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Announcer: It’s time now on KROS for Financial Focus, brought to you by NelsonCorp Wealth Management. The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representative securities offered through Cambridge Investment Research Incorporated, a broker-dealer, member FINRA, SIPC. Investment advisor representative Cambridge Investment Research Advisors Incorporated, a registered investment advisor. Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. Now here’s today’s Financial Focus program.
Nate Kreinbrink: Good morning, and welcome to this week’s Financial Focus, brought to you each and every Wednesday morning right here on KROS. This is Nate. John joining me this morning. It’s been a few weeks. You’ve been busy down in the Quad City Office for a few weeks, so back in the old seat again, huh?
John Nelson: Yeah, that’s right. Good to be back.
Nate Kreinbrink: It’s another pleasant Wednesday morning out there. I think the temperature’s supposed to get up into the 60 today, which will definitely be appreciated and long overdue. I think we can mostly agree with that. Exciting time, Major League Baseball opening day is tomorrow, so that long season is ahead of us and all the excitement. Had a guy come in yesterday that’s a Reds fan. I’m a Reds fan as well and was kind of joking around with him. He’s like, “Well, we’re still in first place in the division.” Every team out there is optimistic at this time of the year. They’re all in first place and seeing how the season is going to fold out.
John Nelson: Yeah, exactly. We’re working on that Reds fan, Nate. We got to get you over to the Cubs.
Nate Kreinbrink: We got to keep some in the office. Andy from our tax side of it over there, he’s a Cardinals fan, so we almost got that NL Central covered and have some bragging rights going on. But I think the Reds are still a few years away. That division is just going to be tough again. Cubs are going to be right up there. Cardinals made some moves in the off season to be up there. Brewers obviously have pretty much everybody coming back from where they were. Pirates have been just a pesky team the last couple of years. Reds made a few moves, I think, to improve them a little bit, but it’s just from their standpoint it’s a tough division to be kind of rebuilding and doing that transition when you have all that talent and you’re playing these quality teams night in and night out that they do in that division.
John Nelson: Absolutely. Definitely competitive.
Nate Kreinbrink: Getting into today’s program, John and I kind of went back and forth a little bit and kind of settled on one term that we keep continuing to see in the meetings that we’ve had with our clients, conversations that we’ve had with them, and that’s diversification. Most people are probably familiar with the term diversification. They compare it to not having all your eggs in one basket, basically. But they don’t truly understand where that falls into the overall financial planning aspect and the different areas where diversification comes into play.
The one main area, and we touch on this thing throughout a few different shows, is just the type of accounts that you own. This goes into traditional IRAs, Roth IRAs, taxable accounts, the 401(k)s and things like that, and the biggest difference with all of those is, one, when you’re able to access that money and if there’s a penalty coming out of it, and two, and most importantly, is how each of those accounts are taxed.
We’ve talked about tax-deferred accounts. These are your traditional 401(k)s, your traditional IRAs, where you get that tax deduction up front for putting money into those accounts, but when you take those assets out of the account later on down the road, they’re taxed to you. So whatever income, whatever taxes are at that point in time, whatever amount you withdraw from those tax-deferred accounts, you’re taxed and that raises your income in the year that you do that.
On the flip side, you have Roth IRAs, and those are, you get no deduction up front when you put those contributions in, but when you take those out on the back side, they come out tax-free. And then taxable accounts are ones that you get the tax form back at the end of every year, and you pay taxes on your yearly tax return on any capital gains, on any dividends, on any interest that you do. So where that comes into play is having options, and we’ve hit all the time, and the people that have the most successful retirement plan are usually the people that have the most options in retirement.
John Nelson: Absolutely. That’s a big point, and the diversification always comes back to people thinking stocks, bonds, real estate, spreading your money out so you’re not concentrated in one specific area. That’s important, and we spend a lot of time talking about that, but what’s more important we feel, especially going forward, is the tax diversification that Nate brought up. Having money, not only all your money in a 401(k) plan. Saving in there is extremely important, but if you’re all in tax-deferred money, there’s a big IOU attached to that account balance that’s going to be paid at some point. And people will often ask, “Well, how much?” It depends what tax rates are when you need your money.
That is great to have that money saved up, but to have some diversification, which is becoming easier and easier for people to do. It used to be a lot of Roth IRAs. That’s the only type of Roth accounts people thought in terms of. Today you now see Roth sides to 401(k) plans and 403(b) plans. It’s only going to continue to give and provide more options to all participants saving in retirement plans at work. Again, the smaller employers will lag this, but generally speaking, things have really picked up, where you can decide on your contributions, do you want to go to the pretax side of your 401(k) plan or do you want to go to the Roth side?
And again, spending some time, not just making a quick decision that “Oh, all my money needs to go to the Roth side,” but spending some time looking at your tax situation and given where you are at this stage in your life can help determine what may make sense for you and your family going forward, to give optionality in retirement, which every retiree wants.
Nate Kreinbrink: Right. And I think that’s important for people to understand as well. When they get into retirement, there are certain things that are tied to your income. How much of your Social Security benefit is taxed, how much you’re going to pay in your Medicare premiums, and so on and so on. And it’s common, it’s very common for people to come in and 95% of the money that they have saved up for their retirement is in a tax-deferred asset, most notably probably a 401(k). They’ve done as much as they can, they saved as much as they can, they saved up this big amount of money in their 401(k), but oh by the way, they’re forgetting that down the road they’re going to have to take money out of that account.
At 70-1/2, they have what we call a required minimum distribution, an RMD, where the IRS basically says, “You haven’t taken money out of this account, you haven’t paid taxes on this account up until this point, you have to start taking some money out. Whether you need this money or not, you have to start taking some out of that.” So all of a sudden they have their Social Security benefits, they maybe have a pension that’s coming in, and now all of a sudden they throw this RMD on top of it, so their income goes from a lower amount one day to the next day when they have to take this out, it jumps up dramatically. And now all of a sudden the amount that they are paying on their Medicare premium almost doubles overnight.
So it’s just some of these things that we want to have people be aware of. If we can do some type of planning now in these stages, to try to eliminate some of those unexpected circumstances down the road, people are going to be in a much better place. And they’re going to end up keeping more money in their pocket and less money paying into taxes, which I think everyone is in agreement of, that’s what they want.
John Nelson: Yeah. And back to the whole idea of the pretax dollars, which many people have harped on for many, many years, take that deduction today while you’re earning good money, and when you retire you’ll be in a lower tax bracket, so you can take it out then and pay the taxes, and it won’t be as bad. That has been the philosophy, and in some cases that works well. But in a lot of cases what Nate just brought up and how it affects these other items, people don’t usually retire on 20 or 30% of what they were making while they were working.
So if incomes are fairly similar or slightly below where they were, when you factor in Social Security benefits and other items, that makes a strong case for putting some, maybe not all but some, money to the Roth side, because once retirement does get here and you are drawing money from these accounts, you totally lose control. And when RMDs kick in, you have to take that money out. It’s not maybe, you have to take that money out. It just gives you no flexibility at that point in retirement of controlling taxes for you.
Nate Kreinbrink: All great points, and we’re getting close on time, but I did want to touch on another point of diversification, and that is asset allocation and how your accounts are allocated. Most people when they think of diversification, they think of, “Well, I got to have a certain amount here, a certain amount here, a certain amount there,” but they don’t truly understand how that means. And when we talk to a lot of people and ask them how their 401(k)s are allocated, most people kind of look at them with us with kind of a sheepish look on their face, where they’re just kind of, “Well, I don’t really know. I haven’t changed it since we started.”
Or they call me, they say, “Well, I’m in this fund where it automatically adjusts it for me.” Well, what they’re usually referring to are target date funds. A lot of times people don’t quite truly understand how a target date fund works. Those fund works, they based it off of your age and how close you are to usually it’s age 65. The closer you get to age 65, your account is then going to automatically adjust you from more in stocks to more in bonds and fixed income types of thing the closer you get to that age 65. Whether the markets are up 50%, whether the markets are down 50%, they’re going to automatically put you into those things.
Not saying that target date funds are bad. They do have a purpose, but I think when people understand truly how they are and what they may potentially be giving up or sacrificing during those times, I think it’s an eye-opening thing. So again, understand how that is. And people also at times look at, if we ask them how they are, and they say, “Well, we looked at the report, and this fund was up 15% over the last three years, so I went into that fund.” Well, if that’s the theory, you probably missed the dance on that fund. If it’s already up 15%, the likelihood that it’s going to continue to go up another 15% isn’t as good as technically if you look at a fund that’s maybe down 15%. Maybe that’s the one we maybe want to look at a little more seriously.
John Nelson: Yeah, all important points, and again, nobody has a crystal ball, the answers to all of these items, but spending the time and looking at them and not making just quick elections on a form or online, we spend a lot of time with our clients looking at things like this. It’s important for their long-term success.
Nate Kreinbrink: If you have questions on any of your allocations, and if you’re in the right place, we work with over a hundred different businesses across the area, Quad City, just all over, where we help them with specific 401(k) options. We get their information from their plan and then send you out recommendations that we would maybe look at and adjust it accordingly. But again, you’ve done a great job saving. Over the last couple of years you’ve probably had decent returns on it. We don’t want to give them back. And if we can do some things to eliminate some of that, you’re going to be better off.
Wanted to say real quick before we do run out of time here, is that every Friday NelsonCorp Wealth Management is wearing Jeans for Charity. Money raised in the month of March will be donated to the Glow Walk anti-bullying and suicide prevention event. John, I appreciate you joining me today.
John Nelson: Yeah, you bet. Happy to be here.
Nate Kreinbrink: Again, Nate and John with NelsonCorp Wealth Management, bringing you this week’s Financial Focus. Thanks for tuning in, and have a great rest of your week.
Announcer: Financial Focus is a production of NelsonCorp Wealth Management in Clinton and Davenport. The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representative securities offered through Cambridge Investment Research Incorporated, a broker-dealer, member FINRA, SIPC. Investment advisor representative Cambridge Investment Research Advisors Incorporated, a registered investment advisor. Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. For more information, visit our website at www.nelsoncorp.com.
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