Talking Taxes, Inflation and Bucket Strategies

Reflecting on the common conversations they are having with their near-retiree clients, advisers say there is broad certainty that taxes will increase in the future, and also a lot of fear about a market correction.

As the founder and lead retirement planner at Rich Life Advisors, Beau Henderson’s advisory practice focuses almost exclusively on serving investors who are within a 10-year window of retirement.

Now in his 21st year as an adviser, Henderson says he has learned a lot in running his own independent firm, having first cut his teeth at a big insurance brokerage. For context, Rich Life Advisors was founded in 2007 with an exclusive focus on individual retirement planning, Social Security optimization and beneficiary liquidity planning.

“We founded the firm based on the belief that there was a lack of truly holistic retirement planning advice available for people,” Henderson says. “That vision has served us well ever since, including during this challenging time of the pandemic. I hate to be critical, but honestly, the bar is still pretty low out there in terms of what the typical adviser can do to actually help an individual create an efficient retirement spending and estate strategy.”

Henderson says the advisory industry has for decades been more or less exclusively focused on the accumulation and maximization of wealth, and while the conversation about income planning has increased, the real capabilities of advisers and providers have not necessarily kept pace. What’s more, he believes near-retiree investors are catching onto this dynamic, and that they will vote with their feet when they feel their advisers aren’t meeting their needs.

“The job is pretty easy when you are only thinking about accumulating assets,” Henderson says. “The hard part of the job, and my favorite part of the job, is helping people actually envision, plan and then tackle their retirement. It doesn’t help the adviser that a lot of the providers out there are structed entirely around accumulation, too. So many of them still aren’t prepared, for example, to help people take distributions in the most tax efficient way possible.”

Henderson says he has had many new clients come in asking for help only after they failed to put a plan in place and are now facing an unnecessary six-figure required minimum distribution (RMD) that they don’t want or need to take.

“What does more effective retirement income advice look like?” he asks. “In my view, a lot of it has to do with creating tax diversification—that is, making sure people aren’t just hitting retirement with all their money stocked away in a traditional 401(k) plan. For the vast majority of people, using both Roth-style accounts and traditional tax-sheltered savings will be important.”

Beyond this, Henderson preaches the central importance of helping people actually envision what they want their life in retirement to look like.

“This vision is actually central to the job of pursuing the most tax-efficient investment and income strategies,” he says. “Only once we know what their lifestyle and goals are in the different parts of retirement can we decide how to best structure the portfolio and how to draw income.”

On this point and others, Henderson’s outlook mirrors another adviser who is outspoken about the importance of studying the tax-side of the retirement income conversation: Ed Slott, a CPA and IRA expert with Ed Slott and Co. who also offers adviser training courses in collaboration with the American College of Financial Services. Among the biggest issues he sees in the marketplace today is the tendency of (unadvised) investors to use the RMD age as the main proxy/input in deciding when to start drawing down their tax-advantaged savings.

“People need to remember that every year you wait for the RMD age, the more quickly that money will ultimately have to come out in the future, which means the annual distributions and the annual taxes are potentially going to be higher,” Slott says. “Advisers and accountants should look at this very carefully and help people to make the optimal decision. Perhaps a person should consider a Roth conversion, for example, rather than wait for the 72 RMD age.”

Henderson agrees, noting that many of his clients ultimately choose—thanks to his suggestions—to enact small-but-regular conversions of tax-sheltered assets into after-tax Roth accounts. Sometimes this strategy may result in a person paying more income tax in a given year than they otherwise would have, but in the long run, the strategy proves more effective than simply deferring taxes as long as possible.

Henderson and Slott are also both in the camp that believes it is more likely that income taxes will increase over the next decade or two—and there is especially little chance they will decrease after so much COVID-19 related stimulus. This outlook, which they say is shared by the vast majority of their clients, makes tax diversification even more important.

“This type of planning is challenging, but it adds a great deal of value to what we are doing for our clients,” Slott says.

In terms of stewarding clients’ assets while they are in retirement, Henderson says his firm is designing a lot of bucket strategies. This approach is, at least in part, so popular because many of his clients are anxious about a potential market correction. The bucket approach involves segregating a client’s assets into three pools, the first being totally liquid and meant for spending in the next year or two. The second bucket covers year two through 10 and may be invested in high quality fixed income or certificates of deposit. The final bucket is fully invested in equities and other accumulation vehicles, with a particular focus on beating inflation and meeting the clients’ legacy goals.   

“My personal view is that we’ve been in such a low inflationary environment for so long that we are poised for at least moderate inflation going forward,” Henderson says. “How fast or how significant that will be, I can’t say. What I am worried about is when I come across people with a half a million dollars meant to fund their retirement and it’s all in a cash savings account. We have a short cultural memory, so I think a lot of people have forgotten how bad the sting of inflation can really be.”