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Here are some of the highlights from the AICPA’s ENGAGE conference in Las Vegas, which will help you provide more value to your planning clients.

There are almost more “tribes” of financial planners in this world than you can count: NAPFA, FPA, CFA, Nazrudin, Retreat, dually-registered, wirehouse—but none of them are quite like the CPA planners who gather every year at the ENGAGE conference in Las Vegas.  Unlike advisors at other conferences, you tend to overhear ENGAGE attendees amiably conversing in a language all their own, using terms like QCDs, Roth conversions, SALT deduction caps, upstream planning and QPRTs. 

The various planning-related presentations tend to be heavily tilted toward technical tax and estate planning issues, or else they delve into planning areas where the numbers can get complicated, like asset location or taking steps to keep required minimum IRA distributions below certain tax thresholds. 

This year was no different.  And as one navigates the detailed presentations on Section 199A deductions and IRA distribution planning, the most accessible way to get the best thinking of the CPA planner crowd are the panel discussions, where each expert is asked to describe his or her best ideas—that is, the most powerful strategies they’re applying for the benefit of their clients. 

This year ENGAGE included three of these sessions.

Let’s start with the “Best Ideas” panel, moderated, according to longstanding tradition, by Lyle Benson, of LK Benson & Co. in Towson, MD.  This year’s expert lineup included Ted Sarenski of  Blue Ocean Strategic Capital in Syracuse, NY; Julie Welch of Meara Welch Brown in Leawood, KS; and Steve Siegel of The Siegel Group in Morristown, NJ. 

Welch and Sarenski started the discussion by offering their views on multi-year tax planning, and strategies to keep their clients’ future required minimum IRA distributions (RMDs) below the highest tax rates (and meanwhile also reducing the tax bite on Social Security benefits).  These “down-the-road tax reduction” strategies are counterintuitive for many clients, because it requires them to voluntarily pay more taxes today than they have to.

The simplest situation is where clients have retired several years before age 70 1/2, when their RMDs begin.  During those interim years they can use their taxable account to pay living expenses, essentially bringing their taxable income down close to zero.  Instead of celebrating a string of zero federal tax years, the panelists recommend that their clients do a series of partial Roth conversions, gradually whittling down the size of their traditional IRAs while filling up the 22% or (sometimes) the 24% tax bracket.  The bargain is that they can get ordinary income out of the IRA accounts at near-capital gains tax rates.

Siegel added that some clients might have legitimate itemized deductions, like mortgage interest, contributions to charity or they can take bonus depreciation on equipment investments in a pass-through entity, which would allow for even larger Roth conversions to fit under the 22% bracket.  He also told the audience, referencing the new Section 199A qualified business income deduction for pass-through entities, that some business owners might want to use Roth conversions to raise their taxable income in low-income years so they can take full advantage of the 199A deduction. 

“It won’t apply to everybody,” he told the group, “but for some clients you can use your 20% qualified business income deduction to pay for a significant portion of the income tax on your Roth IRA conversions.”

One additional benefit to Roth conversions: There was a lot of talk about the SECURE Act passed by the U.S. House of Representatives right before the conference—most notably a provision where inherited IRAs would have to be distributed to the heirs within ten years, rather than the stretch-out arrangements under current law.  For people with large IRAs (which includes many planning clients), the heirs could end up with a substantial tax bill when those assets come out.  But if they inherit Roth IRA assets, the money comes out tax free.  Effectively, the parents are paying the (ordinary income) taxes on behalf of their kids, and if these are partial conversions, they’re reducing the distribution amounts from the inherited traditional IRA, and hopefully keeping the kids out of the highest tax brackets.

Switching topics, Benson asked the panelists how they were helping clients navigate the $10,000 limitation on deducting state and local taxes (SALT) and the higher standard deduction.  Welch admitted that a lot fewer people are itemizing their deductions under the current law, so she’s having clients group several years worth of charitable contributions into a single year to get over the threshold and get a deduction for their contributions. 

Sarenski said he’s encouraged several of his clients to make substantial charitable gifts of highly-appreciated stock.  “You avoid the 20% capital gains tax and most of the time 3.8% on top of that,” he said.  “And if you contribute those assets to a charitable remainder trust, you can get a tax deduction and create an income for life.”

Meanwhile, Welch is having some of her clients, who don’t need their RMDs for living expenses, make qualified charitable distributions (QCDs).  The required distribution amount comes directly out of the IRA to a charity, and never shows up on the client’s tax return.  The net result is to give the client back his/her charitable deduction for the contribution, which might otherwise have been compromised due to the higher standard deduction.

The topic shifted to estate planning, and Benson noted that a lot fewer clients are worried about paying federal estate taxes these days, now that the exemption is $11.4 million per individual, $22.8 million for couples.  Siegel said that for clients below these thresholds, his focus has shifted from minimizing estate taxes to getting the maximum step-up in basis (to fair market value) on appreciated property at the death of a client. 

“With elderly clients, we’re counseling them not to make gifts of low basis assets to their children, who would then get the donor’s basis as their basis,” he said.  “We say to them: hang onto those assets until you pass and allow your heirs to get a stepped-up basis for your appreciated assets.  If you want to make gifts, we’ll look over your portfolio and you can give away something with a higher basis.”

Then he offered another strategy, known as upstream planning.  The client owns highly-appreciated assets, which can be (this is counterintuitive) gifted to the elderly parents or grandparents, with the understanding that the client will inherit those assets back at their death.  “If they live beyond one year, and the assets are included in the estate, and are given back to the donor,” said Siegel, “the donor gets a stepped-up basis.”

What if the parents or grandparents don’t live a full year after receiving the gift?  If the asset passes back to the donor, Internal Revenue code Section 1014(e) forbids the donor from getting the step-up in basis.  So Siegel would have the parents/grandparents sign a document that says, “if I have received an asset from my child during my lifetime, and if I held that asset for more than a year, I hereby give it back to my child.  However, if I survive for less than one year, it passes to my grandchild.” 

Since the grandchild is not the donor, Siegel believes that the grandchild would get the step-up in basis.

Siegel recommended that advisors in the audience talk to their clients and their prospective heirs about larger assets.  He gave the example of a personal residence.  You talk with the kids about what they plan to do if they inherit the residence.  If they plan to sell it, then that asset should pass on and get the step-up in basis.  But a vacation home on the beach or a resort area might be a different story.  The kids might want to keep that as their vacation spot, and it could stay in the family for four or five generations. 

“In that case, you can put the vacation home in a QPRT [qualified personal residence trust] or some more sophisticated planning tool,” said Siegel, “where the basis is carried over for four or five generations, and who cares?  You’re not selling it anyway.”

Siegel also has a wary eye on the sunset provisions of the 2018 Tax Cuts and Jobs Act, and on the prevailing political winds.  What happens in nine years when the federal estate tax exemption comes back to the 2017 number indexed for inflation—which might be around $6 million?  He noted that Democratic candidates want to drop the exemption back down to $3.5 million.  “Today, while clients have this large exemption,” said Siegel, “they might be thinking about use it or lose it, about ways to make gifts, transfer assets and take advantage of the large exemption before it goes away.”

Switching topics again, Welch and Siegel said that when they counsel divorcing clients, they pay attention to the cost basis of the assets that are being divided.  The goal is to prevent the spouse they represent from receiving assets that have a low basis (and therefore Uncle Sam owns a higher percentage of it), while the other spouse walks away with assets that may have the same appraised value, but a higher basis. 

Retirement assumptions

Another panel discussion addressed the key assumptions that expert advisors are making around client retirement issues.  The panel included Sarenski, alongside Scott Sprinkle of Sprinkle Financial Consultants in Littleton, CO; Brooke Salvini of Salvini Financial Planning in Avila Beach, CA; Michael Goodman of Wealthstream Advisors in New York, NY: and Mark Astrinos of Libra Wealth in San Francisco. 

The first part of the panel discussion revolved around the tendency of CPAs to focus on the numbers.  The panelists recommended that advisors first step back and help clients define what they plan to do in retirement.  Sprinkle accomplishes this by pulling out a blank calendar and asking clients what they plan to do each day of the week.  If all the client can come up with is “play golf,” then more thinking may be required. 

Sarenski said that advisors should prepare for a husband and wife having very different visions about their retirement—which they may not have shared with each other.  “I’ve had cases where the husband says: I’ve been on the road all the time.  I’m sick of traveling.  I don’t want to do it any more.  While the wife says: I’ve stayed home, raised the children and had my career locally, but I never got out of town.  He doesn’t like to travel; she does.”

What to do?  “As a CPA, I always had the answers,” said Sarenski.  “As a financial planner, all I have is questions.”  You might ask about spending time together in vacation locations, or planning a trip with the children or grandchildren. 

Astrinos works with younger entrepreneurs who might retire and then pick up another career.  “I ask a lot of questions about what their ideal day is, where they ideally would want to live, and get into deep discovery,” he said.  One example is a couple in their 30s who always wanted to live abroad.  With Astrinos’s help, they’re living in Italy for three months this summer, and the husband is working remotely.  “It’s their dream come true, and I’m helping them do it,” Astrinos said.

Goodman warned that younger retirees can be complicated, because they may not realize how much savings they’ll need to cover a very long retirement.  “I try not to use the word ‘retirement;’” he said.  “I talk about being ‘unemployed’ for that period, because it really does change their mindset about the psychology of having enough money to be unemployed for that long.”

Other younger clients, he added, want to work full-on for several years, take a break, work again and then take another break.  “That makes it very difficult, from an assumption standpoint, trying to run projections for these folks,” said Goodman.  “And some of them haven’t yet lived through a time of market stress.”

Should clients work in retirement?  Goodman said that he encourages his clients to stay active, whether it be earning an income or supporting causes.  “If they have a job that they don’t like or are forced to retire,” he added, “I will emphasize that they don’t need to replace their former income.  Even 25% of their income does wonderful things for their projections.”  As an example: a neurosurgeon client was unhappy with his stressful job situation.  He quit, went back to school for year and emerged as a radiologist, which he enjoys despite the lower salary.

Salvini said that the key is that clients get to the point where they have the choice of whether to work or not.  “I’ve found that my clients are working longer than they originally thought,” she said, “now that they know they have the freedom to retire whenever they want.”

What return assumptions are the panelists using in their planning software?  Here, the conversation moved a bit outside the box.  Sprinkle said that the real issue is not the rate of return; it’s the sequence of returns.  A 7% return on stocks over a 30-year retirement looks very different if there are some very bad years at the start and the best years are at the end, than if the sequence is reversed.  “I think we’re too busy with software and looking at rates of return,” he said.  “When you retire, sequence really controls how successful your retirement is going to be, and how aggressive you can be in your drawdowns, and what type of reserves you need.”

Goodman pays less attention to projected rates of return than to the REQUIRED rate of return; that is, what the client needs to get from the markets in order to enjoy a comfortable retirement.  “What’s the lowest rate of return that will work in their plan?” he asked.  “I’ll say: if we only earned 4% a year, your plan will work.  How does that feel?  Does that change your mindset about risk?”

Salvini said that some clients will raise their risk tolerance even though their required return is low, because they’re determined to leave a legacy.  “Then we start thinking multi-family and across multiple lifespans,” she said.  “It gets to be a lot more interesting calculation and intellectual exercise than just: what is the return going to be over the next 20 years?”

Another assumption: how long are the panelists assuming that clients will live?  Sarenski’s default assumption is that at least one spouse will live to age 95. 

Why?  “Whenever I do talks on Social Security,” he said, “I cite the statistics that if a couple has made it to age 65, there is a 50% chance that one of the two will make it to age 95.”  If the client is obese and a heavy smoker, Sarenski might lower that estimate, while some 65-year-old clients will talk about their parents living happily in their 90s.  “For those, we might carry it out to 100 or 105,” Sarenski said.

Salvini’s default estimate is 100, and Sprinkle pointed out that with medical advances, it’s conceivable that younger clients today could live to 115.

Astrinos pointed out that the longer lifespan assumptions can put a lot of stress on a plan, because he (and, indeed, the entire panel) use a higher-than-current inflation rate assumption, making the living expenses much higher in those last 10 years of an extended life.  Then you add the possibility of long-term care and added healthcare expenditures, which creates a lot of back-end (inflated) costs that would have to be met.

All of this is dancing around the obvious question: what are the panelists assuming that clients can take out of their portfolios, safely, each year in retirement?  This has long been defined by the Bengen studies, which show that 4% (or 4.5% for a diversified portfolio) of the initial portfolio, adjusted with inflation thereafter, is a safe withdrawal rate.

Salvini said that she might use the 4% rule as a guidepost, but her first priority is to help clients reduce or manage their fixed expenses, putting as much of their spending as possible into the discretionary category.  “That allows them to be much more flexible in a market downturn,” she said.

Goodman added that his clients seldom live in a linear world; some years they travel, they have to replace cars every few years, and he said that some of the most erratic balance sheet items are gifts or expenditures on behalf of grandchildren.  His solution is to estimate fixed expenses, and then model the more discretionary expenditures, expecting that there will be regular re-evaluations of the client’s financial condition.

Sprinkle has a unique way of modeling discretionary expenses; he has clients set up an annual “fun bucket” of money that they can spend any way they want to.  Sarenski noted that these discretionary expenditures might be higher in the early years of retirement, and taper off in the later years. 

Instead of relying on the 4% rule, Sarenski creates portfolios with five years of safe investments.  If the market goes down in those critical early years, then the client can liquidate the short-term bonds in the portfolio for living expenses, and not have to sell equities at a loss.  If the markets go up, then some of the money in stocks can be taken off the table to replenish the safe investments in the portfolio.

Astrinos has encountered a problem that many advisors will recognize: clients whose portfolios are large enough that they can retire comfortably, but they have trouble breaking a lifetime habit of saving.  “With some clients, I’ve found that the same philosophy that allowed them to become very wealthy is the mentality that does not allow them to enjoy life,” he said.  “I try to help them think about things that would be enjoyable for them,” Astrinos added.  “Is it creating a family trip?  Is it having experiences that they would enjoy?” 

Sprinkle told of one such client who finally decided to contribute a generous amount to 529 plans for his grandchildren.  “It was the most successful thing I have ever seen,” he said.  “He didn’t create trust babies; he created college graduates.”

How much should you assume that clients will have to pay in medical expenses during retirement?  Sarenski starts with the Medicare costs: at least $135.50 per person for Part B, another $35 per person for Part D coverage.  Then he asks if the clients are taking expensive medications.  This could add $5,100 each in out-of-pocket costs.  Of course, if clients are making more than $170,000 in joint income (yet another reason to reduce RMDs) then Part B costs could be triple that amount.

“For the less-wealthy client,” said Sarenski, “they could be looking at $19,000 a year in base costs, and that doesn’t count eyeglasses or their hearing aids.”

What about long-term care costs?  Astrinos assumes roughly $80,000 a year for the last two years of his clients’ lives, and then talks to them about long-term care coverage.  “If they have equity in their house, then that could be part of the long-term care plan,” he added.

Salvini uses a more gradual approach; she looks at when the client might need more housework help, or help with the gardens, more money for Task Rabbit, and later fitting the house with guard rails and a ramp instead of front steps.  Her goal is to add help gradually as needed, so clients can settle into their homes when they’re more dependent on home care.

The insurance question can be complicated; many clients are afraid of spending money on something that they might never use.  “When I talk with clients, I’ll reframe that objection,” said Sarenski.  “I’ll say, you buy homeowner’s insurance. When you drive home from work at night, do you hope your house is burning, so you can use the coverage?  Do you hope you have a major accident on that trip so you can use your auto insurance?  Then he’ll point to the $5,000 a year cost for a client with a $2 million portfolio.  “I’ll tell them that this represents four tenths of one percent to protect their $2 million,” Sarenski told the audience.  “That helps them think of it a little differently: I am spending my money now to protect my assets.”

But clients may not even have to spend that.  Sarenski said that it is not unusual for clients to come into his office, retired or near retirement, with a collection of cash value life insurance policies that they’ve picked up over the years from brothers-in-law and neighbors who happened to be insurance agents. 

“Now that they’re retiring, there’s no need for that coverage,” said Sarenski.   “So we do a 1035 exchange, take that cash value and turn it into other types of insurance with a long-term care rider.”

The subject turned to something that came up in the “best ideas” panel: smoothing out income (and tax rates) by taking early IRA withdrawals or doing Roth conversions.  “Taxes are on relative discounts right now,” said Astrinos.  “So this is an opportunity for clients who are in that window [between retirement and RMDs] to do things like conversions and IRA distributions.

Sprinkle added that if the SECURE Act is ever passed by the Senate in its present form, that window will be a bit longer: the first RMD wouldn’t have to come out until age 72.

Goodman is also using that window to reset the cost basis of highly-appreciated assets, selling now, taking the capital gains hit at relatively low tax rates, then buying the asset back again in client portfolios.  “It’s a great way to get out of some legacy stock positions,” he said.  “And your taxable portfolio becomes almost untaxable later in retirement.”

Astrinos is having some of his clients gift appreciated assets to kids who are beyond the kiddie tax age.  “Maybe they’re going to graduate school, they need to pay for tuition, they have very low income,” he said.  “They can sell the assets and pay no capital gains tax.  It’s one of the more interesting planning ideas that I’ve done recently.”

Portfolio management in retirement

The third panel at ENGAGE featured Michael Kitces (“Nerd’s Eye View”), plus Wade Pfau and Michael Finke, both on the faculty of the American College.  Somebody on Twitter described it as “a Mt. Rushmore of financial planning research.”  The topic was “best retirement ideas.”

The discussion started with the panelists’ recommendations for taking Social Security benefits: wait until age 70 or take the benefits early.  Kitces said that his default advice is wait, because the benefit increases by 8% a year from 66 to 70.  “Depending on your assumptions about interest rates and growth rates, your break-even is somewhere in your mid-80s,” he said.  “For married couples, the higher payment for you also becomes a higher payment for your spouse as a survivor benefit.”

But the recommendations can get messy for couples.  Kitces will have the higher-earning spouse delay to 70, but the other spouse can take benefits as early as possible, and then switch over to survivor benefits.  “Delaying the lower earner only wins as long as both of them are simultaneously alive, which is not an odds-on bet, actuarially,” he said.

Finke said that the odds of coming out ahead by waiting until age 70 are actually greater for typical financial planning clients, who are wealthier and have better access to a healthy lifestyle and health care.  “Higher-earning Americans live longer,” he said, “which means that their mortality table looks different than the mortality that is used to calculate the bonus that people get for deferring Social Security.”

Finke addressed the common client concern that Social Security will go bankrupt, or that Congress will means-test the benefits and reduce or eliminate them for people who can afford retirement on their own.  He said that he believes Congress will come up with a solution between now and 2035, when the Social Security trust fund is due to be depleted.

And even if it IS depleted, that doesn’t mean the end of Social Security benefits.  Pfau pointed out that the Social Security Administration’s calculations show that even if nothing is done, the money still being paid in by existing workers will be enough to pay for 75% of current benefits.  “Social Security won’t disappear entirely,” he told the audience.  As to means testing, Pfau expects that the benefits will not be taken away entirely—and right now the various Congressional proposals for fixing the system aren’t focusing on means-testing solutions.

Kitces added that the current proposal in Congress would raise the current 12.4% Social Security tax to 15.2%, which would fix solvency for another 100 years.  “Across the entire wage base of the entire economy, that is not a trivial economic impact,” he admitted.  “But we’re not talking about a world where we need to confiscate the benefits from the top 50% of earners or drive tax rates up to 50%.  We are literally talking about less than three percentage points.”

Like the previous panel, this panel addressed the 4% safe distribution rate—but from a slightly different angle.  Pfau noted that his research has shown that the 4% rule has worked 100% of the time in the U.S. over the last century, but only 68% around the world.  He worries about current conditions here in the U.S. 

“Interest rates are lower than they have been except in the early 1940s, and stock market valuations are higher than they ever have been in the statistical data,” he said.  We have never had such high valuations and low interest rates at the same time.  And,” Pfau added, “the 4% rule assumes that investors earn index market returns, so there are no investment fees, no advisory fees, no client misbehavior, and the investor is always rebalancing when they are supposed to every year.”

Finke is just as worried about the 4% assumption, but for different reasons.  “If you look at changes in longevity over the last 20 years,” he said, “men who were in the top 10% of income have gained six years in longevity.  Bengen,” he added, “made the assumption that the maximum time horizon was 30 years in retirement.  But that may not be true any more.”

And the sequence of returns matters too.  Finke said that he and Pfau looked at the safety of the 4% rule for a client who has a negative 30% return on a balanced portfolio in the first year of retirement—pretty close to the 2008 experience.  “If that happens, then their probability of success goes from 95% to something close to 48%,” he said.

Kitces was less gloomy.  He pointed out that most clients have more diversified portfolios than the 50/50 allocation in the Bengen research, which raises average annual returns a bit.    “I think it’s helpful to remember that the 4% number survived through some horrifically bad historical scenarios,” he added.  “The 4% rule works if you retired in 1929, and experienced an 89% drop, peak to trough, in your first three years of retirement.  If the S&P fell from 2,900 down to 500, it would still not be as bad as the Great Depression scenario that it survived.” 

If the markets went down much more than that, we would be looking at a crisis in the entire economic system, where clients would be experiencing bigger problems than just their distribution pattern.

And Finke added that his own research shows that clients aren’t actually spending the way the studies anticipate.  “We followed retirees through retirement to see if they were actually spending down their assets,” he said.  “We found that, for the most part, they are not spending that money down.  They spent the most in the first year after retirement,” he added, “and then in after-inflation terms, their spending went down every single year.”  The rate of decline was the highest through their 70s, and then continued to decline, albeit more slowly, as they hit their 80s and 90s. 

“So,” Finke concluded, “this whole idea of maintaining the same lifestyle at 90 that we had at 65 is probably not realistic.  We become less able to spend at age 90 than at age 65.  That’s good news for the sustainability of portfolios.”  He added that spending tends to be surprisingly even when measured in nominal (non-inflation-adjusted) dollars, which means that non-inflation-indexed income sources like pensions or immediate annuities may be more relevant for paying retirement expenses than some might believe.

Just like the previous panel, Finke talked about the extreme savers, the people who have saved all their lives and now have trouble spending in retirement.  He cited the parable of the ant and the grasshopper.  You know the story: the ant worked diligently all summer storing away food while the grasshopper danced the summer away, and the grasshopper starved while the ant survived the winter.  He noted that few financial planning clients are grasshopper types, while ants have a tendency to maintain their current spending habits. 

“I would ask the ants,” says Finke, “why are you preserving your assets in retirement?  Is it that you want to give the money to your kids? They would say, no, my kids have good jobs.  They don’t need the money.  And I would tell them: well, there are only two places where it can go.  It can either go to your kids, or you can enjoy it now.

Kitces said that he tends to see two kinds of ants: the normal ant, and the pathological ant—the difference being that the latter clients have an irrational fear of running out of money despite having more than they can spend.  If they happen to be engineering types, he can go deeply into the mathematics and convince them that they actually are okay with spending a little more. 

Others, he might propose one-off spending.  “I would say, how would it look if we took $10,000 or $20,000 out of the portfolio and did a trip with all the kids and grandkids—and just have this amazing family experience,” he said.  “I can’t get them to lift their lifestyle by $2,000 a month, but we’ve found that if we frame it as: wouldn’t it be neat if you did this personal experience, it actually makes a dent in the problem.”

Later on, the panel returned to the question of managing sequence of return risk, and Pfau ticked off some ways that a reverse mortgage might address each of them.  “There are several ways to manage that risk,” Pfau told the group.  “The first is to just lower the withdrawal rate from the portfolio, and you can take a reverse mortgage, use that to pay some of the expenses, and lower the initial distribution rate.”

Second: you can have a cash reserve that will pay expenses during market downturns, and a reverse mortgage can become a replacement for that cash reserve, serving as a buffer asset.  “If markets are doing well, you spend from the portfolio,” said Pfau.  “If markets are doing poorly, you spend from the reverse mortgage, which helps you avoid selling portfolio assets at a loss.”

Third, you can take a 10-year payment option, like an annuity, where the reverse mortgage provides a monthly income while the portfolio continues to grow. 

Finke said that he views each asset in the portfolio as having a different job when you’re building a retirement income.  The bond assets are there to fund the fixed costs.  The equities are there to fund the discretionary expenses, which are flexible.

Kitces said that he feels that planners don’t spend enough time discussing with clients what may be the most important lever in the retirement planning equation: their ability to change their spending habits if the markets go down.  “Spending tends to rein in on its own when horrible things happen,” he said.  “Most people do it naturally.  But we have no way to model it as planners with clients.  The truth is that nobody actually fails,” he added.  “We tend to talk in Monte Carlo terms, that you have a 95% chance of success and a 5% chance of failure, and everybody hears ‘failure’ and they’re thinking bag lady living under a bridge.  In most cases, clients make adjustments long before something like that happens.”

As a result, Kitces doesn’t talk about the chances of failure; he says that the client has a 5% probability of ‘adjustment.’  “The natural question is: what kind of ‘adjustment’ are we talking about? Then I’ll say: Okay, let me show you.  And then we can start having much more constructive conversations, like:

-There is a 5% chance you might have to give up the second home at some point, in order to make all this come together.  Are you okay with that? 

-That would be a bummer, but yeah, if bad things are happening, okay; we’ll get rid of the vacation home.”

The panelists touched on annuities; what role do they play in retirement portfolios?  Pfau said that at the end of the day, there are three basic ways that a client can find his/her retirement spending goal: 1) using a bond ladder, 2) investing in a diversified investment portfolio, or 3) buying a simple income annuity.  He noted that a simple income annuity really is a bond ladder, but the client gets an additional spending source through the mortality credits or risk pooling—what he called “the subsidies of the short-lived to the long-lived.”

If you’re analyzing your alternatives, think of bonds as the baseline, and stocks as a bond yield plus a risk premium on top.  Annuities are a bond yield plus mortality credits on top.  Pfau’s conclusion: that advisors should shift away from bonds, and consider a way to allocate between annuities and stocks or other risky assets.

“That can lay a foundation for a more efficient retirement outcome,” he said.  “You get more legacy from a given asset base than bonds are able to provide, because bonds don’t have that longevity protection or that possibility for higher returns.”

Finke noted that quotes on a simple single-premium annuity are extremely competitive—and therefore efficient.  “It is like building a bond ladder up to your expected longevity,” he said.  “But if I build a bond ladder to my expected longevity, I have a 50% chance of outliving it.  If I buy an income annuity with the exact same amount of money, that gives me a 100% chance that I am never going to outlive that money.  I am going to be able to spend that income even if I live to age 115 or longer.”

Finke added later that clients can cover a good part of the 4% rule or fixed living expenses with annuitized income, which takes a lot of the pressure off of the remainder of the portfolio.  It’s another way to minimize the sequence of return risk.  And for the clients who are ants, it’s a way to get them to spend a little more in retirement.  They’ll spend a guaranteed monthly paycheck, where they might feel uncomfortable spending down their portfolio.

Kitces agreed with the idea that buying an immediate income annuity reduces sequence of return risk.  “If I take a portion of your money and I annuitize it, and you start getting checks for life, people will spend those first,” he said.  “They’ll leave the portfolio alone until they need to draw on it, which reduces the withdrawal pressure and therefore the sequence risk pressure.”

But Kitces added that this means that a client’s equity allocation is gradually drifting higher in retirement, as the fixed income (annuity) assets are spent first.  He and Pfau have published research suggesting that clients would have statistically greater chances of retirement sustainability if they raise their equity allocation gradually through retirement, but this can be a tough sell. 

“If I went to my clients and said, hey, I’ve got a great idea: we are going to buy more stocks every year as you get older,” Kitces said, “the response would be: what the hell are you talking about?  But if you say: I have a great idea: we’re going to build some safety for you with this income annuity and then we’re going to spend that down first and build this ladder of bonds to protect your early retirement, and spend that first, it sounds like a completely normal rational thing to do.  And yet it is actually the same thing and has the same effect.”

Finally, Kitces said that immediate annuities are the bet that you want to make.  If you die young, the insurance company pockets the full single premium and you “lose,” but you don’t eat cat food in retirement.  If you live longer than your life expectancy (and Finke had earlier said that many planning clients will), then you will never be without an income.

The last topic was asset location and tax-aware decumulation of a retirement portfolio.  Pfau said that you want to have your most tax-efficient assets (U.S. stock index funds) in the taxable account, while tax-deferred accounts hold the lower-returning tax-inefficient assets (bonds).  The Roth, meanwhile, will hold higher-yielding volatile assets (emerging market and small value funds).

Withdrawal sequencing is about paying taxes when you’re in a lower marginal tax bracket, he added.  “That can open up a lot of opportunities,” Pfau said, “with Roth conversions, taking distributions from the Roth to avoid going into the higher marginal tax bracket, delaying Social Security, and so forth.”

Finke pointed out that most clients look at the dollar value of their accounts, but don’t realize that a dollar in a traditional IRA is worth less than a dollar in a taxable or Roth account.  “$1 million in a Roth is worth roughly the same as $1.5 million in a traditional IRA,” he said.  “In retirement, those Roth dollars go significantly farther than the traditional IRA dollars.”

It’s hard to overstate how unusual these types of presentations are in the advisor space, where the audience gets to look over the shoulders of some of the most sophisticated advisors, researchers and professionals, and where the topics are focused on helping advisors apply nitty-gritty technical expertise.  The ENGAGE panel discussions have become a great tradition, which showcase the best ideas in applied technical planning.