Jenine:

Hello, everybody. Thank you so much for joining us for today's version of Straight Talk. I say us, because I have fabulous repeat guests with me. So if you recall Doug Orton, who runs our business development team, and Eric Zubris, who is senior strategist with our muni strategies. Now, what possibly could these two have in common to join me today? Taxes. Taxes, and do you know what I found out right before we began? There's one other thing that they have in common. If you could picture each of them with mullets. Is that correct?

Eric:

That is correct, unfortunately.

Doug:

My mullet was glorious.

Jenine:

So I think you both are brilliant. However, I am questioning the fact that you thought a mullet was a good idea. In particularly, you, Eric, who admitted you had what was referred to-

Eric:

A rat tail.

Jenine:

A rat tail.

Eric:

I also had my initials shaved in the side of my head and braids, as well.

Jenine:

Now, I'm wondering whether I should have invited somebody else at this time.

Eric:

Yes.

Jenine:

But, so Doug, last time you were with us, you talked about our What Keeps You Up At Night Checklist from our heritage planning program. So talk to me about taxes and what other materials you think would be relevant for that conversation.

Doug:

Yeah. When we talked about the What Keeps You Up At Night Checklist last time, we focused on what we might think of as more the softer side, how to choose a nursing home for your parents, what to do in a divorce, but we also have things on the more technical side. If you want to talk to your clients about Social Security, or Medicare, or-

Jenine:

I didn't think nursing homes and divorce was soft, but go ahead.

Doug:

Well-

Jenine:

I don't mean to interrupt you.

Doug:

There you go. There you go, and then my favorite topic, which is taxes. Because one of the things that we try to get at are, where are the gaps in a client's understanding of what they're trying to do? If you think about taxes, particularly about retirement, there's a lot of nomenclature that we use that's misleading. So somebody might talk about, "What will my tax rate be in retirement?" when we know it's multiple tax rates.

And so there's a lot more complexity around taxes, and since most affluent taxpayers or retirees, taxes are their number one expense, they need to understand that risk. Even if we don't have any tax law changes, a couple is going to have some big changes. One of the things I plan for is after I die, Amber's tax situation is going to be drastically different, and if she's not ready for it, that's a risk that's going to cause problems.

Jenine:

Okay. So what do retirees need to do and think about?

Doug:

Yeah. So I think if we think about taxes as, "I'm going to be retired for 30 years, and my tax rate is going to change over time consistently," I think what we need to prepare them for is to have some tax diversification. The idea that if I go into retirement with a tax-concentrated portfolio, where that's your traditional IRA, traditional 401(k), and Social Security, that is all ordinary income. If me, as the retiree, and my financial advisor, and my tax advisor realize that my tax situation's gone sideways, there's nothing we can do.

Jenine:

Got it.

Doug:

But if we've built a tax-diversified portfolio, where we've added in some Roth for tax-free income when we need it, and we have a taxable account so we can get tax-free income from munis, we can get tax preferred from equities, we can get ordinary income if we need that, now you have a structure that is a lot more flexible. We can have better conversations with clients, because I view it as everything's a trade-off.

We talk about a tax-advantaged account versus a tax-disadvantaged account. I don't think that's accurate. The taxable account has advantages, that I can get those different tax treatments when I need it. I give up deferral that I'd have in the 401(k), but the 401(k) has disadvantages in that it converts all my tax preferred income into ordinary.

Then, lastly, I think particularly from an advisor's perspective, if you're having a conversation with an affluent client, and you ask them, "Do you have a tax-diversified retirement portfolio?" almost all of them are going to say, "I don't know what you're talking about." And so that allows you to compete with their current advisor on something that they don't already have or they don't know they already have rather than competing on just the portfolio.

Jenine:

That's a great question. Say it again, because that's a great question for everyone to write down when they're prospecting.

Doug:

So it's asking a client, "Do you have a tax-diversified portfolio?" Nine times out of 10, they're going to say, "What does that mean?" Now, you can differentiate yourself by explaining what that is.

Jenine:

Yeah. I should ask Ryan, who's my LPL guy, do I have a tax-diversified portfolio? I'm calling you. So we've heard the rise of SMAs and ETFs. Obviously, this is a big topic, right, or else those vehicles wouldn't be rolling out and on the rise so much. But take me back to what you said about Amber, and I don't want you to pass away anytime soon. But let's just fake your death for a moment. Eric, you told me you are four years older than Allison.

Eric:

That's right.

Jenine:

So statistically speaking, you should pay attention, because this will affect Allison, as well.

Eric:

Thanks for that reminder. Appreciate that.

Jenine:

Yes.

Eric:

That's good.

Jenine:

Yes.

Eric:

Okay.

Jenine:

But what do you mean by her tax bills kind of blow up?

Doug:

Yeah. So hopefully, I die at a reasonable age. So let's say I'm 90 years old.

Jenine:

And you stopped hitting the fast food. I saw that on your expenses.

Doug:

I did. I did.

Jenine:

So that's working for you.

Doug:

I've given up the McDonald's. I've probably got another five years of lifespan in me.

Jenine:

That great.

Doug:

So when I pass away, she's got to start filing a single tax return. And so even though her income's probably going to go down a little bit, because one Social Security benefit goes away, her federal income taxes might be higher. The percentage of her Social Security that is taxable-

Jenine:

Do we have a chart on this?

Doug:

We do, but we're going to get to that when we talk about Medicare, which is right up now.

Jenine:

Oh. Okay.

Doug:

So that's the third piece, is that your Medicare premiums are based on your income and your filing status. And so there's a lot of scenarios where when I die, Amber has to switch to filing singly. Her Medicare premiums, as a single person, might be higher than the premiums were for both of us added together.

Jenine:

So this is a really important slide. So walk me through. Let's spend a little more time here. Walk me through again what this is showing.

Doug:

So what it's saying is let's say that Amber and I, we've done well saving for retirement, so we have $250,000 a year of income. You can see that barely increases our Medicare premiums at all. But then, if I die, let's say her premiums go down by, or her income goes down by, let's say, 30,000. That puts her at 220. You can see she's almost at the max level. So her premium as a single person, if my eyes were better, I could read that, I think it's 649, versus our premiums as individuals were in the 200s.

Jenine:

Wow.

Doug:

So it's a significant increase, and to make this worse is she doesn't have any control over her taxable income at this point. Because if I die at 90, she's 89. Her RMDs, her required distributions from retirement accounts, are really high. So even if she wants to dial back her income, her taxable income, she has no control over it. And so we call this the survivor's tax trap, and I think there's two reasons you want to talk to your clients about it. One, it's a risk that they need to control, but two, the scariest statistic in our business is that 60% of widows change advisors after the husband dies. It's because they have a perception that that was their husband's financial advisor.

But if you're our financial advisor, and you're talking to us about, "Doug, Amber, this is what's going to happen when Doug passes away. This is a big risk for Amber as a survivor. Here's what we need to do to protect Amber from that risk," it's very difficult for her to now perceive the advisor as my advisor rather than ours or even hers. If I don't like it, like I'm like, "Well, this isn't something I want to say," who cares? I'm going to die eight years before her. You'll retain the assets anyway. She's the critical piece of the relationship, and the survivor's tax trap ties right into Medicare, ties into Social Security, and cements your brand as their or her advisor to protect those assets.

Jenine:

Great point. So the two slides that you had up there, we have that for people listening in to get access to.

Doug:

Absolutely. So the first piece is take control of taxes in retirement. That's a client-approved piece. What I like about it is we didn't show it, but the back has a blank grid. So particularly if you're talking to a prospect, you can start asking questions about what they hold and what the tax status is, but I would also use it for a client. Because there are clients who, just like I lie to my doctor, they lie to their financial advisor, or they forget to bring up other assets.

So if you have that conversation of, "We need to figure out if you have a tax-diversified portfolio, so we need to go through everything you own. It's okay if you have assets other places, but I need to know about them in order to do planning for you." And so that way, you can uncover those assets that are held away. If they're invested appropriately, fine. You can leave them. If they own things that are terrible, later, you can have the conversation about improving what they hold.

Jenine:

That's great. That's great. Eric.

Doug:

Yes?

Jenine:

Nothing screams taxes more than munis.

Eric:

That's right.

Jenine:

Last time you were here, you were super excited about the muni asset class.

Eric:

That's right.

Jenine:

You're smiling.

Eric:

Yes.

Jenine:

You're chomping at the bit.

Eric:

I just can't wait.

Jenine:

You've been waiting patiently while Doug has been going through his comments.

Eric:

Yes.

Jenine:

You still excited?

Eric:

Still excited, and also, don't lie to your doctor. That's not good thing. So don't do that.

Doug:

It's probably bad.

Eric:

Yeah. Yeah. Absolutely. The good is you probably could replay last year when I was out here 18 months ago, and it's the same message. So last year when I was here, I said there was attractive yields. The fundamentals were solid, and investor demand actually started to come back to the asset class. 18 months later, still have really good yields. Fundamentals are still in a good place. But the one thing that's really interesting is investor demand for the asset class accelerated. In the last year, we've seen, already, about $90 billion into the asset class in the last year. So that's pretty significant. So the three pillars of fundamentals, technicals, and valuations are very much intact.

The one thing we didn't talk about when I was here 18 months ago is just the resilient performance of this asset class, and hopefully, the chart there is showing up on the screen shortly. But over the last 18 months, it hasn't been the cleanest journey for this asset class. If you think about we had the volatility following Liberation Day. The asset class lost 4% in one week.

Jenine:

Wow.

Eric:

You basically lost a years worth of coupon clip in one week.

Jenine:

Yeah.

Eric:

The asset class was negative through July, and now we have all this volatility with the Iran conflict. It's just shaking the asset class over and over and over again. What you can see from the chart is if you look at cumulative performance, you've gotten over 6%. Then, because munis have that tax-advantage income, you got to do a tax equivalent return on things. Now, you're looking at a return of seven to 10%. So what I always highlight for folks now is the muni market keeps taking a licking but keeps on ticking. I don't know if that's like the, it's the Energizer Bunny of fixed income.

Jenine:

Oh. I love a good, yeah, I love a good rhyme.

Eric:

But I think with the fundamentals, technicals, and valuation, and the resilient performance, that's something I think people need to keep in mind, especially given when you look over the last 30 years, and you look at things that are rolling 12-month basis, munis are positive close to 90% of the time.

Jenine:

Wow. So definitely, looking back at this asset class, it's not your grandfather's asset class anymore.

Eric:

No.

Jenine:

We can say that.

Eric:

Yep.

Jenine:

So what does ... Put MFS. Give me a plug. What do we do different?

Eric:

Yeah. Yeah. Happy to. So I think first and foremost, all managers take risk, but I think it's how you manage that risk, is critical. The muni market is still a high-quality, low-default asset class. I'm not going to deny that, but it is a very inefficient market. It's a $4.4 trillion market. It's very fragmented. There are over one million individual securities across sectors, quality, coupon structure. So there's a lot of things you have to kind of factor in.

I think MFS has done an incredible job managing through some of these volatile periods for, really, two reasons, one, the integration into our global investment platform. Then, secondly, and I think this is unique to a lot of muni managers, is that we have a dedicated in-house legal team that helps our analysts, so to kind of unpack each of these integration into our global investment platform.

So why is that important? So the muni analysts aren't just working in a silo. They're not just looking at an individual credit for a hospital and then not talking to anyone else. They're collaborating across the equity analysts, the corporate analysts, the quant team, the chief economist to get a better understanding of, what are housing trends look like? Housing trends matter. Price value, I don't know about you, but my house keeps going up, and what does my property tax value keep doing? Keep going up. Those are factors you have to keep in mind when it comes to looking at a bond that's backed by those.

The same thing goes for consumer behavior. If consumers don't continue to consume, then what happens to tax revenue? It declines. So getting a broader perspective of things is critical. Then, secondly, in-house legal team, I don't know about you, but every time I read through these documents, they're written by attorneys. Sometimes, they can only be deciphered by attorneys. So having someone there where analysts can consult with to look at assessing the risks, looking at legal protections. Are there aggressive assumptions? Does this issuer believe that this huge amount of revenue is going to come through, and that clearly is just not going to be the case? So the point is that there's risks. It's still a high-quality asset class, but you can't go into this asset class blindly. You clearly have to kind of dig deeper to make those better investment decisions.

Jenine:

Yeah. No better partner than a company that's obsessed with risk. That, one could say, is MFS.

Doug:

That's right. So not to hijack your time, but I got completely smoked on my taxes in April. So if I want to add in some munis, should I go the mutual fund wrapper, the ETF, the SMA? What's the best way to access it?

Eric:

So it's going to depend. Clearly, you expected me to say that, but I was listening to every word you were saying earlier, by the way. Just couldn't get enough of it. But you were talking about tax diversification, and I think it's the same thing when it comes to your investment portfolio. When I think about the most common investment vehicles, and Jenine mentioned them, SMAs, individual bonds, ETFs, open-end funds, they're all great vehicles. But they all serve a purpose, and they all have strengths and weaknesses.

So what I have educated people on is, what are the strengths, what are the weaknesses of each of those vehicles? But honestly, people should be building a portfolio of different kinds of vehicles. The reason for is you have SMA individual bonds that give you this predictability of cash flow, preservation of capital, but what's some weaknesses? Maybe you don't have a huge amount of assets to create a diversified portfolio, and the same thing ...

Then, if you think about an ETF or an open-end fund, you get access to that management to make different decisions based on opportunities, risks in the market. You get daily liquidity. But what I also think is interesting is when you look at ETFs and open-end funds, you're broadening your opportunity set. So when you take something like SMAs that tend to have a limited opportunity set and couple it with active ETFs or open-end funds, it broadens and optimizes that one portfolio.

The one thing I would suggest and folks to reconsider it is fees are clearly important. Right? Taxes are important, but clearly, there's been this focus on fees. In the muni space, given some of the things I've already said, all the inefficiencies in the market, I still see people buying passive ETFs, and I feel like this is the one market where you want to be active. Anyone can look at the data, and over and over again, over full-market cycles, active has outperformed passive. So that'd be the one thing that I would highly suggest, is to go active over passive when it comes to the muni space.

Jenine:

There must be a strategy that you are super excited you want to talk about, though. You must have your favorite. We all have favorites.

Eric:

Yes. So the good is representing MFS, we have a full menu of options to choose from if it's a short duration, intermediate duration, long, high-yield credits. If you look at the rankings, I mean, if you look over the rankings over the three and five-year period, and this is one of the most volatile periods we've seen in the muni market in a long time, and the rankings are fantastic.

But if I had to just pick one, the one I'm most excited about that continues to put up incredible results is our muni intermediate capabilities. I think of muni intermediate as sort of the sweet spot between yield and duration, so you're not too short. You're not too long. You're getting this competitive yield, and I think when you think about the rate environment we're living in, it's definitely given us a lot of volatility.

So kind of being in that sweet spot is nice. Last time I looked, I think eighth percentile since inception, which is pretty incredible. If you think about the period of time of 2022 to 2025, it's one of only four other funds that have had top third rankings every single year, just basically highlighting the durability of results over time. If someone doesn't want the open-end fund, the good is we also have an active ETF. That is a wrapper that people are gravitating to. So I think the intermediate space is definitely something I would have people start looking at a little bit more, especially at MFS.

Jenine:

That's great. So when did that come out again? 2000?

Eric:

2021. So we just hit a five-year track record and then ticker symbol MIUIX. Then, for the ETF, it's MFSM.

Jenine:

MFSN.

Eric:

Yeah. We're unique, aren't we?

Jenine:

We are unique.

Eric:

Yeah, yeah, yeah.

Jenine:

Nice. So let's roll to questions. We had a couple of questions come in, and I think we have time for two for each. But actually, when you were talking about taxes, I was thinking about our good friend on the team, Karen Ireland-

Doug:

Yep.

Jenine:

... who is our Social Security guru, and she sent us an email that was, in my mind, a little unsettling about the Social Security fund and when it was going to deplete.

Doug:

Yes.

Jenine:

Which makes me think, okay, first off, what was the year?

Doug:

2032 is the current estimate.

Jenine:

2032.

Doug:

Pretty close.

Jenine:

It's pretty close.

Doug:

Pretty close. Yep.

Jenine:

Which means, and I am, I believe, working longer than 2032, so that makes me unsettled. So either Social Security is going to be gone, or we're going to have to fund it through increased-

Doug:

Yeah. So let me cover the first part of that first, because-

Jenine:

Okay, because I might cry.

Doug:

I hope I have good news.

Jenine:

Okay.

Doug:

So if the Social Security fund completely depletes, it's not that Social Security will go away. If Congress doesn't do anything, they'll just lower the benefits automatically, and it changes every time they run the numbers. But it's about 80% of what you would see on your statement is what they're projecting they could pay. It varies. Sometimes, it's 78. Sometimes, it's 82, but it's right in that range. So don't worry. The checks won't just disappear.

Jenine:

Okay.

Doug:

The issue that I see is we're getting pretty close to that date, and the way they've fixed it before is to push the pain really far into the future so that it doesn't affect the people passing the law. Like the increase in the retirement age was signed by Reagan, and we're just finishing it up now. So you have a really long window. We don't have time for that. So there's no real consensus on what they'll probably do, but it's got to be the shorter-term fixes, things like getting rid of the cap on how much of your income you actually pay Social Security on or changing the FICA tax. It's probably going to be one of those options if they wait right until the deadline.

Jenine:

Okay. Okay.

Doug:

To get into what I would talk to a client about is if we think your Social Security benefit might go down by 20%, if you're decent way away from retirement, how much do you need to save each year until then to make up the gap? And so that way, it gives the client a little bit of confidence that, "Okay. If they don't fix it, and my Social Security gets cut, I'm fine." If they fix it, well, then you have more money in retirement, and nobody complains about that.

Jenine:

Okay. All right. Brian, going to have to call me. All right. Doug, this question is for you from Robert in California, how to best manage effective tax rates in retirement by deciding how much to withdraw from tax-deferred, taxable, and tax-free accounts.

Doug:

So this is one of those that I hate to give an, "It depends," answer, but it's something that you're going to make that decision, I think, each and every year. And so it's a conversation between the retiree, their financial advisor, their tax advisor if you need it. The important part is if you built the tax-diversified portfolio upfront, you have all the different levers to play.

What I mean by a year-by-year decision, let's say the client comes in and says, "We want to buy an RV. It's going to be $200,000. We hate borrowing money, so we're going to take a withdrawal." That might be a use for some sort of tax advantage withdrawal like a Roth so they don't blow everything up, blow up their Medicare premiums and all that sort of stuff. But then, there's no reason the next year, you might go back to predominantly taxable. So it's a discussion I'd have at the beginning of the year about, what are those lumpy expenses that are going to come up, and maybe that's the way we adjust it.

Jenine:

But those are great. I think those are great points. I mean, we always talk about the value of advice, and, I mean, that's extremely valuable. Don't you own an RV?

Doug:

I do. I do.

Jenine:

Yeah. Look at him light up.

Eric:

Did it cost 200,000?

Doug:

Not quite.

Eric:

Did you write it off like a home equity loan, too?

Doug:

My financial decisions, I don't want to give away all my credibility, because it wasn't a good decision. I love it, and I love the van.

Eric:

It goes back to the-

Doug:

But financially, not the best idea.

Jenine:

Right. It goes back to the rat tail.

Doug:

Yeah.

Eric:

Okay.

Jenine:

All right. So Eric-

Doug:

Yeah. I didn't have a rat tail.

Eric:

Decisions. Yep.

Doug:

Yep.

Jenine:

Eric, this question from Indiana, what are your thoughts? Actually, we get this question a lot. What are your thoughts on unrated municipal bonds?

Eric:

Yeah. I get that question a lot, too. Yeah. I always feel like more people spend a lot of their time in fixed income talking about taxable fixed income, and you don't really see the not-rated portion. Then, if you buy a muni bond, especially if it's invested in the higher-yielding segment of the market, you start to see, oh, 30, 40% of the portfolios in not-rated bonds.

What I think is interesting is if you look at the high-yield index, the percentage of bonds that are not rated is actually getting larger, and larger, and larger. What people don't realize is an issuer that's looking to borrow has to pay Moody's, Fitch, and S&P to get that rating. So if you're a well-known issuer in the market, you already know you're going to get demand for your paper-

Jenine:

Why pay for it?

Eric:

Why pay for it? So a lot of times, issuers won't come into it, but it doesn't mean you just are complacent. Again, to get another MFS plug and things like that, I mean, we're underwriting that bond even if it doesn't have a rating and trying to assign our own rating internally to ensure that we're comfortable for the risk. But yeah. I mean, there are some bonds out there that are not rated, and you need to be really careful in terms of what kind of assumptions they have and their revenue. So being selective in that space is critical, but not rated is not going away. It's just part of the market that we're-

Jenine:

It sounds like it might be growing.

Eric:

It is growing.

Jenine:

Yeah.

Eric:

Yeah.

Jenine:

Yeah. Great. All right. Doug, this comes from Texas. What is the optimal time to start Roth conversion when retiring at 60 years old?

Doug:

So this is another one that I would look at each year. Traditionally, what'll happen is if you retire at 60, and you're not on Social Security yet, your income's a little lower, that tends to argue that a Roth conversion might be a good idea. Not to give anybody tax advice, but looking at your current tax bracket and seeing how much you can add in income to fill that up but not creep into the next bracket, that's most likely to be ideal.

Then, when you hit 62, and you've got to have that decision of, "Do I sign up for Social Security or not?" there's a pretty good argument for, "Maybe I don't." Use that time between 62 and 70 to do more conversions, and then you've maximized your Social Security at 70. But I think, not to make advisors do more work, running the model both ways, one taking at 62, one waiting at 70, doing the conversions, and then you've at least got the math on both sides to show the client. Let them make the decision then.

Jenine:

Great. Last one, because we are definitely running out of time. This is for you, Eric. What keeps you up at night in the muni market? You're all happy and excited about it, second time. Something must keep you up at night.

Eric:

I think a repeat of 2022, as for those, remember that time. It was the central bank all across the globe aggressively hiking interest rates. Clearly, that's not going to be good for fixed income. Munis had its second-worst year ever, and then it led to a huge outflow cycle, meaning people were just leaving in droves. Not our base case, but that would be the worst-case scenario, is that all of a sudden, inflation gets out of control. Then, the central banks have to come in and hike aggressively as they did back in 2022. That, then, leads to investors leaving, and that exacerbates the situation. Not our base case, but that would be the one thing that keeps me up at night.

Jenine:

Keeps you up at night.

Eric:

Yeah.

Jenine:

All right. Now, we are at time. Give me your key takeaway that you want everyone to walk away, Eric and then Doug.

Eric:

Yeah. I mean, I said it earlier. If you think about just demand is strong. I think we're already at $46 billion. That is the second-fastest on record for the muni market. Yields are super attractive. The income is back in fixed income, and the fundamentals are still in a good place. But the one thing that we have to keep in mind is volatility isn't going away. We're not living in a vacuum. There's going to be volatile moments, and we have to continue to just kind of stay with the asset class. When we get those periods of volatility, it's also a buying opportunity, as well.

Doug:

Awesome. So I would say it's about flexibility and diversification when you think about tax risk, that if we build a flexible structure where you've got a variety of different taxation options through the taxable account, the Roth, the traditional, then you've reduced your risk. Because if we can't predict what's going to happen, that's the way we're going to protect ourselves.

Jenine:

Perfect. I have two things. I like Straight Talk, because it's timely. Then, I feel like I finally have breaking news. So we do have a piece from a member of your team-

Doug:

Oh. Yeah.

Jenine:

... Andrew Gordon, which is like the hottest, hottest piece that everybody is asking for. Trump Accounts.

Doug:

Yeah. So-

Jenine:

So we-

Doug:

Yep.

Jenine:

Yeah. Go ahead. No.

Doug:

So I was going to say when Trump Accounts first came out, the way the law was written, we're all like, how do you actually use that? Now that we've gotten more guidance, the short version is it works a lot like a non-deductible IRA, but for kids.

Jenine:

Hey.

Doug:

So if you put $5,000 in for a newborn, model out what that's worth at 65, it's eye-popping numbers.

Jenine:

That's wonderful. So we do have a what it is, how to look at it, how to take advantage of it. For a lot of you who do not realize, the Russell One Value had its reclassification, one of the biggest changes in that index, and we do have a one-pager on that. Because everyone should be aware of it. We are at time. Thank you so much for joining me again, and I am sure you guys will be back. Because nobody is going to pass away anytime soon. So we will have you, definitely, back in.

Eric:

Okay.

Jenine:

Thank you for reaching out and taking the time to watch Straight Talk. Have a good one.

 

 

 

The views expressed in this presentation are those of the presenter. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product. MFS does not provide legal, tax, or accounting advice. Clients of MFS should obtain their own independent tax and legal advice based on their particular circumstances.

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