Can I Avoid IRMAA Surcharges on Medicare Part B and Part D?

Contributed by: Nick Defenthaler, CFP®, RICP®

In 2023, Medicare Part B premiums for 95% of Americans will be $164.90/mo. However, the other 5% will have to face what’s known as the Income Related Monthly Adjustment Amount or IRMAA and pay higher Part B and D premiums. Each year, the chart below is updated, and in most cases, premiums increase gradually with inflation, as do the income parameters associated with each premium tier.

Source: Medicare.gov

Receiving communication that you’re subject to IRMAA and facing higher Medicare premiums is never a pleasant notification. With proper planning, however, there are strategies to potentially avoid IRMAA both now and in the future.

But first, let’s do a quick refresher on the basics

Medicare bases your premium on your latest tax return filed with the IRS. For example, when your 2023 Part B and D premiums were determined (likely occurred in October/November 2022), Medicare used your 2021 tax return to track income. If you are married and your Modified Adjusted Gross Income (MAGI) was over $194,000 in 2021 ($97,000 for single filers), you’re paying more for Part B and D premiums aka subject to IRMAA. Unlike how our tax brackets function, Medicare income thresholds are a true cliff. You could be $1 over the $194,000 threshold and that’s all it takes to increase your premiums for the year! As mentioned previously, your Part B and D premiums are based off of your Modified Adjusted Gross Income or MAGI. The calculation for MAGI is slightly different and unique from the typical Adjusted Gross Income (AGI) calculation as MAGI includes certain income “add back” items such as tax-free municipal bond interest. Simply put, while muni bond interest might function as tax-free income on your return, it does get factored into the equation when determining whether or not you’re subject to IRMAA.

Navigating IRMAA with Roth IRA conversion and portfolio income 

Given our historically low tax environment, Roth IRA conversions are as popular as ever. Current tax rates are set to expire in 2026, but this could occur sooner, depending on our political landscape. When a Roth conversion occurs, a client moves money from their Traditional IRA to a Roth IRA for future tax-free growth. When the funds are converted to the Roth, a taxable event occurs, and the funds converted are considered taxable in the year the conversion takes place. Because Roth IRA conversions add to your income for the year, it’s common for the conversion to be the root cause of an IRMAA if proper planning does not occur. What makes this even trickier is the two-year lookback period. So, for clients considering Roth conversions, the magic age to begin being cognizant of the Medicare income thresholds is not at age 65 when Medicare begins, but rather age 63 because it’s that year’s tax return that will ultimately determine your Medicare premiums at age 65! 

Now that there are no “do-overs” with Roth conversions (Roth conversion re-characterizations went away in 2018), our preference in most cases is to do Roth conversions in November or December for clients who are age 63 and older. By that time, we will have a clear picture of total income for the year. I can’t tell you how often we’ve seen situations where clients confidently believe their income will be a certain amount but ends up being much higher due to an unexpected income event.

Another way to navigate IRMAA is by being cognizant of income from after-tax investment/brokerage accounts. Things like capital gains, dividends, interest, etc., all factor into the MAGI calculation previously mentioned. Being intentional with the asset location of accounts can potentially help save thousands in Medicare premiums.

Ways to reduce income to potentially lower part B and D premiums

Qualified Charitable Distribution (QCD) 

• If you’re over 70 ½ and subject to Required Minimum Distributions (RMD), gifting funds from your IRA directly to a charity prevents income from hitting your tax return. This reduction in income could help shield you from IRMAA. 

Contributing to a tax-deductible retirement account such as a 401k, 403b, IRA, SEP-IRA, etc.

• Depositing funds into one of these retirement accounts reduces MAGI and could help prevent IRMAA.

Deferring income into another year 

• Whether it means drawing income from an after-tax investment account for cash flow needs or holding off on selling a stock that would create a capital gain towards year-end, being strategic with the timing of income generation could prove to be wise when navigating IRMAA. 

Accelerating business expenses to reduce income 

• Small business owners who could be facing higher Medicare premiums might consider accelerating expenses in certain years, which in turn drives taxable income lower if they’re flirting with IRMAA. 

Putting IRMAA into perspective 

Higher Medicare premiums are essentially a form of additional tax, which can help us put things into perspective. For example, if a couple decides to do aggressive Roth IRA conversions to maximize the 22% tax bracket and MAGI ends up being $200,000, their federal tax bill will be approximately $30,000. This translates into an effective/average tax rate of 15% ($30,000 / $200,000). However, if you factor in the IRMAA, it will end up being about $1,700 total for the couple between the higher Part B and D premiums. This additional "tax" ends up only pushing the effective tax rate to 15.85% - less than a 1% increase! I highlight this not to trivialize a $1,700 additional cost for the year, as this is real money we're talking about here. That said, I do feel it's appropriate to zoom out a bit and maintain perspective on the big picture. If we forgo savvy planning opportunities to save a bit on Medicare premiums, we could end up costing ourselves much more down the line. However, not taking IRMAA into consideration is also a miss in our opinion. Like anything in investment and financial planning, a balanced approach is prudent when navigating IRMAA – there is never a "one size fits all" solution. 

Fighting back on IRMAA

If you've received notification that your Medicare Part B and D premiums are increasing due to IRMAA, there could be ways to reverse the decision. The most common situation is when a recent retiree starts Medicare and, in the latest tax return on file with the IRS, shows a much higher income level. Retirement is one example of what Medicare would consider a "life-changing event," in which case form SSA-44 can be completed, submitted with supporting documentation, and could lead to lower premiums. Other "life-changing events" would include:

• Marriage

• Divorce

• Death of a spouse 

• Work stoppage

• Work reduction

• Loss of income producing property 

• Loss of pension income 

• Employer settlement payment 

Medicare would not consider higher income in one given year due to a Roth IRA conversion or realizing a large capital gain a life-changing event that would warrant a reduction in premium. This highlights the importance of planning accordingly with these items.

If you disagree with Medicare's decision in determining your premiums, you have the ability to have a right to appeal by filing a "request for reconsideration" using form SSA-561-U2.

Conclusion

As you can see, the topic of IRMAA is enough to make anyone's head spin. To learn more, visit the Social Security Administration's website dedicated to this topic. Prudent planning around your Medicare premiums is just one example of much of the work we do for clients that extends well beyond managing investments that we believe add real value over time. 

If you or someone you care about is struggling with how to put all of these pieces together to achieve a favorable outcome, we are here to help. Our team of CERTIFIED FINANCIAL PLANNER™ professionals offers a complimentary "second opinion meeting" to address your most pressing financial questions and concerns. In many cases, by the end of this 30-45 minute discussion, it will make sense to continue the conversation of possibly working together. Other times, it will not, but our team can assure you that you will hang up the phone walking away with questions answered and a plan moving forward. We look forward to the conversation!

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) I the U.S. which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James.

There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Center for Financial Planning, Inc. Center for Financial Planning, Inc. is not a registered broker/dealer and is independent of Raymond James Financial Services.

Don’t Fall Victim to the Widow’s Penalty!

Contributed by: Nick Defenthaler, CFP®, RICP®

Several years ago, after starting a new relationship with a newly widowed client, I received a confused phone call from her. She had received communication from Medicare that her Part B & D premiums would be significantly increasing for the year. To make matters worse, she also noticed when filing her most recent tax return that she was now in a much higher tax bracket. What happened? Now that her husband was deceased, she was receiving less in Social Security and taking fewer withdrawals from her retirement accounts. Her total income had decreased, so why would she have to pay more tax and Medicare premiums? Unfortunately, she was a victim of what’s known as the “widow’s penalty.”

Less Income and More Taxes – What Gives?

Simply put, the widow’s penalty is when a surviving spouse ends up paying more taxes on less income after the death of their spouse. This happens when a widow or widower starts filing as a single filer the year after their spouse’s death.

When the first spouse dies, the surviving spouse typically sees a reduction in income. While the surviving spouse will continue to receive the greater of the two social security benefits, they will no longer receive the lower benefit. Additionally, they will lose any other income tied only to the deceased spouse, such as employment income, single-life annuity payments, or pensions with reduced or no survivor benefits. Depending on how much income was tied to the deceased spouse, the surviving spouse’s fixed income could see a sizeable decrease.

At the same time, the surviving spouse starts receiving less income, and they find themselves subject to higher taxes.

With some unique exceptions, the surviving spouse is required to start filing taxes as single instead of as married filing jointly in the year following their spouse’s death. In 2023, that means they will hit the 22% bracket at only $44,725 in income. Married filers do not reach the 22% bracket until they have more than $95,375 in income. Unfortunately, even if income remains the same, widowed tax filers will inevitably pay higher tax rates on this same income level. 

Tax brackets are not the only place surviving spouses are penalized. Like the client in my story above, many surviving spouses see their Medicare premiums increase even though their income has decreased because of how the income-related monthly adjusted amount (IRMAA) is calculated (click HERE to visit our dedicated Medicare resource page). Specifically, single filers with a modified adjusted gross income of more than $97,000 are required to pay a surcharge on their Medicare premiums, whereas there is no surcharge until a couple who is married filing jointly reaches $194,000 of income. This means that a couple could have an income of $120,000 and not be subjected to the Medicare IRMAA surcharge, but if the surviving spouse has an income of $100,000, their premium will increase by almost $1,000 per year. In this same example, the widow would now be in the 22% bracket (as compared to the 12% bracket with $120k of income filing jointly) and be paying $3,600 more in federal tax!

Proactive Planning

Short of remarrying, there is no way to avoid the widow’s penalty. However, if your spouse has recently passed away, there may be some steps you can take to minimize your total tax liability.

For most widows, the year their spouse dies will be the last year they will be allowed to use the higher married filing jointly tax brackets. In some cases, it can make sense to strategically realize income during the year of death to minimize the surviving spouse’s lifetime tax bill. A surviving spouse might do this by converting savings from a Traditional IRA to a Roth IRA while they are still subject to the married filing jointly rates.

Several years ago, I was working with a couple (we’ll call them John and Mary), and after several years in a long-term care assisted living facility, John sadly passed away at age 85. Because John and Mary did not have long-term care insurance, they had sizeable out-of-pocket medical expenses that resulted in a significant medical deduction in the year of John’s passing. Several months after her husband’s passing, I met with Mary and suggested we convert over $100,000 from her IRA to a Roth IRA. Because this was the last year she could file jointly on her taxes along with the significant medical deduction that was only present the year John passed, Mary only paid an average tax rate of 10% on the $100,000 we converted. As we stand here today, Mary is now filing single and finds herself in the 24% tax bracket (which will likely increase to 28% in 2026 as our current low tax rates are set to expire at the end of 2025!)

The widow’s penalty should be on every married couple’s radar. While it’s possible that while both spouses are living, their tax rate will always remain the same, as we’ve highlighted above, unless both spouses pass away within a very short period of time from one another, higher taxes and Medicare premiums are likely inevitable. However, proper planning could help to dramatically reduce the impact this penalty could have on your plan.

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Raymond James and its advisers do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Any opinions are those of Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James.

Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment advisory services offered through Center for Financial Planning, Inc. Center for Financial Planning, Inc., is not a registered broker/dealer and is independent of Raymond James Financial Services.

The information contained in this blog has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Maximizing your 401k Contributions: Nuances to Save you Money

Contributed by: Nick Defenthaler, CFP®, RICP®

When starting a career, we are always told to contribute at least the minimum needed to get the full company match in our 401k (typically between 4% and 8%, depending on how your plan is structured). “Never throw away free money!” is a phrase we use quite often with children of clients who are starting that first job out of college.

But what about those who are well established in their career and fully maximizing 401k contributions ($22,500 for 2023, $29,000 if you are over the age of 50)? They should not have to worry about not receiving their full employer match, right? Well, depending on how your 401k plan is structured at work, the answer is yes! 

Let me provide an example to explain what I am referring to:
Let’s say Heather (age 54) earns a salary of $325,000 and elects to contribute 18% of her salary to her 401k. Because Heather has elected to contribute a percentage of her salary to her 401k instead of a set dollar figure, she will max out her contributions ($29,000) by the end of June each year. Let us also assume that Heather receives a 5% employer match on her 401k – this translates into $16,250/yr ($325,000 x 5%). If Heather does not have what is known as a “true up” feature within her plan, her employer will stop making matching contributions on her behalf halfway through the year – the point at which she maxed out for the year and contributions stopped. In this hypothetical example, not having the “true up” feature would cost Heather over $8,000 in matching dollars for the year!

So, how can you ensure you receive the matching dollars you are fully entitled to within your 401k? 
The first step I recommend is reaching out to your benefits director or 401k plan provider and asking them if your plan offers the “true up” feature. If it does, you are in the clear – regardless of when you max out for the year with your contributions, you will be receiving the full company match you are entitled to. 

If your plan does not offer the “true up” feature and you plan on maximizing your 401k contributions for the year, I would strongly suggest electing to defer a dollar amount instead of a percentage of your salary. For example, if you are over 50, plan on contributing $29,000 to your 401k this year, and if you are paid bi-weekly, elect to defer $1,115.38 every pay period ($1,115.38 x 26 pay periods = $29,000). Doing so will ensure you maximize your benefit by the end of December and not end up like Heather, who maxes out by the end of June and potentially loses out on significant matching dollars.  

Subtle nuances such as the “true up” 401k feature exist all around us in financial planning, and they can potentially have a large impact on the long-term success of your overall financial game plan. If you have questions on how to best utilize your employer’s 401k or retirement savings vehicle, please don’t hesitate to reach out to us for guidance. 

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Examples are hypothetical and are not representative of every employer's retirement plan. Not all employers offer matching 401(k) contributions. Please contact your employer's benefits department or retirement plan provider for terms on potential matching contributions.

Any opinions are those of Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc.

Your 1099 Overview

Contributed by: Nick Defenthaler, CFP®, RICP®

Tax season is in full swing, and 1099s are being developed and distributed by Raymond James and other brokerage firms. The two most common accounts clients own are retirement accounts (Roth IRAs, Traditional IRAs, SEP-IRAs, etc.) or after-tax investment/brokerage accounts (Joint brokerage account, individual brokerage account, trust brokerage account, etc.). Because retirement accounts and after-tax accounts are vastly different from a tax perspective, the 1099s that are generated will be much different as well. Let’s review the differences.

Retirement Accounts (Traditional IRAs, Roth IRAs, SEP-IRAs, 401k, 403b, etc.)

Retirement accounts produce what is known as a 1099-R. Yes, you guessed it – the “R” stands for retirement account! Because retirement accounts are tax-deferred vehicles, the IRS only cares about how much was withdrawn from the account and if there was any tax withheld on those distributions (the 1099-R is also accompanied by form 5498, which also shows any contributions to the retirement account). Because of the simplicity and what is captured on this tax form, I commonly refer to a client’s 1099-R as their “retirement account’s W2”. Given the tax-deferred nature of retirement accounts, portfolio income such as dividends, interest, and capital gains are completely irrelevant from a tax reporting standpoint. These income sources also do not play a role within the 1099-R, so far less accounting goes into producing the 1099-R. This means they are released early in the year – typically in late January/early February (around the same time most W2s are produced for those still working). For those over 70 ½ that have chosen to facilitate gifts to charity through their IRA by utilizing the Qualified Charitable Distribution or ‘QCD’ strategy (click here to learn more about QCDs), Raymond James now captures these gifts on the 1099-R to ensure your tax preparer is aware and factors them into your tax return.

After-Tax Investment/Brokerage Accounts (Trust accounts, joint accounts, individual accounts, etc.)

After-tax investment or ‘brokerage accounts’ are very different from retirement accounts regarding tax reporting. Because these accounts are funded with after-tax dollars and not held in a retirement account, there is no tax deferral. This means that income sources such as dividends, interest, and capital gains are taxable to clients each year – the 1099 produced for these accounts captures this data so your tax preparer can accurately complete your tax return each year. Within the 1099 summary, there are three common sections:

• 1099-Div: Reports dividends paid throughout the year

• 1099-Int: Reports interest paid throughout the year

• 1099-B: Reports capital gains or losses generated throughout the year

Unlike retirement accounts that are tax-deferred, dividends, interest, and capital gains/losses play a significant role within the 1099 because they are reportable on your tax return each year. Therefore, a significant amount of accounting from the various investments within your account is required to determine these figures captured on your 1099. Because taxes are not withheld in these accounts if distributions ever occur, withdrawals are not captured on these 1099s as they would be on a 1099-R. Given the extensive accounting that arises to ensure errors are not made on reportable income, the earliest these 1099s become available is typically mid-February. That said, it is quite common for many 1099s to be distributed closer to mid-March. Because of this, I recommend consulting with your tax professional to see if filing a tax extension is appropriate for your situation.

As you can see, there are important differences between these different tax reporting documents. Having a better understanding of each will make your upcoming tax season more manageable. If our team can be of help with your tax forms or any other areas, please feel free to reach out!

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Center for Financial Planning, Inc. Center for Financial Planning, Inc. is not a registered broker/dealer and is independent of Raymond James Financial Services.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Conversions from IRA to Roth may be subject to its own five-year holding period. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals of contributions along with any earnings are permitted. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

Why Retirement Planning is Like Climbing Mount Everest

Contributed by: Nick Defenthaler, CFP®, RICP®

Mount Everest. One of the most beautiful natural wonders in the world. With an elevation of just over 29,000 feet, it's the highest mountain above sea level. As you would expect, climbing Mount Everest is a challenging and dangerous feat. Sadly, over 375 people have lost their lives making the trek. However, one thing that might surprise you is that the vast majority who have died on the mountain didn't pass away while climbing to the top. Believe it or not, the climb down or descent has caused the greatest fatalities. 

Case in point, Eric Arnold was a multiple Mount Everest climber who sadly died in 2016 on one of his climbs. Before he passed, he was interviewed by a local media outlet and was quoted as saying, "two-thirds of the accidents happen on the way down. If you get euphoric and think, 'I have reached my goal,' the most dangerous part is still ahead of you." Eric's quote struck me, and I couldn't help but think of the parallels his words had with retirement planning and how we, as advisers, help serve clients. Let me explain.   

Most of us will work 40+ years, save diligently, and hopefully invest wisely with the guidance of a trusted professional and the goal of retiring and happily living out the 'golden years.' It can be an exhilarating feeling – getting to the end of your career and knowing that you've accumulated sufficient assets to achieve the goals you've set for yourself and your family. However, we can't forget that the climb is only halfway done. We have to continue working together and develop a quality plan to help you on your climb down the mountain as well! When do I take Social Security? Which pension option should I elect? How do I navigate Medicare? Which accounts do I draw from to get me the money I need to live on in the most tax-efficient manner? How should my investment strategy change now that I'll be withdrawing from my portfolio instead of depositing funds? 

Even though you've reached the peak of the mountain – aka retirement - we must recognize that the work is far from over. There are still monumental financial decisions that will be made during the years you aren't working that most of us can't afford to get wrong. Ironically, this is when we find that many folks who have been fantastic "do-it-yourself" investors ultimately reach out to establish a professional relationship, given the magnitude of these ongoing decisions. They are ready for the "descent" and wish to delegate the financial matters in their lives to someone they trust. Our goal as your trusted advisor is to serve as your financial steward and help guide you, so you can focus your well-deserved time and energy in retirement on areas of your life that provide you meaning, fulfillment, and joy. 

As with those who climb Mount Everest, many financial plans that are in good shape when entering retirement can easily be derailed on the descent or when funds start to be withdrawn from your portfolio – aka the "decumulation" phase of retirement planning. A quality financial and investment strategy doesn't end upon retirement – this is when proper planning becomes even more critical, especially during periods of uncertainty and market volatility like we're currently experiencing. Reach out to us if we can help you on the climb – both up and down the mountain.  

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Any opinions are those Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Center for Financial Planning, Inc.

Investing involves risk and you may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Proactive Approaches to Navigate Market Volatility

Contributed by: Nick Defenthaler, CFP®, RICP®

2022 has been like a Michigan highway this year for financial markets – lots of potholes and certainly not a smooth ride to your destination. What makes this year's market volatility so frustrating is that we have seen the bond market struggle alongside equity markets. In most market corrections, bonds have a negative correlation with stocks, which is just a fancy way of saying stocks Zig when bonds Zag – they move in different directions when things get ugly. While this is a general rule of thumb, as we have seen this year, there are periods where stocks and bonds can be down at the same time (click here to learn more and read our latest quarterly Investment Commentary).

A reasonable question that many of our clients have either asked us directly or are likely thinking to themselves is, "what moves should we be making given the current state of the economy and market?". Our firm does not believe in market timing or abandoning an evidence-based investment strategy because of market volatility that we believe comes with being a long-term investor. However, this certainly does not mean that we sit around doing nothing! In addition to making strategic adjustments within your portfolio that align with our current view and outlook for fixed income and equity markets, there are several financial planning concepts we review and consider that have been proven to add value to a client's financial plan over time. Let's dig into what some of those strategies are:

Tax Loss Harvesting 

Intentionally selling positions at a loss within an after-tax investment account (trust account, joint, individual account, etc.) to help offset capital gains generated in the future, or even a portion of your ordinary income, is something we act on frequently for clients during times of market volatility. When loss harvesting is completed, we invest the sale proceeds in a similar fund for 31 days, so you are not "out of the market" and, in many cases, re-purchase the exact positions we sold one month prior. Click here to learn more about this strategy and why it can help improve the most important return for any investor – your AFTER-TAX rate of return! 

Roth IRA Conversions 

Given our historically low tax environment and a strong likelihood that these low rates expire at the end of 2025 (2017 Tax Cuts & Jobs Act), moving funds from Traditional IRAs to Roth IRAs through income acceleration has been a popular strategy over the past five years. Roth IRA conversions become an even more compelling strategy during times of market volatility because you can convert more shares of an investment at the same target dollar amount for the conversion. 

For example, if Joe Client (age 62) plans to convert $30,000 to his Roth IRA in 2022 to maximize the 12% marginal tax bracket, we might consider converting funds of his ABC stock mutual fund. With being currently valued at $10/share, we would be converting 3,000 shares. However, because of recent market volatility, ABC mutual fund's share price has dropped to $8.50/share – down 15%. This means we can still target the same $30,000 conversion to maximize the appropriate tax bracket; however, we can now convert nearly 3,530 shares – 530 more than before the decline in share price. When the market recovers, the "snap back growth" with additional shares will occur completely tax-free within the Roth IRA!

Portfolio Rebalancing 

Buying low and selling high – the cornerstone of almost every investment strategy! At its core, that is really what portfolio rebalancing is all about. When we proactively manage your investments and allocation, your planner and our dedicated in-house investment department are working in tandem, reviewing your plan to ensure your target allocation is always in balance. Thinking back to late March 2020 in the depths of the COVID bear market, a client who had a target portfolio mix of 60% stock, 40% bond was now sitting at roughly 54% stock, 46% bonds because equity markets were down 30+% and many bond funds were up 3-5% for the year. When we hit certain thresholds that made sense for each client's customized financial plan, we sold bonds in positive territory and bought stocks funds that were trading at a deep discount to get the client back to their target allocation of 60% stock, 40% bond. Let's be honest – rebalancing when markets are up where we are trimming profits (which we did a lot of last year, especially in Q4 2021) is a lot easier than selling our safe, more conservative bonds and buying stock when there is fear and uncertainty in markets. That said, in our opinion, a disciplined and intentional rebalancing strategy under EVERY market condition is key to helping you achieve the rate of return necessary to attain your short and long-term financial goals. 

Cash Reserves  

While working, especially in our younger years, it is always a great idea to have at least three months of living expenses set aside as an emergency fund. Having even more in cash (6-24 months) might be advisable, depending on one's career. However, as you enter the wonderful world of retirement, you no longer have to protect against a sudden loss of employment income. If that was a concern, chances are you would not be in a position to retire in the first place! Having adequate cash reserves when you are in "distribution mode" is key. In most years, the S&P 500 will fall 5% or more on three to four separate occasions, and on average, it is common to see a pullback of 14% or more at least once a year. Check out the chart below that JP Morgan updates annually – it is a favorite of mine for a self-proclaimed "financial planning nerd." However, despite those intra-year disruptions, markets typically end the year in positive territory about 75% of the time. 

Think of having adequate cash in your investment accounts to support your monthly or periodic portfolio distributions as your umbrella to keep you dry during a brief rain shower. So how do we do this? What's the strategy? Concepts that we have seen work well for the hundreds of retired clients we have the pleasure of serving are simple yet incredibly effective:

• Having dividends, interest, and capital gain distributions pay to cash instead of being re-invested – we consider this our "dry powder."

• Portfolio rebalancing – as noted above, trimming profits or areas of your investments that have become overweight are naturally good ways to rebuild your cash bucket to help support your retirement income needs.

Helping to construct and navigate your financial plan is truly our passion. Thank you for your continued trust and confidence in our team. We are grateful to be part of your financial team!

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability. Conversions from IRA to Roth may be subject to its own five-year holding period. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals of contributions along with any earnings are permitted. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion. Matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor for more information. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability.

Is My Pension Subject to Michigan Income Tax?

Contributed by: Nick Defenthaler, CFP®, RICP®

It is hard to believe, but it has been ten years since former Michigan Governor Rick Snyder signed his budget balancing plan into law, which became effective in 2012. As a result, Michigan joined the majority of states in the country in taxing pension and retirement account income (401k, 403b, IRA, distributions) at the state income tax rate of 4.25%. 

As a refresher, here are the different age categories that will determine the taxability of your pension:

1) IF YOU WERE BORN BEFORE 1946:

• Benefits are exempt from Michigan state tax up to $54,404 if filing single, or $108,808 if married filing jointly.

2) IF YOU WERE BORN BETWEEN 1946 AND 1952:

• Benefits are exempt from Michigan state tax up to $20,000 if filing single, or $40,000 if married filing jointly.

3) IF YOU WERE BORN AFTER 1952:

• Benefits are fully taxable in Michigan.

What happens when spouses have birth years in different age categories? Great question! The state has offered favorable treatment in this situation and uses the oldest spouse’s birthdate to determine the applicable age category. For example, if Mark (age 69, born in 1953) and Tina (age 74, born in 1948) have combined pension and IRA income of $60,000, only $20,000 of it will be subject to Michigan state income tax ($60,000 – $40,000). Tina’s birth year of 1948 is used to determine the applicable exemption amount – in this case, $40,000 because they file their taxes jointly. 

Taxing retirement benefits has been a controversial topic in Michigan. As we sit here today, Governor Whitmer is advocating for a repeal of taxing retirees – however, no formal proposal has been released at this time. The following states are the only ones that do not tax retirement income (most of which do not carry any state tax at all) – Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, Illinois, Mississippi, Pennsylvania, and Wyoming. Also, Michigan is one of 37 states that still does not tax Social Security benefits.

Here is a neat look at how the various states across the country match up against one another when it comes to the various forms of taxation:

Source: www.michigan.gov/taxes

Taxes, both federal and state, play a major role in one’s overall retirement income planning strategy. In many cases, there are strategies that could potentially reduce your overall tax bill by being strategic on which accounts you draw from in retirement or how you choose to turn on various forms of fixed retirement income. If you would like to dig into your situation to see if there are planning opportunities you should be taking advantage of, please reach out to us for guidance or a second opinion.

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Reviewing your Social Security Benefit Statement

Contributed by: Nick Defenthaler, CFP®, RICP®

According to the Social Security Administration, on average, Social Security will replace about 40% of one’s pre‐retirement earnings. Given the diligent savings and consistently wise financial decisions many of our clients at The Center have made over the years, this percentage might not be quite as high. However, in our experience, Social Security is still a vital component of one’s retirement plan. Let’s review some of the important aspects of benefit statements to ensure you’re feeling confident about your future retirement income.

History of Mailed Statements

In 1999, the Social Security Administration (SSA) began mailing paper copies of Social Security statements to most American workers. Since that time, through several budget reduction initiatives, this process has dramatically changed. As we stand here today, no worker under the age of 60 receives a projected benefit statement by mail. Only those who receive statements by mail are both 60 and older and have not yet registered for an online SSA account.

Online Access – The “my Social Security” Platform

I have to hand it to Social Security – they’ve done a fantastic job, in my opinion, by creating a very user-friendly and easy‐to‐follow online platform to view benefit statements and projections. To create a user account or to sign in to your existing account, click here. If you have not set your account up and wish to do so, you’ll be prompted to provide some basic personal identifiable information such as your name, Social Security number, date of birth, address, e‐mail address, etc. The SSA has also made several great cyber security improvements, including dual‐factor authentication and a photo of a state‐issued photo ID, such as a driver’s license, to verify identification. This is similar to a mobile check deposit that many banks now offer on a smartphone.

Interpreting your Projected Future Income

Benefit projections at various ages can be found on page 2 of your Social Security statement. As you’ve likely heard your advisor share in the past, each year you delay benefits, you’ll see close to an 8% permanent increase on your income stream. Considering our low‐interest‐rate environment and historically high cost of retirement income, this guaranteed increase is highly attractive. It’s important to note that estimated benefits are shown on your statement in today’s dollars and do not take inflation into account. That said, the latest 2020 annual reports from SSA and Medicare Boards of Trustees use 2.4% as an expected future annual inflation amount. Click here to learn more about the sizeable cost of living adjustment in 2022 for those currently receiving Social Security. You should also be aware that Social Security assumes your current earnings continue until “retirement age,” which is not necessarily the same as “full retirement age.” This can potentially be a significant issue for those retiring earlier (i.e., before age 60 in most cases). Click here to learn more about how your income benefits are determined.

Earnings History and Fixing Errors

Page 3 of your Social Security statement details the earnings that the SSA has on file for each year since an individual began working. Believe it or not, SSA does make mistakes! Our team makes it a best practice to review a client’s earnings history on the statement to see if there are any significant outlier years. In most cases, there’s a good reason for an outlier year with income, but it’s simply an error in others. If you do notice an error with your earnings that needs to be fixed to ensure it does not negatively impact your future Social Security benefit, you have a few options. Once supporting documentation is gathered (i.e., old tax returns, W2s, etc.), you can contact the SSA by phone (800‐722‐1213), visit a local SSA office, or complete Form SSA-7008.

Believe it or not, in some circumstances depending on filing strategies, one can generate as much as $1M in total lifetime benefits from Social Security! If you have yet to file, however, there’s a good chance it’s been a bit since you’ve reviewed your benefit statement. If our team can help interpret your benefit statements, please feel free to reach out. The stakes are too high with Social Security, and we are here to help you in any way we can!

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Nick Defenthaler, CFP®, RICP®, and not necessarily those of Raymond James. Every Investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment, Prior to making an investment decision, please consult with your financial advisor about your individual situation.

How The Historically High Cost Of Retirement Income Affects Your Financial Plan

Contributed by: Nick Defenthaler, CFP®, RICP®

Now more than ever, we find ourselves reminiscing. And if you’re like me, it’s usually about the simple things in life that were so easy to take for granted. Like going out to eat with a large group of friends, having a surprise birthday party for a loved one, or attending a sporting event or concert with a packed arena filled with 30,000 fans having a great time. COVID has caused this reminiscing to occur and it has also played a role in reminiscing of a world where investors used to receive a reasonable yield on portfolios for a relatively low level of risk.

Interest rates have been on a steady decline for several decades now, so COVID certainly isn’t the only culprit to blame here. That said, reductions in interest rates by the Federal Reserve when the pandemic occurred in spring 2020, certainly did not help. As an advisor who typically works with clients who are within 5 years of retirement or currently retired, it’s common to hear comments like, “When we’re drawing funds from our accounts, we can just live off of the interest which should be at least 4% - 5%!”. Given historical dividend and bond yield averages and the fact that if we go back to the late 90s, an investor could purchase a 10 year US treasury bond yielding roughly 7% (essentially risk-free being that the debt was backed by the US government), I can absolutely see why those who lived through this time frame and likely saw their parents living off this level of interest would make these sort of comments. The sad reality is this – the good old days of living off portfolio interest and yield are pretty much dead right now (unless of course, you have a very low portfolio withdrawal rate) and it will likely remain this way for an extended period.

One way to look at this is that the average, historical “cost” to generate $1,000 of annual income from a 50% stock, 50% bond balanced portfolio has been approximately $25,000 (translates into an average yield of 4%). Today, an investor utilizing the same balanced portfolio must invest $80,000 to achieve the $1,000 annual income goal. This is a 320% increase in the “cost” of creating portfolio income!  

It’s worth noting that this is not an issue unique to the United States. The rising cost of portfolio income is a global conundrum as many countries are currently navigating negative interest rate environments (ex. Switzerland, Denmark and Japan). Click here to learn more about what this actually means and how negative interest rates affect investors. Below is a chart showing the history of the 10-year US government bond and US large cap equities from 1870 to 2020.

Source: Robert Shiller http://www.econ.yale.edu/~shiller/

The chart is a powerful visual and highlights how yields on financial assets have taken a nosedive, especially since the 1980s. The average bond yield over 150 years has been 4.5% and the average dividend yield has been 4.1%. As of December 2020, bond yields were at 0.9% and dividend yields stood at 1.6% - quite the difference from the historical average!

So why this dramatic reduction in yields? It’s a phenomenon likely caused by several factors that we could spend several hours talking about. Some experts suggest that companies have increasingly used stock repurchases to return money to shareholders which coupled with high equity valuations have decreased dividend yields globally. Bond yields have plummeted, in part from a flight to safety following the onset of the pandemic as well as the Federal Reserve’s asset purchasing program and reduction of rates that has been a decade-long trend.

The good news is that a low-interest rate environment has been favorable for stocks as many investors (especially large institutional endowments and hedge funds) are realizing that bonds yields and returns will not satisfy the return requirements for their clients which has led to more capital flowing into the equity markets, therefore, creating a tailwind for equities.

Investors must be cautious when “stretching for yield”, especially retirees in distribution mode. Lower quality, high yield bonds offer the yields they do for a reason – they carry significantly more risk than government and high quality corporate and mortgage-backed bonds. In fact, many “junk bonds” that offer much higher yields, typically have a very similar correlation to stocks which means that these bonds will not offer anywhere near the downside protection that high quality bonds will during bear markets and times of volatility. In 2020, it was not uncommon to see many well-respected high yield bond mutual funds down close to 25% amid the brief bear market we experienced. That said, many of these positions ended the year in positive territory but the ride along the way was a very bumpy one, especially for a bond holding!

The reality is simple – investors who wish to generate historical average yields in their portfolio must take on significantly more risk to do so. It’s also important to note that higher yields do not necessarily translate into higher returns. US large cap value stocks are a perfect example of this. Value stocks, which historically have outperformed growth stocks dating back to the 1920s, have underperformed growth stocks in a meaningful way over the last 5 years. This underperformance is actually part of a longer trend that has extended nearly 20 years. Value companies (think Warren Buffet style of investing) will pay dividends, but if stock price appreciation is muted, the total return for the stock will suffer. Some would argue that the underperformance has been partially caused by investors seeking yield thus causing many dividend-paying value companies to become overbought. In many cases, the risk to reward of “stretching for yield” just isn’t there right now for investors, especially for those in the distribution phase. It simply would not be prudent to meaningfully increase the risk of a client’s allocation for a slight increase in income generated from the portfolio.

As we’ve had to do so much over the past year with COVID, it’s important for investors, especially retirees, to shift their expectations and mindset when it comes to portfolio income. Viewing one’s principal as untouchable and believing yield and income will be sufficient in most cases to support spending in retirement is a mistake, in my opinion. Maximizing total return (price appreciation and income) with an appropriate level of risk will be even more critical in our new normal of low rates that, unfortunately, has no sign of leaving anytime soon.

Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

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Views expressed are not necessarily those of Raymond James and are subject to change without notice. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.

How Much Guaranteed Income Should You Have In Retirement?

Contributed by: Nick Defenthaler, CFP®, RICP®

How much guaranteed income (we’re talking Social Security, pension, and annuity income) should you have in retirement? I am frequently asked this by clients who are nearing or entering retirement AND are seeking our guidance on how to create not only a tax-efficient but well-diversified retirement paycheck. 

“The 50% Rule”

Although every situation is unique, in most cases, we want to see roughly 50% or more of a retiree’s spending need satisfied by fixed income. For example, if your goal is to spend $140,000 before-tax (gross) in retirement, ideally, we’d want to see roughly $70,000 or more come from a combination of Social Security, pension, or an annuity income stream. Reason being, this generally means less reliance on the portfolio for your spending needs. Of course, the withdrawal rate on your portfolio will also come into play when determining if your spending goal would be sustainable throughout retirement. To learn more about our thoughts on the “4% rule” and sequence of return risk, click here.  

Below is an illustration we use frequently with clients to help show where their retirement paycheck will be coming from. The chart also displays the portfolio withdrawal rate to give clients an idea if their desired spending level is realistic or not over the long-term.

Cash Targets

Once we have an idea of what is required to come from your actual portfolio to supplement your spending goal, we’ll typically leave 6 – 12 months (or more depending of course on someone’s risk tolerance) of cash on the “sidelines” to ensure the safety of your short-term cash needs. Believe it or not, since 1980, the average intra-year market decline for the S&P 500 has been 13.8%. Over those 40 years, however, 30 (75% of the time) have ended the year in positive territory:

Market declines are imminent and we want to plan ahead to help mitigate their potential impact. By having cash available at all times for your spending needs, it allows you to still receive income from your portfolio while giving it time to “heal” and recover – something that typically occurs within a 12-month time frame.

A real-world example of this is a client situation that occurred in late March 2020 when the market was going through its bottoming process due to COVID. I received a phone call from a couple who had an unforeseen long-term care event occur which required a one-time distribution that was close to 8% of their entire portfolio. At the time, the stock portion of their accounts was down north of 30% but thankfully, due to their 50% weighting in bonds, their total portfolio was down roughly 17% (still very painful considering the conservative allocation, however). We collectively decided to draw the income need entirely from several of the bond funds that were actually in positive territory at the time. While this did skew their overall allocation a bit and positioned them closer to 58% stock, 42% bond, we did not want to sell any of the equity funds that had been beaten up so badly. This proved to be a winning strategy as the equity funds we held off on selling ended the year up over 15%.  

As you begin the home stretch of your working career, it’s very important to begin dialing in on what you’re actually spending now, compared to what you’d like to spend in retirement.  Sometimes the numbers are very close and oftentimes, they are quite different.  As clients approach retirement, we work together to help determine this magic number and provide analysis on whether or not the spending goal is sustainable over the long-term.  From there, it’s our job to help re-create a retirement paycheck for you that meets your own unique goals.  Don’t hesitate to reach out if we can ever offer a first or second opinion on the best way to create your own retirement paycheck.

Nick Defenthaler, CFP®, RICP® is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.

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Opinions expressed are those of the author but not necessarily those of Raymond James, and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Charts in this article are for illustration purposes only.