Advice from Professionals

[Snaggletooth]

This will be a lengthy post, centering on the advice of professionals which are more designed for the advisors than the recipients. Good topic for the offseason when we're not so busy.

The public at large is not savvy about financial matters and depend on professionals for advice. Advice from a banker might be to invest in a CD for 0.5% or lower. Advice from Stockbrokers are probably more selfish since the fallacies are deviously hidden. I hope the public at large cannot say this about the tax preparation industry, although the cash advance loans could easily qualify for those of us involved.

Myth: "Put as much money in your 401k or retirement as you possibly can. The truth is the 401k custodians take a heavy bounty of cream off the top, and pass the rest down to participants. A participant can do very well if he puts in what the company matches because there is an instant doubling of money. Beyond that, the custodians can make as much as the participant. The name is "Other Peoples Money."
Myth: "The statements sent to recipients show that no one is taking anything." The truth is in more cases than not, the custodian is keeping two sets of books. (and believe it or not, it is legal). Put $8000 in one of these accounts and take it out three years later. They call it a "prepayment" thing, but their set of books may show you only have $7450. Maybe $550 doesn't sound like much, but this could easily be more than the account has earned in 3 years.
Possible Myth: "investing in a retirement account saves you $$ in taxes." Quite possibly true, but withdrawing at a later age (when you don't necessarily need the money) results in Ordinary Income. Investing in stocks with qualified dividends and capital gains gives LTCG treatment.
Also: LTCG and Qualified Dividends are tax free up to $80,000+ for a married couple, and this is adjusted for inflation. Retirement income is ordinary income at any level. If you can get this much tax benefit, why bother to even put it in a retirement account?
Myth: Mutual funds give you the benefit of diversification and the experience of fund managers who know what they're doing. Truth: The average age of a fund manager is 28 years old. Most have never seen a bear market until recently. With the money you would put into retirement, buy your own stocks and diversify yourself.
Myth: Diversification of mutual funds protects against bad stocks. This is an appealing argument, but if an investor will choose stocks in diverse industries, the same benefit exists. If a crash occurs over all stocks, mutual funds will crash with them. And they will continue to charge their fees even in a crash.
Myth: Mutual funds are the most appropriate investment for which your retirement account will enjoy. Truth: The fees for a typical mutual fund are diabolically hidden, and the real money shown is a shrink-wrapped amount of that shown on your statement. In fact, the real reason you are told they are "appropriate" is because they refuse to even offer anything except mutual funds.

Does the conventional wisdom coming from these sources have upsides? Yes, but not as much when compared to other investment strategies. Do I expect these people to work for nothing? No, but I believe they should be more upfront and charge maybe a 1% portfolio fee, maybe more for a small account.

I had my eyes opened long ago when a local insurance man was selling annuities, life insurance products, retirement accounts, and mutual funds. When he died, many of his customers found out he had absolutely NONE of the products he sold, but had a fortune in stocks.

A different kind of post, and lengthy. Maybe I deserve rotten tomatoes, but I hope you know more than you did.

[kathyc2]

LOL!

You start by saying public is not financially savvy and then say they should buy individual stocks that they select themselves. WTH?

Some of what you claim is flat out wrong, other things are subject to interpretation.

Instead of complaining about mutual funds, how about you educate yourself to provide some longer term tax planning instead of saying you hate it when clients ask advise about taking SS benefits?

[New York Enrolled Agent]

Also: LTCG and Qualified Dividends are tax free up to $80,000+ for a married couple, and this is adjusted for inflation. Retirement income is ordinary income at any level. If you can get this much tax benefit, why bother to even put it in a retirement account?

Wow - I never knew that. Just leave it out of gross income - is that what you do?

I'll tell my clients with thousands and thousands of dollars in their retirements accounts, they were utter fools.

[EvenKeelTax]

"Myth: put as much money into your 401k as you can."

Why is this a myth? For some people yes, but not for many. I have clients who earn a few hundred thousand dollars a year, all w2 wages, and maxing out the 401k saves 40 cents on the dollar (state and federal combined) for every dollar they contribute, and that's not even considering employer-matching. When they retire odds are they won't even be close to that tax bracket.

I don't give investment advice to anyone in an official, on-the-clock capacity. I just do taxes and relate my personal experiences regarding IRAs, 401ks, and stocks. I tell people what has and hasn't worked for me in the past, and I refer them to a local investment firm if they want real, paid advice.

[kathyc2]

maxing out the 401k saves 40 cents on the dollar (state and federal combined) for every dollar they contribute,

It's deferring the tax not saving it.

[Rapid Robert]

"LTCG and Qualified Dividends are tax free up to $80,000+ for a married couple, and this is adjusted for inflation. Retirement income is ordinary income at any level"

This comment (from the OP) is conflating two very different things. Only earnings from investments are possibly subject to LTCG tax rates, while in retirement accounts, both the earnings and contributions themselves have never been taxed previously. Contrast to the accounts with taxable cap gains: the contributions were all after tax.

So it becomes an optimization problem -- pay current tax rate on contributions, then somewhat lower rate in the future on earnings, or else pay future tax rate on contributions plus earnings, no special lower rate. No one knows enough to pick the "correct" option. Plus, state taxes may vary (California has no special LTCG rate), and the effect of even LTCG on taxation of Soc. Sec. benefits can be significant.

My personal approach to many of the items raised here is diversification - I have retirement money split between regular investment account, Trad. IRA, and Roth IRA (and unrealized gain in my residence equity). I always have the option in any given year of using the source of funds that best fits my current tax situation.

[Rapid Robert]

"withdrawing at a later age (when you don't necessarily need the money)"

This is a myth. You have to withdraw (RMDs) in order to pay the tax you agreed to eventually pay when you first deferred it. It has nothing to do with whether you need the money (that's the myth), you can always just turn around and re-invest your RMD less the tax you agreed to pay (or give it away).

[Snaggletooth]

I knew this was coming. You folks must really love me...

I'll respond to some of these, not that anyone is going to change their mind...

public is not financially savvy and then say they should buy individual stocks that they select themselves. WTH?

On the surface this comment makes sense. The unsavvy investor could put his money in something that will tank. Like Blockbuster Videos. However, savvy or not, an investor could overwhelmingly out earn mutual funds by choosing as few as 10 public stocks from a dartboard. (By the way Kathy, lest you think I spurn all your advice, I met with my rental people last night and presented putting their property into a C Corp - I presented both sides, and based on the strength of your article, they chose to keep their property out of the C corp).


Wow - I never knew that. Just leave it out of gross income - is that what you do?

NYEA coming from you I was really surprised, as I regard you as among the most knowledgeable tax person ever. You have got to know how the exemption work. Of course, you DON'T leave it out of gross income. Nor AGI, nor even taxable income. If there are LTCG and QDividends, you are migrated away from the tax tables onto a separate calculation worksheet. The worksheet is published by the IRS and duplicated in the software package.

I'll tell my clients with thousands and thousands of dollars in their retirements accounts, they were utter fools.

No, but for them it may be too late - to a degree. They have built their thousands and thousands of dollars set up to charge themselves ordinary income upon withdrawal. Not utter fools but were unaware of other options. As a matter of fact, if they have a bad year, they might even take some of it out and sell it to receive LTCG later.

You have to withdraw (RMDs) in order to pay the tax you agreed to eventually pay when you first deferred it.

RR you have, inadvertently I'm sure, supported my point. If you have invested outside the scope of a retirement plan, you don't have to do ANY of the things you suggest. With a mixture of good and bad stocks, you can sell the losers and take a tax break in the year of sale. If you have winners you don't even take gains unless you choose to sell.

I will concede that my positions on these subjects is not always better than the conventional wisdom. But better returns are subject to a degree of risk, and even that is not always true. The entire purpose is to emphasize that bankers, stockbrokers, investment counselors, etc. do not universally have the well-being of their constituents. Very similar to "I'm from the government and I'm here to help you."

"Senator, I thought the government had a war on poverty."
"That's right, lady. The government is at war with poverty."
"Then how come I'm still poor??"
"You lost."

Consider the difference between an 8% return and a 6% return because a fund is taking 2% off the top. Seems fair and imperceptable at first glance. But $1000 at 8% over 35 years returns $14,785 and the same amount at 6% over the same time period returns $7,686. Even if only short-term (3-4 years), the typical sales commission for a mutual fund sold in a retirement plan is 6.5%, meaning the participant gets 93.5% of the money that has been put in.

Have fun with this, folks. I've never been the most popular kid on the block...

[EvenKeelTax]

It's deferring the tax not saving it.

Well in theory at retirement age, at least in Maine, my clients with retirement accounts will ALL be in a lower tax bracket. No tax on SSA, $10,000 per person from retirement income (most 1099-R income I see) excluded from state tax. Someone getting taxed at about 33% federal, 7% state now should try to defer as much income as possible, at least in my opinion.

[kathyc2]

NYEA coming from you I was really surprised, as I regard you as among the most knowledgeable tax person ever. You have got to know how the exemption work. Of course, you DON'T leave it out of gross income. Nor AGI, nor even taxable income. If there are LTCG and QDividends, you are migrated away from the tax tables onto a separate calculation worksheet. The worksheet is published by the IRS and duplicated in the software package.

LOL! It was quite obvious that NY's comment was sarcasm to your poorly worded claim of "tax free". Using 2023 rates a couple both over age 65 and combined SS benefits of 60,000 with 43K of qualified dividends and LTCG if no other income will produce taxable income of 43K that is taxed at a rate of 0. This couple could have their 60K SS and 20K of ordinary (retirement) income and have essentially zero taxable income. What you forget to include is that when they put money into the retirement account, that amount reduced their taxable income for the years of contribution. Also, on the NQ accounts, the dividends and CG during those years were likely not taxed at zero rate. If the amount of the QD and CG is less than the 43K, they are leaving free money on the table. You seem to want to have a one size fits all approach, and that is rarely in the interest of the client. If you want to mitigate the total tax a client pays in retirement, you need to look at the entire picture not just one of two things. If a client is currently working but approaching retirement and all their investments are currently in NQ accounts you are not looking out for their interest if you don't calculate potential savings of putting some of the money in NQ accounts into retirement accounts if the total picture is that they can deduct the contributions now and because income will be low enough in retirement, they can get the money out later free of tax. At the very least, put as much as eligible into a Roth.

You don't like mutual funds, fine, don't invest in them. I have no idea where you are coming up the the "facts" that fund managers are 28 years old. The funds I'm in have several managers and the vast majority of them have more than 28 years of experience. Non of my funds have expenses of more than 1%. The expense ratios are not "hidden" as you claim, but clearly stated on charts that show historical returns and also the regular and summary prospectus. Even after the fees, they more often than not out preform S&P. You might get lucky and find 10 stocks that out preform S&P, but highly doubtful. No one claims that diversification is total protection. If a company goes belly up, you are going to feel is less if you have .00001% percent of your funds in it instead of 10%.

Yes, there are some shady investment advisors just like there are shady tax preparers.