same earnings history, so their Social Security benefits were going to be the same.

And we said what would happen if all four of those people, all with different amounts of money and different types of taxed accounts, so some tax-free, some tax-deferred, some taxable, all taxable, all tax-deferred, etc., what’s the difference in the outcome just from that tax allocation? And the numbers are shocking. They are absolutely shocking. And so, we always say don’t ever save money into anything until you know what the objective is when you want to take the money out. Now, you may not know what the tax law is going to be in the future, but generally speaking, if you know that, then you can start to form that longer-term tax plan.

[00:06:55] JoAnn Huber: Right. And the one thing we do know about tax law is it’s always going to be changing, but we plan based on what we know today. And so, we say, okay, if we know, we’re going to have to take this money out. I mean, you’ve had Ed Slott on so many times, and he’s fabulous at talking about the time bomb with the IRAs.

[00:07:13] Dean Barber: 401(k)’s.

[00:07:14] JoAnn Huber: And we have to be aware of that and know if you have that tax-deferred account, you’re going to have to pay tax on it at some point. And so, a key feature of tax planning is saying, okay, when do I want to pay the tax on that? Put yourself in control rather than allowing the government to dictate, you have to take out X amount once you start the required minimum distributions. And that’s really what tax planning is all about, is deciding how you’re going to take your money, but if all you’ve done is put your money in tax-deferred, you really have no choice. And so, that’s why it’s important to start…

[00:07:44] Dean Barber: You can’t paint yourself into the corner.

[00:07:45] JoAnn Huber: Yeah, you’re stuck. And so, you have to start while you’re working to make sure that you’re putting the money in the right types of buckets and giving yourself tax diversification so you have some choices once you get to retirement on where you are going to take those funds.

[00:07:58] Dean Barber: And when it comes to tax law changes, if you already have your plan built based on current tax laws, and we get that new tax law that comes in, it’s really easy inside of the financial plan to go in and say, okay, these are the tax law changes that were made. This is how it affects your overall plan. These are the adjustments now that we need to make. And they don’t become an emotional adjustment. They don’t become a knee-jerk reaction.

They are a very logical and reasoned discussion of why you need to do things differently, and it requires flexibility. This is one of the reasons, JoAnn, why I think that people’s investments need to remain flexible. Locking money into something for long periods of time doesn’t make any sense because if the tax law changes, and you can’t change how that money is allocated, you could be in big trouble, I mean…

[00:08:58] JoAnn Huber: Right. I mean, how many times have we seen people where there’s a market correction and they’ve been so afraid about paying taxes that they haven’t been willing to change the portfolio up, but that market correction comes and all of a sudden, the amount they lose in the investment is more than they ever would have paid in tax if they are stuck on just not having a diverse portfolio.

[00:09:18] Dean Barber: Right. Well, what you’re talking about there is really somebody saying I’m not going to sell something because if I sell it, I might have to pay taxes on it.

[00:09:23] JoAnn Huber: Right. Tax avoidance might not be the ultimate goal. We’re trying to keep the money in your pocket to do what you want.

[00:09:31] Dean Barber: Right. In our industry, we call that letting the tax tail wag the investment dog. Right now, we both know that the dog and the tail are both the same part of the same animal, right?

[00:09:42] JoAnn Huber: Right. And we want them to work together.

[00:09:43] Dean Barber: We want them to work together. And so, if you go through the steps of creating that well-thought-out financial plan and your CERTIFIED FINANCIAL PLANNER™ professional sits with your CPA, your risk management expert, your estate planning attorney, and they all collaborate on your behalf, and you have these changes in the tax law, okay, fine. Let’s get the team together and let’s talk about how this whole thing plays out. It reminds me, going back to Episode 21 here of The Guided Retirement Show.

I interviewed a gentleman who was the CEO of ConAgra, since retired, and he was talking about how people really need to think when they go into retirement like they are the CEO of their retirement and understand that a good CEO is going to surround themselves with good people. Somebody is going to be in charge of the tax department. Somebody is going to be in charge of the investment department, somebody is going to be in charge of the legal department, and somebody is going to be in charge of the risk management department.

Knowing that that CEO needs to give the vision and the direction and say, this is really what I want to have happened, but you’ve got to have all these other people to work together collaboratively that all are hearing it from the same voice at the same time and say, how do we come together and make this happen?

But our industry has made people believe, JoAnn, that the financial services industry is all about investment. You and I know that the investment should be the very last discussion that anybody has with any financial planner because the person that’s out there that is looking to retire or who is already retired, they need to start thinking of themselves as the CEO and they need to be able to lay their vision out to that team of professionals. And it doesn’t matter if you got $500,000, if you got a million, if you got $10 million, $100 million, you have to be able to do that and find that team of trusted advisors that can work on your behalf because the amount of money that a team like that can save you and earn for you over time will pale in comparison to what you’ll ever pay them.

[00:11:41] JoAnn Huber: Right. That’s the thing that we see so often when people are working with the CPA here, the investment advisor here, and there’s not that communication going on, we see mistakes made. It might not be that the tax return was prepared wrong or there’s something wrong with the financial plan, but it’s just not optimized. And so, they’re losing out on opportunities that they could have realized throughout the years. Now, they’re going to be okay, but they’re not going to be as great as they could have been.

[00:12:10] Dean Barber: So, it was 2017, I believe, when the Tax Cuts and Jobs Act passed. Is that right? And in that Tax Cuts and Jobs Act, one of the things that they did was they changed the standard deduction, personal exemptions, and they changed the way that itemized deductions are working, right?

[00:12:29] JoAnn Huber: Right.

[00:12:30] Dean Barber: And so, I ran into a situation and I haven’t even got a chance to share this with you, but I talked with one of the other CPAs here in the firm about it. So, I ran into a situation where this couple, they both had lost their spouses and then they remarried and they had a financial advisor. I won’t call it a financial planner because what the guy was doing had nothing, it didn’t even resemble…

[00:12:52] JoAnn Huber: Investment management, maybe.

[00:12:53] Dean Barber: Yeah, investment management, that was it. The person CPA said, “Hey, you need to start doing something different. We need to get your investment guy over here and talk to him because you’re facing a big tax time bomb here with leaving money down to your kids. It’s all in these tax-deferred accounts.” And so, I gathered all the documents. We talked about what they wanted to do. And one of the first things that I did was review the tax returns and something jumped out at me that I thought was odd. So, it caused me to do a little bit more investigation.

What it was was I was speaking specifically with the wife here because she was the one that the CPA was most concerned about, and I looked at her tax return and I noticed that she filed married filing separate and did an itemized deduction of only $5,300. Alright, now, you and I both know that the standard deduction for the elderly is, what? $13,000? $12,000 plus, somewhere in that.

[00:14:01] JoAnn Huber: It’s about $14,050.

[00:14:03] Dean Barber: $14,000, okay. So, she only was able to take off of her income, the $5,300, because the CPA was forced to do an itemized deduction for her because he did itemized deduction for her husband. And the thing was when I got to talking to the CPA that the CPA did itemized deductions for the husband, but he was only able to itemize, it was about $15,000. So, he was barely over the standard deduction amount, and then she lost all that standard deduction. I said, “Why are you doing this?” The CPA says, “Well, this is what they’ve done ever since they got married.” Well, prior to the 2017 Tax Cuts and Jobs Act, that may have made sense, okay. I said, “Tell me more about why you did that.”

Let’s look at his tax return. Well, most of the money that he used that he was able to itemize was he was giving money to charity. And so, I asked the CPA, I said, “Has he given the money through a qualified charitable distribution?” A QCD, which is simply for our listeners that don’t know what that is, you’re giving money directly to charity from an IRA. And she said, “No, he doesn’t have any IRAs.” I said, “Oh, okay.” I said, “Well, she’s got a mountain of IRAs.”

I said, “Plug this into your tax program real quick. Do married filing jointly, take the standard deduction. Let’s give 100% of the charitable contributions out of her IRA through a QCD and then let’s just have him reimburse her the cash.” And what difference would that make? Almost $7,000 in unnecessary taxes for the last four years because the financial advisor and the CPA didn’t talk. And that happens, we see it day in and day out.

[00:15:50] JoAnn Huber: Well, and sometimes you’ll have clients come in and say, I don’t care how much more I pay in tax, we’re filing separate, and you’re like, okay, but it’s crazy how just little changes like that can make such a big difference because they really didn’t make that much of a change. They changed how they were giving their charity and their filing status, yet it saved them $7,000.

[00:16:11] Dean Barber: And that’s just this year.

[00:16:12] JoAnn Huber: One year, right.

[00:16:12] Dean Barber: That’s just this year.

[00:16:13] JoAnn Huber: And so, those are the kind of things that tax planning helps you with and having that overall financial plan.

[00:16:17] Dean Barber: So, then what we were able to do, JoAnn, was beyond that. Now, we got the adjusted gross income down to a level where we’re able to go up to $90,000 of conversions from her traditional IRA to a Roth IRA, and the effective tax rate on that is going to be like maybe 13% or 14%. And with the SECURE Act that came in where her children are going to be forced to put all that money out of the IRA within a 10-year period, and they’re already in way higher brackets than she’s ever going to be in, now, we’re going to save not just a ton of money for them today, but we’re going to save a ton of money for the beneficiaries in the future.

[00:16:55] JoAnn Huber: And you’re probably saving them quite a bit in Medicare premiums as well.

[00:16:59] Dean Barber: Yes.

[00:17:00] JoAnn Huber: So, when you put all of those things together…

[00:17:03] Dean Barber: It’s a big deal.

[00:17:04] JoAnn Huber: They’ve got to be asking themselves, why did we wait so long?

[00:17:06] Dean Barber: Exactly, and you know what this is? We’re not talking about somebody that’s uberwealthy here. We’re talking about a husband that had a nice pension, and a wife that had maybe a million dollars in tax-deferred accounts. So, this is not the ultra-wealthy, but the actual impact over a 10-year period is probably going to be somewhere in the neighborhood of a couple of hundred thousand dollars of taxes. That’s significant to somebody at that wealth level.

[00:17:31] JoAnn Huber: Right. Well, at any wealth level, let’s face it, most people get their wealth by being frugal as they’re going through life.

[00:17:38] Dean Barber: Yet we simply do tax compliance. That’s what general people do. They do tax compliance. Like here’s all my stuff. How much do I owe? Am I going to get a refund? And they think the taxes are just a matter of fact. They’re not looking at the big picture because if you don’t have a financial plan at first, like you said earlier on, you’re never going to be able to do it.

[00:17:57] JoAnn Huber: And that’s the beauty of tax planning and financial planning is finding those little– I mean, that’s what gives me a lot of satisfaction, is when we can find those little wins that when you take it and multiply it over the number of years, it actually adds up to a pretty big amount.

[00:18:10] Dean Barber: Right. And the whole thing was that they were– and then this couple, then they were super frustrated. They’re like, why didn’t somebody point this out? And when I pointed it out to the CPA, she’s like, wow. Yeah, that will make a big difference. I’m like, Hello? I mean…

[00:18:26] JoAnn Huber: Don’t want to tell you how to do your job.

[00:18:27] Dean Barber: Well, and to be fair, there was no financial plan for that CPA to refer to, to say this is the overall objective, right? So, at that point in time, really all she can do is file the tax return, which makes it difficult. Now, the reason I tell that story is because it was the tax law changes that took place with the Tax Cuts and Jobs Act and then the SECURE Act that caused these people to miss an opportunity. So, with the speed at which tax law changes are coming at us, with the speed at which Congress is putting out all of these new spending bills, I think I added up the other day, this year alone, if this $3.5 trillion spending package that the Democrats are presenting right now passes, we’ll be over $6.2 trillion in additional spending this year alone in 2021.

[00:19:30] JoAnn Huber: And at some point, they’re going to have to increase taxes.

[00:19:33] Dean Barber: Yeah, and where is the money going to come from?

[00:19:37] JoAnn Huber: From everyone.

[00:19:38] Dean Barber: It has to.

[00:19:39] JoAnn Huber: I mean, you can’t just take it from the top 1%. It’s going to come from everyone.

[00:19:43] Dean Barber: There’s not enough money in that top 1%. Even if we confiscated every dollar that the top 1% had, you’re not going to put a dent in it. What happens in these tax law changes affects the millionaire next door, just like this couple that I just talked about, right? They would have paid well over $200,000 too much in tax over a 10-year period just because they lacked the financial plan and lacked the coordinated team effort of a CFP working with a CPA to identify these opportunities. And the average everyday American out there, they have these same opportunities that are in front of them, but unless they’re working with the right people, they’ll never find them.

[00:20:21] JoAnn Huber: Right. And so, that’s why you’ve got to have a team. Let the experts work with you. Go enjoy your retirement. While you’re working, you have kids at home and leave someone else to do what they do and are experts at and you go do what you’re good at.

[00:20:36] Dean Barber: Let’s talk just for a few minutes here, JoAnn. And I want to remind our listeners that we’re recording this mid-August 2021. By the time you’re listening to it, I don’t know when it’ll be because podcasts are out there forever, but there are some pretty crazy things in this $3.5 trillion spending package. And it’s not just a spending package, it’s actually a tax package as well. It’s all rolled into one giant bill. So, some of the things in there that I think people need to be aware of, and of course, you can’t make a plan based on these things that are in the plan now because if something gets passed, it’ll be totally different.

[00:21:11] JoAnn Huber: Right. And I think it’s important to point out that there’s not just one bill out there. As you have said, there are so many bills that are being introduced, and then there’s all these amendments that keep getting thrown out there. So, we really don’t know what is going to be in the final law that goes into place, but there’s a lot of things that are being talked about. And I think, let’s just dig into some of those.

[00:21:31] Dean Barber: And one of the things that we do know is that Congress has a limited amount of time in order to get whatever they want pushed through because there’s a a hance that during the midterm elections that we have a switch in the balance of power in either the House or the Senate or both. And if that happens, then you’ve got a stalemate. And so, anything is going to be done has to be done now while the Democrats have control of the House and the Senate and they have the White House.

[00:22:03] JoAnn Huber: And that’s why I think they’re going to really push and use reconciliation if they need to, to get things through by the end of the year.

[00:22:10] Dean Barber: So, what are some of the things that you want to highlight here?

[00:22:12] JoAnn Huber: The thing that I keep getting phone calls about is capital gains are now going to be taxed as ordinary income. And for most of the people we deal with, it’s probably not going to impact them because they’re saying you have to have income of over a million dollars before that ordinary income tax rate comes into play. So, the question I have is, well, how are they defining that million dollars? Is it a million dollars of capital gains? Will it include qualified dividends? Is it taxable income?

So, there’s a lot of uncertainty, but I think the important thing to realize is, is nobody knows right now, and you have to make good decisions based on what we do know. And if it’s not going to impact you, quiet the noise, don’t worry about it, and just go about doing what you know you need to do with your plan that’s in place.

[00:23:00] Dean Barber: Now, what about the reduction in the unified credit? That’s out there, too, right?

[00:23:04] JoAnn Huber: For the estate plan.

[00:23:05] Dean Barber: Yeah.

[00:23:06] JoAnn Huber: Yeah. And on the heels of the capital gains is getting rid of the step-up in basis.

[00:23:13] Dean Barber: Right. So, clearly, getting rid of the step-up in basis will create a massive windfall to Congress or to the coffers of the federal government without raising taxes.

[00:23:27] JoAnn Huber: Right. And so, you reduce the exemption amount, the unified credit amount, and who knows where that will land.

[00:23:33] Dean Barber: Well, I think the married couple, they’re all the way down to like $7 million, and right now, we’re over $23 million.

[00:23:38] JoAnn Huber: Right. And then, I’ve also heard things where we might go to a million, and then for a couple, it’s $2 million. And so, we don’t know where that’s going to land. I think it’s going to be higher than that.

[00:23:46] Dean Barber: To me, that’s not the biggest deal.

[00:23:47] JoAnn Huber: It’s not. What do you think is the biggest deal?

[00:23:48] Dean Barber: The step-up in basis is the biggest deal.

[00:23:49] JoAnn Huber: That’s what I think, too.

[00:23:50] Dean Barber: Can you explain what that means just for people that aren’t familiar?

[00:23:53] JoAnn Huber: So, if you have an account like a stock and bond account, when you die, the basis then becomes whatever the fair market value is on the date of death.

[00:24:03] Dean Barber: So, let’s assume as an example. Let’s say I bought Apple stock and I paid $10,000 for it. Now, it’s worth a million. I die.

[00:24:10] JoAnn Huber: And so, right now, if you were to die, you would get the step-up in basis to a million dollars. And then, if your kids want to sell it, they wouldn’t have to pay any tax on it because they sell it for the million. It’s worth a million.

[00:24:22] Dean Barber: So, the beneficiary is the one that gets the step-up in basis.

[00:24:25] JoAnn Huber: Right.

[00:24:26] Dean Barber: Right?

[00:24:26] JoAnn Huber: But if they get rid of that step-up in basis, now, your kids are going to have to pay tax on the difference between the million dollars and that $10,000 basis.

[00:24:35] Dean Barber: Whether they sell it or not.

[00:24:37] JoAnn Huber: Yes.

[00:24:37] Dean Barber: Right. So, now, it’s a capital gain that wasn’t even realized, but because they eliminate the step-up in basis, you’re going to have to pay taxes on that capital gain at death at whatever your tax rate is, and if you get somebody like that, that’s got a big appreciated stock, they’ve got a big appreciated– and they’ve talked about, not including farmers in that, but businesses, small businesses, those types of things, that could be something that destroys small businesses. It could destroy the transfer of wealth from one generation to the next. Oh, and by the way, I think I saw in that piece where they’re talking about the unified credit of raising the estate tax all the way up to 60%, 6-0, 60%.

[00:25:27] JoAnn Huber: Yeah, but we don’t know what’s going to happen.

[00:25:30] Dean Barber: You know why they’re doing it?

[00:25:32] JoAnn Huber: They need more money.

[00:25:33] Dean Barber: They need more money, right. And look, if anybody watching or listening right now gets as infuriated with Congress as I do and as you do, JoAnn, there’s only one way to fight it, and that’s to create the financial plan and understand the rules, get the CPA and the CFP to sit down together, and craft that plan so that you don’t pay one more dollar than you absolutely have to.

[00:25:58] JoAnn Huber: If you’re not happy with Congress, who are you electing? And you get your say every so often and make sure you’re exercising that right to vote.

[00:26:07] Dean Barber: Yeah, I think if anything comes back on this, JoAnn, it’s really people need to take personal responsibility. They need to start thinking of themselves as the CEO of their own finances and figure out what professionals they need to hire and start crafting that plan sooner rather than later because the sooner you have it in place, then these tax law changes when they do come, and there will be more, you can plug it into the plan and say, here’s how it’s going to impact you. Here are the things that we need to do, the steps we need to take in order to reduce that tax as much as we possibly can, staying within the confines of the law.

[00:26:41] JoAnn Huber: I agree. I mean, it sounds really simple when you put it like that.

[00:26:46] Dean Barber: It is. It takes a lot of work up front, a lot of work up front, but that work up front pays dividends for years.

[00:26:54] JoAnn Huber: Right, because it’s a lot easier to just update things and keep it going because we know your life is not set in stone. And so, it’s a very fluid plan that if your wants and wishes change, we’re going to be able to update the plan. The tax law changes. We’re able to update it. So, it’s really easy to look at changes and say, okay, how does this impact me? And am I still okay?

[00:27:14] Dean Barber: It’s what everybody wants to know, right?

[00:27:17] JoAnn Huber: It is.

[00:27:18] Dean Barber: Alright. So, if you’re listening or if you’re watching, check out a link in the show notes. You can click that link, request a complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ professionals, one of our CPAs. We can have that conversation by phone. We can do a virtual meeting. We’re happy to meet with you in person.

If you haven’t caught all of the episodes that I’ve had JoAnn in on, go to Episode 1, Episode 2, Episode 18, and Episode 35. And then, also check out the two episodes with Ed Slott. They’re all about taxes. And look, here’s the thing. As long as you live in the United States and you have money or make money, taxes are going to be a fact of your life. The goal here is to make sure that we pay the least amount of tax possible over your lifetime, not just in a single year. Alright.

[00:28:03] JoAnn Huber: And that’s the key, yes. It’s not just one year. We’re looking long-term.

[00:28:08] Dean Barber: Well, JoAnn, I know you’re busy all the time, and I appreciate you taking the time to join me here on The Guided Retirement Show. Again, it’s a long walk down the hall going to the studio here, but…

[00:28:16] JoAnn Huber: But it’s great to be here to chat with you.

[00:28:17] Dean Barber: Alright. Thanks for being here.

[CLOSING]

[00:28:19] Dean Barber: Thank you again for joining me here on The Guided Retirement Show. I’m Dean Barber. Catch all the episodes. Make sure that you subscribe to The Guided Retirement Show and share it with your friends. If you’re watching us on YouTube, make sure to give us a thumbs-up. Again, share with your friends. For a link in the show notes, you can request a complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ professionals or one of our CPAs. We can do a phone call, we can do a virtual meeting, or we’re happy to meet with you in person.

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