Safeguarding Your Retirement: Mastering Tax Diversification and Advisor Collaboration

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How can you safeguard your retirement nest egg from unpredictable tax changes? Tune into the Wolf Financial Podcast to uncover the secrets of tax diversification and its critical role in shaping a resilient investment portfolio. We use the example of a hypothetical couple to illustrate the diverse tax treatments of accounts like traditional IRAs, 401(k)s, after-tax brokerage accounts, and Roth IRAs. You'll gain valuable insights into the strategic advantages and potential pitfalls of each account type, and learn how to maximize tax efficiency in your investments.

In the latter half of this enlightening episode, we stress the indispensable value of collaborating with seasoned advisors who have a deep understanding of the tax code. Discover why both investment and tax diversification are crucial, and explore the educational strategies that can help you navigate the inherent risks of investing. Remember, tailored advice from tax, legal, or investment professionals is key to making informed decisions. We'll also highlight the importance of regulatory memberships and professional affiliations that underpin the credibility of advisory services, and remind you that past performance does not guarantee future success. Don't miss out on this episode packed with expert tips to help you optimize returns and mitigate tax liabilities.

Learn more about Wolf Financial Advisory:
https://www.wolffinancialadvisory.com/

Disclosure: Robert Wolf, James Koenig, Sara Wolf, and Michael Rock are investment advisor representatives of, and securities and advisory services are offered through, USA Financial Securities. Member FINRA/SIPC. Additionally, Amanda Opulskas and Adam Wallace are registered non-solicitors of USA Financial Securities, A registered investment advisor. 6020 E. Fulton St., Ada, MI 49301. Wolf Advisory Services and Wolf Financial Advisory are not affiliated with USA Financial Securities.

The strategies and concepts discussed are for educational purposes only and do not represent specific investment, tax, or estate planning advice. Investing carries an inherent element of risk and it is in everyone’s best interests to consult a tax, legal, or investment professional. The opinions expressed herein are not meant to provide specific investment advice or serve as a prediction for future stock market performance. Past performance does not guarantee future results. Securities and advisory services are offered through USA Financial Securities, member FINRA/SIPC. A registered investment adviser. Wolf Financial Advisory and USA Financial Securities are not affiliated entities.

Episode Transcript

Voiceover (00:01):
The strategies and concepts discussed are for
educational purposes only and donot represent specific
investment, tax or estateplanning advice.
Investing carries an inherentelement of risk and it is in
everyone's best interests toconsult a tax, legal or
investment professional.
Past performance does notguarantee future results.
Securities and advisoryservices are offered through USA

(00:23):
Financial Securities MemberFINRA/ SIPC, a registered
investment advisor.
Wolf Financial Advisory are notaffiliated with USA Financial
Securities.
Wolf Financial Advisory.
When it's important to you,it's important to us.

Rob Wolf (00:55):
Good day, Rob Wolf here and today we're going to
talk a little bit aboutportfolio construction in an
uncertain tax environment.
You know many people who arevery successful not only look at
investment diversification, butthey also look at tax
diversification when it comes tobuilding their portfolio.
What do I mean by taxdiversification?

(01:16):
Well, what I mean is that youhave different buckets of money
that are taxed differently andbecause they're taxed
differently, the IRS andCongress gives us some tax
benefits over certain buckets ofmoney that other buckets of
money don't get those same taxbenefits.

(01:40):
So how do I build a portfolio,or how should I consider
building out a portfolio throughthe lens of income taxes?
So let's start with an example.
Let's say I have a gentlemanand his wife.

(02:02):
They are 65.
They have just hit the pinnacleof their work career.
They are now retiring, theyhave traditional IRA, 401k, they
got after-tax brokerageaccounts and they have Roth IRAs
.
This is a common scenario thatI see when people think they've

(02:29):
done a really good job with taxdiversification, but a few more
tweaks will make it even better.
First of all, how is your IRAand your 401k going to get taxed
when you distribute the money?
Well, it's going to get taxedat what's called ordinary income

(02:51):
tax rates.
Ordinary income tax rates rightnow is anywhere from zero to
37%.
The more income you have, thehigher your overall income tax
bracket.
Okay, but from a risk standpoint, if I own a stock in my
traditional IRA and that stockappreciates so let's say I own

(03:18):
Amazon stock and I bought thatAmazon stock for $50,000 and
it's grown to $200,000.
And I decide I'm going to sellthat Amazon stock and I'm going
to distribute it.
Well, how is that going to gettaxed?

(03:39):
Well, I'm going to end upgetting a 1099 from my IRA
custodian for $200,000.
Now you say well, wait a second, don't I get a capital gains
treatment, which would be at alower tax rate?
No, you don't.
The reason is the money'scoming from a pre-tax investment

(04:04):
.
Reason is the money's comingfrom a pre-tax investment All
pre-tax distributions are goingto be subject to ordinary income
tax.
So when I'm thinking aboutportfolio construction, how do I
take this through the lens oftaxes?
Well, what gets taxed asordinary income?

(04:25):
Iras, 401ks, interest from thebank, bond, interest from an
after-tax account All thosethings are subject to ordinary
income tax.
What is not subject to ordinaryincome tax?
Well, let's say I had that sameAmazon stock in my after-tax

(04:49):
brokerage account.
This is an account that I justfunded over the years outside of
my retirement plans and Ibought $50,000 of Amazon stock
in my after-tax brokerageaccount.
It may be owned by me, perhapsme and my wife, or maybe it's
owned by my trust.
It's an after-tax account that,as it earns interest and
dividends, I get a 1099 DIV atthe end of the year.

(05:11):
Well, if I sold that Amazon inthat type of an account, I would
get what's called capital gaintreatment, which means, instead
of probably paying ordinaryincome taxes in the 22 or 24%
bracket, my maximum tax rate oncapital gains assuming my

(05:35):
overall income, married, filingjointly, is under 400,000, is
only going to be 15%.
What's better, 15% or 22?
I would say 15%, wouldn't you?
But here's the kicker Sometimesour investments don't always
work out the way we hope theywould.

(05:55):
So you may have your favoritehorror story when it comes to
investments.
But let's just say you put that$50,000 into something that did
not perform well and it droppedall the way down to $15,000.
We all have investment storieslike that.
Well, if I had that in mytraditional IRA and I ended up

(06:19):
selling that loser for $15,000.
When I bought it for $50,000,and then I distributed that
$15,000 to me, guess what?
I got to pay taxes on that$15,000.
I don't get to write off theloss because you're not allowed
to write off a loss on pre-taxdollars.

(06:42):
But if I had that sameinvestment in an after-tax
investment, it went from $50,000all the way down to $15,000,
and then I cashed it out and Idid something else with the
money.
Well, guess what?
I get to write off $35,000 as acapital loss on my Schedule D

(07:05):
on my income tax return.
I get a tax benefit forrealizing a loss on my after-tax
account.
So now I need to be thinkingokay.
Well, my IRA is always subjectto ordinary income, never get
capital gains treatment, neverget capital loss treatment.

(07:29):
Oh and, by the way, all mypre-tax dollars, if it's taxable
to me, it's going to be taxableto my kids.
There's no step up in costbasis.
So is Congress giving us anytax incentive to take risk with
those dollars?
I would say absolutely not.

(07:52):
We have no tax incentive totake risk with those dollars,
whereas we do have tax incentiveto take risk with my after-tax
funds because I get capital gaintreatment, I get capital loss
treatment and I get step-up incost basis and I have even more

(08:14):
tax incentive to take risk withmy Roth IRA.
With my Roth IRA Because, unlikeafter-tax funds, as the Roth
earns interest, as it earnsdividends, as I distribute that

(08:36):
money, it's never subject to tax.
Once I've owned that thing forfive years and I'm past 59 and a
half, I have access to all thatmoney income tax-free and those
distributions don't cause anyof my social security in of
themselves to become taxable andI can leave all that money
income tax-free to my kids.
So if you're thinking aboutportfolio construction and you

(09:01):
say you know what I reallydesire to have some safety in my
portfolio, where should I havemy safety?
Well, obviously you're going tohave your bank, you're going to
have bank dollars where you'regoing to have your emergency
fund and you're going to haveyour monthly cash flow budget,

(09:22):
right.
But the balance of your safetyyou may want to consider having
within your IRA or your 401k,especially in retirement,
because those are the dollarswhere you don't get any tax
incentive to take risk with thatmoney.
Those are also the dollars thatare meant to supplement your

(09:45):
income.
They were never meant to bedollars to take huge lump sums
from.
If I got a million dollar IRA,do I want to take $500,000 out
of it?
Probably not.
Why?
Because it's all going to besubject to ordinary income tax.
I'm not going to be taking biglump sums from my IRA.

(10:09):
In most cases, however, with myafter-tax money or even my Roth
money, those are designed forlump sum distributions.
Why?
Because we have tax incentiveson those accounts capital gain
treatment, tax-free treatment or, worst case, capital loss

(10:35):
treatment if we have to triggera loss.
Most people when they come tome're, they're just the opposite
.
They have all their risk intheir ira because they built all
their money in their 401k.
They were the most aggressivethere.
They had all the equities,everything.
Where do they have the safety?

(10:55):
Well, they have all their a lotof their safety in the bank.
It's in c, it's in the savings,or they may have an after-tax
account that's got some bond andmutual funds.
Guess what folks, if thatsounds like you, then almost all
your money is subject to theworst tax rates in the land.

(11:23):
You really need to consider notonly portfolio diversification
but tax diversification, takingrisk with those assets that the
IRS and Congress give you taxincentive to take risk with.
By doing that, it's going togive you the best chance to be

(11:58):
able to continue to build wealthand transfer wealth to the next
generation.
It sounds complicated, but itreally isn't.
The biggest thing that you haveto do in order to do this is
you got to make sure that yougot more than one type of money.
You can't have all your moneyin a traditional IRA or 401k.

(12:19):
If you do, you have no taxplanning that you can do
realistically, because it's allgoing to be subject to ordinary
income.
Ideally, you would have threedifferent buckets of money your
pre-tax, your after-tax and yourRoth IRA and then you choose to

(12:40):
take risk through the lens oftaxes on those accounts where
you have incentive to take riskwith.
I would argue that for most ofmy clients, they build their
Roth IRA up as legacy dollars togo to their kids, because they
want to leave those tax-freedollars to their kids.

(13:03):
I can also make the argumentthat because it is for legacy
purposes in that situation thatmoney has the longest time
horizon associated with it.
It's the life expectancy of thesurviving spouse plus 10, the

(13:23):
maximum number of years aninheritance can be stretched as
an inherited Roth.
So if me and my wife are in ourmid-60s and we expect one of us
to live to 90, that's 25 yearsplus 10.
That's 35 years that this moneypotentially can be growing

(13:48):
tax-free.
Do I want that to be my mostaggressive piece of my portfolio
?
Probably that's the case, right, because we got the longest
time horizon, we have the mosttax incentives with that money.
Everything fits the bill whenit comes to that scenario, okay.

(14:11):
So when it comes to theafter-tax money the accounts you
get your 1099 DIV from, you gotto pay taxes as you go.
It's good to consider takingrisk with that money too,
because you're getting thecapital gain treatment, you're
getting the capital losstreatment and you get step up in
cost basis, okay.

(14:32):
So if I have Tesla stock, Ihave a client that's got Tesla
stock over a million dollars ofTesla stock His cost basis is a
hundred thousand dollars.
He hit it just right.
Well, guess what?
If he leaves it upon death tohis heirs, they inherit it at
its current value of a milliondollars.
They sell it the next day notax.

(14:53):
Whereas if I own that Teslastock all in a traditional IRA,
it doesn't matter what my costbasis is.
I'm going to end up having topay tax on a million bucks and
they're going to end up havingto pay tax on a million bucks.
Where would you rather own thatTesla stock?
Ideally, either your after-taxaccount or your Roth IRA right?

(15:14):
Roth IRA?
Even better, because I know Ihave access to all those gains
income tax-free.
I don't even have to worryabout capital gains in my Roth
in my Roth.
So it's just a different way oflooking at building your
portfolio through the lens oftaxes.

(15:34):
If you are interested in thistype of strategy, it's important
to deal with an advisor and anadvisory firm that understands
how the tax code works, thatunderstand the importance not
only of investmentdiversification, but also tax

(15:56):
diversification.

Voiceover (15:58):
Thank you for listening to the Wolf Financial
Podcast.
For additional informationabout our firm, please visit our
website wolfadvisoryservices.
com.
Wolf Financial Advisory.
The strategies and conceptsdiscussed are for educational
purposes only and do notrepresent specific investment,

(16:19):
tax or estate planning advice.
Investing carries an inherentelement of risk and it is in
everyone's best interests toconsult a tax, legal or
investment professional.
Past performance does notguarantee future results.
Securities and advisoryservices are offered through USA
Financial Securities memberFINRA/ SIPC, a registered

(16:39):
investment advisor.
Wolf Financial Advisory are notaffiliated with USA Financial
Securities.