Last year, we released our white paper, The 125% Credit Union Executive, with ground-breaking data describing how credit union leaders could unlock up to 25% more in assets from their executive benefits by applying optimized executive financial strategies. In late 2022, the Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 was passed, including a specific provision that offers credit union executives additional opportunities to gain even more value—up to 40% according to ACT’s analysis—from their existing benefits.
In this episode of “C.U. on the Show,” ACT Advisors Operations Manager Nicolette Speziale, CFP® takes over as guest host to interview ACT Advisors founder Doug English, CFP® and partner Wes Johnson, CFP® about the changes, their unique implications, and what credit union executives should consider in their wealth management strategy before and after retirement to reach its maximum potential.
SECURE Act 2.0 RMD Provision
The specific provision that can potentially increase an executive’s financial outcomes by up to 40% is the newly increased required minimum distribution (RMD) age of 73 or 75 for those born after 1960. The RMD is the income amount retirees must distribute from certain retirement accounts, such as traditional IRAs and 401(k)s, once they’ve reached the federal RMD age.
Why is this important to credit union executives? In the previously published white paper, Doug and Wes explain how credit union leaders are in a unique tax situation before and immediately following retirement, which they dub the “tax delta superpower.” The significant difference in tax brackets executives experience following retirement, along with their various income sources and benefits, enable several tax-planning and income-distribution strategies to save more.
For example, with income sources and benefits, such as a 457(f), collateral-assignment split- dollar plan, bonuses, 401(k), and others, executives have control over when and from which source they can withdraw income. This control allows them to manipulate their cash flow and manage their tax liability for various situations, such as qualifying for low-cost health insurance, charitable giving, or harvesting capital gains. With the RMD age increase, executives have more time to apply these strategies.
Optimized Executive Financial Strategies for CU Leaders
Doug and Wes also discuss actionable takeaways for credit union executives to optimize their financial plan before and through retirement, using the firm’s data and the new SECURE Act 2.0 opportunity. They reinforce the sophisticated solutions available to executives, the importance of a customized plan, and the various levers they can pull for maximum results, such as reducing taxable income, allocating risk, and harvesting losses.
Stream the episode to hear Doug and Wes discuss these points in light of the SECURE Act 2.0 changes, plus:
- The key differences between an executive benefits strategist and a traditional financial advisor
- Why a one-size-fits-all approach that may work for starting employees, such as lifestyle or target date funds, doesn’t consider the level of complexity leaders in the executive suite experience
- How credit unions and their league partners can engage ACT Advisors for non-sales education on these topics as a CUNA Mutual-approved non-competitor speaker
Hear the show now.
Audio Transcription (pulled from the podcast)
Doug (00:01)
Hi, welcome to the podcast. This is Doug English. And I have some special guests with me today. We were delighted to have noticed an influx of new listeners following our episode featuring Rodney Hood. So we’re delighted to have you join us. You know, if you haven’t listened to board member Hood’s episode, please go ahead and do that; it was quite exceptional. He’s coming back in August to do a Q&A-style session. And we’re looking forward to that. So if you’ve been with us for the first time or for a long time, we extend a warm welcome to you. This podcast is focused on bold leadership in the credit union movement, bold ideas to move the credit union movement upward to build its strength and make sure it exists in perpetuity. So here with me today, I have two CERTIFIED FINANCIAL PLANNERs™ from the team at Act Advisors. Our Operations Manager Nicolette Speziale is going to be interviewing me and my partner Wes Johnson about the SECURE Act and the changes in it that allow credit union leaders to do some pretty interesting things with executive benefits. So with that, Nicolette, over to you.
Nicolette Speziale (01:18)
Hi, Doug. Hi, Wes. Thanks for having me on. I’ve been working behind the scenes for a while now. And I have to say, I am so excited to be joining in on the discussion today. So let’s talk about SECURE Act 2.0, which passed in late 2022. I know it had a lot of provisions; what are some of the key changes credit union leaders should be paying attention to?
Doug (01:43)
The one I want to talk about the most is the one that is really impacting credit union leaders, which is the change in required minimum distributions. You know, we’ve all seen the requirement that happens with any pre-tax plan—it used to be you got to age 70 and then you had to take money out of your plan. And the amount you would have to take would be fairly small, and that would increase every year for the rest of your life. But over the years that has changed and it keeps getting pushed further out. It was 70. And then it went to 72. And now for people that are not yet 72, it is 73 when you have to start these distributions. And for people born after 1960, it’s all the way to 75. So because of the particular way executive benefits work in the credit union movement, this additional time before you have to start required minimum distributions is a massive opportunity that has caused further analysis of how much you can get out of credit union executive benefits. We proved a few years back that with good layering and risk location and strategy, you can get 25% more out of your executive benefits. Well now because of the SECURE Act, we calculate you can get 40% more from your executive benefits if you follow some of the strategies we’re going to tell you how to do today.
Nicolette Speziale (03:17)
Excellent. When new laws like SECURE 2.0 pass, Doug, I know you’re examining all the provisions in them looking for potential planning opportunities, and you’re looking at everything through the lens of an executive financial strategist. Now that term might not be familiar to everyone. Could you shed some light on the role of an EFS and how it differs from an EBS and maybe talk about what sets it apart from a traditional financial advisor or a financial planner?
Doug (03:50)
Yeah, what we’re trying to do with the term executive financial strategist is differentiate the work we and others in the industry will be doing to help credit union leaders that stands apart from the work the executive benefits folks do and traditional financial advisors. So executive benefits specialists, in the first place they do the work with a collateral assignment, 457(f) and (b), and they work with the board and deal with the regulatory issues of compliance. And that’s a complex job that sort of stands on its own. What we executive financial strategists do is to help you take those benefits and have it make sense with the way you put it together with your 401(k) with your personal investment accounts and how you decide what to spend first—there’s a whole lot to that. And that’s where you get that increase in expected value from from 25 to 40% more by applying those sorts of strategies. And then your traditional financial adviser of course has never seen a collateral assignment or a 457(b). And it isn’t really suited to kind of do the strategy part of this but they may be managing your IRA or rollover 401(k). And that’s fine. That doesn’t have to be affected, I don’t think.
Nicolette Speziale (05:18)
All right, so a credit union would partner with an EBS to put the plans in place. And then they would also bring in an executive financial strategist to make sure the plans are integrated and optimized. And that really helps the executive team get the best value from their benefits.
Doug (05:39)
What most folks in credit unions don’t understand is if they have a collateral assignment plan, and full disclosure, we are not compensated by anybody that is not a client of ours, the executive benefits firms do not pay us; we do not get kickbacks from anybody. But when we analyze an executive’s financial projections we see that most of you will not pay more than 5% income tax from retirement until mandatory distribution age. And that’s because when you’re working with your executive benefits specialist, the average replacement ratio, and I know I’m probably jumping ahead, but it’s kind of what I do. The replacement ratio we see, the executive benefits designed into the plan, is about at least 60%. So they’re having the collateral assignment plan create an income stream for the executive that is targeted at 60% of the final average salary of the executive. Well, that 60% replacement is also tax-free income. So when we take that material and put it into someone’s financial plan, most of the time that income stream alone is sufficient to fill in their budget. So they don’t have to take money from other sources. And when that occurs, there’s no income tax. So you end up paying literally no tax for sometimes a decade. And in that there is a massive, massive opportunity to do a whole bunch of other things I think we’re going to talk about.
Nicolette Speziale (07:23)
Yeah, let’s get to it. Doug, in your white paper, The 125% Credit Union Executive, that you released last year, you presented a case study that really showed executive financial strategy in action. Then SECURE 2.0 got passed, as you mentioned earlier, so we’re going to revisit The 125% Executive in light of SECURE 2.0. So why don’t you dive in and tell us more.
Doug (07:49)
So in the first place, let’s look at what happens in credit unions that causes this need for this level, this new role of executive financial strategist. It’s a different kind of analysis, the complexity you see in the credit union executive suite. You start out in the job, you get a 401(k), these days it’s automatically invested, you’re automatically enrolled and it automatically increases for you. So you don’t really have to worry about it. And then you work your tail off for a long time and get into the executive suite. And then you have no additional savings ability, right? Because the 401(k) contribution limit is kept the same; the amount you can put in as an executive is the same amount you’re able to put in as a starting employee because it’s a federal maximum. Well, so then you work with the executive benefits, and you get 457(b) and 457(f) and collateral assignment. And each one of these things have different funding frequencies for how often the money goes in. Sometimes, some of them are taxable. Sometimes it’s tax-free, and there are different withdrawal frequencies on the other side, in much different tax structures. And then usually 10 or 15 different investment options per plan. And I think until we did some of this analysis, it was really not clear that you should treat the plans very differently. You should not be doing the same thing across the plans; you should be building a custom investment philosophy around each one after you have figured out when you’re going to spend that particular one. So we built the case and we kind of tried to use a middle market credit union executive. I’ll just kind of give a couple of particulars because this is obviously just an auditory experience. We had a CEO who was making $300,000. She had a $700,000 401(k) and another $100,000 457(b). Like many credit union executives—they are charitable people—she gives $10,000 away to charity and has a taxable portfolio of $300,000. And the plan is for this executive to retire at 62. And that’s what we often see; the number one age folks seem to want to get out of the workforce is at age 62. When we first engage with the credit union and kind of see what’s going on in an executive strategy, you see pretty consistent things, you see the 457(b) being planned to pay out over 10 years, and usually people keep the 457(b), actually a higher risk. And the reason is an easy one; it’s because it’s a smaller account—it doesn’t seem like as big a deal to have your 457(b) go up and down a lot when your 401(k) is five times the value. But it’s actually not the right strategy. Because the 401(k) usually is going to be the last thing you’re going to spend now, where you wouldn’t even touch it maybe until 75. So usually that’s what you see in the plan, the 401(k) is usually into a lifestyle mutual fund. If you’re going to retire in 2040, most of the time you’ll see an executive with a 2040 fund. Again, in our work, we find that is leaving a huge amount of money on the table, because the 2040 fund is being aligned with your retirement date. And that is what the industry teaches us to do. That’s the right move for most people because that’s when they’re going to start consuming the 401(k). But if you’ve got a suite of executive benefits, and you’ve done your analysis, you’re probably going to find you’re not going to need that money until you’re forced to take that money. And of course, you’ve got to do the math, if that’s the case for each individual but that’s what we usually find. So most of the time the 401(k) does not have enough risk in it. And then, as I mentioned earlier, usually you see 60% targeted replacement ratios built into the collateral assignment. And when you put that in your personal budget for most folks, that’s going to cover it for the years between retirement and mandatory distributions. Well, if that’s the case, and you’re retiring, and you need to buy health insurance, there’s an incredible thing you can do, which is you can qualify, you can potentially qualify, I should say, for Obamacare, because Obamacare has these income limits; you must have a certain amount of income, and not too much. And when you do you get tax credits, and the tax credits virtually eliminate the cost of healthcare before age 65. So you can purposely design your income to say I’m going to pull just the right amount from the 457(b) or from taxable portfolios. And in doing that, I’m going to be able to qualify for Obamacare and not have to pay much of anything for healthcare between retirement and age 65. So when we build a financial plan and kind of look through where executives typically start out, what we’re used to seeing is that our analysis says, hey, it works. We test their resources against their budget, and then run a Monte Carlo analysis; that’s a way of saying do they have enough? And the answer we usually get is yes, of course they have enough because they saved aggressively, they work with their executive benefits specialist. And the plan works. And you’ll end up with a value of usually millions of dollars when they have a legacy that goes on to their heirs but our work shows outcomes can be improved in the 40% area using proper strategy and layering of when you take your money. So how it usually works is when an executive retires, the year they retire, the annual leave and sick leave get paid out. Sometimes the year they retire. Sometimes it’s the next year if you retire at the end of the year. Well, that’s always enough money in the cases I’ve seen to take care of that first year’s need for income. And then instead of taking the 457(b) out over a decade, usually what the common advice is, we find it’s often optimal to take the 457(b) out over a single year. And that’s because of what yet spikes your tax rate for a single year but then allows all these other things we’re going to talk about to happen in the future years, and they become much more valuable. Then the year after that usually starts the collateral assignment distributions and that goes on. Those three things for most of the folks we see are sufficient to cover their income needs all the way until mandatory distributions began at age 73 or 75. So there’s a lot of opportunity in building this all out—you have to do the work and gather information and put it into software and get your tax rates projected for your years before retirement and your years in retirement. Before retirement, we often see executives’ tax brackets, the effective rates in the 27 to 35% range. And that’s just about as high as it gets. So if you project those are your rates before retirement, there are some things you can look at and should look at. In the first place, credit union executives are incredibly generous. And we see an amazing amount of charitable giving in the credit union movement. So if that’s something you’re doing in the years before retirement, those usually are the peak tax years for the rest of your life. Well, if that’s the case for you, that means you want those charitable deductions in those years before you retire. So you don’t necessarily not want to be able to give money to your charities in your retirement years. But you can use a strategy called a donor advised fund. And a donor advised fund is sort of like a personal charity that you can open up and contribute money to in advance, during your high tax years. And then you distribute the money out to the charity over many years. So what that does is that allows you to have the tax deduction in high tax year but yet give the money to the charity over however many years you need to give it to them. So the way I like to say that credit union executives’ superpower that is not known is tax delta. It’s the difference between your effective rates before retirement and your effective rates in retirement; very commonly that tax delta will be 30%. That 30% is your opportunity if you use this tax delta properly. So number one is to try to get you the deduction on the charity before you retire. Because that’s when you get your very high tax rates. And then when you get into retirement a year with very low or zero capital gains rates very often. And so that brings up our next subject, which is in the credit union movement, you see cash payouts executives get from just bonus plans or a 457(f) paying out or a stay put bonus paying out, or you just constantly save money. So if that’s the case, and you have a taxable portfolio, again, remember your superpower in the credit union movement is tax delta. So you got to take advantage of that in this space. So if you have a taxable portfolio, you need to use or you need to at least look at a tax strategy for investing. And we have my partner Wes on the call with us today. And he’s going to talk a little bit about the way direct indexing works. Direct indexing is a tax strategy that is run in an investment portfolio. But it is particularly powerful for credit union leaders because of your superpower, which is tax delta; there’s a massive difference between your tax rates. So Wes, if you would please walk us through how you build and run the direct indexing portfolios and why it’s particularly powerful in credit unions.
Wes Johnson (19:04)
Sure. So to start with, direct indexing is really only usable in non-qualified accounts, so not retirement accounts. So because everything that happens in those accounts are taxable events, we can do things in those accounts that turn out to help you tax-wise. So what direct indexing is, we’re just taking an index, let’s just say the S&P 500 and we’re going to replicate it using some number of stocks. The S&P 500 contains 500 stocks; we can replicate it using about 200 stocks. So why in the world would you go through all that work of buying 200 individual stocks when you could just buy SNP, the ticker symbol for the S&P 500? And the reason is tax control. So we use software to select the couple hundred stocks that will replicate the S&P 500 and by owning the individual components of the index, when one of them is down we can sell it and harvest that loss. So kind of the most generic example is let’s say we own Home Depot stock and is one of those 200 stocks and Home Depot stock goes down; it’s now below what we paid for it, we sell it, realize that capital loss, and then we immediately replace it with a stock that behaves exactly the same, let’s say for example, Lowe’s stock. So we do that generally on a weekly basis; we’ll look at the basket of 200 stocks and anything that is below what we paid for it, we will sell it. It’s called a tax cost harvest trade, and then we’ll replace it with something that keeps the 200 basket of stocks behaving as much like the S&P 500 as possible. And generally you’re going to have the same investment experience as you would if you just bought the index. If the index is down 10, this direct indexing is probably down 10. If the index is up 10, you’re probably up 10. So it’s the same rollercoaster ride. The difference is you’re harvesting losses all along the way that you can at some point use to offset gains. So while you’re in a high tax bracket, we’re going to try to harvest losses. And then when you’re retired and your tax bracket drops significantly, we can actually shift that strategy to harvest gains, where your capital gains rate would probably be zero during those years. So we can actually take those gains at that time. But it’s really all about tax control by owning the individual components of the index. We can choose to sell what’s at a loss when you need a loss, or we can sell what’s at a gain when you need gains.
Doug (21:43)
Thanks, Wes. And I know we’re not the only one that does direct indexing but we think we’re the only one that’s really thought hard about how to take direct indexing and apply it to credit union leaders. Because your superpower gives you an unusual situation. We will see folks outside of the credit union movement with 35% tax rates before retirement. But then when they go into retirement they are drawing usually from a combination of their taxable and before-tax portfolios that will see their rates usually go from 35 maybe to something like 15 or 20 but you guys will go from 35 to five. And that’s the very unique thing you need to be planning for and taking advantage of. That’s where you get the donor advised fund idea. That’s where direct indexing becomes particularly powerful. That’s where you’re able to kind of control when the income comes in and give you access to the ability to potentially qualify for Obamacare. And then you can fill up tax brackets with Roth conversions. So in the years before age 65, you do not need to engineer your income to qualify for those Obamacare credits. So you have to get just the right amount of income to be able to do that. So you probably don’t want to do Roth conversions in those years, or at least we don’t have our executive do that in the example. But after Medicare age comes along, you can do Roth conversions all the way until required minimum distributions start. And what we do in our example is we project someone’s tax rate. So we can see how high the rate of tax they’re going to pay once they hit age 75. And then we have the software to fill up the tax bracket below that all the way every year between 65 and 75. And that can add up to be a huge amount of money being converted each year from pre-tax 401(k) over into the Roth. Yes, you pay tax on ordinary income rates when you do that. But you can control it; you can design how much that is. In our example, we kept the effective rate for the executive at 10% or below in those years. And then we calculated that person is going to have a 13% rate after they get to be age 75 and never go below that again. So you can do that same kind of thing. But you’ve got to have your projections built out to be able to tell what’s coming so you understand what level of opportunity you have pulling the lever on one asset versus the other. The other thing I’m sure our listeners want to hear about, as I mentioned, the lifestyle fund, the use of a fund for 2030 or 2040 or retirement days. We commonly see folks do that because those funds are convenient, right? They automatically invest, they automatically get more conservative but they align the risk of the fund with traditional expectations, which is you retire, you’re going to need this. But in most credit union executives’ cases, if you’ve got executive benefits, you’re going to retire. And you’re not going to need that 401(k), usually for a very long time. So you want to get that calculated, and then at the very least match the fund you’re using with the design of your planned consumption, not with the date of your retirement. And by doing that, you can have more risk in the 401(k). And in most cases, you’re going to have very little risk in the 457(b) because as you know, that’s money that is often going to be optimal to pay out in a very short period of time. I hope I covered everything you wanted me to.
Nicolette Speziale (26:06)
You did, you did. That was a lot of information. And I really enjoyed hearing about the tax delta superpower. What you and Wes have detailed today are specialized income timing, risk allocation, and tax planning strategies credit union executives can put in place right now to boost their benefits. In the case study, can you summarize what the bottom line was for the executive who implemented these strategies?
Doug (26:33)
So when you take and you put all these things together, that’s where you get to drive up the expected overall value that an executive receives by 40%. It’s the sum of all of these things added together. In our example, you get $2 million more in portfolio value by following this process. And of course, that all depends on how much you have now. If you saved two years of healthcare expenses by being careful about what kind of income you take in those years, you save a whole ton of money on income taxes because you do Roth conversions in very low years. And then you save some more money on the donor advised fund strategy because you’re taking advantage of your tax delta, funding a donor advised fund in the high years and then giving it to charity in the lower tax years.
Nicolette Speziale (27:33)
Thanks, Doug. That was fantastic information. For credit union leaders interested in executive financial strategy, what steps can they take? Or what resources can they explore to learn more?
Doug (27:45)
Our outcome is to strengthen the credit union movement; we want to boost the benefits, we want to help the entire credit union movement to get more from their executive benefits by up to 40% through this kind of work. So it is a lot, right, I just blew through years of work we did figuring that out. We need to provide this education over and over and over again, at league meetings, at industry events, and executive benefits companies meetings. We’ve already been doing some of that; you’ll see that on our social media. And we offer to do that to your leagues, to your chapter meetings, to your credit union industry events; I want to be out teaching the industry how to make more other benefits. We’ll also be doing web events to try to get folks more information about that. So our mission is to make sure we’re able to strengthen the movement. And to do that, we’ve got to help you be able to take advantage of these strategies. So if you have connections with your league leaders, and I know you do, please send an email to Doug@act-advisors.com along with an introduction to your league. Folks, we are specifically on the approved list as a non-competitor by CUNA Mutual since we don’t sell any executive benefits products, and that means we are eligible to teach at your events and we’d sure love to do that. Well thank you, Nicolette and Wes, for joining me on the podcast today. I hope our listeners are starting to get some of the ideas for how powerful the executive benefits are that we have in the credit union movement, and how if you combine them in the right way, you can get so much more out of them. We’re here to get that information out. We believe strongly in the good that is done by the credit union movement and we’re here to help. So thank you for listening. Thank you for your help and we will look forward to hearing from you in the future.
Nicolette Speziale (30:00)
Thanks, Doug.
Wes Johnson (30:02)
Doug, thanks for having me on your show as well.
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