Bad financial advice is like gambling with your future. Can this person be saved?
Scott: Barbara Healy is a financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, Chartered Retirement Planning Counselor, and has been with Hanson McClain for over a decade. She meets with clients in Northern California. So Barbara, welcome to Hanson McClain.
Barbara Healy: Thank you, it's good to be back.
Scott: Well, it's always nice to have you on the program, Barbara.
Barbara: Thank you.
Scott: So tell us about the individual, or couple you're working with and what the issue was.
Barbara: There's a 65-year old retired executive. She was taking too much from her investments, so it was quickly eroding the portfolio value. She was taking something like 10% or 12% of the portfolio value.
Pat: And that's when you met her?
Pat: Okay. Single lady? Oh, you said widow.
Barbara: Widow? Yes. She retired 10 years earlier, at 55. So here's how this developed. You think, "Okay, how do we get to this point," because when you watch the portfolio value reduce, either you're taking distributions and then the market takes a hit, it just feels like a double-whammy. And it is, really. So she retired young, at 55, that was a first contributing factor. So the longer we draw on her funds, the more pressure on the portfolio. Right? But the bigger mistakes, I should say, would be from the two professionals who gave her advice, a CPA and a former advisor. The CPA said, "Buy the biggest house you can to maximize your tax deduction."
Scott: No way.
Barbara: Quote, unquote. Guys, you get this question, too. What time of year do clients typically ask if they should buy a rental?
Pat: When they file their tax return.
Scott: Yeah, spring.
Barbara: Right. I mean, no one likes it but is it necessarily the best thing to do...?
Pat: Yeah, you don't spend a dollar to save 30 cents, that's just basic math.
Scott: Wait. How old was she when she was advised to buy the biggest house? Was she married at the time?
Barbara: No, widowed. And she was a successful executive, worked overseas, and you know, she retired young but became a widow and, you know, none of us can understand what that might be like, so understandably she left at 55. But that's when the CPA said, "Buy the biggest house you can."
Pat: All right. First mistake.
Barbara: First. Then second, from a former advisor, and this is the key, they recommended she take her monthly income that she needed exclusively from the trust. She had a Roth, she had an IRA, but the advice was, "Leave those alone." The problem is, the trust was eventually drained. Right? So here's what happens, she withdraws $9,000 per month and gets very comfortable on that income. And she has a low taxable income, which is coming from the trust. Perfect. But to get the same $9,000, once the trust runs out, from the IRA, you need to take $12,000...
Pat: And for the rest of the listeners, the reason there is...because the trust was primarily taxed before, which means if you do a distribution for money that sits outside of an IRA, most of it's going to come to you tax-free. From an IRA, it's going to be taxable. That's interesting, Barbara.
Barbara: Right. Yeah.
Pat: So all of a sudden, this percentage, the distribution goes up.
Barbara: Exactly. And again, any market blip is just unnerving for her. And, you know, she had a safety net of some inheritance, but you know, there's no guarantee of that. Her mother's in her 90s and could use it for care. So had she come to us at retirement, we would have advised distribution sequencing. I mean, it sounds like a fancy term but it's the ability to hedge tax rates so as not to have all of your income taxed one way.
Pat: Yeah, you might have a little bit coming from everywhere. Right?
Barbara: Right. So each type of account has different tax implications. I've heard you guys talk about this on the show a lot. Roth monies, distributions, tax-free. Trust, Pat, as you just said, distributions aren't taxed but you have dividends and capital gains, and maybe some tax losses that can offset the gains, so you can do some tax planning. But an IRA, ordinary income, just like you were telling the caller, and that's typically a client's highest tax rate. So it's challenging. And we don't know the future of what tax rates will be, nor do we know which type of tax will apply. Might they suddenly say...well, you guys know, I mean, you've been doing this 25 years, I'm close to that. It wasn't all that long ago that capital gains were taxed as ordinary income.
Scott: That's right, oh yeah. So here's the situation, a woman comes to you, 65-years old, been widowed for a number of years, CPA recommends she buy the big house, so she buys a big house...
Pat: How big was her mortgage approximately?
Scott: Some other advisor tells her, "Why don't you just spend down your trust account, let these other dollars grow," so now she's got this kind of lopsided portfolio and she can't maintain the distribution she's got now. What did you do to help? I mean, you know, we're not magicians, right? As financial advisors, you can only do so much. So what did you recommend?
Barbara: Slowly, carefully, strongly recommended that she get out from under that $350,000 mortgage, and that is not an easy message to hear. Can you imagine? I mean, someone tells you, "You need to move." I mean, that's not an easy message but she understood the math of it. You know, bright lady. But she understood the math and her house is just about sold, and since she became a client, she did slowly start to reduce her distribution, so she dropped it 500 bucks for 6 months and we see how she did on that, then we drop it another $500, so that's helped. But, you know, the takeaway is you need the big picture advice, and you need someone who can plan, do some cash flow planning. This isn't simple stuff.
Scott: The CPA looked at her taxes, this other investment professional of some sort just looked at it from an investment standpoint, and you, as a CERTIFIED FINANCIAL PLANNER™ professional, said, "How do we put all this stuff together and what makes the most sense? How can we make sure you can maintain your standard of living?"
Pat: And quite frankly, the client had the wherewithal to understand that the situation needed to change. Some clients don't.
Scott: That's why they came and talked to Barbara, right?
Pat: Yeah, some clients just pretend that they'll be okay.
Pat: Well, that is a good story, Barbara. Thank you.
Scott: Thanks for sharing, Barbara.
Pat: Thanks, as always, for being part of the team here, at Hanson McClain.
Barbara: Well, thank you.