The Pothole in Wealth Management

Good Logic vs. Bad Logic

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)

Case Study

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

Efficient Distribution from Assets

Least Efficient OrderStrategy 1 (Bad Logic)

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

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

Source: Wealthy and Wise

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.

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.

Most Efficient OrderStrategy 2 (Good Logic)

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

Efficient Distribution from Assets

Least Efficient OrderStrategy 1 (Bad Logic)

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

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

Strategy 1 vs. 2

Long-range Net Worth

is increased over

Strategy 1by 339%simply

by selecting the most efficient

distribution order.

The Scotts’ Net WorthStrategy 1 - Bad Logic

vs. Strategy 2 - Good Logic

Source: Wealthy and Wise

The Scott’s Wealth to HeirsStrategy 1 - Bad Logic

vs. Strategy 2 - Good Logic

Source: Wealthy and Wise

Strategy 1 vs. 2

Long-range Wealth to Heirs is

increased by 286%.

Overall Results at the End of 40 Years

Ages 95/90

Source: Wealthy and Wise

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

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 Converting the Scott’s IRAs to Roth IRAs with the income tax on the conversion withdrawn from their assets;

2. 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 . . .

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

The Scotts’ Net WorthStrategy 1- Bad Logic

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

Source: Wealthy and Wise

The Scotts’ Wealth to HeirsStrategy 1 - Bad Logic

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

Source: Wealthy and Wise

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.

Overall Results at the End of 40 Years

Ages 95/90

Source: Wealthy and Wise

Source: Wealthy and Wise

Long-Range Hypothetical Net Worth

An Additional Advantage for Heirs

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

Ages 95/90

Text

Source: Wealthy and Wise

Ages 95/90

Text

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

Source: Wealthy and Wise

Ages 95/90

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

Source: Wealthy and Wise

Ages 95/90