August 15, 2023 • 32 mins
If you’re retired, you can’t wait around for the next bonus or stock to vest when you have a large expense. When you’re on a fixed income it’s more important than ever to find the best way to pull funds for large expenses.
In today’s episode, James explains how to find the best way to pay for large expenses in retirement while answering a listener’s question.
Questions Answered:
Should you use IRAs (or other assets), cash, or finance to pay for large expenses with today’s high-interest rates?
What considerations should you take into account when planning for a big expense in retirement?
Timestamps:
0:00 Intro
3:48 Cashflow
8:46 Taxes
10:52 Timing
13:14 Example
20:58 Investment
27:04 Legacy
30:32 Outro
Create Your Custom Strategy ⬇️
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
What do you do when you need funds for a homie model
, or any large expense for thatmatter.
But you're retired, you knowhow a fixed-income source is and
you can't just wait around fora bonus to hit or for more stock
to vest, like maybe you couldin your working years.
Finding the best way to pullfunds for large expense is very
important in retirement andthat's the topic of today's
episode of ready for retirement.
This is another episode ofready for retirement.
(00:23):
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is based upon alistener question and I'm going
to call this listener Sarah.
Sarah submitted a question andshe said this hi, james, I enjoy
the thoughtfulness of yourtechnical analysis.
When your listeners posequestions.
(00:44):
You're very thoughtful and yourinsight is invaluable.
I hope you consider thisquestion.
I am retired, age 62, recentlywidowed and I'm planning an
extensive remodel of my old homeso that I can age in place by
reducing the number of steps,widen doorways, etc.
The cost of the renovation maybe $800,000.
I have about $700,000 inbrokerage accounts.
(01:06):
Capital gains are probablyabout a hundred thousand dollars
after a step up, a basis in onemillion dollars and IRAs and a
$100,000 in a Roth IRA.
My current living expenses arecovered by a pension and
survivor social security andhealth care premiums Including
Irma charges and Medicaresupplement plans, when eligible,
will be completely covered by aprevious employer I know so
(01:27):
lucky.
The house, as well as whateverremains of the accounts, will be
left to airs.
So I was considering convertingsome of the IRAs to Roth over
the next 10 years.
What would be the best way topay for the renovation?
Should I use the brokerageaccounts to pay cash or finance
a portion of it in today's highinterest rate environment?
Thanks for your considerationand thanks for the podcast from
(01:47):
Sarah.
Well, sarah, thank you verymuch for that question.
Thank you to all of you whosubmit questions.
I do read all of them and I tryto pick the ones that I think
will be applicable to the mostamount of people.
Not that this specificsituation per se will be the
exact same as everyone else, butthe principles that we can
extract from it can absolutelybe applied to many different
situations.
So I like this topic for anumber of reasons, but before we
(02:10):
jump into the episode and theoutline and the content.
Here let's highlight the reviewof the week.
This review comes from Drewnine house and drew gives the
podcast five stars.
He says I subscribed about 15financial podcasts.
This one is amazing Simple,easy to follow, engaging and
actionable.
I've learned so much and itreally motivated me to dig into
(02:31):
all my financial planning,getting accounts bonus points.
It keeps me distracted andentertained while exercising.
Well do, thank you very muchfor that review.
I'm glad that I get to keep youentertained and distracted
while exercising.
That's great.
I don't know if I could listento a financial podcast while
exercising.
I'm glad that you can.
And thank you very much fortaking the time to leave that
review.
Thank you to all of you whohave done so and if you've not
(02:53):
yet done so, or this is maybeyour first time listening, if
you're enjoying the podcastwould appreciate you sharing it
with others or leaving a review.
That will help more people findthe show when they search on
Apple podcasts, google podcast,spotify or wherever else you
listen to your podcasts.
So with that, let's jump intothe episode.
So, going back to Sarah'squestion I mentioned, I like
(03:13):
this question a lot because itblends many different issues.
It's not just a simple blackand white question, like it may
seem at the outset how should Ifinance this renovation?
Should I finance it and borrowmoney against my home to pay for
this, or should I use myexisting brokerage account, iras
, other assets, to pay for it?
So there's many differentconsiderations and, as always, I
(03:35):
cannot give a direct answer orany specific advice to Sarah or
anyone else, but what I can dois I can unpack the different
considerations and issues thatyou need to be aware of to make
the best decision for you, thefirst of which, the first
consideration, in my opinion, issimply the cash flow
Consideration.
Now granted, sarah is in a veryunique situation, and the
(03:57):
uniqueness of her situation isthat she doesn't technically,
quote-unquote, need any of herportfolio.
Her needs are covered by socialsecurity and by pension.
So are her health care needs.
So, technically, you could lookat the 1.8 million or so that
she has in her portfolio and saythat is all Access to an extent
(04:17):
.
Now, I don't want to say it'sexcess.
In the standpoint of the onlypurpose of your portfolios to
generate a monthly income stream, that's absolutely not the case
.
What Sarah is highlighting hereis a very important thing that
you should be thinking aboutwith your portfolio how do I
enhance my standard of living,how can I provide for myself my
ability to do what I need to doand, in Sarah's case that's, how
(04:38):
can I prepare a place that willallow me to age in place?
However, the first thing that Ido think of is what income
needs do you have from yourportfolio?
Does your portfolio need tosupplement social security or a
pension to allow you to livecomfortably and do what you want
to do?
For many people, for mostpeople, I'd argue yes, but in
Sarah's case, she's in theunique position where she
(05:00):
doesn't need any of herportfolio, at least for basic
living expenses, at least notfor today.
So theoretically, from a cashflow consideration or a cash
flow standpoint, sarah could sayI'm gonna dump all 1.8 million
of my portfolio Into this homerenovation and still be okay, at
least on paper.
Now, obviously, I wouldn'trecommend that, but for most of
us, what we have to askourselves is what will this
(05:22):
investment do in my cash flow,this investment being the home
renovation.
If, even in Sarah's case butlet's assume, because Sarah did
need some that 1.8 milliondollars, which is a million in
an IRA, 100,000 in a Roth IRAand $700,000 in a brokerage
account.
Technically, if she was livingoff that portfolio, then any
(05:42):
reduction in portfolio balancebecause it's being spent to
finance this project.
What that means is acorresponding reduction in how
much income your portfolio cancreate.
So maybe you're not Sarah, butyou're asking yourself these
same questions.
Well, the first thing to keepin mind is if I pay all cash, if
I use these assets to financethe project or to pay for the
project, can you afford thatreduction in income?
(06:05):
By reducing your portfolio, youcan still create the income
that you need to meet all yourneeds.
That's the first question foranyone who's looking to use part
of their portfolio to pay forthis.
The second thing that this coulddo to your cash flow is let's
assume that Sarah, or you orwhoever's considering this,
doesn't use their portfolio topay for this, but instead they
(06:25):
finance it.
They say I'm going to borrowagainst the value of my home.
I'm going to use the proceedsfrom that to finance this.
Well, what does that look like?
Your portfolio balance is stillthe same.
In Sarah's case, you'd stillhave the $1.8 million.
But now what she would need todo is understand can I now
afford that mortgage paymentbecause my expenses have gone up
Because, unless this was sometype of reverse mortgage, but in
(06:48):
a conventional mortgage or evena HELOC, there's going to be
some payment required.
So your expenses go up as youstart to pay that loan back.
So those are the things thatanyone should be thinking of as
cash flow considerations.
My first thought for Sarah andgranted, I don't know Sarah, I
don't know her history, I don'tknow where she lives, there's a
number of things I don't knowabout her but I guess my first
(07:10):
question would be does it makesense to do an $800,000
renovation or could it possiblymake more sense to sell this
home and purchase a new one?
Get everything you need interms of wider doorways,
reducing or eliminating anystairs, everything else that
needs to be done to age in placeand still come out ahead from a
(07:30):
price perspective.
Now, there's a big emotionalcomponent to this.
Sarah mentioned she's recentlywidowed.
My guess is this is a home thatshe and her husband lived in.
I'm sure there's a lot ofmemories in this property, so I
don't want to negate any of thator minimize any of that.
That's a huge consideration andone that, in my mind, is
totally fine to justify adecision fully based upon that,
(07:52):
assuming the finances still makesense.
But what I would look at andjust from the math side, the
problem solving side there was astep up in basis when husband
would have passed.
Now I don't know if Sarah livesin a community property state
or a common law state.
Depending on that, that woulddetermine how much of the home
had to step up in basis.
Sarah would also have theability to exclude some capital
(08:12):
gains if she sold a home.
So not saying that it's theright option, but at least make
sure it's considered, becausewhen we look at cash flow
considerations, even if Sarahdoesn't necessarily need her
portfolio, this is a prettysignificant expense.
And how can we accomplish thedesired goal, which is a place
to age in place, withoutsacrificing in terms of
(08:33):
overspending or doing anythingthat could be done in a more
cost effective way, without, ofcourse, minimizing the emotional
component of this as well?
So just some thoughts that Iwould be thinking through if I
was taking a look at this aswell.
The second consideration so,after cash, though, I'd also
want to understand and I thinkthis is a big one for a lot of
people tax considerations.
So I look at the situation and,right off the bat, there's so
(08:55):
many different things you coulddo to reduce taxes.
There's potential tax gainharvesting, there's potential
Roth conversions, there's thepotential of mortgage interest
deductions and so much more and,like I said, because I don't
know Sarah's specific situation,it's hard to tell which of
these would be best.
But let's just quickly gothrough each of these to see how
might they apply.
Well, number one, tax gainharvesting.
(09:17):
So I've talked about this before, but what tax gain harvesting
is is it's the concept that,depending upon what your taxable
income is, you may be able torealize some long term capital
gains and potentially paynothing in taxes on that.
So if you are single in yourtaxable income and keep in mind,
taxable income is your adjustedgross income, so the top line
(09:39):
number minus any deductions,whether it's a standard
deduction or an itemizeddeduction so taxable income of
$44,625 or less in 2023, thenany gains, any long term gains
that you realize up until thatthreshold, are taxed at 0% at
the federal level.
That's, if you're single, ifyou're married, finally jointly
(10:02):
then any taxable income under$89,250, if it's a long term
gain that's being realized isalso taxed at 0% at the federal
level.
So why do I bring that up?
Well, a pretty significantportion of Sarah's portfolio is
in a brokerage account and onthat brokerage account she
alluded to the fact there's beena step up in basis, which would
(10:23):
have happened when her husbandpassed, but there are still
gains Now those gains, dependingon what Sarah's income is,
maybe tax different tax rates Ifshe can sell just enough each
year to stay under thatthreshold that I talked about.
So for her $44,625 of taxableincome, then any gains up until
that point would be tax free atthe federal level.
(10:45):
Depending on the state thatSarah lives in, they may or may
not be taxable, but that dependsupon the specific state that
she lives in.
So another thing to considerwith this, with Sarah
specifically, is the timing ofwhen she needs the funds.
This probably isn't forrenovation, where she's going to
draw out a little bit of fundsevery year for the next handful
of years.
She might need to make someserious investment into this
(11:06):
soon.
But do you at least consider,does it make sense to sell some
of these gains or realize someof these gains that I have in my
brokerage account this year,maybe some next year, and maybe
in doing that she saves the 15%in federal taxes she otherwise
would have paid if she had soldall these funds or realized all
these gains in year one.
Again, I do not know Sarah'ssituation, I don't know what tax
(11:30):
bracket she is in, I don't knowhow much she has coming in from
pension or social security orwhat state she's in.
So this is all hypothetical,just illustrating this, but it's
certainly something I wouldconsider.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
(11:50):
legal or other financial advice.
It is for informationalpurposes only.
The next thing I'd consider isRoth conversions, at least to
illustrate what would thepotential tax savings be of
doing this.
So let's just say, for example,that Sarah uses all of her
brokerage account and maybe partof her IRAs to fund the
entirety of her home renovation.
Well, she now has pension andsocial security that are
(12:12):
covering all of her needs.
She now has the remainder ofher portfolio that is extra to
an extent, and it sounds likeher intention is to maximize
that for her heirs.
So let's just make up somenumbers.
These are arbitrary numbersthat I'm making up to try to get
some sense of what tax bracketSarah might be in.
I'm going to assume that shehas a pension of let's call it
3,000 per month, so 36,000 peryear, and that she has social
(12:35):
security of $15,000 per yearright now, so 51,000 per year
coming in.
I'm just going to assume thatthat's the income that she's
living in or living on.
I should say, but again, thoseare my numbers, not hers.
Well, if those were her numbers, then Sarah would be somewhere
in the middle of the 12% taxbracket, most likely today
depends on her deductions,depends upon a number of other
(12:57):
things, but Sarah would be inthe middle of the 12% tax
bracket today.
What we have to do anytime we'redoing a Roth conversion, it's
not enough just to know where weare today from a tax standpoint
.
We need to know where we'lllikely be in the future.
And where we'll be in thefuture is really a function of
two things Number one, yourtaxable income sources and
(13:17):
number two, where tax bracketswill actually be, which we can't
know a certainty, but we can gobased upon some basic
information.
So let's assume, or let's fastforward, I should say, to when
Sarah's age 75, that's whenshe's going to be required to
start taking some distributionsfrom her IRA.
Well, if she doesn't touch herIRA at all because, again, she
(13:38):
just paid for the whole homeexpense, she has all her needs
covered her IRA might just growand compound.
Well, if it grows by 6% peryear on average for the next 13
years so she's 62 today, we'recomparing this to age 75, then
$1 million will grow to about$2.1 million.
At that time, her first yearrequired distribution, based
(13:59):
upon that portfolio value, mightbe somewhere around $80,000.
Well, what's happened at thattime in 13 years?
A couple of things.
Current tax brackets havesunset.
So the existing brackets thatwe have today of 10%, 12%, 22%,
so on and so forth, those willsunset, which means those will
go up between about 3 or 4% perbracket after 2025, unless
(14:22):
something changes.
So we know, or we can at leastassume, anything can happen and
something will happen, mostlikely between now and 13 years
from now.
But even if we just start withthe assumption that we're not
going to be in today's taxbrackets, we'll still be under
the new brackets and really thenew brackets are just the old
brackets once current tax lawsunsets after 2025.
(14:44):
That being said, we can't justtake that $80,000 projected RMD
and tack it on to the socialsecurity and the pension that
Sarah's receiving today.
Why?
Well, because tax brackets alsohave an inflation adjustment.
So if you notice each year whatit takes to be in the 10%
bracket or 12% bracket or 22 or24, whatever the bracket might
(15:07):
be those numbers go up a littlebit each year to adjust for
inflation.
So $80,000 of an RMD in thefuture might be more or less
equivalent to about call it,$55,000 or so today.
And if that's a littleconfusing, all I essentially did
was said what's the inflationadjusted equivalent of $80,000
(15:27):
per year in 13 years backed downtill today?
So a present value of that it'sabout $55,000.
Essentially, asking, if taxbrackets go up by about
inflation, then we can't justtack on $80,000 of an RMD on top
of social security and pensiontoday.
We need to tack it on.
But what the inflation adjustedequivalent of that might be?
(15:48):
So maybe about $55,000.
So if that doesn't make sense,it's kind of besides the point.
But what it tells us is thatSarah might be at the top of
about the 25% bracket by thetime that she is 75.
And why I say that is becauseshe would still have social
security, she would still haveher pension, she would also have
(16:09):
her required minimumdistribution and if those three
income sources were all she had,she would be at the top of
about the 25% tax bracket.
25% tax bracket doesn't existtoday.
It's a 22% bracket.
But remember, we're assumingthat that has sunset after 2025.
So why does it important toknow that?
Well, it's important to knowthat because today, based upon
(16:31):
the numbers, we're assumingSarah might be in the 12%
bracket so she can move moneyfrom her IRA to her Roth IRA the
12% bracket.
She's probably going to bebetter off and simply waiting
until she's forced to distributethose funds, but doing so at a
higher tax bracket, in this case, more than double what she's
currently at at the federallevel, which would push her into
(16:51):
an higher tax bracket than shereally needs to be in.
So this is just the way youwant to look at Roth conversions
, and that doesn't mean Sarahshould take her whole million
dollars and push it into a RothIRA, because we have to keep in
mind that every dollar we moveinto our IRA has the potential
to push us into higher brackets.
So you want to find that fineline of converting enough today
for it to be financiallybeneficial to you, but not
(17:13):
convert so much that you end uppaying more in taxes at today's
rates than you would had yousimply better managed your Roth
conversion process.
So that's something that Iwould look to.
And the other tax part that Iwould look at is potentially
refinancing the home.
Now, in a lot of cases I wouldsteer away from this, even for
non-financial reasons, but itdoes at least make sense to
consider it.
So let's assume I know Sarahsaid that the cost for
(17:36):
innovations is $800,000.
Let's assume it was only$750,000.
I say $750,000 because that'sthe limit on mortgages of how
much you can write off theinterest against.
So if you have $500,000mortgage balance, you can write
off 100% of the interest on yourtax return.
If you have a million dollarsin mortgage interest, well, you
(17:56):
can still only write off$750,000 of the mortgage
interest.
So let's just use that numberas a nice round number.
And let's assume that Sarahcould get a mortgage at 7%.
Well, another quick side noteon a mortgage if Sarah was just
to take out that mortgage andshe used it to invest in a
business or spend or dosomething else with, she can't
(18:17):
actually write off that mortgageinterest.
Part of the new mortgage laws afew years back was that you can
only write off mortgageinterest if you are using the
proceeds to renovate your homeor it's going to be used to
improve your home.
In Sarah's case, that would bethe issue, or that would be the
case, so she could fully writethis off.
Now here's what this would looklike and here's how it plays in
(18:38):
from a tax planning standpoint.
If she were to get a 7%mortgage interest rate on a
$750,000 mortgage, her monthlyprincipal and interest payment
would be $4,990 per month On anannual basis.
That comes out to $59,880 peryear.
Now there's some cash flowconsiderations with that.
That we briefly touched uponearlier.
(19:00):
I want to focus on the taxconsiderations.
With this Her first yearpayment towards that mortgage,
the first 12 months, she'spaying $59,880 in that year.
However, of that, a full$52,258 is totally there's fully
interest, so very little isactually going to the principal
(19:21):
and that's important becausethat's all fully deductible.
So if we're looking atcombining Roth conversions with
this, now what you essentiallyhave is, when you do a Roth
conversion, you're creatingincome.
Well, if we can simultaneouslycreate some deductions, that's
helping to offset the income.
Now there is still the cost ofthe interest and you're never
reducing, dollar for dollar whatyou're paying an interest by
(19:42):
what you're reducing in taxes.
So I never want people to say Ishould just get a mortgage
because of the write offs.
No, let's say you pay a dollara mortgage interest and you're
30% tax bracket.
It saves you 30 cents in taxes.
So you're still out 70 cents.
But what it does is it dampensa little bit the actual cost of
the mortgage, the actual cost ofthat interest.
So, theoretically, in Sarah'ssituation, the first year's
(20:06):
interest payment is $52,258,then she could create, via Roth
conversions or some other incomesource, another $52,258 of
income without it making hertaxable income any higher.
So it's pretty significant tocombine these types of
deductions with other thingsthat create the income.
(20:26):
Now, it's still probablyrecommend against this in many
different cases for manydifferent reasons.
But peace of mind, simplicity,simple cash flow those are all
reasons not to get a mortgageinvolved with this.
Yes, maybe there's somepotential tax benefits, but if
it's going to cause less peaceof mind, if it's going to cause
stress, if it's going to makecash flow more difficult to
(20:46):
manage, then in many cases, inmy opinion at least those are
reasons the offset any benefitscreated by the mortgage interest
tax deduction.
So those are some taxconsiderations.
The next thing I would look atis the investment consideration.
Now, this is where you have tolook at the spreadsheet answer,
the paper answer, versus whatactually works in reality.
But on paper, on thespreadsheet, what you do is you
(21:09):
look at the interest rate of themortgage versus the growth you
could potentially get on yourinvested funds and you compare
the two and If the mortgageinterest rate is higher than in
many cases, you say you knowwhat maybe just makes more sense
to pay cash for this renovationor use funds to pay for the
renovation Versus.
If you had what we had maybethree years ago or so, two years
ago or so, and you could get aninterest rate of 3%, will you
(21:31):
look at that and you say, okay,if I'm gonna have a mortgage
that's at 3% interest and I'mgonna hold that for 15 years or
30 years, I've got a pretty highlikelihood of performing better
than that over the duration ofthe mortgage.
And if that's the case, you maybe more inclined to keep funds
invested and Finance a projectlike this, as opposed to having
to sell funds and you have theopportunity cost what they could
(21:52):
have grown by instead of usingthem to pay for the project.
Well, the thing now is interestrates are closer to 7%.
So what you have to do is youhave to say, okay, we have a new
threshold or we have a newhurdle that we'd have to be able
to cross or exceed if we thinkit makes more sense to Invest or
keep funds invested by gettinga mortgage.
But to look at it moreprecisely, you kind of have to
(22:15):
look at the after tax equivalentof that interest rate.
Because you can deduct theinterest that you're paying on
the mortgage.
The actual impact here cash flowor the actual effective rate is
Less because there's some taxsavings associated with it.
For example, if you earn a 20%tax bracket and you pay $30,000
in a year in mortgage interest,so when you're deducting all of
(22:35):
it on your tax return, then thatsaves you $6,000 in taxes.
So you paid $30,000 in interest.
It saves you $6,000 in taxes.
The actual cost was $24,000 ofinterest in that example.
So the higher your tax bracket,the lower your effective
interest rate, because thatoffset or that deduction is
saving you more and more dollarsbecause you're in a higher tax
(22:58):
bracket.
So in Sarah's case let's assumeshe's in a 20% tax bracket 7%
interest rate effectivelybecomes a 5.6% interest rate,
because 5.6% is 80% or 20% lessthan that7.
This isn't fully accuratebecause of the timing of cash
flows and because the way thatmortgages are amortized.
For example, in the first yearSarah would end up paying, on
(23:21):
her standard mortgage payment,$52,258 in interest, versus in
your 30 of a 30-year mortgage,same exact payment but only
paying $2,210 in interest.
So even though it's the samepayment, the same interest rate,
in the first year she's savingfar more in taxes with the
interest rate deduction than sheis in the final year.
(23:43):
And that's just howamortization works.
However, just for simplicity,let's just assume that in
Sarah's case you could get a 7%mortgage rate and we're gonna
say, effectively that's a 5.6%interest rate after the tax
deductions that would provide.
So we have to do that as ahurdle.
Do we think that Sarah'sinvestments could return more
than 5.6%?
If so, you might be a bit moreinclined to keep your money
(24:06):
invested in finance this projectversus Understanding simply
paying for this project out ofhand or out of portfolio or with
cash on hand.
That's like getting a return of5.6%.
When you realize the mortgageinterest, you wouldn't have to
be paying over the course of thelifetime of a loan.
In many cases, especially whenyou're retired and especially
(24:27):
when you're living on this money, you're gonna err on the side
of being a bit more conservative, especially because interest
rates have risen so much in thelast couple of years.
That being said, let's assumeSarah does go ahead and move
forward with selling her fullbrokerage account and using that
to pay for the cost of therenovation.
What I will say is this withher remaining assets so the IRA
(24:49):
and the Roth IRA and she'sprobably maybe using bits of the
IRA or Roth IRA to Complimentwhat she sells some brokerage
account in order to make thisrenovation but with those
remaining assets, she now haswhat I would call more risk
capacity To take in thoseaccounts.
Here's what I mean by that.
Let's assume the market's down50% Is she could handle it,
(25:11):
financially speaking at least.
And she could handle it becauseshe still has her pension, she
still has her social security.
She essentially paid cash forthe renovation.
So the market's down 50%.
Her 1.1 million remaining inher portfolio is maybe now worth
550,000, but she doesn't haveto sell it.
She doesn't have to liquidateit because she's not dependent
(25:31):
upon that money to live on.
Now.
It's not fun, but emotionallyshe could do that.
If you're listening to this, orif Sarah was in a different
position, where she did dependon her portfolio to supplement
her pension or social security,she would not have as much risk
capacity.
She couldn't afford a 50%drawdown, knowing that on top of
(25:51):
that drawdown she's also havingto draw funds from her
portfolio.
So when you look at this fromthat standpoint, we have to
understand it's not just lookingat this from okay, should we
take the guaranteed payoff ofthe mortgage and effectively get
a 5.6 return in Sarah's casefor that, versus should we
borrow money and invest, orrather remain invested or keep
(26:12):
the brokerage account invested,hoping to exceed that 5.6%?
That's not the only aspect ofinvestment considerations that
we want to look at.
Even assuming you sell thebrokerage account to fund the
renovation, what does that dofor our risk capacity and our
risk tolerance with theremaining assets?
So that's certainly somethingthat should be looked at as well
, especially if Sarah's viewingthe IRA and Roth IRA as legacy
(26:37):
money, so money she's trying tomaximize not just from an
investment standpoint but alsofrom a tax standpoint, to
ultimately pass on to heirs.
If that's the case, then weabsolutely need to know Sarah's
risk tolerance and her comfortlevel with investing.
But we also need to know howwould we align these assets if
we know they're not being usedtoday for Sarah's purposes.
Rather, she wants to maximizethose for 2030 plus years, to
(27:00):
ultimately pass down to futuregenerations in her heirs.
And this then ties into thefourth consideration, which is
really legacy considerations.
We just covered how assetallocation or investment
decisions should be framed froma legacy standpoint, but there's
also things like taxconsiderations.
Instead of just looking atSarah's tax bracket today and
her tax bracket once RMDs kickin to determine things like Roth
(27:21):
conversions, sarah should alsobe at least considering her
heirs tax bracket, or at leasther projected tax bracket, at
the time when they might beinheriting some of these funds.
Now, that's a difficult thingto do.
What you're trying to do isyou're trying to project out how
long will Sarah live?
Is it 20, 25, 30 years?
You're trying to project outwhere will her children be in
terms of their income and taxbrackets at that time.
(27:43):
You're trying to project outwhere will tax brackets even be
20, 30 years in the future.
So, granted, this is adifficult thing to do with
precision, maybe it's animpossible thing to do with
precision, but it's at least aconsideration that we should be
making Understand.
Generally speaking, what taxbracket might they be in, based
upon career paths or incomepotential, or where they might
be versus what we know aboutSarah and her current tax
(28:06):
bracket?
Another aspect of the legacypiece is this is does investing
$800,000 into the current homeincrease the value of the home
by $800,000 or more?
If not, are you better offselling the home and purchasing
an entirely different home thatalready meets your needs and is
more likely to be a largerassets for heirs?
Now, really big disclaimer.
(28:27):
I almost hesitate to even saythat that should not be the
first priority.
Your first priority should notbe are these renovations going
to provide more assets for myheirs 20, 30 years in the future
?
Your quality of life shouldabsolutely be your top priority.
I see this and this is myopinion, and you're entitled to
your own.
But too many people sacrificingtheir own quality of life and
(28:48):
retirement or their own peace ofmind and retirement, trying to
do everything they can tomaximize portfolio or home or
things that will ultimatelyenhance their heirs long after
they're gone.
Now, my personal philosophy isthat's not the right way to
approach it, but to each theirown.
It is your money.
It is yours to do what you wantwith it.
I just don't think that's awisest thing to do.
(29:09):
Instead, I think there is agood balance.
But the reason I say this andgoing back to the home that
Sarah's looking to renovate,what you sometimes see is people
doing highly customized thingsto their home that really fit
their needs, which is wonderful,and again, it adds to more
quality of life, whichabsolutely should be the goal.
But when it comes time to sellthat home, those features really
don't mean anything, or atleast don't mean as much to new
(29:30):
buyers.
So it's very possible that an$800,000 investment in the home
might not increase the homevalue by that much, depending on
when and who ultimately buysthe home, which might not be for
20, 30 years.
And again, that should not bethe first consideration.
The first consideration is ifthis is a home that you love,
sarah, if this is a home thatyou have memories in maybe this
(29:51):
is a home where you raise yourfamily or wonderful things
happened you might look at thisand say you know what.
Getting $800,000 in the homedoes nothing really for the home
value, but what it does do isit allows me to continue living
in the place that I love, maybearound the people that I love.
That alone is enough, knowingthat you've got good financial
situation around you, you havestable income, you still have
(30:13):
liquid portfolio assets.
Don't do everything just fromthe what's going to return the
investment or get the greatestreturn on investment.
Look at things through what'sgoing to enhance quality of life
and then return an investment,and tax savings and other
considerations should be used tosupplement that, but those
should not be the firstconsiderations.
So, as we're looking again atSarah's situation, her specifics
(30:36):
are probably not almostcertainly not your specifics,
whether it's regards to hercashless situation versus your
cashless situation, or her taxsituation versus your tax
situation, or investments orlegacy or whatever the case
might be.
But I hope that as we start tounpack this, you can start to
see how different considerationsare going to have different
responses by different peoplebecause of their unique
(30:59):
circumstances.
So I hope this was helpful tosee Sarah.
Thank you very much forsubmitting that question.
Thank you to all of you who arelistening.
Always appreciate you takingthe time to do so.
If you haven't already left areview for the show, please go
ahead and do so, but that is itfor today's episode and I look
forward to seeing you all nexttime.
Thank you for listening toanother episode of the Ready for
(31:20):
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscuss in this podcast is
(31:41):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
What do you do when you need funds for a homie model
, or any large expense for thatmatter.
But you're retired, you knowhow a fixed-income source is and
you can't just wait around fora bonus to hit or for more stock
to vest, like maybe you couldin your working years.
Finding the best way to pullfunds for large expense is very
important in retirement andthat's the topic of today's
episode of ready for retirement.
This is another episode ofready for retirement.
(00:23):
I'm your host, james Kanol, andI'm here to teach you how to
get the most out of life withyour money.
And now on to the episode.
Today's episode is based upon alistener question and I'm going
to call this listener Sarah.
Sarah submitted a question andshe said this hi, james, I enjoy
the thoughtfulness of yourtechnical analysis.
When your listeners posequestions.
(00:44):
You're very thoughtful and yourinsight is invaluable.
I hope you consider thisquestion.
I am retired, age 62, recentlywidowed and I'm planning an
extensive remodel of my old homeso that I can age in place by
reducing the number of steps,widen doorways, etc.
The cost of the renovation maybe $800,000.
I have about $700,000 inbrokerage accounts.
(01:06):
Capital gains are probablyabout a hundred thousand dollars
after a step up, a basis in onemillion dollars and IRAs and a
$100,000 in a Roth IRA.
My current living expenses arecovered by a pension and
survivor social security andhealth care premiums Including
Irma charges and Medicaresupplement plans, when eligible,
will be completely covered by aprevious employer I know so
(01:27):
lucky.
The house, as well as whateverremains of the accounts, will be
left to airs.
So I was considering convertingsome of the IRAs to Roth over
the next 10 years.
What would be the best way topay for the renovation?
Should I use the brokerageaccounts to pay cash or finance
a portion of it in today's highinterest rate environment?
Thanks for your considerationand thanks for the podcast from
(01:47):
Sarah.
Well, sarah, thank you verymuch for that question.
Thank you to all of you whosubmit questions.
I do read all of them and I tryto pick the ones that I think
will be applicable to the mostamount of people.
Not that this specificsituation per se will be the
exact same as everyone else, butthe principles that we can
extract from it can absolutelybe applied to many different
situations.
So I like this topic for anumber of reasons, but before we
(02:10):
jump into the episode and theoutline and the content.
Here let's highlight the reviewof the week.
This review comes from Drewnine house and drew gives the
podcast five stars.
He says I subscribed about 15financial podcasts.
This one is amazing Simple,easy to follow, engaging and
actionable.
I've learned so much and itreally motivated me to dig into
(02:31):
all my financial planning,getting accounts bonus points.
It keeps me distracted andentertained while exercising.
Well do, thank you very muchfor that review.
I'm glad that I get to keep youentertained and distracted
while exercising.
That's great.
I don't know if I could listento a financial podcast while
exercising.
I'm glad that you can.
And thank you very much fortaking the time to leave that
review.
Thank you to all of you whohave done so and if you've not
(02:53):
yet done so, or this is maybeyour first time listening, if
you're enjoying the podcastwould appreciate you sharing it
with others or leaving a review.
That will help more people findthe show when they search on
Apple podcasts, google podcast,spotify or wherever else you
listen to your podcasts.
So with that, let's jump intothe episode.
So, going back to Sarah'squestion I mentioned, I like
(03:13):
this question a lot because itblends many different issues.
It's not just a simple blackand white question, like it may
seem at the outset how should Ifinance this renovation?
Should I finance it and borrowmoney against my home to pay for
this, or should I use myexisting brokerage account, iras
, other assets, to pay for it?
So there's many differentconsiderations and, as always, I
(03:35):
cannot give a direct answer orany specific advice to Sarah or
anyone else, but what I can dois I can unpack the different
considerations and issues thatyou need to be aware of to make
the best decision for you, thefirst of which, the first
consideration, in my opinion, issimply the cash flow
Consideration.
Now granted, sarah is in a veryunique situation, and the
(03:57):
uniqueness of her situation isthat she doesn't technically,
quote-unquote, need any of herportfolio.
Her needs are covered by socialsecurity and by pension.
So are her health care needs.
So, technically, you could lookat the 1.8 million or so that
she has in her portfolio and saythat is all Access to an extent
(04:17):
.
Now, I don't want to say it'sexcess.
In the standpoint of the onlypurpose of your portfolios to
generate a monthly income stream, that's absolutely not the case
.
What Sarah is highlighting hereis a very important thing that
you should be thinking aboutwith your portfolio how do I
enhance my standard of living,how can I provide for myself my
ability to do what I need to doand, in Sarah's case that's, how
(04:38):
can I prepare a place that willallow me to age in place?
However, the first thing that Ido think of is what income
needs do you have from yourportfolio?
Does your portfolio need tosupplement social security or a
pension to allow you to livecomfortably and do what you want
to do?
For many people, for mostpeople, I'd argue yes, but in
Sarah's case, she's in theunique position where she
(05:00):
doesn't need any of herportfolio, at least for basic
living expenses, at least notfor today.
So theoretically, from a cashflow consideration or a cash
flow standpoint, sarah could sayI'm gonna dump all 1.8 million
of my portfolio Into this homerenovation and still be okay, at
least on paper.
Now, obviously, I wouldn'trecommend that, but for most of
us, what we have to askourselves is what will this
(05:22):
investment do in my cash flow,this investment being the home
renovation.
If, even in Sarah's case butlet's assume, because Sarah did
need some that 1.8 milliondollars, which is a million in
an IRA, 100,000 in a Roth IRAand $700,000 in a brokerage
account.
Technically, if she was livingoff that portfolio, then any
(05:42):
reduction in portfolio balancebecause it's being spent to
finance this project.
What that means is acorresponding reduction in how
much income your portfolio cancreate.
So maybe you're not Sarah, butyou're asking yourself these
same questions.
Well, the first thing to keepin mind is if I pay all cash, if
I use these assets to financethe project or to pay for the
project, can you afford thatreduction in income?
(06:05):
By reducing your portfolio, youcan still create the income
that you need to meet all yourneeds.
That's the first question foranyone who's looking to use part
of their portfolio to pay forthis.
The second thing that this coulddo to your cash flow is let's
assume that Sarah, or you orwhoever's considering this,
doesn't use their portfolio topay for this, but instead they
(06:25):
finance it.
They say I'm going to borrowagainst the value of my home.
I'm going to use the proceedsfrom that to finance this.
Well, what does that look like?
Your portfolio balance is stillthe same.
In Sarah's case, you'd stillhave the $1.8 million.
But now what she would need todo is understand can I now
afford that mortgage paymentbecause my expenses have gone up
Because, unless this was sometype of reverse mortgage, but in
(06:48):
a conventional mortgage or evena HELOC, there's going to be
some payment required.
So your expenses go up as youstart to pay that loan back.
So those are the things thatanyone should be thinking of as
cash flow considerations.
My first thought for Sarah andgranted, I don't know Sarah, I
don't know her history, I don'tknow where she lives, there's a
number of things I don't knowabout her but I guess my first
(07:10):
question would be does it makesense to do an $800,000
renovation or could it possiblymake more sense to sell this
home and purchase a new one?
Get everything you need interms of wider doorways,
reducing or eliminating anystairs, everything else that
needs to be done to age in placeand still come out ahead from a
(07:30):
price perspective.
Now, there's a big emotionalcomponent to this.
Sarah mentioned she's recentlywidowed.
My guess is this is a home thatshe and her husband lived in.
I'm sure there's a lot ofmemories in this property, so I
don't want to negate any of thator minimize any of that.
That's a huge consideration andone that, in my mind, is
totally fine to justify adecision fully based upon that,
(07:52):
assuming the finances still makesense.
But what I would look at andjust from the math side, the
problem solving side there was astep up in basis when husband
would have passed.
Now I don't know if Sarah livesin a community property state
or a common law state.
Depending on that, that woulddetermine how much of the home
had to step up in basis.
Sarah would also have theability to exclude some capital
(08:12):
gains if she sold a home.
So not saying that it's theright option, but at least make
sure it's considered, becausewhen we look at cash flow
considerations, even if Sarahdoesn't necessarily need her
portfolio, this is a prettysignificant expense.
And how can we accomplish thedesired goal, which is a place
to age in place, withoutsacrificing in terms of
(08:33):
overspending or doing anythingthat could be done in a more
cost effective way, without, ofcourse, minimizing the emotional
component of this as well?
So just some thoughts that Iwould be thinking through if I
was taking a look at this aswell.
The second consideration so,after cash, though, I'd also
want to understand and I thinkthis is a big one for a lot of
people tax considerations.
So I look at the situation and,right off the bat, there's so
(08:55):
many different things you coulddo to reduce taxes.
There's potential tax gainharvesting, there's potential
Roth conversions, there's thepotential of mortgage interest
deductions and so much more and,like I said, because I don't
know Sarah's specific situation,it's hard to tell which of
these would be best.
But let's just quickly gothrough each of these to see how
might they apply.
Well, number one, tax gainharvesting.
(09:17):
So I've talked about this before, but what tax gain harvesting
is is it's the concept that,depending upon what your taxable
income is, you may be able torealize some long term capital
gains and potentially paynothing in taxes on that.
So if you are single in yourtaxable income and keep in mind,
taxable income is your adjustedgross income, so the top line
(09:39):
number minus any deductions,whether it's a standard
deduction or an itemizeddeduction so taxable income of
$44,625 or less in 2023, thenany gains, any long term gains
that you realize up until thatthreshold, are taxed at 0% at
the federal level.
That's, if you're single, ifyou're married, finally jointly
(10:02):
then any taxable income under$89,250, if it's a long term
gain that's being realized isalso taxed at 0% at the federal
level.
So why do I bring that up?
Well, a pretty significantportion of Sarah's portfolio is
in a brokerage account and onthat brokerage account she
alluded to the fact there's beena step up in basis, which would
(10:23):
have happened when her husbandpassed, but there are still
gains Now those gains, dependingon what Sarah's income is,
maybe tax different tax rates Ifshe can sell just enough each
year to stay under thatthreshold that I talked about.
So for her $44,625 of taxableincome, then any gains up until
that point would be tax free atthe federal level.
(10:45):
Depending on the state thatSarah lives in, they may or may
not be taxable, but that dependsupon the specific state that
she lives in.
So another thing to considerwith this, with Sarah
specifically, is the timing ofwhen she needs the funds.
This probably isn't forrenovation, where she's going to
draw out a little bit of fundsevery year for the next handful
of years.
She might need to make someserious investment into this
(11:06):
soon.
But do you at least consider,does it make sense to sell some
of these gains or realize someof these gains that I have in my
brokerage account this year,maybe some next year, and maybe
in doing that she saves the 15%in federal taxes she otherwise
would have paid if she had soldall these funds or realized all
these gains in year one.
Again, I do not know Sarah'ssituation, I don't know what tax
(11:30):
bracket she is in, I don't knowhow much she has coming in from
pension or social security orwhat state she's in.
So this is all hypothetical,just illustrating this, but it's
certainly something I wouldconsider.
Hey everyone, it's me again forthe Disclaimer.
Please be smart about this.
Before doing anything, pleasebe sure to consult with your tax
planner or financial planner.
Nothing in this podcast shouldbe construed as investment, tax,
(11:50):
legal or other financial advice.
It is for informationalpurposes only.
The next thing I'd consider isRoth conversions, at least to
illustrate what would thepotential tax savings be of
doing this.
So let's just say, for example,that Sarah uses all of her
brokerage account and maybe partof her IRAs to fund the
entirety of her home renovation.
Well, she now has pension andsocial security that are
(12:12):
covering all of her needs.
She now has the remainder ofher portfolio that is extra to
an extent, and it sounds likeher intention is to maximize
that for her heirs.
So let's just make up somenumbers.
These are arbitrary numbersthat I'm making up to try to get
some sense of what tax bracketSarah might be in.
I'm going to assume that shehas a pension of let's call it
3,000 per month, so 36,000 peryear, and that she has social
(12:35):
security of $15,000 per yearright now, so 51,000 per year
coming in.
I'm just going to assume thatthat's the income that she's
living in or living on.
I should say, but again, thoseare my numbers, not hers.
Well, if those were her numbers, then Sarah would be somewhere
in the middle of the 12% taxbracket, most likely today
depends on her deductions,depends upon a number of other
(12:57):
things, but Sarah would be inthe middle of the 12% tax
bracket today.
What we have to do anytime we'redoing a Roth conversion, it's
not enough just to know where weare today from a tax standpoint
.
We need to know where we'lllikely be in the future.
And where we'll be in thefuture is really a function of
two things Number one, yourtaxable income sources and
(13:17):
number two, where tax bracketswill actually be, which we can't
know a certainty, but we can gobased upon some basic
information.
So let's assume, or let's fastforward, I should say, to when
Sarah's age 75, that's whenshe's going to be required to
start taking some distributionsfrom her IRA.
Well, if she doesn't touch herIRA at all because, again, she
(13:38):
just paid for the whole homeexpense, she has all her needs
covered her IRA might just growand compound.
Well, if it grows by 6% peryear on average for the next 13
years so she's 62 today, we'recomparing this to age 75, then
$1 million will grow to about$2.1 million.
At that time, her first yearrequired distribution, based
(13:59):
upon that portfolio value, mightbe somewhere around $80,000.
Well, what's happened at thattime in 13 years?
A couple of things.
Current tax brackets havesunset.
So the existing brackets thatwe have today of 10%, 12%, 22%,
so on and so forth, those willsunset, which means those will
go up between about 3 or 4% perbracket after 2025, unless
(14:22):
something changes.
So we know, or we can at leastassume, anything can happen and
something will happen, mostlikely between now and 13 years
from now.
But even if we just start withthe assumption that we're not
going to be in today's taxbrackets, we'll still be under
the new brackets and really thenew brackets are just the old
brackets once current tax lawsunsets after 2025.
(14:44):
That being said, we can't justtake that $80,000 projected RMD
and tack it on to the socialsecurity and the pension that
Sarah's receiving today.
Why?
Well, because tax brackets alsohave an inflation adjustment.
So if you notice each year whatit takes to be in the 10%
bracket or 12% bracket or 22 or24, whatever the bracket might
(15:07):
be those numbers go up a littlebit each year to adjust for
inflation.
So $80,000 of an RMD in thefuture might be more or less
equivalent to about call it,$55,000 or so today.
And if that's a littleconfusing, all I essentially did
was said what's the inflationadjusted equivalent of $80,000
(15:27):
per year in 13 years backed downtill today?
So a present value of that it'sabout $55,000.
Essentially, asking, if taxbrackets go up by about
inflation, then we can't justtack on $80,000 of an RMD on top
of social security and pensiontoday.
We need to tack it on.
But what the inflation adjustedequivalent of that might be?
(15:48):
So maybe about $55,000.
So if that doesn't make sense,it's kind of besides the point.
But what it tells us is thatSarah might be at the top of
about the 25% bracket by thetime that she is 75.
And why I say that is becauseshe would still have social
security, she would still haveher pension, she would also have
(16:09):
her required minimumdistribution and if those three
income sources were all she had,she would be at the top of
about the 25% tax bracket.
25% tax bracket doesn't existtoday.
It's a 22% bracket.
But remember, we're assumingthat that has sunset after 2025.
So why does it important toknow that?
Well, it's important to knowthat because today, based upon
(16:31):
the numbers, we're assumingSarah might be in the 12%
bracket so she can move moneyfrom her IRA to her Roth IRA the
12% bracket.
She's probably going to bebetter off and simply waiting
until she's forced to distributethose funds, but doing so at a
higher tax bracket, in this case, more than double what she's
currently at at the federallevel, which would push her into
(16:51):
an higher tax bracket than shereally needs to be in.
So this is just the way youwant to look at Roth conversions
, and that doesn't mean Sarahshould take her whole million
dollars and push it into a RothIRA, because we have to keep in
mind that every dollar we moveinto our IRA has the potential
to push us into higher brackets.
So you want to find that fineline of converting enough today
for it to be financiallybeneficial to you, but not
(17:13):
convert so much that you end uppaying more in taxes at today's
rates than you would had yousimply better managed your Roth
conversion process.
So that's something that Iwould look to.
And the other tax part that Iwould look at is potentially
refinancing the home.
Now, in a lot of cases I wouldsteer away from this, even for
non-financial reasons, but itdoes at least make sense to
consider it.
So let's assume I know Sarahsaid that the cost for
(17:36):
innovations is $800,000.
Let's assume it was only$750,000.
I say $750,000 because that'sthe limit on mortgages of how
much you can write off theinterest against.
So if you have $500,000mortgage balance, you can write
off 100% of the interest on yourtax return.
If you have a million dollarsin mortgage interest, well, you
(17:56):
can still only write off$750,000 of the mortgage
interest.
So let's just use that numberas a nice round number.
And let's assume that Sarahcould get a mortgage at 7%.
Well, another quick side noteon a mortgage if Sarah was just
to take out that mortgage andshe used it to invest in a
business or spend or dosomething else with, she can't
(18:17):
actually write off that mortgageinterest.
Part of the new mortgage laws afew years back was that you can
only write off mortgageinterest if you are using the
proceeds to renovate your homeor it's going to be used to
improve your home.
In Sarah's case, that would bethe issue, or that would be the
case, so she could fully writethis off.
Now here's what this would looklike and here's how it plays in
(18:38):
from a tax planning standpoint.
If she were to get a 7%mortgage interest rate on a
$750,000 mortgage, her monthlyprincipal and interest payment
would be $4,990 per month On anannual basis.
That comes out to $59,880 peryear.
Now there's some cash flowconsiderations with that.
That we briefly touched uponearlier.
(19:00):
I want to focus on the taxconsiderations.
With this Her first yearpayment towards that mortgage,
the first 12 months, she'spaying $59,880 in that year.
However, of that, a full$52,258 is totally there's fully
interest, so very little isactually going to the principal
(19:21):
and that's important becausethat's all fully deductible.
So if we're looking atcombining Roth conversions with
this, now what you essentiallyhave is, when you do a Roth
conversion, you're creatingincome.
Well, if we can simultaneouslycreate some deductions, that's
helping to offset the income.
Now there is still the cost ofthe interest and you're never
reducing, dollar for dollar whatyou're paying an interest by
(19:42):
what you're reducing in taxes.
So I never want people to say Ishould just get a mortgage
because of the write offs.
No, let's say you pay a dollara mortgage interest and you're
30% tax bracket.
It saves you 30 cents in taxes.
So you're still out 70 cents.
But what it does is it dampensa little bit the actual cost of
the mortgage, the actual cost ofthat interest.
So, theoretically, in Sarah'ssituation, the first year's
(20:06):
interest payment is $52,258,then she could create, via Roth
conversions or some other incomesource, another $52,258 of
income without it making hertaxable income any higher.
So it's pretty significant tocombine these types of
deductions with other thingsthat create the income.
(20:26):
Now, it's still probablyrecommend against this in many
different cases for manydifferent reasons.
But peace of mind, simplicity,simple cash flow those are all
reasons not to get a mortgageinvolved with this.
Yes, maybe there's somepotential tax benefits, but if
it's going to cause less peaceof mind, if it's going to cause
stress, if it's going to makecash flow more difficult to
(20:46):
manage, then in many cases, inmy opinion at least those are
reasons the offset any benefitscreated by the mortgage interest
tax deduction.
So those are some taxconsiderations.
The next thing I would look atis the investment consideration.
Now, this is where you have tolook at the spreadsheet answer,
the paper answer, versus whatactually works in reality.
But on paper, on thespreadsheet, what you do is you
(21:09):
look at the interest rate of themortgage versus the growth you
could potentially get on yourinvested funds and you compare
the two and If the mortgageinterest rate is higher than in
many cases, you say you knowwhat maybe just makes more sense
to pay cash for this renovationor use funds to pay for the
renovation Versus.
If you had what we had maybethree years ago or so, two years
ago or so, and you could get aninterest rate of 3%, will you
(21:31):
look at that and you say, okay,if I'm gonna have a mortgage
that's at 3% interest and I'mgonna hold that for 15 years or
30 years, I've got a pretty highlikelihood of performing better
than that over the duration ofthe mortgage.
And if that's the case, you maybe more inclined to keep funds
invested and Finance a projectlike this, as opposed to having
to sell funds and you have theopportunity cost what they could
(21:52):
have grown by instead of usingthem to pay for the project.
Well, the thing now is interestrates are closer to 7%.
So what you have to do is youhave to say, okay, we have a new
threshold or we have a newhurdle that we'd have to be able
to cross or exceed if we thinkit makes more sense to Invest or
keep funds invested by gettinga mortgage.
But to look at it moreprecisely, you kind of have to
(22:15):
look at the after tax equivalentof that interest rate.
Because you can deduct theinterest that you're paying on
the mortgage.
The actual impact here cash flowor the actual effective rate is
Less because there's some taxsavings associated with it.
For example, if you earn a 20%tax bracket and you pay $30,000
in a year in mortgage interest,so when you're deducting all of
(22:35):
it on your tax return, then thatsaves you $6,000 in taxes.
So you paid $30,000 in interest.
It saves you $6,000 in taxes.
The actual cost was $24,000 ofinterest in that example.
So the higher your tax bracket,the lower your effective
interest rate, because thatoffset or that deduction is
saving you more and more dollarsbecause you're in a higher tax
(22:58):
bracket.
So in Sarah's case let's assumeshe's in a 20% tax bracket 7%
interest rate effectivelybecomes a 5.6% interest rate,
because 5.6% is 80% or 20% lessthan that7.
This isn't fully accuratebecause of the timing of cash
flows and because the way thatmortgages are amortized.
For example, in the first yearSarah would end up paying, on
(23:21):
her standard mortgage payment,$52,258 in interest, versus in
your 30 of a 30-year mortgage,same exact payment but only
paying $2,210 in interest.
So even though it's the samepayment, the same interest rate,
in the first year she's savingfar more in taxes with the
interest rate deduction than sheis in the final year.
(23:43):
And that's just howamortization works.
However, just for simplicity,let's just assume that in
Sarah's case you could get a 7%mortgage rate and we're gonna
say, effectively that's a 5.6%interest rate after the tax
deductions that would provide.
So we have to do that as ahurdle.
Do we think that Sarah'sinvestments could return more
than 5.6%?
If so, you might be a bit moreinclined to keep your money
(24:06):
invested in finance this projectversus Understanding simply
paying for this project out ofhand or out of portfolio or with
cash on hand.
That's like getting a return of5.6%.
When you realize the mortgageinterest, you wouldn't have to
be paying over the course of thelifetime of a loan.
In many cases, especially whenyou're retired and especially
(24:27):
when you're living on this money, you're gonna err on the side
of being a bit more conservative, especially because interest
rates have risen so much in thelast couple of years.
That being said, let's assumeSarah does go ahead and move
forward with selling her fullbrokerage account and using that
to pay for the cost of therenovation.
What I will say is this withher remaining assets so the IRA
(24:49):
and the Roth IRA and she'sprobably maybe using bits of the
IRA or Roth IRA to Complimentwhat she sells some brokerage
account in order to make thisrenovation but with those
remaining assets, she now haswhat I would call more risk
capacity To take in thoseaccounts.
Here's what I mean by that.
Let's assume the market's down50% Is she could handle it,
(25:11):
financially speaking at least.
And she could handle it becauseshe still has her pension, she
still has her social security.
She essentially paid cash forthe renovation.
So the market's down 50%.
Her 1.1 million remaining inher portfolio is maybe now worth
550,000, but she doesn't haveto sell it.
She doesn't have to liquidateit because she's not dependent
(25:31):
upon that money to live on.
Now.
It's not fun, but emotionallyshe could do that.
If you're listening to this, orif Sarah was in a different
position, where she did dependon her portfolio to supplement
her pension or social security,she would not have as much risk
capacity.
She couldn't afford a 50%drawdown, knowing that on top of
(25:51):
that drawdown she's also havingto draw funds from her
portfolio.
So when you look at this fromthat standpoint, we have to
understand it's not just lookingat this from okay, should we
take the guaranteed payoff ofthe mortgage and effectively get
a 5.6 return in Sarah's casefor that, versus should we
borrow money and invest, orrather remain invested or keep
(26:12):
the brokerage account invested,hoping to exceed that 5.6%?
That's not the only aspect ofinvestment considerations that
we want to look at.
Even assuming you sell thebrokerage account to fund the
renovation, what does that dofor our risk capacity and our
risk tolerance with theremaining assets?
So that's certainly somethingthat should be looked at as well
, especially if Sarah's viewingthe IRA and Roth IRA as legacy
(26:37):
money, so money she's trying tomaximize not just from an
investment standpoint but alsofrom a tax standpoint, to
ultimately pass on to heirs.
If that's the case, then weabsolutely need to know Sarah's
risk tolerance and her comfortlevel with investing.
But we also need to know howwould we align these assets if
we know they're not being usedtoday for Sarah's purposes.
Rather, she wants to maximizethose for 2030 plus years, to
(27:00):
ultimately pass down to futuregenerations in her heirs.
And this then ties into thefourth consideration, which is
really legacy considerations.
We just covered how assetallocation or investment
decisions should be framed froma legacy standpoint, but there's
also things like taxconsiderations.
Instead of just looking atSarah's tax bracket today and
her tax bracket once RMDs kickin to determine things like Roth
(27:21):
conversions, sarah should alsobe at least considering her
heirs tax bracket, or at leasther projected tax bracket, at
the time when they might beinheriting some of these funds.
Now, that's a difficult thingto do.
What you're trying to do isyou're trying to project out how
long will Sarah live?
Is it 20, 25, 30 years?
You're trying to project outwhere will her children be in
terms of their income and taxbrackets at that time.
(27:43):
You're trying to project outwhere will tax brackets even be
20, 30 years in the future.
So, granted, this is adifficult thing to do with
precision, maybe it's animpossible thing to do with
precision, but it's at least aconsideration that we should be
making Understand.
Generally speaking, what taxbracket might they be in, based
upon career paths or incomepotential, or where they might
be versus what we know aboutSarah and her current tax
(28:06):
bracket?
Another aspect of the legacypiece is this is does investing
$800,000 into the current homeincrease the value of the home
by $800,000 or more?
If not, are you better offselling the home and purchasing
an entirely different home thatalready meets your needs and is
more likely to be a largerassets for heirs?
Now, really big disclaimer.
(28:27):
I almost hesitate to even saythat that should not be the
first priority.
Your first priority should notbe are these renovations going
to provide more assets for myheirs 20, 30 years in the future
?
Your quality of life shouldabsolutely be your top priority.
I see this and this is myopinion, and you're entitled to
your own.
But too many people sacrificingtheir own quality of life and
(28:48):
retirement or their own peace ofmind and retirement, trying to
do everything they can tomaximize portfolio or home or
things that will ultimatelyenhance their heirs long after
they're gone.
Now, my personal philosophy isthat's not the right way to
approach it, but to each theirown.
It is your money.
It is yours to do what you wantwith it.
I just don't think that's awisest thing to do.
(29:09):
Instead, I think there is agood balance.
But the reason I say this andgoing back to the home that
Sarah's looking to renovate,what you sometimes see is people
doing highly customized thingsto their home that really fit
their needs, which is wonderful,and again, it adds to more
quality of life, whichabsolutely should be the goal.
But when it comes time to sellthat home, those features really
don't mean anything, or atleast don't mean as much to new
(29:30):
buyers.
So it's very possible that an$800,000 investment in the home
might not increase the homevalue by that much, depending on
when and who ultimately buysthe home, which might not be for
20, 30 years.
And again, that should not bethe first consideration.
The first consideration is ifthis is a home that you love,
sarah, if this is a home thatyou have memories in maybe this
(29:51):
is a home where you raise yourfamily or wonderful things
happened you might look at thisand say you know what.
Getting $800,000 in the homedoes nothing really for the home
value, but what it does do isit allows me to continue living
in the place that I love, maybearound the people that I love.
That alone is enough, knowingthat you've got good financial
situation around you, you havestable income, you still have
(30:13):
liquid portfolio assets.
Don't do everything just fromthe what's going to return the
investment or get the greatestreturn on investment.
Look at things through what'sgoing to enhance quality of life
and then return an investment,and tax savings and other
considerations should be used tosupplement that, but those
should not be the firstconsiderations.
So, as we're looking again atSarah's situation, her specifics
(30:36):
are probably not almostcertainly not your specifics,
whether it's regards to hercashless situation versus your
cashless situation, or her taxsituation versus your tax
situation, or investments orlegacy or whatever the case
might be.
But I hope that as we start tounpack this, you can start to
see how different considerationsare going to have different
responses by different peoplebecause of their unique
(30:59):
circumstances.
So I hope this was helpful tosee Sarah.
Thank you very much forsubmitting that question.
Thank you to all of you who arelistening.
Always appreciate you takingthe time to do so.
If you haven't already left areview for the show, please go
ahead and do so, but that is itfor today's episode and I look
forward to seeing you all nexttime.
Thank you for listening toanother episode of the Ready for
(31:20):
Retirement podcast.
If you want to see how RootFinancial can help you implement
the techniques I discussed inthis podcast, then go to
rootfinancialpartnerscom andclick start here, where you can
schedule a call to one of ouradvisors.
We work with clients all overthe country and we love the
opportunity to speak with youabout your goals and how we
might be able to help.
And please remember nothing wediscuss in this podcast is
(31:41):
intended to serve as advice.
You should always consult afinancial, legal or tax
professional who's familiar withyour unique circumstances
before making any financialdecisions.
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