Seeing the Whole Picture
I like to believe that I am fearless. I have jumped out of an airplane several times. I have run all 26.2 miles of a marathon. Yet each of us has our nemesis, and the one fear I cannot seem to conquer is my fear of the dentist. I know it is silly and irrational. Fortunately I have found a dentist's office which is willing to work with me on this. I don't schedule routine visits, they keep track of when I am due and call me when they have a last minute cancellation. They understand that my anxiety would cause sleepless nights if I knew I had a dentist appointment coming up.
My goal is to get in and get out as quickly as I can. I'll sit down, they can do their thing, and then let me pay and leave. I don't want to discuss my teeth. I don't want to know what is coming next. Just do it. I hate when they ask me questions about non-dental issues like which drugs I take for high cholesterol. Quit wasting my time and let me leave!
I know some of our clients see our service similar to the way I see the dentist; necessary, but unpleasant. They want to come in, conduct their business, and leave. I am sure they hate when I ask questions about matters which are seemingly unrelated to matter at hand, but if I understand their entire financial situation I can sometimes offer solutions which save them considerable expense.
That happened recently. A new client came in for our first meeting. They had one issue on their agenda; but I wanted to see a complete picture.
The client is a married couple in their late 30's and early 40's with two children. One child is graduating high school this year, the other is elementary school. They are victims of the economic downturn. First, he lost his job. Later, she lost hers. They decided to start a new business but it has been slow to develop. He has since returned to the workforce, but at a significantly lower salary than he was accustomed. She continues to work on the new business full time and may soon have a deal closed to provide the capital they need to take the business to the next level.
Until financing is secured things are tight. Too tight. After a few unexpected expenses related to home repairs, their emergency reserves are down to a week's expenses. Maybe two. They came to me to get money from his IRA, regardless of the tax and penalties, so their emergency fund can return to a comfortable status … just in case.
As I asked questions I learned that they have three primary financial assets. He has an IRA, she has an old 401(k) with her former employer, and they also have a 529 plan for their oldest child. We discussed what the impact of taking a withdrawal from each account would be.
His IRA was put in a variable annuity with income guarantees about two years ago. While I did not facilitate that transaction, I agree with the choice they made. Since IRA's must ultimately provide an income, VA's with income guarantees are often a good solution. But they are not a good source for early liquidity. In addition to any IRA distribution being fully taxable, and the additional 10% federal excise tax because he is younger than 59 ½, the annuity is still in its surrender charge period. Taking money out of his IRA would cost at least fifty percent of the amount withdrawn. I told them we could do it, but there were cheaper solutions.
Her retirement fund is still with her former employer. The paperwork is a little more complex, but as a former employee she can access all or part of her balance. Any withdrawal payable to her would still be fully taxable and subject to the excise tax, but at least they would not have to pay the surrender charge.
Instead of either of those options, I suggested they consider the 529 plan. Withdrawals from 529 plans are tax free as long as they are spent on qualified educational expenses in the same calendar year as the distribution. Their son has selected a small private college. While they did get a phenomenal financial aid package, they will be spending more on his education this year than they want to withdraw for "just in case". They can take the withdrawal from the 529 plan now and put it in their emergency reserves. If things go well there will be no need for the emergency fund, their business will secure the financing, and when the college bills arrive late this summer the money will be there. If things do not go according to plan, they can spend the money in the emergency fund now and replace it with a taxable withdrawal from a retirement plan when the education bills arrive. It will still be expensive, but at that point it is unavoidable. By delaying the withdrawal from a retirement plan until it is the only option, they may not be paying taxes on money they don't actually need.
The clients really liked the plan and took immediate steps to implement it. I feel great because they have the potential to save thousands of dollars in taxes. There is no guarantee that this strategy will succeed, and the strategies presented are not appropriate for every investor. Individual clients should review with their financial advisor the terms, conditions, and risks involved with specific products or accounts.
The next time my dentist "wastes my time" asking questions, I am going to have to remember this case and realize that the professional probably knows how to take care of me better than I do.
Photo Jeff Eitzman – Uber Dentist – Colour (1 of 4) by royblumenthal