The Pothole in Wealth Management Good Logic vs. Bad Logic

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The Pothole in Wealth Management Good Logic vs. Bad Logic

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The Pothole in Wealth Management Good Logic vs. Bad Logic

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The Pothole in

Wealth Management

Good Logic vs. Bad Logic

Case Study

Simon and Ann Scott, age 55 and 50, plan to retire in 10 years. They have the following liquid assets:

$ 1,000,000 Certificate of Deposit -- assumed yield: 4.00%

$ 1,000,000 Muni Bond Fund -- assumed yield: 3.50%

$ 3,500,000 Mutual Funds -- assumed yield: 7.00% growth; 1% dividend

(cost basis: $2,000,000)

$ 500,000 Simon’s IRA -- assumed yield: 8.00%

$ 500,000 Ann’s IRA-- assumed yield: 8.00%

$ 6,500,000 Total (plus $900,000 in home value & personal property)

Assume Simon and Ann want $25,000 a month in after tax retirement cash flow – compounding annually by 3.00% as an inflationoffset.

Efficient Distribution from Assets

Let’s provide the cash flow but compare the “least efficient” withdrawal order to the “most efficient”.

Least Efficient Order

Strategy 1 (Bad Logic)

500,000 Simon’s IRA

500,000 Ann’s IRA

3,500,000 Equity Account

1,000,000 Tax Exempt Account

1,000,000 CD

Efficient Distribution from Assets

Let’s provide the cash flow but compare the “least efficient” withdrawal order to the “most efficient”.

Least Efficient Order

Strategy 1 (Bad Logic)

Most Efficient Order

Strategy 2 (Good Logic)

500,000 Simon’s IRA

500,000 Ann’s IRA

3,500,000 Equity Account

1,000,000 Tax Exempt Account

1,000,000 CD

1,000,000 CD

1,000,000 Tax Exempt Account

3,500,000 Equity Account

500,000 Ann’s IRA

500,000 Simon’s IRA

The order in which liquid assets are accessed for cash flow should be prioritized in order to produce the highest possible long-range Net Worth.

This is generally the most overlooked aspect of wealth planning– even by the most sophisticated Monte Carlo simulations -- due to the complex coding required.

Source: Wealthy and Wise

The Scotts’ Net Worth

Strategy 1 - Bad Logic

vs.

Strategy 2 - Good Logic

Strategy 1 vs. 2

Long-range Net Worth is increased over Strategy 1

by 339%

simply

by selecting the most efficient distribution order.

Source: Wealthy and Wise

The Scott’s Wealth to Heirs

Strategy 1 - Bad Logic

vs.

Strategy 2 - Good Logic

Strategy 1 vs. 2

Long-range Wealth to Heirs is increased by 286%.

Source: Wealthy and Wise

Overall Results at the End of 40 Years

Ages 95/90

Source: Wealthy and Wise

With over $12.5 millionmore in Net Worth, let’s do a little tax planning by introducing Strategy 3which involves:

Converting the Scott’s IRAs to Roth IRAs with the income tax on the conversion withdrawn from their assets;

Adding a Wealth Replacement Trust (“W.R.T.”) that is funded with $2 million of survivor life insurance covering both Simon and Ann.

With Strategy 3 (Good Logic + Roth IRAs + W.R.T.), the Scotts will make annual gifts of $20,000 a year to fund the policy owned by the irrevocable trust drawn in favor of their three adult children.

The funds for the gifts are also withdrawn from their assets so their retirement cash flow is unaffected. This will reduce their Net Worth. Perhaps not. Let’s see . . .

The Scotts’ Net Worth

Strategy 1- Bad Logic

vs.

Strategy 3 - Good Logic + Roth IRAs + W. R. T.

Strategy

1 vs. 3

Long-range Net Worth is increased over Strategy 1

by 436% due to the efficiency of the Roth IRAs (even though the income tax cost of the Roth conversions is withdrawn from assets).

Source: Wealthy and Wise

Source: Wealthy and Wise

The Scotts’ Wealth to Heirs

Strategy 1 - Bad Logic

vs.

Strategy 3 - Good Logic + Roth IRAs + W. R. T.

Strategy

1 vs. 3

Long-range Wealth to Heirs is increased by 615% -- caused by the efficiency of the Roth IRAs and the life insurance in the trust.

Source: Wealthy and Wise

Overall Results at the End of 40 Years

Ages 95/90

Source: Wealthy and Wise

An Additional Advantage for Heirs

Long-Range Hypothetical Net Worth

Source: Wealthy and Wise

Let’s take a last look at all three Strategies . . .

Ages 95/90

Text

Source: Wealthy and Wise

Let’s take a last look at all three Strategies . . .

Ages 95/90

Text

Source: Wealthy and Wise

Let’s take a last look at all three Strategies . . .

Ages 95/90

Ages 95/90

Source: Wealthy and Wise