The Tax Bomb in Your Retirement Accounts: One Advisor’s Passion for Helping Retirees Avoid Taxes

Editor’s note: In 2019, Horsesmouth’s most popular articles showed advisors were keenly interested in client service and communicating value. Your favorite stories drilled down in areas like taxes, retirement distributions, Social Security and Medicare to increase expertise and help you enlighten clients and exceed their expectations—often with the assistance of new technology. From more than 500 articles published this year, our members found this one to be among the best.

Editor’s note: In this edition of What’s Working Now, an AdvisorRADIO feature in which Horsesmouth members tell us about recent success they have had running and growing their businesses, we hear from advisor Josh Scandlen, who recently wrote and published The Tax Bomb in Your Retirement Accounts: How the Roth IRA Helps You Avoid It

The following article includes edited excerpts of Josh’s thoughts and advice. Or you can listen to the full interview by clicking the audio file below.

I worked at Vanguard and then Charles Schwab, then took a little detour as a business banker for a couple of years, and then was an advisor with Legg Mason which became Smith Barney. Through it all, Horsesmouth has been an invaluable part of my career. I tried to live without it during the Great Recession and quickly found I couldn’t.

Now I run my own firm, which isn’t really an RIA because I don’t manage money. It’s my personal mission to get more advisors to not manage money. We need to serve middle America.

I worked at USAA for 10 years as a senior wealth manger, and it was wonderful. But then USAA pulled back on their wealth management platform, and I tried a couple of RIAs to see if the grass was greener “on the other side.” It wasn’t. There are some good people in our industry, that’s for sure, but not enough of them are helping the people who really need it.

Stepping into the breach: talking taxes with clients

My mom was a bookkeeper as I was growing up. She’d go to the library and look at Value Line, that monstrosity of an encyclopedia of investment data. Maybe it was osmosis or something, but I’ve always been interested in the tax code. Even as a high schooler I would prepare my tax return and make some money preparing my friends’ as well.

Long story short, I got tired of looking for alpha. And I don’t think anyone can really generate alpha by charging one percent. That made me think, “How can I serve the client?” The best answer for that came from training I got at my small business banking school at First Citizens Bank. We were trained to look at a tax return in order to present a loan to the lending committee. I loved it. Then I found Robert Keebler, Ed Slott, Jeff Levine, and other guys who were doing stuff with taxes.

These guys all do a great job with taxes. But the problem is they mostly advise advisors. They don’t know how to talk taxes to their clients. And that’s a huge deficiency. I’d like to step into that gap.

The need is there and hopefully there are plenty of other advisors who are willing to get into tax advising. It boggles the mind that some advisors think they “can’t give tax advice.” Are you giving investment advice without a CFA? A CFP is not the same as a CFA, but planners give investment advice.

It’s just silly. At the end of the day we’re hurting ourselves as an industry because we can’t tell people the reality of it because we’re worried about compliance. You’re not preparing tax returns! I don’t think you can call yourself an advisor if you don’t advise on taxes.

Now, if you want to call yourself solely an investment advisor, that’s something else. But, as I see it, don’t call yourself a financial advisor. Every single person you talk to will have a tax issue. If you say “Oh, I can’t give tax advice!” then get a CFA because you’re not an investment advisor unless you have that certification.

The 1040 starts the conversation

The first thing I would tell a client looking at retirement is that we need to look at the 1040, first and foremost. Frankly, I couldn’t care less about the investment statements because the 1040 will show everything anyway. We look at the form to find out if the client is married, when Social Security is kicking in, how much qualified money they have versus taxable money. You’ve got to look at the schedules. The CPA might say, “Mrs. Smith, you should keep the mortgage because you need the tax deduction.” But the standard deduction for a married couple over 65 is now $26,600—they probably won’t itemize, so it doesn’t matter if there’s a mortgage interest deduction or not.

I talk to the client and we look at the numbers. We run the numbers and find the taxable income after you factor in standard deductions. That income might be $26,000, for example. I wonder if a good tax advisor or good financial advisor could find some work to do given they have $800,000 in an IRA but taxable income is $26,000. I really don’t see how you can avoid talking about that—you have to give tax advice in this situation.

You might need to call the CPA. Say, “This is the strategy we need to implement and I need your blessing on it.” The CPA will probably say, “Thank goodness you’re doing this because I don’t have the time to!” Thank goodness there’s somebody else who can partner with me to look after my clients. It’s a win-win-win for you, the client, and the tax advisor.

Common tax problems in retirement

People have huge problems when they run into large RMDs. Let’s say a client has a $35,000 RMD and that’s only going to go up as she ages. That raises the bottom line for Adjusted Gross Income and makes Social Security more taxable, and increases premiums for Medicare Part B and D!

The tax brackets for Social Security have not been adjusted since 1983, so more and more people have more of their benefits subject to taxation. And if that wasn’t enough, it might push you into the 22% income tax bracket where you have to pay taxes on capital gains. So you have a four for one. Every dollar that increases your taxable income increases taxes or premiums four different ways. Advisors have to talk about this with clients!

I was working with a divorcee up in New Jersey who had to take a large IRA distribution to pay for property taxes. I looked at her 1040 and saw that the distribution made her tax bracket effectively 35% because it affected so many other areas. It was bad planning, and I just didn’t know better at the time. And frankly, at that point there was nothing she could have done about it. It was too late. Every single penny that came from her IRA would make the tax bill worse.

Roth IRAs and biting the bullet sooner rather than later

I am a big proponent of the Roth IRA. Once we get people with a low taxable income, we need to start moving money over to a Roth, bar none. The golden age of tax planning is 60–70. Ideally you postpone Social Security until you’re 70 to get delayed earnings credits. And let’s say someone retires at 62, that gives us eight years of low income to move money from the traditional IRA to the Roth without having any RMD concerns whatsoever and not have any taxes on Social Security either.

The Medicare surcharge kicks in at $170,000 for a couple married filing jointly, in 2018. So if your AGI is less than that you won’t have to pay any extra for Medicare. And let’s say your taxable income is $26,000, you have $50,000 you can move into a Roth without moving up a tax bracket. This is what I say all the time on my YouTube channel and in my books.

Why would you not take advantage of that and start moving $50,000 a year into a Roth? Sure it will cost you in taxes now, but you’ll never pay taxes later. You won’t be subject to Social Security or Medicare taxes. It’s the most wonderful thing in the world but people don’t do it because they’ve been trained to defer taxes at all costs. And that’s such bad advice.

The number one reason people don’t take my advice is that they don’t want to bite the bullet. They don’t want to pay money to the IRS that they don’t have to. A lot of people have a hard time writing out that check to the IRS. I tell people, “Look, you’re the one paying taxes, not me. I can show you how good it is in Excel spreadsheets, but you’ve just got to be prepared to pay the tax man.” Taxes will always have to be paid. The question is, should you do it now or later? The answer is “Now!” in most cases.

The tax bomb in your retirement accounts

I wrote The Tax Bomb in Your Retirement Accounts: How the Roth IRA Helps You Avoid It because I realized that Roth IRAs just don’t get the attention they deserve. I care about middle- and lower-class Americans, the people who are saving as much as they can and are scared they won’t be able to retire. And they think there won’t be any tax consequences when they do. These are the people who should be looking at Roths. It affects them, but there wasn’t much literature out there on the topic.

The format of this book kind of grew out of a long blog post. I thought it was going to be, “21 Reasons You Need a Roth.” But then I changed it. It’s about 18,000 words, 70 pages in paperback. It’s so small you can’t fit anything on the spine, but I think it’s the right size. Yet it definitely has value. You have to have value or no one will come back to it, but it doesn’t have to be a treatise.

Writing a book absolutely gives you credibility and it also drives revenue. I advertise through sponsored listings on Amazon, and I’ve had clients who found my book through those ads. I also have the PDF as the landing page on my email sign up. I sent out 20 copies to a woman in HR, and I’ve gotten a number of calls from members of her staff who are interested in chatting with me.

So it’s a wonderful marketing piece, but more than anything I wanted to put knowledge out there that would appeal to regular people. I was just looking at something the other day from Vanguard, which has great information. But they do what a lot of firms do. They were talking about the tax consequences for people who are in the 35% tax bracket.

The vast majority of people are not in that bracket in retirement. They’re in the 12% or 22% bracket. It’s these people who make up America. And they need more advice and we’re not giving it to them. My book was a way to say, “You don’t need to be rich or a PhD to figure this out. But if you are ignorant, you’re making a mistake.”

The writing process

This is my second book. My first, Strategic Money Planning: Eight Easy Ways to Put Your House in Order was more of a note from 48-year-old Josh to 30-year-old Josh explaining the things I would have done differently. I wrote and published that pretty quickly because I wanted to see if I could do it and how I could do it. I published it through Amazon, in a Kindle version. (You can charge $4.49 for an ebook version and $8.99 for the paperback.)

My process for writing is to get up early in the morning and do all my research and write before I have to start my day and the kids get up. I have four, the oldest who just started college. Morning is the time when my mind is fresh. I’m drinking my coffee, there are very few distractions, and I love it. I live off that.

Every writer seems to say the same thing. You’ve got to time block and do the same time each and every day and just make sure you do it. Even if it’s crappy. Just do it. Because then you’ll build up that muscle.

(The drawback is, I’m looking at what Nassim Taleb calls the antilibrary; I’m looking at it right now. I got all these flipping books I want to read! And in my head I got all these books I want to write. Your time is limited. You only have an hour and a half each morning to do stuff!)

I had an editor for my first book but the turnaround took longer than I wanted, so I went ahead and relied on myself for this one. But in hindsight I should have gone with the editor again. I’ve found a couple issues that should have been corrected. It’s hard to edit yourself because you are reading your own language and may not see what another person could see.

Some down-to-earth advice

My advice to other advisors is to get beyond the fact that we’re credentialed and qualified and just talk to people normally. We don’t need to come across like we know it all. There’s a reason the mainstream media writes to a fifth-grade mentality. It’s not because they think people are stupid, but because it’s easier to consume. If you write it on a level that everyday people can understand, they’ll think, “Hey, this is a guy who speaks my language.”

You’re not trying to impress Jeremy Siegel. You should be trying to impress Mr. and Mrs. Jones in Peoria. That’s the way you should look at it and if you can do that, you will make headway. If you can’t, you’re gonna be like everybody else out there and no one’s gonna care. Really, they won’t.

Talk to Joe, the chemical engineer working in Kingsport, Tenn. He’s got a degree in chemical engineering, he’s smart about what he knows, but he’s also smart enough to know what he doesn’t know.

Just talk to this guy—and his wife, in particular. That’s what I always look at. Talk to the widow, the person who will survive him and is going to live longer in retirement. When she understands, man, you will make a fan for life. I’m telling you. That’s why my YouTube channel is just going crazy. (We are at 10,000 subscribers now!) I hear it all the time, “Finally, some guy I can understand.”