Paul Merriman

Paul Merriman is a nationally recognized authority on mutual funds, index investing and asset allocation. He founded a Seattle-based investment advisory firm in 1983, but is now retired and devoted to educating investors, through weekly articles on Marketwatch.com. In 2013 Merriman created The Merriman Financial Education Foundation, dedicated to providing comprehensive financial education to investors, [...]


Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 15 out of 100 top ETF Power Users by RIA channel (2023), was [...]

Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

Published On
February 19, 2019
Paul Merriman: Are These Two Funds the Only Ones You Need for Life?

Nationally recognized investing expert Paul Merriman makes the case that owning just two funds for life is a “home-run” investing strategy for some investors. Plus, Joe and Big Al answer your money questions: how should teachers, and others without Social Security or pension, save for retirement? How do you record flexible spending account contributions on your taxes? How long should you keep your tax records?  And of course, this wouldn’t be YMYW without some talk about Roth IRAs – specifically, making Roth conversions and back door Roth contributions.

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Show Notes

  • (00:46) Paul Merriman: Teaching Financial Literacy to Kids and 2 Funds For Life
  • (12:43) Paul Merriman: 2 Funds For Life
  • (21:54) Teachers: How to Save for Retirement Without Social Security or Pension (Video)
  • (28:39) SEP IRA, Solo 401(k), Company 401(k) and Roth Conversions (Video)
  • (31:31) Back Door Roth Contributions
  • (33:34) How Long Should I Keep Tax Records?
  • (36:23) How Do I Record My Flexible Spending Account Contributions on My Taxes? (Video)


Today on Your Money, Your Wealth®, nationally recognized investing expert Paul Merriman makes the case that owning just two funds for life is a “home-run” investing strategy for some investors. Stick around and find out which two funds. Plus, Joe and Big Al answer your money questions: how should teachers, and others without Social Security or pension, save for retirement? How do you record flexible spending account contributions on your taxes? How long should you keep your tax records? And of course, this wouldn’t be YMYW without some talk about Roth IRAs – specifically, the fellas deliberate on making Roth conversions and back door Roth contributions. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson CFP®, and Big Al Clopine, CPA.

:46 – Paul Merriman: Teaching Financial Literacy to Kids and 2 Funds For Life

Joe: Got my good friend Paul Merriman. He is a legend in our business. He’s done more good for the average investor than I can ever imagine anyone else do. So without further ado, want to welcome Paul back to the program. How have you been bud?

Paul: Joe, I’ve been great. And by the way, thank you. My life is about trying to help people who don’t know what the heck to do about their investments, and you guys perform an amazing service for people. I’m out trying to help high school kids and college kids. So I kind of go above and beyond where you guys go, unless maybe you’re out doing the same thing and I just didn’t know about it?

Joe: You know, I tried to do that, Paul, once. That’s a tough gig. That’s a tough job.

Paul: (laughs) I get more nervous talking to a bunch of high school kids than I do a roomful of 200 adults. It’s a whole different world. But I do love it, and I am getting some work done. So thanks for the comments.

Joe: I’m just curious on that, with the curriculum that you teach high school kids, I would imagine it is pretty much similar to a lot of the other work that you’re doing. Because I would say most adults have probably the same financial knowledge that someone in high school does.

Paul: You’re exactly right. After 45 minutes with those kids, they actually know the difference between load and no-load, low expense and high expense, one stock versus a thousand, high taxes versus low taxes. I mean, none of this stuff is difficult. It’s just that, as you know, Wall Street tries to make people believe that it’s complex and they just can’t deal with it.

Joe: Yeah. Without question. I’m really excited to talk to you today. I know you have a new initiative to change the world of investing. And I’m really intrigued by this “2 Funds for Life” concept. Let’s talk a little bit about that. What’ve you been working on?

Paul; Well, I’ve been looking for a way to simplify the process, because people like your firm, and when you manage money for people, and my old firm when they manage money for people, they use a very sophisticated strategy – lots of different asset classes, rebalancing, tax management, blah, blah, blah. It’s too complex for the individual investor. And the individual investor that needs the most help is that first-time investor coming right out of college, going to work, got their first 401(k). And what should they be doing with that money to invest for the long term? Well, I know the best, absolutely for them, the best investment is just a simple target date fund. Because if you think about it Joe, well, at least when I was first involved in investing back in the mid-60s, most of my friends that I knew that went to work somewhere, they were all of a sudden in a pension plan. I mean, they had to stay there for 40 years or something to get it, but they had a kind of a guaranteed saving program for retirement. They didn’t have to worry about putting the money aside, it got taken out of their pocket before they even knew it was there. They didn’t have to worry about where to invest the money, they didn’t have to worry about how to change the asset allocation as they got closer to retirement. What the pension fund did, they took care of all of that in a professional manner. The public is not really smart enough or experienced enough to do this, and it gets complex emotionally when it’s your money. Enter the target date fund. All you’ve got to do, as you know, is figure out what year you want to retire, use the target date fund that comes the closest to that, and all of that gets taken care of for you. It is as close to a perfect investment for the small investor than I know because it goes beyond indexing. Because it takes care of that balance between equity and fixed income that you do not get out of an index fund. So it is special. Now, I heard through the grapevine that you’re not as big a fan about target date funds as I am, and I want to know why.

Joe: (laughs) I don’t know where you’re getting your information from, Mr. Meriman. Let’s talk about a couple of things that maybe you can educate me on. So when you look at a target date fund, I’m an absolute huge fan of the target date fund for accumulation purposes. So, if you have a young investor, if you have you know someone in their 20s, 30s, 40s, or even 50s, I don’t care, and they’re not sophisticated enough of what value vs. growth or small vs. large or international vs. emerging markets, if they don’t want to go through all of that, I think the target date fund works out perfectly. Where I have some problems with it is just on the distribution of assets as they’re trying to create income. That’s my only beef. I think some of them are filled with a little bit too high of fees. I think some of them, it’s a very complex marketplace. So you take a look at one target date fund and you can take a look at another target date fund, even though, let’s say, it’s both 2025 target date of my retirement, and they have totally different risk parameters. And I think sometimes, I don’t know, is that the manager? Is it that company trying to add a little bit more risk to show higher returns to confuse the average investor to gain more assets? I don’t know. So I mean, there’s just a lot of things, because what, I mean 50 percent of the assets are going into these products. I think Wall Street have figured out, “hey, this is a really good product to gather more assets,” and I think with anything like that there could be some abuse in really what the public is thinking they’re getting vs. reality.

Paul: I agree with everything that you’ve said. I absolutely agree. In fact, I’ve even got more complaints than you do. My first complaint that really irritates me is that a target date fund for a 21-year-old or 25 or 30, is going to have 10 percent sitting in a bond fund. Why would we ever, ever want to put a 21-year-old in a bond fund that is going to cost him, for every 10 percent – or her – for every 10 percent in bonds, it’s stealing half a percent a year during those early years of accumulation. That, I think, is an outrage. The second outrage I have is they don’t put any small cap in there. They don’t put enough small cap to move the needle one bit, because all of them, almost all of them are building their target date fund on large-cap blend, the Total Market Index U.S., Total Market Index International, and throw in some bonds, and that’s kind of it. The problem with that – and you guys, I know you’re in favor of this – you’d want to see not only some small cap in that portfolio, you’d want to see some value in that portfolio because there’s so much evidence that those asset classes add value long-term. So, here’s what 2 Funds for Life does – and it’s not going to make up the creative portfolio, as good of a kind of a portfolio as you would put together for somebody, or that I would have when I was in the business – in fact, my own portfolio has 10 different major asset classes in it. Well, you can’t do that with these young people, unfortunately. So how about this. How about a formula that takes a 20-year-old, or a 30-year-old, I don’t care how old they are, and it says, “look, you need to build a portfolio with the concept of a target date fund. But how much should go in that target date fund?” When you are 20 years old I want you to be smart enough to multiply your age by 1.5. Whatever that amount is, that’s the percent you’re in the target date fund. The balance of the fund is going to go, if you want to be aggressive, into a small-cap value, and I hope, index fund, Joe, and I think you’d wish for the same.

Joe: Absolutely.

Paul: And by the time, let’s say, the 20-year-old is 30 years old, it’s now 45 percent in the target date fund, and 55 percent in the small-cap value. So what’s happening is not only are the managers of the target date fund ratcheting down the risk as the person gets older, so is your exposure to small-cap value. Now would I rather have a portfolio that’s a combination of international value and large and small and U.S. large and small value? Sure I would, but the problem is that makes it all very complex. And it turns out from the studies that we’ve done, if you invested in a look-a-like of the glide path from Vanguard – because they are the giant in the target date business – that from 1970 to 2017, the compound rate of return would have been such that you would have turned your many years of investing in that 401(k) plan to about $6 million if you use their strategy as it is built today. If you use this 2 Funds for Life, use small-cap value, instead of $6.12 million, the average return – and there’s a whole range, I mean it was like a Monte Carlo bootstrapping kind of way of investigating the long-term return – but the average return was about $2 million higher. Now, if we could give somebody a strategy that would give them decent exposure to equities, the right amount of big cap, and close to the right amount of small cap, and the right amount of value, and we can do that with two funds, I think – and by the way, as you know, I don’t make a penny on this stuff, I’m just trying to help people do better, leave more to their families, retire earlier, whatever it might be – this, I think, is a true home run. And I’ll just quit talking here in a second. You might say you don’t want to be so aggressive to be in small-cap value because certainly, it is more aggressive than large-cap value. But even if you just used large-cap value, you still added almost $1.5 million, or a little more than $1.5 million to what you would have in retirement. Just because you were willing to add that extra value, that extra large cap, and increase the risk. Yeah, you do increase the risk when you do this. But that’s one of the big problems with target date funds. They’re built for the most average individual you could ever imagine in your life!

(Joe laughs)

If you were the average investor, you wouldn’t be listening to YMYW! Check out the show notes for today’s episode at YourMoneyYourWealth.com for the transcript for this interview and all our past interviews with other investing experts like Liz Ann Sonders from Schwab, David Kelly from JP Morgan, and Larry Swedroe from Buckingham. In the coming weeks, behavioral finance expert Dr. Daniel Crosby returns to YMYW to tell us about his latest book, The Behavioral Investor, and we’ll talk to Tanja Hester, who retired at the age of 38 – she’s got a new book called Work Optional: Retire Early the Non-Penny-Pinching Way.” Subscribe at YourMoneyYourWealth.com to get new episodes as soon as they’re released – and click “share” to help your friends become above-average investors too! Now, more about 2 Funds for Life with Paul Merriman.

12:43 – Paul Merriman: 2 Funds For Life

Joe: Well let me crack this egg open a little bit because I got multiple questions for you on the functionality of it, how often that you adjust, but more importantly, let’s talk in generalities just about a target date fund. Share with our listeners here, what is the genesis behind it, how does it work? Because I think still a lot of people hear target date fund, or an L Fund if I’ve got the TSP plan or whatever, lifestyle funds, and everything else in between. Just talk a little bit about how let’s say a Vanguard or any other company that puts these together, how do they put them together and how do they work?

Paul: Well, the way they work is somebody smart and experienced is making a decision about somebody who’s 40 or 50 years away from retirement. How much of their portfolio should be in equities? And then, of course, they have to make the decision about how much of the equities are in large companies and small companies and growth and value – they take care of all of that. Now you hit it early on. They do come to the table with a bias. And one of the biases they have is to put together that portfolio so it doesn’t confuse people. So that if the market goes down, their fund better go down. And when the market goes up, then their fund better go up, because by God, if you don’t go up (laughs when the market’s going up, people are gonna think you don’t understand what you’re doing! So they build them to be kind of acceptable to the average investor, not taking a lot of risk, but early on, almost all equities. 10 percent in bonds, let’s say. In fact, I even asked John Bogle – I spent 90 minutes with him in his office a couple of years ago – and I asked him, “why the bonds? What are you doing with bonds in the portfolio for a 20-year-old? And he said, “you know, we just want to expose them to the idea of what fixed income is about.” And of course, my response is, “Why not educate them as to why they shouldn’t have it when they’re 20?!” But they do that. And so, as the investor gets older – and by the way, they don’t have any more than 10 percent fixed income until the investor is about 40 years of age. That’s good. And then, to the extent that they’re going to have fixed income, I certainly wouldn’t want any more than 10 percent. But from age 40 on until they’re 65, the bond part keeps growing, and the equities keep shrinking because less equity means less risk. It also means less return. But at some point in your life, you’ve got to realize that your ability to produce income is declining and your willingness to take risk should be declining at the same time, and you should be preparing for having more or less some sort of guaranteed income when you finally, let’s say, reach 65. The beauty is, they do it all. The investor simply has to put the money in the 401(k), it gets managed, and then let’s say you meet this magic age of 65. Well, these 401(k) plans, they’re more than happy to manage the money until the day that you die. And for a lot of investors, that’s exactly what they want, because they don’t want to deal with this stuff. They want somebody else to. So it is the automated process that you and I both believe that an investor should have. They should have index funds. We both believe in that. And index funds are kind of an automated way of investing. Then they’re expecting that person putting money into the 401(k) or the IRA to be dollar cost averaging into that investment. Buying more shares when the market is down, buying fewer shares when the market is up. Again, it’s automated. And then, taking care of that correction on how much in fixed income and how much in equity. What more does the average investor need except to make sure that equity portfolio gets exposed to some asset classes that have a hundred-year history of doing better than the S&P 500? I want young people to have those asset classes.

Joe: So if I unwrap this even further, so you looked at the target date fund and said, “OK, with all these attributes for the average investor, when they’re young, they have more equities than bonds, and as they age, that is going to get more and more conservative. And usually around 40 years of age is the bigger turning point, so 40 to 65, you’re going to see a bigger shift in that portfolio that’s automated that is going to go more towards bonds toward stocks, so when they retire, they’re not going to have a huge equity portfolio that would be damaging to their overall retirement.

Paul: You did it in 30 seconds. I did it in five minutes. That was perfect.

Joe: (laughs) But then you looked at it and you said, there are some flaws here, because a 20-year-old investor should not have 10 percent of the portfolio in bonds, and there’s no real I guess maybe a juice, kicker or a booster, to steal your words, within the portfolio to help a 20 year old that is earmarked for retirement 40 years from now to get a higher expected rate of return. And using the science of investing and the academic research and studies that you’ve done for many, many years, and using some of the brightest minds in Wall Street or academia, is to say, hey, there are asset classes here that will produce a higher expected return over the long term. The downside of that, or the tradeoff, is that they’re going to have to take on a little bit more risk to get that higher expected return. But who cares? They’re 20 years old they can afford to take the risk.

Paul: And if I could add one thing because you’re doing this so well, the way that formula works, when you turn 65, 66, that extra kicker, that small-cap value – it’s gone.

Joe: Zero. Yep. Perfect. But you’re adding more equities because you said 10 percent is too much in bonds. I want more equities in younger years. And so you came up with the formula 1.5 times your age. That’s how much money you want in the target date fund, so 30 percent in the target date fund, 70 percent in small-cap value. And then you ran that number throughout their age, and by just doing that, you’re able to produce, of course, on average, and you know, forgive me compliance, and there are no guarantees, and all of that, roughly a couple million dollars extra in their pocket – just by holding an extra fund.

Paul: Exactly. And now, to be fair, there are a lot of assumptions you make. Do you increase the amount of money that you put away each year by inflation? There are all sorts of things you run through to see what the real world might look like. And anytime we look back, I don’t care if we’re looking at actual performance or hypothetical performance, anything in the past is hypothetical because you can never recreate what was done in the past, ever, the same way it happened.

Joe: But I love the concept, Paul. I mean I think you’re really onto something. And I think the average investor, the average 401(k) investor, or anyone for that matter, needs you in their life. They need this information because all it is is going to take them an extra 30 seconds out of their life to basically generate maybe 25 to 30, 40 percent higher income for their overall retirement if they can just follow some simple steps.

Paul: And all they need to do, Joe, is, we created 2FundsForLife.com as a place that they can go and just see this work that we’ve done and not be bothered with all that other great information that we have. (laughs) But 2FundsForLife.com.

Joe: Everyone, please check this out. 2FundsForLife.com. Mr. Paul Merriman, it’s been such a treat and a pleasure to have you on the show once again, and again, thank you so much for everything you do.

Paul: You bet. Keep up the good work, you guys. Bye bye now.

Joe: All right. Take care. See ya, Paul. That’s Paul Merriman, folks.

We’re about to open up the emails, but first, we’ve got a free book for ya. If you’ve got questions about your financial situation, go to YourMoneyYourWealth.com and scroll down to where it says “Ask Joe and Al on Air.” If you’re on your smartphone or if you’ve got a microphone on your computer, just click the record button, ask your question, and we’ll play it back and they’ll answer you right here on the podcast, and we’ll send you a free copy of the book “Think, Act and Invest Like Warren Buffett” by Larry Swedroe, with a forward by Joe and Big Al, just for recording your question! No microphone? You can submit your question on a text form too. Just go to YourMoneyYourWealth.com, click “Ask Joe and Al on Air,” ask a question, get a free book! Now, let’s get to some of your money questions.

21:54 – Teachers: How to Save for Retirement Without Social Security or Pension

Joe: We got Anna. “Hello Joe and Al, I love your funny and thoughtful podcast.” Well, thank you, Anna. “I’m a teacher in my mid-40s at a state school. I opted out of the underfunded pension system when I started the job a decade ago. Instead, I contribute to a defined contribution plan and various supplemental retirement accounts. Unfortunately, in my state, I’m ineligible to contribute to Social Security, so no pension and no Social Security. However, I do live in a LCOL, low cost of living area, and I’m recently able to save more than I spend – $40K per year into retirement accounts – and I’m thinking about adjusting my portfolio to take the lack of Social Security or pension into account. What do you think are the pros and cons of these ideas? All right, Anna. She’s saving $40,000 a year?

Al: Yeah that’s excellent.

Joe: Solid. Mid-40’s? She’s gonna be just fine. What, why you rolling your eyes at me?

Andi: I didn’t roll my eyes, I smiled and then I’m looking at the rest of her question.

Joe: Got it, whatever. (laughs) Okay. “Take a chunk of my savings each year, $10k, and put it into I-Bonds creating a safe inflation-protected bond ladder.” Number one, what do you think about that idea?

Al: What’s an I-Bond? Inflation?

Joe: An I-Bond? It’s like a double-E bond. It’s just a government bond. Never heard of an I-Bond?

Al: I have, I just can’t answer the question without knowing exactly what is. (laughs)

Joe: Got it. Or maybe it could put it in “1,” bonds creating a safe inflation… but I believe it’s I-Bonds.

Andi: I think it’s I-Bonds.

Al: Yeah that’s what it looks like, I-Bonds, so I do believe, Anna, you should have some of your money in bonds. I don’t know that you necessarily need to buy a bond. I might buy a bond fund, and I might stay shorter-term just because when you look at the long-term rates of bonds versus stocks, you don’t get much extra benefit, much extra income for a longer-term bond and you have a lot more risk. But I do agree with putting some in bonds, and whether it’s $10,000, that’s about 25%. That could be about right.

Joe: I disagree with that. You’re mid 40s, Anna, so you’re a little bit older than me.

Al: (laughs) Not much.

Joe: You got 20 years of work left. I think as you get closer to retirement you’re going to need as much capital as you possibly can to accumulate. So I get what you’re doing here is you’re saying I need a supplement for my pension and Social Security, so let me put $10,000 a year in I-Bonds. I-Bonds are paying, what, 2 percent? In 20 years, I don’t think that’s a good idea. I think you want to continue to save the $40,000 in a globally diversified portfolio and don’t segment it. Don’t try to bucketize this thing. You look for a target rate of return over 20 years, let’s say, what do you think, Al? Globally diversified portfolio, 20 years, call it six and a half percent? Are you fine with that?

Al: Yeah I would be fine with that.

Joe: Okay. And then if she does that, she’s got $1.5 million. I’m assuming she has money already saved. So that’s if she started today and she saved $40,000, and she got six and a half percent return on that $40,000 savings per year. At the end of 20 years, she’s got that. And if I take a 4 percent distribution from that, that’s $62,000. As a teacher I’m guessing, what do you make as a teacher – $80,000?

Al: $60, 70, 80.

Joe: $80,000? I mean some administrators might make $100,000 and some.

Andi: Kinda depends on where you are in the country too. And we don’t know what state she’s in.

Joe: So I don’t know, $62,000. That’s, of course, the future value of that… (Joe calculates) It’s always good to do calculations on the air, isn’t it?

Al: (laughs) Yeah it is, here we can see it.

Joe: Uh-huh. It’s about $42,000. Can you live off of $42,000? If you’re good then you’re all set and keep doing what you’re doing and have a global diversified – don’t try to segment.

Al: Yeah and that was assuming you don’t have anything saved now.

Joe: But she’s in our mid-40s and she’s cranking $40,000? She probably has some cash there. Number two question. “Use my tax-deferred retirement accounts and combined short term TIP funds and long term TIP funds to create a sort of liability matching strategy.” Anna! Are you a pension hedge fund manager?? No, I would not do that. She’s trying to – this is what like big pensions do, and they match ladders with liabilities, and the liability, in her case, would be an income stream or income payment. I disagree with that strategy as well. I like the TIPS though, what a TIP is is a treasury inflated protected security, Alan.

Al: Yes, that I knew.

Joe: Okay. Any other comments on that strategy?

Al: No. Agreed. Okay. Her third comment is “more is better.”

Joe: “Stick with the total return portfolio but perhaps choose a more conservative allocation, say move to 50 fixed income 50 stocks to substitute for Social Security. Cheers and thank you for all your work.” All right Anna.

Al: Yeah. Now you’re on the right track. But that’s too conservative. And that’s assuming you have a 20-year threshold.

Joe: Yeah, Anna, if you’re retiring in the next five years, well then all bets are off. Then just ignore everything that I just said. But if you’re retiring at 65, let’s say. Because you’re looking for a supplement of Social Security. I love the fact that you’re concerned of saying you know what, I don’t have Social Security, I’m not going to have a pension, but I have all these supplemental retirement accounts that let me put $40,000 in a year. If you continue to do that, I think you’ll be fine. And it sounds like she lives in, what did she say?
Andi: A low cost of living area.

Joe: LCOL? FMO…?

Andi: What are you trying to say, Joe? (laughs)

Joe: I dunno. FOMO?

Andi: Fear of missing out?

Joe: Yeah that’s what I meant to say.

Andi: Okay. FOMO.

Joe: Loco?

Al: Let me just say. if you do have 20 years, I would go at a minimum 60% stocks. I might do 70 percent stocks, I might even do 80 percent if I could handle the fluctuations.

Joe: Volatility. Yeah. I have roughly the same time horizon. My portfolio is 100 percent stocks. So there you go. All right Anna I hope that helps. Good luck with everything. Keep pumping away, keep saving.

28:39 – SEP IRA, Solo 401(k), Company 401(k) and Roth Conversions

Joe: OK. This is Bob. Good ol’ Bobby. He asks me a question, I believe, every week. “Good morning Joe. I’ve asked you questions in the past,” Yes I know Bob, “but I hope you can help clarify a few things. Due to my income, I can’t do Roth contributions. I would like to do a non-deductible IRA contribution and then do a backdoor Roth conversion.” Look at Bob. He’s just all over it. Boom. “The problem is I have a SEP IRA with about $50,000 in it. I’m checking with my 401(k) company if I’m able to roll my SEP into the company 401(k). If I can’t do that, I know you said I can do a solo 401(k). These are my questions. I have a SEP because, in addition to my W-2 wages, I also have 1099 income. I contribute to the SEP every year and get a tax deduction. Is it possible to have a company 401(k) and a solo 401(k)? Also, can you still take a tax deduction if I put money into the SEP and roll it over into either the company 401(k) or solo 401(k)? Sorry for the long list, thank you in advance for your advice.” All right. I’ll take the easy ones…

Al: (laughs) There’s a lot there – in a minute and a half.

Joe: Okay. Yes Bob, you can do a solo 401(k), and if your company has a 401(k), but you have a maximum contribution limit to those plans.

Al: Yeah. If you’re over 50, $25,000 this year, for 2019, the sum of both plans.

Joe: So if you’re not maxing out your company plan, yes you could do that to a maximum amount of $25,000 If you set up a solo 401(k), you would not contribute to the SEP anymore, you would contribute to the solo 401(k) and take the deduction there. Instead of saying, here, let me put it into the SEP plan, take the deduction roll it into the solo 401(k). I mean, you’re just taking on too many steps and making a way too complicated. The solo 401(k) would replace the SEP.

Al: Yeah. And it’s the same computation. So don’t worry about it.

Joe: Right. Exactly. So I would do this: set up a solo 401(k), roll the SEP into the solo 401(k), contribute to both your 401(k) and the solo 401(k) to a maximum of $25,000, then you could do backdoor Roth IRA conversions to your heart’s content. The problem is if you’re saving more than $25,000. If you’re already saving the $25,000 into your 401(k) plan and then you’re adding another let’s say 10, $20,000, whatever that number is, into the SEP plan, then that plan’s not going to work. You’re not going to be able to do backdoor Roth, you do the SEP contribution, get the tax deduction, look at your tax return, and then maybe do small conversions along the way.

31:31 – Back Door Roth Contributions

Joe: All right. We got a James from San Diego. He goes, yeah, “my wife is planning to retire in May. She has a 401(k) that we plan to roll over into her IRA. We have been doing backdoor Roth IRA contributions for several years. Would she still be able to do a back door Roth contribution before she retires, or would that transfer now be counted as taxable, since she would no longer have a zero balance in her traditional IRA at the end of the year? Here’s what I’m gonna do James. The answer’s yes, because she’s gonna blow up the pro-rata  and aggregation rule. And I believe you probably already know what that means because you’re asking the question. The IRS is gonna take a look at the total balances of all your IRAs, and it doesn’t matter. It’s the end of the year balance, it’s not the beginning of the year. So if she’s got more IRAs or anything like that within that twelve month period, they’re going to do an aggregate of all of those IRAs and then they’re going to divide what you have in basis, in this scenario let’s say she did the backdoor Roth $5,500 of basis, they’re going to divide it into the total amount of IRA dollars and then that’s going to be your ratio that will be tax free. So it still might make sense. Still might make sense, but just know that it’s not going to be a 100 percent tax free.

The money side of retirement is critically important, but so is what the heck you’re going to do with your time once you retire. What do you want to do with that time? If reading and watching some great TV are on your list, I’ve got just the thing for you. This week on the YMYW TV show, Joe and big Al are all about Successful Retirement Lifestyle Planning, and we’ve got a free Retirement Lifestyle Guide to go along with! You’ll find both the TV show and the free guide in the show notes for today’s podcast at YourMoneyYourWealth.com. Now, getting back to your money questions, and hey, check those show notes for videos of Joe and Al answering some of these questions too! Not this next one though!

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33:34 – How Long Should I Keep Tax Records?

Joe: I’m going to go with Judi from San Diego. “I have tax records going back eons. When I search online, I’m told to keep them forever, seven years, three years etc. I know I keep receipts for capital improvements until I sell my house, I think. But what about checkbook registers, tax forms, W-2s, 1099s? Who do I believe about what to keep and for how long? I’m going to trust you three, Andi most of all. 🙂 Thanks.” Oh, did Andi write this? Is this Andi from San Diego?

Al: Do you want to answer that, Andi?

Andi: I did actually look it up. And I think if Judi is going to trust anybody it should be the IRS. So I found the information on the IRS website. Keep copies of your file tax returns like forever, number one.

Al: Yes. So I will tell you each one if I agree or disagree – I agree with that.

Andi: Okay cool. If you didn’t file or you filed fraudulently, keep your records indefinitely.

Al: I agree with that to be and the reason is because the IRS, if they can show that you did fraud or fraudulent transactions or fraudulent tax return they can audit you for as long as they want.

Joe: There is no statute of limitations.

Al: Correct.

Andi: And I would say that Judi, because she listens to Your Money, Your Wealth®, she’s probably not the type to have filed fraudulently or not filed at all. Keep records for seven years if you file a claim for a loss from worthless securities or a bad debt deduction.

Al: OK. I would say the same.

Andi: Keep records for six years if you didn’t report income you should have and it’s more than 25 percent of the gross income shown on your return.

Al: OK I’ll go along with that.

Andi: And then keep employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later.

Al: And I will say five years, and the reason I will say that is because for those that live in the state of California, the franchise tax board can audit you for a year longer than the IRS.

Andi: Well yeah, that’s the thing, this is all IRS information.

Al: And I will boil this down even simpler. So just keep stuff for seven years. Keep tax returns forever. Keep receipts, like when you bought your home, your escrow statement, until sell that home, and keep everything else for seven years – and the reason I say that is really five years is enough. But I’m just trying to give a little cushion here. But after seven years, chuck most everything except the tax returns themselves.

Andi: Now interestingly the IRS does also say that…

Joe: This is not interesting at all, by the way. But go ahead.

Andi: …your records you should make sure that you keep them for non-tax purposes that you might have. But I don’t know what those would be – why you would need to keep them for any non-tax purposes.

Al: Well maybe you’re to write your memoirs and you need to go back to your receipts to remind you what you did. (laughs)

36:23 – How Do I Record My Flexible Spending Account Contributions on My Taxes?

Joe: I think this one goes to you first, Al. We got Clint. From Ponce-y Inlet Florida.

Andi: I think it’s Ponce Inlet, but I’m not sure.

Joe: Ponzi scheme, Florida. “Hi, Andi. Wave emoji.” What did we do without emojis, Al?

Al: I don’t know. We didn’t know how we felt just reading stuff.

Joe: Smiley face. “Could you pass along this question for Big Al for me, please? I have elected to have $2500 taken incrementally from my bi-weekly paychecks in 2018. While plugging my information away into the major online tax preparation site, I’ve noticed that there is no line item for FSA funds. I checked with four different online preparation websites and cannot get a clear answer. Has this calculation already been formulated in my adjusted gross income? Hey, thank you so much for your help.”

Al: Clint, that’s a great question. So FSA, maybe I’ll talk about what that is. Flexible Spending Account. Some companies offer this. Not all, but some companies offer it, and generally, you can put up to $2500 into a flexible spending account. It comes out of your pay. So you actually elect it to come out of your pay pre-tax. That’s right. And so what happens then is, now instead of making $100 or whatever you make for the day, you make $90.

Joe: Wow, Clint. Jeez. (laughs)

Al: (laughs) I was just trying to give an example. be quiet.

Joe: So Clint. You’re only making a hundred bucks. (laughs)

Al: Per hour. (laughs) Anyway, so the point is, your pay is already reduced by this. And what happens is this money sort of gets set aside and can be used for certain things in accordance with the plan. And if you don’t use it, you lose it at year end, but you never pay tax on it. Now, it’s on your W-2. It’s on line 14, which is the “other” box. It doesn’t affect, it’s just information only. So rest assured that it’s already been deducted from your gross pay.

Joe: So I guess Clint, to say it this way too, if you have a 401(k) through your employer, and let’s say that you put $10,000 into your 401(k) plan pre-tax, and you make $100,000 a year, there is not a line item on the 1040 for 401(k)s either. It’s going to come out pre-tax, it’s going to show right on the front line – you’re not going to add that in unless you’re self-employed.

Al: Yeah but I will say, the tax software does want you to put the 401(k) numbers in there, but it does not require the FSA because it’s already been deducted. It’s not relevant to taxes.

Joe: Okay. I did not know that… why would you put have to put the 401(k) in the tax software?

Al: Because what if you have two employers and you maxed out both plans? The software is going to say you did too much, you gotta pay some back.

Joe: Got it. How about my… well the FSA is a payroll deducted – I could do to FSA plans then too is what you’re saying?

Al: No one would know that.

Joe: No… All right, there you go Clint. Get another job because you’re only making 100 bucks anyway. (laughs) All right, that’s it for us, hopefully, you enjoyed the show, guys. For Big Al Clopine, I’m Joe Anderson, the show is called Your Money, Your Wealth®.


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Special thanks to today’s guest, Paul Merriman. Learn more about the 2 Funds for Life investing strategy at 2FundsForLife.com. Subscribe to the podcast on Google Podcasts, Apple Podcasts, Spotify, listen on YouTube or find it on your favorite podcast app.

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