Episode #145: How to Plan for Stock Market & Tax Rate Volatility

Many Americans are worried about their retirement savings, and in our current environment, are realizing that they may not be able to maintain their lifestyle. In this episode of Money script Monday, Brian presents a proven strategy to help mitigate two significant risks you will face in retirement.


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Video transcription

Hi, welcome to another episode of Money Script Monday. My name is Brian Manderscheid.

Today we're going to talk about how to plan for stock market and tax rate volatility. Now, these are two things, two risks in retirement that are certain to happen when you do retire.

However, we can start effectively planning today to help mitigate those risks using a proven strategy and process to help you put you on a path for a successful retirement.

If you're interested in how to do that, there is, if you scroll down below, a complete financial plan we created for one of our clients that you can view and you can contact the advisor who sent you this video for more information.

Stock Market Volatility & Sequence of Returns Risk

First, stock market volatility and sequence of returns.

What I did is I looked at a hypothetical 5-year scenario with random rates return of negative 25%, fall by rebound of 20%, 15%, 5%, and 15%.


This just represents a hypothetical situation in the stock market. You're never going to have level or linear returns in the stock market.

You're going to have your ups and downs, the ebbs and flows, the good years and the bad years.

The problem in the distribution years, two things. One is you can lose money in the stock market and those losses, as far as sequence of returns, may happen when you start retiring.

Negative years in the stock market when you retire in the early years has a significant impact on your ability to successfully retire.

So, what I did is I took this 5-year timeframe, same sequence of returns, and I repeated that five times to get 25 years of returns.

And what I did is I looked at a million dollars at the start of the analysis.

So, let's say somebody worked their entire life. They saved and had a million-dollar nest egg by the time they retired. Applied the 4% withdrawal rule, so $40,000 of income, and I used a 3% inflation rate.

You can see in this account number one, we started off with a million dollars. We lost 25% to start off, which is a negative, which would be bad for sequence of returns risk.

We were left with $750,000 and we had to take a withdrawal of $40,000, only further creating us in a bigger hole.

So now our million dollars, just after one year of retirement, was down to $710,000.

Now, you can see in this hypothetical scenario, we have four good years of a rebound. So, at the end of the 5-year timeframe, right, $979,000.

So, you may be thinking yourself, I average 6% over that timeframe. I'm left with roughly what I had when I started, and I had all that income over that five-year timeframe.

However, if we continue this 5-year sequence through 25 years, you can see in the 25th year, we have an $81,000 income need based on the 3% inflation rate, cost of living adjustment.

And we're left with $194,000. That's a 25-year retirement.

If you're 65 and you live till age 90, there's roughly a 50% chance that you'll make it there. And if you're married, that probability increases.

So, there's about coin-flip chance that in this pretty favorable scenario with a 6% average return in the stock market, you still could run out of money or be forced to live off less.

Looking at account number two, I'm not looking at this green line here, which I'm going to talk about here in a little bit.

I'm just looking at the same exact red line. The sequence of returns, the same exact sequence for 25 years.

The only difference I'm doing is I'm not taking a withdrawal when the stock market drops.

So, rather than having to take out $40,000 when we have a negative 25% year, you can see we're at $750,000.

Although we had a painful loss, we didn't have to further hurt the problem by having to take a withdrawal while we're down. I continued that same sequence.

You can see at the end of the five years, we're actually left with more than a million dollars at the end of the five years just by not having to take that initial $40,000 withdrawal.

If we continue this all the way through 25 years, you can see rather than having $194,000, we're at almost $900,000, $700,000 more over 25 years, purely by not tapping into stock market-based investments when the stock market is down.

Now, how could you effectively do this? You'd have to have a second pot of money, something that's safe to pull from when the stock market's down.

Something that when the stock market goes down 25%, you're getting zero, but you're still getting competitive rates of return when the stock market increases.

I'm going to talk more about that green line and that solution near the end of this video. So that is the first problem. Stock market risks and volatility.

Tax Rate Volatility

Let's dive into tax rate volatility. So, I imagine that these two things all certainly happen, and that certainly is the case with tax rate volatility.

What your tax rate is today is certain to not be that rate forever for the course of your working years and retirement.

Tax Rate Volatility

To prove that, I looked at the last 28 years of the federal marginal tax brackets. Now you can see '92, and you may be somewhere in the middle of this, but in 1992, the top marginal federal tax bracket was 31%.

Very next year, that jumped up to almost 40%, stayed relatively level till 2003 when it dropped down to 35%.

You can see in 2013, it increased back up to near 40%. And it held there for about four years till 2018 when it dropped down to 37%.

Now, the current top marginal tax bracket of 37% is good tail 2025, at which point we hit the fiscal cliff, and the tax rates sunset in 2026, the tax cuts and Jobs Act sunset and tax rates will increase and revert back to what they were before those changes.

Now that's as the law stands today, and you can see all the times tax rates changed over a 20-year timeframe.

There were seven changes over the course of 28 years. So, the probability is you'll probably have roughly the same amount of changes over the course of your retirement.

And although we know that the tax rates are certain to increase in 2026, we don't know if they'll change even more.

Now, to look at this, we have to ask ourselves, "You know, what's the likely scenario? Our tax rates can be the same, higher or lower than the future.”

If we think about it, we have trillions of dollars in national debt and we just recently added trillions of dollars and federal stimulus to counteract the Coronavirus pandemic.

So, all the debt piled up plus trillions of dollars and more debt. You got to think what's Uncle Sam, what's the government going to need to help reduce the deficit?

At some point, it's probably going to be increased taxes, most likely for the wealthy.

If we were planning for time back 1992 and we had made the decision to contribute to a tax-qualified account like an IRA or 401K, we essentially took a tax postponement when tax rates were low at 31% only to pay upwards of 40% in retirement to access the money when we actually needed it for retirement.

So, when planning for time, you have to ask yourself, do you think tax rates will be the same, higher, lower in the future?

And if the answer is higher, then you need to have a plan to hedge against that.

Now, these are just marginal tax rates. Let's look at effective tax rates. To do that, I looked at the last 20 years from 2000, 2020.

And to start off, I took $100,000 just as gross income and increased that by 3% cost of living adjustment through 20 years.

I picked out the highest and the lowest years, the highest and lowest effective tax rate years.

So, in 2000 was our highest effective tax rate year of 22%. 2018, even though we're taking more income for our income needs due to inflation, our effective tax rate dropped to 17%.

And this is based on married filed jointly. So, the reason I do this analysis, as you can see a 5% difference in the effective tax rates in 25-year timeframe.

And what does that mean for you when you actually retire?

Let's say you needed an $80,000 after-tax spendable income need and you're pulling money from a tax-qualified account like a 401K or IRA.

And in this scenario, the 20% effective tax rate, you'd have to pull $100,000, pay $20,000 in taxes, to net $80,000 to spendable income.

However, let's take that same 5% difference and assume that effective tax rate increases from 20% to 25%.

In that scenario, you'd have to pull out almost $107,000 pay $27,000 in taxes to arrive at your $80,000 of spendable income.

If the situation gets even worse and your effective tax rate goes up 10%, so, from 20% to 30%, you'd actually need to pull out over $114,000, pay $34,000 in taxes to net you the same 80.

Now, this is where the problem lies. If all your money is in tax-qualified accounts, you need to pull out more to net the same income.

Let's look at the income scenario two. The only difference I'm making here is assuming we have $25,000 of annual tax-free income.

You can see the impact of our effective tax rate. It goes from 22% down to 20%, 17% to 16%.

By having not just tax-qualified accounts but having a separate account that's tax-free will allow you to hedge against future tax increases.

Let's say a new administration comes in, or let's say the government needs more income revenue taxes from you at the time.

You can pull money from your tax-free account during those high tax years, allow your tax-deferred accounts to grow. Likewise, let's say tax rates decrease during a certain period.

You can pull more money from your tax-qualified accounts while taxes are on sale and let your tax-free accounts grow.

The only way to do this is to start planning today to have a tax-free account in the future to hedge against that risk.

So, let's start wrapping things together and talk about really how we can do this, how we can effectively plan for stock market volatility and tax rate volatility.

Well, we'd have to have a product, something that is safe to pull money from when the stock market goes down.

Something that when the stock market goes down 25% in the scenario, we are in zero, we don't lose money.

*We have a floor that will guarantee that we'll never lose money in a down market.

The tradeoff for the floor is we have a cap or some sort of limiting factor in how much we can earn in the stock market rebounds.

That's the key component that we need, is something safe that we can never lose money but also have competitive rates return along the way.

We also need something that is tax-free to help us hedge against tax rate increases.

And when tax rates do go up or if they do, you can pull money from a tax-free account, so you won't have to spend down your tax-qualified accounts so rapidly.

There's only one product in the market that combines both of these two features together, and that's a properly funded, indexed universal life insurance policy.

With an IUL, we have just those features, the ability to not lose when the stock market goes down, the tradeoff being the upside in the stock market up to a limiting factor like a cap or participation rate when the stock market rebounds.

Likewise, if the policy is properly structured, the distributions we take are income tax free, so we don't have to report them and pay taxes in periods of time when the tax rates increase.

So this solution, if you think the solution would be something that would benefit you financially, please contact your financial advisor who sent you this video.

You can also scroll down below to actually see a case that we put together for one of our clients that we effectively mitigated against these risks using this solution to help our clients have a happy and successful retirement.

With that, thank you very much. We'll see you next time.


*Excludes fees or other account management costs applicable to the policy.

The information presented here is not specific to any individual's personal circumstances. These videos are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials or may change at any time and without notice. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstance.

Guarantees provided by insurance products are backed by the claims paying ability of the issuing carrier. Annuity guarantees rely on the financial strength and claims-paying ability of the issuing insurance company. Annuities are insurance products that may be subject to fees, surrender charges and holding periods which vary by carrier. Annuities are NOT FDIC insured.

S&P 500 is an unmanaged index of the shares of 500 widely held, predominantly large capitalization, U.S. exchange-listed common stocks. The index results neither include dividends reinvested nor reflect fees and expenses. Investors cannot invest in any index directly. Guarantees provided by insurance products are backed by the claims paying ability of the issuing carrier.

Investment advisory services offered through LifePro Asset Management, LLC, a registered investment adviser. Investments involve risk and are not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy will be profitable or equal any historical performance.

About Brian Manderscheid

Brian Manderscheid is the Vice President of Case Design at LifePro. He works with financial professionals designing advanced case illustrations that are built for longevity and are always in the best interest of the client.


This information is meant for educational purposes only.

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