Originally Aired: December 2, 2015
Topic: What’s New in Third Edition of Retire Secure! with Jim Lange
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of CPA, Attorney and Retirement Expert Jim Lange
- Jim Lange’s First Rule: Don’t Pay Taxes Now, Pay Taxes Later
- Roth IRA Conversion Is the Exception to ‘Pay Taxes Later’ Rule
- Wording Has to Be Correct When Setting Up Stretch IRA
- Roth IRA Is Beneficial Strategy While Wealth Is Accumulating
- Age 66 to 70 Is the ‘Golden Era’ to Make a Roth IRA conversion
- Death of the Stretch IRA Would Be Huge Blow to Middle-Class Heirs
- Flexible Estate Planning Helps Deal With Life’s Uncertainties
- Charitable Remainder Unitrust Is Good Strategy If Stretch IRA Is Eliminated
- Delay Social Security Distributions for as Long as Possible
- ‘Apply and Suspend’ on Social Security Benefits Lower-Earning Spouses
- Best Investments Are in a Well-Diversified Portfolio of Index Funds
Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
1. Introduction of CPA, Attorney and Retirement Expert Jim Lange
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange, and this week, we’re talking about some of the highlights of the brand new edition of Jim‘s book, Retire Secure! Regular listeners, of course, have heard us talk about it over the years. It’s been endorsed by dozens of industry giants including Charles Schwab, Larry King, Ed Slott, Roger Ibbotson and Jane Bryant Quinn. But it’s been six years since the publication of the second edition, and a lot has changed. So tonight, we’ll tell you about some of the new information in this updated edition, including how tax law changes and the political landscape have led Jim to tweak some of the advice that he gives to retirees and, of course, a lot of the advice has not changed in the new edition, and that’s because it works. We’ll remind you about Jim’s tried-and-true advice on investing, Roth IRAs and Roth IRA conversions, when to take Social Security, and we’ll discuss how to best utilize the flexible estate-planning techniques that Jim and his team have used to draft more than 2,000 wills, trusts and beneficiary plans. So let’s get right to it. Good evening, Jim.
Jim Lange: Good evening.
Dan Weinberg: Let’s talk a little bit about how the third edition came together. It’s been six years. You decided it was time for an update?
Jim Lange: It is. This is my signature book, so I wrote the first edition in 2006, and I literally put my heart and soul into the book and put the best information I knew how, and then I had another update in 2009, and it was overdue. It’s a true labor of love. It’s a lot of lonely hours. I do have some great help though in my office who run some numbers and help me with some of the graphs and charts and even some of the wording. I have a fabulous editor, and we have completed it, it is now at the printers, and we’re going to have a new edition soon. I’m excited!
Dan Weinberg: And let’s get right to the heart of it, sort of distill what readers are going to find in this new edition. If there was one piece of information that you could give listeners that would be simple but highly effective for them, a strategy or a piece of advice, what would that be?
2. Jim Lange’s First Rule: Don’t Pay Taxes Now, Pay Taxes Later
Jim Lange: All right. So, here it is, this one piece of advice. If listeners would actually adhere to this, probably 90 percent of them, maybe more, would be significantly better off, and it’s relatively simple: Don’t pay taxes now, pay taxes later.
Dan Weinberg: OK.
Jim Lange: Again, that’s don’t pay taxes now, pay taxes later. That applies when you are working and you are accumulating money for your retirement, that also applies after you are retired and you’re deciding which stack of dollars to spend first, and then also it applies for your estate planning, which is we want your heirs to pay taxes later, just as we want you to pay taxes later.
Dan Weinberg: Now, how does the pay taxes later square with your fondness for Roth IRAs?
Jim Lange: Except for the Roth!
Dan Weinberg: There we go.
3. Roth IRA Conversion Is the Exception to ‘Pay Taxes Later’ Rule
Jim Lange: So, if you want the complete statement, it’s pay taxes later, except for the Roth. I tried to be simple without the, let’s say, asterisk, but if you want to be complete, it would be pay taxes later, except for the Roth, and in probably more cases than not, adding a Roth component, either a Roth IRA contribution, or, for older and retired listeners, a Roth IRA conversion will likely be a tremendous benefit.
Dan Weinberg: So, let’s break this down then with each stage. How would it work, first of all, in the accumulation stage, when you’re investing and accumulating money for retirement?
Jim Lange: All right. So, let’s say that you are working, or you are self-employed, and let’s assume that there is some money that you have available for your retirement, and let’s just take the two basic ways of doing things. Number one, you could earn the money, pay the tax, invest whatever’s left after you pay the tax, then you have to pay taxes every year on the interest, the dividends, the capital gains, and you’re accumulating money for, let’s say, when you retire. The second way is, if you put the money into a retirement plan like a 401(k) or a 403(b) or even an IRA and you get a deduction for that contribution, or, looked at another way, you don’t have to pay tax on that money, that money will grow income-tax deferred. That is, if you don’t take the money out, you don’t have to pay taxes on it until you do take the money out, and then what will happen is that money will continue to grow.
But if you think about it simplistically, if you put a dollar in and you don’t have to pay tax, then you have a full dollar earning interest for you, and then you earn interest and dividends, et cetera on that, and that continues to grow. If, on the other hand, you have to pay taxes now, now you only have 60 cents, and then when the 60 cents earns some money, you have to pay taxes on that. So, the way it works out over a lifetime is literally the difference between having, you know, zero at the end or having well over a million dollars, just using that simple axiom “Don’t pay taxes now, pay taxes later.” Now, we can get to the Roth, which is the exception, but it’s really important. And by the way, always, always, always take advantage of an employer match. That is, if your employer is willing to match a certain amount, you know, maybe —by the way, the University of Pittsburgh, if you put in 8 percent, they put in 12 percent.
Dan Weinberg: Wow!
Jim Lange: Can you imagine how stupid some of these professors are who are not doing this? Now, most of them are pretty smart, to be fair, but at least smart enough to put in the 8 percent. But even on top of the 8 percent, I still like people to put money in their retirement plan, and it’s very important that they do that.
Dan Weinberg: So then, you’re approaching 65. You’re approaching the distribution stage, as you would call it. What happens then?
Jim Lange: All right, don’t pay taxes now, pay taxes later, except for the Roth. Now, you are, let’s say, retired, and let’s keep it simple. Let’s assume that you have two buckets of money, and you need money from your portfolio, and there’s two different general buckets that you have. One is the bucket that you have already paid tax on. That might be savings, it might be money you inherited, whatever the source of that money is. But basically, other than perhaps some capital gains that you’ll have to pay when you sell whatever the asset is, a stock, bond, whatever it is, and then you might have some capital gains. But let’s, for the moment — well, even if you include that, you have that stack of money. Then the other stack of money is the retirement plan money: the 401(k), the 403(b), the SEP, the KIO, the IRA. So, let’s assume that you have two people and they each have the identical pot of money. They each have IRA money and they each have after-tax dollars. The difference between which one they spend first, and if you’re going to take my advice of don’t pay taxes now, pay taxes later, you’re going to spend the money that you’ve already paid tax on, and you’re going to let the IRA continue to grow tax-deferred. Even starting at 65, the difference can be easily a couple hundred thousand dollars between just the simple matter of which dollars you spend first. Don’t pay taxes now, pay taxes later, except the Roth.
Dan Weinberg: And then we’re going to apply that to, of course, the way that you leave money to your heirs once you get to the estate-planning stage. Talk a little bit about that.
Jim Lange: All right. So, let’s say that you are following that advice, and what you will end up with, because you’re going to be spending your after-tax dollars first, you’re going to be ending up with IRA and traditional retirement plan dollars. And by the way, that’s probably where I do most of my work. Most of my clients and the people that I work with, and frankly, the people that I can give the greatest value to, tend to be IRA heavy. In other words, they have more money in their IRAs and their retirement plans than they have outside. So, I know, let’s say, other lawyers and even estate attorneys might be terrific if somebody has a family business that might be worth millions of dollars, or even they have millions of dollars outside of their IRA, and do we do that work? Sure. Are we really specialized and can we really hone in on that type of client? Not nearly as much as the client who has mainly IRAs. They have 80 percent, 90 percent of their money in IRAs. I sometimes joke that my prototypical client has between 500,000 and 3 million dollars in an IRA, a house, and a Honda and a Toyota, and it’s actually true. A lot of people have that.
So, let’s assume though that you have these two stacks of money, after-tax dollars and IRA dollars, and you die and you leave that money to your heirs. I still want your heirs to pay taxes later. Now you get into something called an inherited IRA. So, let’s say that you are planning to leave money to your children, and you die and — let’s pick a round number — you leave one child a million dollars. Probably, if you have more than one child, you’ll leave it equally. But let’s keep the math simple. You’re going to leave a million dollars to one child in your IRA. So, now, you and your wife are gone. Your child now has this, it’s called an inherited IRA, and remember, nobody’s paid income tax on this money. So whenever your child takes that money out, he’s going to have to pay income tax. What’s the stupidest thing he could do? Take the whole thing out immediately and have to pay income tax on a million dollars. Right now, under the current law, what you can do, or what your child can do, is he can treat that inherited IRA as a special asset and only take a minimum required distribution of the inherited IRA. So, let’s just say, for discussion’s sake, he’s somewhere in his 50s or 60s at your death. What he will do is, he will go to Publication 590, or it’s all over the internet, including my books and website, get a factor, and that factor is based on his life expectancy. It might be, let’s just say, 20 years or 30 years. He would take 30, or let’s use 33 years because the math will be easy. He could take 33, divide it into the balance of the inherited IRA, which is that same as 3 percent. So he has to take out $33,000 and pay income taxes on it. But if the investment earns 6 percent or 8 percent, the investment continues to grow, despite the fact that he’s taking distributions from that inherited IRA. This is going to end up being much more favorable than if he doesn’t; this is called the stretch IRA. If he pays taxes early, we want to pay taxes later, even after you’re gone, and you would set that up appropriately in your will, and, more importantly, the beneficiary designation of your retirement plan, and — and this is one of the tough parts — is to make sure that somebody knows what’s going on so that after you’re gone, this asset is handled correctly.
4. Wording Has to Be Correct When Setting Up Stretch IRA
Jim Lange: If it is not, even just something stupid, like the child transfers it into his name but doesn’t use the right wording. So, let’s say, for discussion’s sake, that one of your parents died and they left you an IRA, and you said, “OK, I’m going to take this million-dollar IRA and I’m going to put it in the name of Dan Weinberg,” or “I’m going to put it in the name of Dan Weinberg IRA.” Oops! You made a mistake. You have to pay tax on the entire million dollars. If, on the other hand, you title the account “Inherited IRA of parent of Dan Weinberg for the benefit of Dan Weinberg,” then you can get this stretch IRA, and it is critical that people do that, and I’ve heard different statistics, but it’s very clear the majority of people botch it. Somebody botches it. The CPA botches it. The financial advisor botches it. The attorney botches it. The client botches it. Somebody usually botches that stretch IRA and it costs a family sometimes 10, sometimes hundreds of thousands of dollars, sometimes even more.
Dan Weinberg: So it really has to be set up before the person dies, or there’s no going back. There’s no getting the stretch IRA after that?
Jim Lange: That’s correct. It has to be set up correctly, and I’d even say more importantly, whoever inherits it, or the representative or attorney or financial advisor, somebody has to know what they are doing afterwards. So, you can set it up perfectly before you die, but if the follow-up isn’t done right, boom! You’re out of luck, and the child may have to pay tax on the whole thing, and by the way, the numbers on that — let’s just say you’re leaving a child a million dollars. If we do the stretch IRA the way I want, that child will literally be $1 million better off during their lifetime than if they have to pay income taxes on the whole thing upfront. So, again, a million-dollar difference for the child just based on don’t pay taxes now, pay taxes later, even after you’re gone.
Dan Weinberg: OK, and you talked about the exception, the Roth IRA and the Roth IRA conversion being the exception to pay taxes later. Can we go through and talk about that in each stage, starting with the accumulation stage?
5. Roth IRA Is Beneficial Strategy While Wealth Is Accumulating
Jim Lange: Sure. In the accumulation stage — and let’s forget about the employer match now, because the employer match is always going to be traditional. The employer is not going to put money in your Roth 401(k) or Roth 403(b), but you have the opportunity, depending on your income and marital status, of contributing to a Roth IRA, or, if your employer has that type of plan, a Roth 401(k) or a Roth 403(b). So what’s the difference? You don’t get a tax deduction upfront, but you do get tax-free growth for the rest of your life, the rest of your spouse’s life, and even the lives of your children and grandchildren under the current law, and when you work the numbers out, in most cases, the Roth is going to be more advantageous in the long run, even though you gave up the tax deduction upfront, and the way I always like to think of it is let’s say you were a farmer, and you had a choice of deducting the seed, the cost of the seed, but you have to pay tax on the harvest. That’s a traditional IRA or 401(k).
Or you could give up your deduction for the seed, but when you have the harvest come in, you don’t have to pay for the harvest. That would be like a Roth. So, the Roth IRA, in general (subject to exception), is going to be better than the traditional IRA, the traditional 401(k), the traditional 403(b). The exception might be if you are towards the end of your career and you’re in a very high tax bracket, then you might be better off with a traditional IRA 401(k), and then do a Roth conversion, which we’ll get to when we talk about the distribution stage. But, in general, don’t pay taxes now, pay taxes later, except for the Roth, and the Roth is going to be more appropriate for most people in the accumulation stage.
Dan Weinberg: And let’s go ahead and talk about that distribution stage and the conversion.
6. Age 66 to 70 Is the ‘Golden Era’ to Make a Roth IRA conversion
Jim Lange: OK. So now, let’s say, you have had a good career, you are making a fair amount of money, and now, you’re, let’s say, in your 60s — let’s just use 66 because we’ll tie into Social Security later. So now you and your spouse are 66 years old. For the last number of years, you’ve been at the top of your game. You’ve been in a high income tax bracket, and let’s assume that you have IRA money, and let’s assume that you also have after-tax dollars, and now you need to go into your portfolio for your dollars, but if you think about this, if you follow my advice on Social Security, we’re going to have the higher earner then do something called “apply and suspend,” which is they’re going to apply for Social Security, but suspend collection. We’re going to have the spouse collect a spousal benefit, which will be one-half of the benefit. We’re going to hold off taking distributions from the IRA. We don’t have income from the job. So that’s going to be your lowest income bracket for the rest of your life because when you’re 70, you’re both going to be taking Social Security and you’re going to have a minimum required distribution of your IRA whether you like it or not, which is going to start at roughly 4 percent, and then keep going on from there. So between 66 and 70, that’s kind of like the golden era to make a Roth IRA conversion. And what that is is, you take, hardly ever all, but a portion of your IRA and, you know, this sounds like a plug, and I guess it is, but our office actually runs the numbers and calculates the exact amount that you should be converting, and then we would be looking to do a conversion of at least a portion of your IRA, where you pay the income taxes upfront, and, in return, you get a Roth IRA, and depending on the amount, but we have some peer-review numbers that show that using some fairly reasonable assumptions that even if you do this in your 60s, you might be better off by maybe $50,000 during your lifetime, even with a $100,000 conversion, and your kids are literally better off by maybe five or six hundred thousand, and grandkids better off by literally millions of dollars, and even if you adjust for inflation, you might be better off by 20 or $30,000, your kids maybe still hundreds of thousands of dollars, and grandkids, maybe eight, nine hundred thousand. That’s just on a hundred thousand.
So, again, we like to maybe do multiple conversions, and by the way, sometimes conversions are good for people who are younger than 66, preferably in a low-income year, or even people after 70. Roth IRA conversions are probably the greatest overlooked strategy that is costing taxpayers and listeners literally millions of dollars because they just don’t know about these opportunities, and they are out there, and I really believe that you should arrange your affairs to best suit you and your family’s needs. There’s nothing illegal about that. Judge Learned Hand made it very clear. There is no law against arranging your affairs so that you will get the greatest benefit from that, and Roth IRA conversions, if I had to think of one strategy that probably most of the listeners of this show and probably most taxpayers in the United States miss, would be people who retire, and at various stages of their career, miss the Roth IRA conversion.
Dan Weinberg: And are there any other specifics in terms of planning for the Roth IRA after you and your spouse have passed away?
Jim Lange: Well, see, let’s go back to if you die with the Roth, because if we talk about which assets to spend first, subject to exception, usually spend your after-tax dollars first, then spend your IRA. So, what are you most likely to die with? Which is the Roth. Now, before, I said that you could take a minimum required distribution of the inherited IRA. Now what you can do is if you die with a Roth and you leave it to, let’s say, your kids, or better yet, even your grandkids, under today’s law, they can take a minimum required distribution of the inherited Roth IRA. So, let’s go back to that million-dollar example.
Well, of course, most people don’t leave a million dollar Roth. Why don’t we do the hundred thousand dollars? So, let’s say that you leave one of your children a hundred thousand dollars in a Roth. Let’s say that, according to the life expectancy tables, they have a 33-year life expectancy. They would have to take out $33,000, which is the minimum required distribution of the inherited Roth IRA, just like they would with the minimum required distribution of the traditional IRA. But the difference is, that $33,000 would be income-tax free. Then, next year, they would take 32 and divide that into the balance, and that distribution would be income-tax free. If we’re going to be really smart and clever, and maybe we leave it to a grandchild that doesn’t have a 39-year life expectancy but maybe a 60- or 70-year life expectancy, we can get maybe 60, 70 years of income-tax free growth after you are gone.
So, that’s what I have done personally is my wife and I made a $250,000 Roth conversion. We did it when, actually, the same year we had a fire, so my income was terrible that year. We converted $250,000. That money presumably would have gone to us in our older age. It is very likely we will not need that money, partly because of the education I’ve done on Roth IRAs and Roth IRA conversions, in which case, that money would go to our daughter, who was about 3 or 4 years old at the time. Since we have second-to-die life insurance and other monies available for our daughter — I hope she isn’t listening because I don’t want her to slack off, but I don’t think she is — that money could go to her, and if the laws still apply, then her children could get the inherited IRA, or, better yet, the inherited Roth IRA. So, we might get a hundred years of tax-free growth, and our family will be literally millions of dollars better off, even taking into consideration the taxes that we had to pay on that $250,000 Roth. So, this is a real opportunity that people often do not take advantage of and should be.
Dan Weinberg: Quickly, before we take our first break, which we have to do in just a minute, you mentioned a couple of times in there “under today’s law.” Is there anything coming down the pipeline — obviously we can’t see into the future — but are there any pending laws that would threaten or affect anything that we’ve already covered here?
7. Death of the Stretch IRA Would Be Huge Blow to Middle-Class Heirs
Jim Lange: Well, this is one of the most miserable subjects that we could talk about, and I hate it, but I’m not trying to sugarcoat this. There is a movement, and I fear it’s going to succeed. President Obama is behind it. Believe it or not, the Republican House and the Republicans in the Senate are behind it, and what they want to do is they want to force your heirs to pay income taxes on the IRA within five years of your death, and that would be pure misery. Now, there are ways that we are using to, let’s say, reduce the damage if that happens, and a lot of people say, “Oh, don’t worry. That won’t happen. We’ve had this stretch IRA for years.” Well, in 2013, we had Obama ready to sign it, all right? We had the Republican House that voted yes, and it was actually the Democratic Senate that — I think the vote was something like 51 to 47 — said no. Now, we have Obama, who wants it, a Republican House, a Republican Senate, and I really fear that if this comes up, and it very well could, that we are going to see what I call the “death of the stretch IRA,” which will change the planning for estate planning. Now, that doesn’t change anything that we are doing at the moment, except there are certain proactive things — maybe we’ll take them up after the break — but that is why I kept saying “under today’s law” because I really fear it. I hate it. But I also think it is stupid to ignore it. So, I do like to address it, and then there are a number of strategies that you could do today in anticipation of the change in the law.
Dan Weinberg: President Obama and the Republican majority and the Senate and the House both supporting a major change here. That’s an unusual pairing to have President Obama and the Republicans in Congress agree on something, especially when it comes to taxes. Can you talk a little bit about why that’s the case?
Jim Lange: Well, sure, and then I’ll maybe irritate everybody because I think they’re both wrong, but for President Obama, it is, let’s say, an elimination of a tax loophole, and he’s saying, “Hey, the IRA and the retirement plan was not meant as an estate planning advantage to families for multiple generations, and the parents, or the IRA owner, had maybe 50, 60, 70 years of tax-deferred growth. It’s time for the IRS or the government to get some of those taxes.” The Republican Senate and the Republican House, on the other hand, are probably advocates of tax simplification. The ability to collect that money would eliminate some of the complexities.
To me, it’s not that complex, but I would eliminate some of the complexities. It would also be a source of revenue that would allow them to lower the tax rates in general, and have some offsetting revenue. Now, personally, I think they’re all wrong because I think that this stretch IRA — where you can have your children continue tax deferral, or, in the event of an inherited Roth IRA, have tax-free growth — is a great thing for middle-class families, and is a great thing that should be perpetuated and encouraging savings, and encouraging investments. So I don’t like the idea, say, of eliminating the estate tax that would help people that have more than $10 million, but then taxing people very, to me, unjustly. And the other thing that I don’t like about it is that you’re changing the rules in the middle of the game. You know, for years, people have set up their retirement and estate plans using certain rules, including the stretch IRA, and now, 10, 20, 30, 40 years into this planning, Obama and the Republican House and Senate want to say, “No, no! We want to change the rules midstream, and we’re not going to grandfather you. We’re not going to protect you by allowing you to use the old law. You have the use the new law.” Now, there is one way that you can get grandfathered, but the price is pretty high.
Dan Weinberg: Is that common for there to not be a grandfather exemption, or, you know, for them not to say, “Starting now with new Roth IRAs or with new plans?”
Jim Lange: Well, in this case, you can get grandfathered, but, like I mentioned, the price is pretty high. You have to die.
Dan Weinberg: Ah, OK!
Jim Lange: So, let’s say, for discussion’s sake, that you die before they change the law. Then you do get the favorable tax treatment, and that favorable tax treatment will continue even if they do change the law. On the other hand, obviously, that’s not a great way to plan, and for, I fear, the majority of the listeners, the law will be changed before they die. So, I think, knowing what that law is coming, and knowing some of the techniques to get around it, or to, at least, reduce or mitigate the damage, is important.
Dan Weinberg: OK. Shifting gears a little bit, if you had one piece of advice, or one single way that married couples could plan their estates and plan for the uncertainties of today’s world, what would that be?
8. Flexible Estate Planning Helps Deal With Life’s Uncertainties
Jim Lange: All right. Well, you mentioned the word “uncertainties,” and think that that is very apt. So let’s think about the uncertainties that you have for estate planning. So let’s say that you and/or your husband or wife are in with the lawyer and you’re trying to figure out the best way to plan for your estate. Well, there’s a whole bunch of things that you don’t know.
The first thing you don’t know is when are you going to die? Who’s going to die first? How much money is there going to be for the survivor? What are the survivor’s needs going to be? What’s going on with the kids? What’s going on with the grandkids? What’s going on with the tax laws? There’s just so many unknowns, so how can you make a firm decision on where you want the money to go and who you want to leave the money to, when you’re guessing at future circumstances. Now, the traditional answer to that is, well, just take your best shot, figure what your, you know, “Well, he’s a little bit older. He’ll probably die first.” “Well, the market’s overvalued. It’s probably going to go down.” People make whatever assumptions they do. “Well, this kid’s doing pretty well. This kid’s not doing pretty well.” They do whatever they’re going to do. They take their best shot. Then, when the circumstances change, they’re supposed to come in and redo the will. By the way, I’ve been doing this for 32 years. People don’t come in and get their will changed very often at all. To me, it is much more prudent to instead come up with a more flexible plan.
Now, I’m going to make a big assumption here. I’m going to assume, what I call, a Leave It to Beaver marriage: original husband, original wife, same kids. I’m also going to assume that you trust your spouse, and let’s assume, for discussion’s sake, the three basic choices of where you’re going to leave your money is either to your surviving spouse, to your kids, or to your grandkids, or a trust for your grandkids, depending on the situation. So, let’s say, for discussion’s sake, that money is really good. That is, there’s a lot of money available, the surviving spouse’s needs aren’t that great, you die with today’s tax law, and there’s significant advantages to having some kids or grandkids inherit part of the assets at the first death. Great. So, that would be good.
But if we force that, and we name kids and grandkids as the primary beneficiary for at least a portion of it, and then the money is bad, the market goes down, the surviving spouse needs the money, then that’s also not good. So, what I think the best answer is, is we let the surviving spouse make the decision of who gets what, and they have nine months within the date of their spouse’s death to make that decision. So, let’s say, for discussion’s sake, you set up this plan, which, by the way, has now received a lot of notoriety. We have literally tens of thousands of entries in Google, and it’s all over the place in the literature. It’s been in the Wall Street Journal, Newsweek, the Tax Advisor, a lot of places, and the other thing is, I’ve been doing it for probably over 20 years. We’ve had quite a few deaths and it has worked just as planned, is we let the survivor make that choice. Maybe they need the whole thing. Maybe they just need part of it. Maybe they should keep the Roth, but they should, and the legal word is “disclaim,” or not accept, part of the IRA, or have part of the IRA go to the grandchildren, or maybe the grandchildren need the money for education, so we have some of that money.
The problem is, we just don’t know what’s going to happen, but if you have the same kids as your spouse, like the old original Leave It to Beaver marriage, which is still me, by the way, and we build in that flexibility, then your spouse gets what we would call a free second look, and they can make a much better decision, and then presumably, they would have the help of either one of the surviving children and/or the attorney, financial advisor, CPA, to help them with that decision. We have been doing that for over 20 years, and it has worked out exceedingly well in practice, maybe not for the person that died, but for the family. The goal, always, is to overprotect the surviving spouse. Nobody wants to have their surviving spouse want for anything, but if we can be smart about it for the kids and the grandkids, then why not overprotect the surviving spouse but be very smart about taxes? That’s what the Lange’s Cascading Beneficiary Plan is, and that’s what we have been doing in practice for over 20 years.
Dan Weinberg: And other than drafting flexible estate plans regarding wills and trusts and IRA beneficiary designations, are there any other proactive things that listeners can do?
9. Charitable Remainder Unitrust Is Good Strategy If Stretch IRA Is Eliminated
Jim Lange: Well, I talked about this death of the stretch IRA, and there are some things that listeners can do. Probably beyond the scope of today’s call, but there is something called a CRUT, a charitable remainder unitrust, that becomes a very useful beneficiary of an IRA or a retirement plan if they do pass the law. The other thing that people can do is, and I hate to bring it up because people don’t like to hear about it, but actually — and I have never been as big a fan as, let’s say, some other people, like Ed Slott, but life insurance becomes much more attractive when you have a significant IRA and you are planning … your estate and you’re planning to leave money that to children and grandchildren. Without getting too technical, there was something called pension rescue, where every year, people took a certain portion of their IRA, they pay tax on it, they bought a life-insurance policy, or, in my world, a second-to-die life-insurance policy, and they showed the math where the kids would be a lot better off. And that was true, but that also assumed that the kids weren’t able to stretch the IRA. Well now, if that law passes and they can’t stretch the IRA, then the numbers that they used were accurate, and sometimes, some of the numbers that we’ve run are children can be better off, literally, by over a million dollars if their parents use an insurance strategy, and the other thing is even if they don’t change the law, it will still be a good thing. If they do change the law, it’ll be a good thing by a long shot. So, that and the charitable remainder unitrust are something that people can do to, let’s say, prepare for the potential death of the stretch IRA.
Dan Weinberg: We mentioned we were going to talk about Social Security. If you Google “When should I take Social Security,” I’m sure you would get a whole lot of answers. I’m going to have you cut through some of those. I know you have strong feelings about when people should take it.
10. Delay Social Security Distributions for as Long as Possible
Jim Lange: I have some very strong feelings, and a lot of listeners aren’t going to like it, and I would say you have to think of what the end goal is. The end goal, to me, and probably the most important thing that people are looking to, either if they’re going to take on their own investments and strategies or get help from a professional, is the primary goal is making sure that there are sufficient assets for both husband and wife to live their lives in the manner in which they want, and have their money last, no matter what happens to the market, for both of their lives. So let’s take that as the primary goal. We never want to have, either when they’re both alive or even just when one spouse is alive, not to have enough money to live comfortably and do what they want. So, what’ll a lot of people do? They go, “Oh boy, I want to take Social Security at age 62.” And they do that, and that is the exact opposite of what I want them to do, and the reason is, is because when you take Social Security early, at 62, or, for that matter, even at 66, you suffer a reduction, or looked at another way, you get a bonus for every year you wait.
So, even just waiting between 66 and 70, you get an 8 percent bonus for every year that you wait between 66 and 70. It’s almost that much between 62 and 66. So, there is, in effect, a breakeven point, because if you took it at 62 and invested that money, which, unfortunately, most people don’t even do that, then there is this, let’s say, theoretical breakeven point, which might be age, say, 84, if you were single, and one of the nice things about having this radio show, and we’ve had about four or five shows just on Social Security with the top Social Security experts in the country, including Jane Bryant Quinn, and probably the best expert is Larry Kotlikoff, and here’s what Larry Kotlikoff says. So, let’s say you’re thinking, “Oh gee, am I going to make it to age 84? I don’t know.” He says, “Hey, if you die early, you’re dead! You should not fear dying early for financial-planning purposes, because if you die early, your financial problems are over. What you should fear is living a long time, and if you are reducing your Social Security by 60 or 70 percent by taking the money early, and then you end up living a long time, you are really hurting yourself.”
11. ‘Apply and Suspend’ on Social Security Benefits Lower-Earning Spouses
Jim Lange: Now, there are even some great strategies if you are married. So, let’s say, for discussion’s sake, that you and your spouse are both 66 years old, and let’s use the old paradigm where the husband made more money and has a higher earnings record for the purposes of Social Security, and unfortunately, due to time, I’m just going to get to the answer without going through all the analysis, but, in general, I would like the husband to do something called “apply and suspend,” where he applies for Social Security, but then he says, “But don’t pay me.” Well, what’s the difference between doing that and doing nothing? Well, by doing that, that means the spouse can apply for a spousal benefit. She gets half of what he was entitled to at 66. That pattern would continue until they are both age 70. At age 70, I would have him collect his full amount. Now, remember, he’s getting an 8 percent raise every year. By the way, she gets an 8 percent raise on her own record, which might then end up surpassing half of his. So, when he’s 70, he’ll take his full amount. She will take the higher of hers with the increases, or half of what he was getting at 66, and literally, the difference between doing this “apply and suspend” and, let’s say, having both spouses take money at 62, and not doing the spousal benefit, can literally be the difference between going broke and having a million dollars.
And the other advantage of having the higher earner hold off is if the higher earner, who, again, has traditionally been the husband, if he dies, then the surviving spouse gets what he was receiving. So, let’s say that he capped it off at $20,000 instead of waiting and maybe getting $35,000. At his death, his wife would get $35,000 if he waited, but maybe only $20,000 if he didn’t.
And by the way, that also brings up some interesting strategies for people who are not married. So, for unmarried folks, you know, same sex or opposite sex, they should consider some of the financial advantages of getting married, if nothing else, for Social Security, for the spousal benefit, and the Social Security death benefit for the surviving spouse. Lot of different, interesting strategies. That’s just really one of them in the Social Security world.
Dan Weinberg: Now, of course, during the course of this hour, we talked about assets. Well, in order to have assets, you need to invest and make some money. So how should listeners invest their portfolios? What’s the best way?
12. Best Investments Are in a Well-Diversified Portfolio of Index Funds
Jim Lange: Well, I have changed my thinking a little bit over the years, and now I have seen the light, and now I am a proponent of low-cost index investing, where basically, instead of trying to beat the market, you try, with a very low cost, of being in the market and having a very well-diversified portfolio of literally thousands of different companies, stretched in every different asset category, that is, large-cap growth and large-cap value, mid-cap growth and mid-cap value, and small-cap growth and small-cap value, and international large, international small, international value, et cetera, et cetera, et cetera. Having a well-diversified portfolio of all those assets in low-cost index funds, whether it is Vanguard, which is probably the best-known and probably one of the best index funds on the market, or the one that we like, which is Dimensional Fund Advisors, which we think has an outstanding record, and we’re always happy to compete with Vanguard investors for that. But without being a commercial for Dimensional Fund Advisors, or for our services in general, the concept of a well-diversified portfolio of index funds is probably going to serve most listeners the best over the long period.
Dan Weinberg: OK. So, we’ve talked about the asset part of it, with index funds. We’ve talked about Roth IRAs, Roth IRA conversions, and we’ve talked about Social Security. How do these strategies work together?
Jim Lange: Well, I do believe that they are a synergy. So, let’s say, for discussion’s sake, we talked about Social Security, and we said that at Social Security, I’m not interested in people taking Social Security at 66, other than the spousal benefit, and we’re going to create, by that Social Security strategy, a very low income for the years between 66 and 70, because we’re holding off on Social Security, we’re holding off on taking our IRA, so now we have a window, in effect, of a very low tax bracket for a four-year period. That’s the perfect time to make a Roth IRA conversion. If we want to tie it into investments, we are a big believer in what we call the ‘bucket approach,’ which means you don’t have one portfolio, you have multiple portfolios. Maybe one portfolio for years one and two, which might be mainly cash and CDs and maturing bond ladders, et cetera. Then another portfolio for longer term money, and then another one for maybe 10 years out, and then the Roth, that might be the legacy money. That might be a hundred percent in investments. So, here, we’re tying in Social Security strategy, Roth strategy, distribution strategy and investment strategy, and then if we’re going to add in the estate planning strategy of the flexibility, that’s where I think that you get these great synergies and, frankly, it’s one of the reasons why our firm has been so successful, why we have a 99 percent retainage rate with our index advisor, and, in effect, one shop, people can get advice on all these areas, and they can have a synergy between those different strategies.
Dan Weinberg: Final thought. We have just about a minute left. I know you have said that each client or listener is a snowflake. So, what works for one person or couple might not work for another. But do you have any broad advice, a good scenario, that might just work for the majority of our listeners?
Jim Lange: Well, every client, or every person, is a snowflake, and different situations require different strategies. If you were going to have our classic, and we even have it in the book of Ed and Emily, I would say don’t pay taxes later, except for the Roth, which means that you’re typically putting in some money in your Roth IRAs as you’re going along. If you’re a little further along, consider the apply and suspend method for Social Security, coupled with Roth IRA conversions, coupled with a Roth IRA conversion plan, coupled with low-cost indexing, coupled with the Lange Cascading Beneficiary Plan, which would be the flexible approach to estate planning, and, to me, if you’re doing all those, again, subject to the snowflake rule or subject to exception, you’re almost always going to be much better off than if you don’t do any of them.
Dan Weinberg: All right, great stuff tonight. A reminder to KQV listeners, you can get a free copy of the third edition of Retire Secure! which is coming soon. You can preorder it at jameslange.com. Use the promo code ‘KQV’ for your free copy.