Strategies for investing in dividend-paying stocks and how the pro-rata rule for Roth conversions work with dividends. Plus, Wealthfront, M1, Paul Merriman, Vanguard? Should young investors use a robo-advisor or pay for financial advice? Joe and Big Al also offer thoughts on a Vanguard portfolio for retirement and ideas for young entrepreneurial small business owners to save as much money as possible in self-employed retirement plans like SEP IRA, SIMPLE IRA, and Solo 401(k).
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- (00:51) How Does the Pro-Rata Roth Conversion Rule Apply to Dividends?
- (07:03) Do I Lose the Dividends if I Sell Dividend-Paying Stocks Before the Dividends are Distributed?
- (17:48) Investing Advice for Under Age 30: Should I Switch from My Robo-Advisor and Pay a Fee for a Financial Advisor?
- (27:41) What Do You Think About This Vanguard Portfolio for Retirement?
- (34:42) SEP-IRA, SIMPLE IRA, Solo 401(k): Retirement Accounts for Small Business Owners
Listen to today’s podcast episode on YouTube:
Today on Your Money, Your Wealth®, Joe and Big Al dive into strategies for investing in stocks that pay dividends and how Roth conversions work with those dividend-paying stocks. Plus, Wealthfront, M1, Paul Merriman, Vanguard? The fellas opine about a young investor using a robo-advisor versus paying for financial advice, and they offer their thoughts on a Vanguard portfolio for retirement. Finally, ideas for young entrepreneurial small business owners to save as much money for retirement as possible. And of course, some stupid jokes and totally off-topic derails along the way. I’m producer Andi Last, but you can call me Hoss, and here are the hosts of Your Money, Your Wealth, Big Al Clopine, CPA, and our host of various sizes, Joe Anderson, CFP®.
How Does the Pro-Rata Roth Conversion Rule Apply to Dividends?
Joe: We got Kenny from Granite City here. “Hello YMYW. Still listening and loving the podcast. Al, Joe, and Andi are the best source of financial information on the net.” Thank you, Kenny. “I’d like to know how the Roth pro-rata rules applies to dividends.” Well, let’s talk about pro-rata rules first of all. Because he might be confused on how the pro-rata rule works.
Al: I suspect.
Joe: So we’ll start there but I’ll read on. “As an example, if an individual on January 2nd were to buy stock such as Realty Income Corp. who pays a monthly dividend, can that person begin drawing that dividend payment tax free and without any other penalties? Or similarly, are there penalties when taking dividend payments from a traditional IRA or 401(k)? I know a better action is to allow the dividends to reinvest until I choose to retire. The purpose of my question is to devise a strategy to trick friends and family to save more for retirement.”
Al: A little trickery.
Al: Put it in cause you can get it out.
Joe: I got it. “Psychologically I believe people enjoy the instant reward. Again the show’s brilliant. I appreciate you taking the time to help us all.” Pro-rata rule. So when you look at the pro-rata rule, that’s usually in regards to a few things. One would be like a conversion.
Joe: Depending on what is basis versus what is non-basis.
Al: Like let’s say you got $5000 in an IRA. And let’s say $1000 of it is- you have basis because you didn’t take a tax deduction for that. So when you convert that $5000 you only pay tax on $4000. That’s what the pro-rata rule is. Or if you take out $100, then $1 out of $5, 20% of that’s taxable. Or 20% tax-free, I should say.
Joe: So, I guess I’m confused on this question, Kenny. When he’s saying what’s a pro-rata rules when it applies to dividends coming out of a Roth.
Al: I think what he’s talking about is the five-year rule. I think maybe- his question really is can I put money into a Roth and take the dividends out without penalty?
Joe: Or any IRA or 401(k)? The answer is no, until you turn 59 and a half.
Al: But there’s a little bit of a- it’s a lot more complicated than that because with a Roth IRA you could devise such a strategy with Roth contributions.
Joe: Because it’s FIFO tax treatment for Roth contribution. So Kenny, let’s say you’re going to do some trickery.
Al: You do trickery. We’re going to tell you how to do it.
Joe: You’re magic man. Get a top hat and a cane and a table-
Al: Look at this. Put some money here and it comes back out. Put the money in the hat, dollars pop out.
Andi: This is why it’s called Your Magic Your Wealth.
Joe: Couple of rings. Start with that trick. That’s always a good one. And then yes, any dollar that lets say one of your friends or family members puts into the Roth IRA, they have full access to those dollars.
Al: In a contribution. So let’s say you put $5000 as a contribution. I don’t care what your dividends are. If dividends are $200 a month, let’s just say. You can pull $200 out a month, at any age, no penalty, no taxation, until you get to that $5000. And then you got to stop because everything else will come out taxable, with a penalty.
Joe: So what- to get technical, you couldn’t necessarily open up a Roth, put the $5000 dollars in and let’s say it did have a $200 amount dividend, which would be pretty nice. And then you tell the custodian pay out the dividend.
Al: You can’t do that.
Joe: You can’t do that. You could take $200 of principle out. It would be the same thing.
Al: You just pretend it’s a dividend.
Joe: You just pretend it’s the dividend. If you keep the dividend in the Roth because you could take the principle out but you can’t necessarily take the growth or earnings interest or the dividends out until 5 years or 59 and a half, whichever is longer.
Al: And then you can do it as long as you want.
Joe: Exactly. So I’m guessing that this is- these people are a little bit younger than 59 and a half.
Al: I’m guessing that too.
Joe: And so it’s like put the $5000 into it, if you want the dividend of $200 a month you can get that tax free. They could do that- in a different way.
Al: It’s trickery.
Joe: Yeah it’s trickery. It’s magic.
Al: Now something else. If a younger person does a Roth conversion they have to wait 5 years to do this trickery.
Joe: Correct. Correct.
Al: So it’s not that simple. But I guess that the answer to your question is no, you’re not allowed to take dividends out. But the workaround is if it’s a contribution you have basis in the contribution and therefore you can take dollars out until you exhaust that basis. You can’t take any more out. If you do a conversion before 59 and a half, you have to wait 5 years for every conversion to start taking the principle out. So it gets more complicated.
Joe: So to recap the question is that you don’t do it. I get it. You’re trying to do- I like where your head’s at, Kenny. It’s like I want to get my buddies and family members to start saving some money. And if they feel that I could get $200 in my pocket by investing the $5000, that’s pretty good. I can see the return on investment. And I’m gonna get more excited and save more money. But be careful with that because the markets turn too. So I see why he is looking at the dividend because if they don’t cut the dividend they’re going to continue to get the check no matter what the value is of the overall account. But they also do cut dividends as well. Appreciate ya still hanging in there with us Kenny. Write us back if you’ve more follow up questions.
Do I Lose the Dividends if I Sell Dividend-Paying Stocks Before the Dividends are Distributed?
Joe: Tom writes in from Chantilly. Is that right?
Al: Yeah. Looks like Chantilly, Virginia.
Andi: Tom has written us before.
Joe: I don’t remember Chantilly, Virginia.
Andi: You had this exact same conversation then.
Joe: I probably did. I’m losing my mind, Andi.
Al: And he still doesn’t remember.
Joe: I know, sorry Tom in Chantilly. Yeah. Now it’s all coming back. Great place. We got “Joe and Big Al. I own several mutual funds. Ticker symbols are RPMGX and PRGFX-” I’m guessing- what is that? T. Rowe Price? Yes, I believe so. Andi, if you want to just fact check me. I’m not sure what those are. They look like maybe a growth fund and a mid-cap fund given the MGX and the GFX.
Al: That would be a good guess.
Al: And so then RP- you think that’s T. Rowe?
Andi: RP is T Rowe Price mid-cap growth fund and the PR is also growth stock.
Joe: So there we have it. “- outside my retirement accounts that generate dividend returns.”
Al: So he’s got these mutual funds outside of retirement.
Joe: So he’s got a little growth fund. He’s got some mid-cap in an actively managed fund that’s given him a little- I love T Rowe Price; so good fund family; decent funds. I have nothing bad to say about that. He’s getting some dividends. His questions are “The dividends are distributed in December-” so there’s an ex-dividend date is what that’s called.
Joe: So he’s looking to “rebalance his holdings based on my overall investment strategy. If I sell these mid-year do I miss out on the dividends? Is it best to wait until January? I cannot find any information and any guidance is greatly appreciated. Love the podcast. You guys are great.” Tom from Chantilly. This a good question.
Al: It is. It’s actually a- it is a good question.
Joe: So he’s investing in mutual funds that create dividends and he’s like I want to rebalance these, I might want to sell them.
Al: But then I’m going to miss out on the dividend.
Joe: So if I held it to July do I get half the dividend? Because they give the dividend out in December, so can I participate even though I owned it part of the year? Or do I have to wait till January? Well first of all, let’s talk about what happens to the price of a stock when a dividend is distributed.
Al: I think that’s the key.
Joe: That is the key. So Alan what happens?
Al: What happens is the day the dividend is declared then the amount of the total dividend to all stockholders- the price of the stock is reduced by that same exact amount. So really all that- nothing really happens. It’s just that you have this stock- we’re going to do a simple example; $10 with $1 dividend just to make it real simple. $10 a share; $1 dividend, which would be a lot. But let’s just say it was just for ease of math. Then now you have $1 in your pocket because you got it but your stock is now worth $9. You still have $10 worth of value. It’s just part of it’s in stock and part of it’s in cash. And that’s what a dividend is. And the truth is if you’re being smart about this you will sell before the dividends are distributed so you don’t have that ordinary income consequence.
Joe: Correct. So Tom, it doesn’t matter.
Al: The truth in terms of raw dollars, it doesn’t matter whatsoever.
Joe: So like Warren Buffett talks about a synthetic dividend. Quite a bit. He doesn’t like- well I wouldn’t say he doesn’t like- but if he had a pick at a stock that provided a dividend or did not provide a dividend, he would much rather go with a company that did not provide a dividend.
Joe: Because he could create his own dividend. Because if he had bought the stock for $10 a share and they don’t distribute a dividend, he could sell $1 of- it’d still have the same effect of another stock that sells at $10 a share that distributes $1 dividend. Because the next day you got $1 in cash but the stock price is only worth $9.
Al: And that’s actually- you have much more control by doing your own dividend that way.
Joe: It’s more tax-efficient that way.
Al: Correct. So in other words, why pay taxes on dividends if you don’t really need the cash?
Al: And that’s the advantage of having a stock that doesn’t declare dividends like Berkshire Hathaway, Warren Buffett’s company. They don’t distribute dividends for that exact reason.
Joe: They reinvest it. They’re reinvesting in their overall company. So there’s no excess cash where they want to provide a dividend.
Al: Now every fund is different; but it’s common for mutual funds to have quarterly dividend distributions. So it’s once a quarter and then they have their capital gain distribution in December. Which is all the gains inside that mutual fund get distributed at that point. So I mean-
Joe: That’s more common.
Al: That’s what’s common.
Joe: Where you’re seeing the mutual fund manager shifting and selling and doing things with inside the mutual fund. So a mutual fund value could go down and you still would receive a tax bill just because the embedded gains that is sitting inside the mutual fund.
Al: That’s true.
Joe: So because the mutual fund manager bought the stock at $5 a share, it went up to $15. And then you bought it. But then the stock went down to $10 a share. But the embedded cost of that overall stock is still $5. And then they sell the stock. You’re going to get hit with the capital gain distribution even though the fund went down in value.
Al: That is true. And so if you’re thinking just strictly a taxes, probably not a great time to buy mutual funds is before they declare their dividend in December.
Joe: Right. The ex-dividend date. You have to look at what is the ex-dividend date and then you also have to look at what is the capital distribution date.
Al: But I know Joe that some people are listening thinking-
Joe: We’re crazy. We’re idiots.
Al: We don’t know what we’re talking about because every time they have a dividend their stock goes up. And here’s what you’re missing- is if you just look at dividends in a bubble it will go down by- the stock price will go down in the amount of the dividend. But stocks go up and down without regard to dividends. They go up and down every day. So some days they’re going to go up while there’s dividend; it looks like you’re getting the best of both worlds.
Joe: Oh, look. I got a dividend and look at the stock price just went up. And the stock price went up because they gave me this dividend.
Al: And sometimes the market goes down after the dividend. It looks like wow, this is the worst stock in the world, look how much it went down. It’s like well part of it’s the dividend you got and part of it is just the stock went down.
Joe: Just understand that stock prices move widely, day by day, week by week, year by year. It doesn’t stay at the same price. If you follow any type of stock just look at the volatility of the overall markets. So stocks move in value all the time. It’s irrelevant of the dividend.
Al: Yes. So I just want to make that point.
Joe: Yes. We’ve gotten in almost fistfights with people.
Joe: No. Not that bad. But I remember I was teaching at Mira Costa College in San Elijo. And he was like I really like dividend-paying stocks and I was like well of course, everyone likes dividend-paying stocks. Why do you like dividend-paying stocks? Well because it gives me income. I said that’s great. And then he’s like but it’s the best of both worlds because I get the capital appreciation and then the dividend. And I was like but do you actually know how it works? I’m not refuting his strategy. It’s a fine strategy.
Al: There’s nothing wrong with it.
Joe: Nothing wrong with it. But I was like this is how a dividend works. The stock price goes down. That’s because the company’s distributing capital out of their company. Of course the value of the company is going to go down as much as they distribute out. No way-
Al: You don’t know what you’re talking about.
Joe: It’s like ok, whatever.
Al: But that is the truth.
Joe: It is. You heard it here folks. So Tom from Chantilly, doesn’t necessarily matter. So if you want to rebalance the overall- But here’s the- this is going back to Kenny with Granite City. Because Kenny is like man, let’s buy these dividend paying stocks because people like to see that income. Even if it’s $10 a share or $4 a share. Let’s say the dividend’s $200. You’re still going to get the $200 dividend unless they cut the dividend. So then that’s why people like the dividend and it’s like I get- I get it. You get cash flow, but do you need it, first of all? And if you’re just going to reinvest it, don’t exclude all the other really good stocks that don’t provide a dividend. Because a lot of those stocks are probably just as good or even better than the stocks that just have dividends.
Al: Because they’re reinvesting for growth and many, many times they do grow more. A lot of the high tech companies Joe, they don’t declare dividends because they’re reinvesting and that tends to be over the long term, a decent sector.
Joe: You look too at what’s a really good sales strategy for someone that is approaching retirement? Is that hey we have a dividend strategy for you. That’s going to pay you income.
Al: Because that’s what you need now.
Joe: Our specialty is creating retirement income for people. So there’s multiple ways that people can potentially do it. We try to do it probably the most tax-efficient way. But for an individual investor if you say create a synthetic dividend and look at a total return approach versus we have these really good stocks that create these dividends, look at the dividend yields what- to the average consumer, that sounds like a better deal- better strategy. Because you’ve heard of dividends before. You know what- a dividend is the income, for the most part.
Al: So you’re saying I can have both. I can take a bite out of the cake and I still have the whole cake.
Joe: You got it. So just understand how all this stuff works. Before you- I guess go into your strategy. So hopefully that helps, Tom. Thanks for the email.
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Investing Advice for Under 30: Should I Switch from My Robo-Advisor and Pay a Fee for a Financial Advisor?
Joe: So we’ve got Allan calling in from El Paso, Texas. “Hi y’all.” I’m a recent convert to financial nerdism and love the podcasts. Apologies in advance for the novel, I try to use small words.” Oh thank you Allan. Here’s a little background on Allan. He’s 29 years old; single; debt-free; making $57,000 annually. It’s his first professional job; recent grad school grad. Congratulations. “I live here in El Paso, Texas. I opened a taxable portfolio and Roth IRA with a robo-advisor prior to attending grad school because I didn’t want the stress over the investments and studies. Now after listening to your show and reading Paul Merriman’s article-” good old Paul.
Al: I like Paul.
Joe: Paul has been on the show many times. Good friend of the show. I can’t believe I just said that. I hate it when people say that.
Al: He’s a good friend.
Joe: A good friend of the show. I’ve never met the guy ever in person.
Al: Never seen him face to face. Hey Paul, my good friend.
Joe: Let’s hug it out.
Al: I know what you look like in pictures.
Joe: But he is a great guy. Professional.
Al: You would be all over me if I said that. At least you’re all over yourself.
Joe: Yes. Sometimes I say stuff like I’m such an idiot. “I feel confident that I can handle the responsibility.” Oh all right. So he wants to manage his money on his own. He’s going to take a deep in.
Al: Read some Paul Merriman articles.
Joe: That’s all you gotta do. Read two Paul Merriman articles and you’re good. “I’m looking to move my taxable account and Roth IRA from Wealthfront to M1 Financial to avoid the 25 basis point annual management fee and to have the freedom to select my own investments.” So he’s going to give us some pro/cons here. “The pro/con: Wealthfront does automatically tax lost harvesting while M1 does not. M1 has fractional shares while Wealthfront does not. The numbers: I have $40,000; $15,000 is currently managed for free due to promotional deal in my taxable account and $6000 in a Roth. The expense ratios on these accounts are .08 and 11 basis points respectively with a 25% fee on top and one has no management fee and the trades are also free. I plan on using Paul Merriman’s ultimate buy and hold strategies for the taxable and tax-deferred accounts which will incur an expense ratio by 28 basis points each annually. To date, my Wealthfront account has averaged $1000 of lost harvested annually. If I make the switch I’ll likely rebalance once a year and do the tax lost harvesting then if convenient. The funds automatically selected by Wealthfront include approximately 34% U.S. stocks, 29% foreign stocks, 20% emerging markets, 10% dividend stocks, natural resources, some municipal bonds and 34% U.S., 24 foreign and emerging.” Man, he’s got a lot of funds. Holy buckets.
Al: The second one was in his Roth. First one was-
Joe: For $6000, he’s got like 15 funds and then for the $40,000-
Al: That’s true.
Joe: Okay so let’s just kind of keep this simple Allan.
Joe: Very simple here. I would- there’s- you could invest in three funds and call it good.
Al: You could. I agree.
Joe: And then wait till that accumulates to probably $100,000 and get more sophisticated with Paul Merriman stuff.
Al: I was thinking the same number, $100,000. Right off the bat just get a low-cost domestic equity fund, a low-cost international equity fund, and a low-cost bond fund. Simple.
Joe: And he’s 30. So it’s probably- it’s gonna be maybe 80/20.
Al: Yeah 80/20 and-
Joe: I’m going 60% U.S. so total U.S. stock market fund. You could pick anyone, Schwab, Vanguard. I don’t care. And then maybe you go 30% total international. And then you got 20% short term bonds.
Al: Or10%. Your math didn’t work.
Joe: What did I say?
Al: 60%, 30% and 20%.
Joe: Oh yeah. That’s why I need a calculator. That’s why I got you Big Al, you’re my accountant.
Al: You know the thing- we talked about this a few episodes ago- I don’t remember which number that podcast was- but we talked about bond funds and we both think it makes sense to have bond funds in your portfolio. But when you’re young and you’re okay with the volatility of the market it’s not even that important to have bond funds.
Joe: I have maybe 10% of my overall portfolio in bonds.
Al: 10%. Okay.
Joe: And I’m 45.
Al: Got it. Would you have 0% if you were 30?
Al: OK. There you go. And Allan’s 29.
Joe: Unless in the brokerage account you’ve got a take a look to say, what’s the money for? If I’m looking to buy a car or a house then I probably would want more bonds.
Al: I suppose if you had money outside of retirement and you wanted to have some easy access that’s not going to go down in value. You’re right.
Joe: So let’s answer his questions. “Should I move the funds to save money for the long term given Wealth runs management’s fees and say goodbye to the automatic tax loss harvesting? Right now I’m paying $100 a year management fees. But I’ve used Nerdwallet’s fee calculator and have calculated the fees on a taxable account over a 30 year period; assuming no future contribution, dividend reinvestments, and 7% growth to be about $45,000. The net capital gains for switching will be about $5000 but my 401(k) contributions will make that a wash. Question number 1) should he pay a fee for financial advice or not? So I think Allan at this point in your life there’s going to be two major reasons why you want to continue to have an advisor in your life. And then you can contemplate to say I don’t need that. I can do that myself. Because he’s a new investor. There’s going to be a time where he will want to make a decision with his money that’s probably not appropriate and that he’ll need someone that doesn’t have an emotional attachment to the money to help him with that decision process. So it’s like I want to sell or I want to do this or my buddy bought Tesla and it’s up. I think I want to buy some of that. And you might make some type of decision with money that might not be in your best interest.
Al: And I think related to that is- and this happened to me about the same age. Maybe I was in my early 30s but to where the- I think it was the Gulf War was just starting and I pulled out of the market completely because I thought-
Joe: Wars make the stocks go down.
Al: Turns out I don’t-
Joe: It’s the opposite.
Al: – I didn’t know what I was talking about. And then I realized and then you try to get back in. And then how do you do that? Because the market went up. Then you wait for it to come back down and it goes up again even more. And so that was actually a pretty good lesson to learn. Don’t try to time the market based upon current events. And that’s the kind of mistake that we see people doing that don’t have the discipline. Now maybe Allan is super disciplined. He reads all these articles and if you feel like he can do it, great. But our experiences for more people than not, they end up making these emotional decisions that end up hurting them.
Joe: Second thing is if you’re just basing this on tax lost harvesting I think you can- if you want to get sophisticated or nerd out on this you could probably do it yourself like with some spreadsheets. But as the money grows and you have more assets within your non-qualified account the tax lost harvesting is going to make a lot bigger difference. But still it’s nothing to sweat out because they were able to harvest $1000 worth of losses for the guy and so that offsets future gains which is it’s a savvy tax move.
Al: I mean 15% tax-free, that’s $150 of savings to cover the $100 annual fee.
Joe: So the tax savings alone is covering the fee.
Al: Seems like it and plus- I’m not sure he’s calculated this right because what he’s thinking about investing, the internal cost and those funds are quite a bit higher than what he’s got. I’m not sure there’s that much savings really.
Joe: Right. Another thing too is that I would look at, is there any other value-added resources or services that the advisor can give you? Such as hey, I’m 29 years old; I’m looking to retire early at 60. How much money should I be saving on an annual basis? What target rate of return should I be thinking about in regards to my overall portfolio? I want to buy a house some year. I’m going to get married – what is that going to look like from a tax perspective? There’s going to be all sorts of life events that happen in Allan’s life that doesn’t- he’s just solely looking at the investment. They’re tax lost harvesting and they’re rebalancing it; and I have a globally diversified portfolio with 400 different funds for $50,000. So I think some of that’s a little overkill. But there could be other services that you might want to lean on Wealth Front or if they have CERTIFIED FINANCIAL PLANNERs™, because that’s a fairly reasonable fee. Maybe they have calculators that you can make other financial decisions on. We got second question here. What is your opinion on the asset allocation of Wealthfront accounts versus Merriman portfolios? I think it’s overkill, Allan. You don’t need that many funds, but I think they’re both fine.
Al: It’s a good way to answer.
Joe: It’s like more’s not always necessarily better.
Al: Especially when you’re first starting. Keep it simple.
Joe: Keep it very simple. I’ve never seen that many funds in my life.
What Do You Think About This Vanguard Portfolio for Retirement?
Joe: We got another one. We got Mike here from Mesquite, Texas. He goes “Big Al, Little Joe. And of course-”
Al: Yeah. Bonanza.
Joe: “- Andi.” Like, what’s up Hoss?
Andi: I think Hoss was like the boss.
Joe: Hoss the boss? Well he’s from Texas. You know, what up Hoss?
Al: I think it’s from Bonanza.
Joe: What the hell’s Bonanza?
Andi: TV show.
Al: It’s a TV show.
Joe: Oh my God.
Al: Little Joe and Hoss. I don’t remember a Big Al on that show.
Joe: Little Joe and Hoss.
Al: And Ben Cartwright. I guess that was his name. Ben. Big Ben.
Andi: “Cartwright is the patriarch of an all-male Nevada ranching family set during and after the Civil War. Bonanza is a story of life on the family’s 1000 acre spread known as the Ponderosa.”
Joe: Bonanza. Is that a restaurant?
Andi: It is now.
Al: It’s also a type of pine tree, Ponderosa Pine.
Andi: “Little Joe, the youngest son Little Joe is the most impetuous and romantic of the offspring.”
Al: Yeah. That’s you.
Joe: There ya go.
Al: But Andi, you’re Hoss.
Andi: I’m Hoss.
Al: Hoss is- he was the big guy.
Joe: Got it. Well maybe that’s where that terminology came from. Hey what’s up hoss? You’ve never heard anyone say that?
Al: No, but I’ll take your word for it.
Joe: Those are usually the ones I don’t want to hang out with? I was gonna say they are usually just- you know-
Al: Okay. Like where do you meet these people?
Joe: Where they say hey what up hoss?
Al: Yeah. Where are you? Is this like trailer parks?
Joe: No, it’s just-they probably- know- they- they have yes I’m trying to be politically correct here.
Al: I know you are here.
Andi: So, the middle son was the warm and loveable giant Hoss.
Joe: All right.
Al: He was lovable.
Joe: He was. And Little Joe was Michael Landon. He was mischievous.
Andi: Oh, okay.
Joe: Got it. Mischievous or mischievous.
Al: Mischievous. What am I trying to say here?
Joe: I don’t know.
Al: Mischievous. Thank you. That’s what I meant.
Joe: Got it. We’re gonna get complaints on this banter.
Al: That’s alright.
Joe: He’s got a portfolio question. “To keep things simple, I’m a big fan of Vanguard and becoming a big fan of your podcast.” All right cool. “What about this portfolio in retirement? 20% Wellington, 20% Wellesley. And then he’s got another 20% global Wellington, global Wellesley and then small cap index and then the total stock market; rebalance yearly for a simple 60/40 portfolio.” You know what? I love it. I don’t- I like the Wellington Fund. I like the global Wellington Fund. I like the total U.S. stock market. You got a little small cap. I would probably go more small cap value; but I’m not giving you advice here. Because small cap growth will underperform in most cases given academic studies-
Al: Over the long term.
Joe: I like these funds. They’re low cost, they’re globally diversified. He’s probably got thousands of companies across the globe. You could probably do it without as many funds.
Al: You could. I actually looked him up just for fun. And the first three have internal charges of around 40 to 45 basis points. And the last two are index funds, they’re like .4, .5.
Joe: The Wellington Fund is a balanced fund.
Al: It’s a balanced fund. It’s just like 30% I think.
Joe: I own Wellington.
Al: And I own this- let’s see, what do I own?
Joe: I own Wellington.
Al: I own the total market fund.
Joe: Yes. And so do I. I own that too. Full disclosure.
Al: I like these funds too. I’m just saying the index funds are cheaper. And I tend to prefer them just because the cost ratio is a little bit less.
Joe: But if- we don’t know anything about Mike. I don’t know how old he is.
Al: No, we don’t know anything.
Joe: I don’t know what his goals are. I don’t know what the income needs to be derived from the portfolio.
Al: I would say-
Joe: I just know, I guess now he’s a fan of Bonanza. And so he’s got to be probably your age.
Al: He might be older. He might be older. Well I would say if Mike is in his 20s and 30s, this is a great portfolio. If he’s probably closer to retirement or in retirement, this might be a little bit aggressive. But we don’t know enough about your goals Mike, to know whether this is the right portfolio for you or not.
Joe: Well it’s 60/40 is what he’s saying. I think that’s fine because the- what’s Wellesley? I don’t know what the- can you give me the mix stock bond on that?
Al: I don’t know how this is 60/40.
Joe: Because there’s- with a Wellington and Wellesley funds, those are balanced funds.
Al: I know but the other two are all stocks.
Joe: But he’s got 20%- he’s only got 30% in those.
Al: He’s got 40%-
Joe: 20% small-cap. You know what I’m saying.
Al: Oh oh oh oh. Yeah you’re right. I was-
Joe: Those are balanced funds. So they have stock in- I mean they have bonds-
Al: I was- I read that wrong. Okay.
Andi: That’s index fund- or income fund.
Joe: You’re fine.
Al: Well anyway, 60/40 is a common portfolio through retirement and for many people that works really well. We just don’t know enough about your situation.
Andi: Hang on a second. I’m trying to pull it up.
Joe: That’s alright. I think I know what- we answered it.
Al: Yeah yeah we did.
Joe: If you like those funds, yes. I don’t know what percentage that you should own in each of them. But it’s a globally diversified, 60/40 split. And he’s kind of splitting hairs with Wellington and Wellesley think a little bit. But-
Al: Yeah a little bit. But the point is the funds are good. Index funds are cheaper in internal costs. But the other ones are not bad in terms of internal cost. But you’re right, they’re more balanced and not necessarily a bad way to go.
Joe: With what VGWIX, that’s probably a little bit more tilted towards value, I believe. So yeah, I like it. I like it a lot. Good work Mike. Thank you for your question.
Learn how to avoid the costliest investing mistakes and how to pursue a better investment experience, right in the podcast show notes at YourMoneyYourWealth.com. The latest all-new episode of Your Money, Your Wealth TV show is all about avoiding those investing mistakes, and our comprehensive guide to investing offers 10 ideas that can help you effectively target long-term wealth in the capital markets. Learn what strategies can help you improve your odds of success and set you up for long-term success. How to let markets work for you. Why chasing past performance is a mistake. The key drivers of expected returns and more.
Retirement Accounts for Small Business Owners
Joe: “Hi Andi, Big Al and medium-sized Joe.”
Andi: You like that?
Al: Medium-sized. Wow.
Joe: I guess. “Johnny G here, somewhere in Iowa.” So we darkened that just for me to read it?
Joe: Got it. “I enjoy listening to your podcast in my paid-in-cash black 2016 Ford Fusion with my dog, Maverick.” Oh that’s very nice.
Al: Got the visual there?
Joe: I do.
Andi: Somebody listens.
Al: I know that’s important.
Joe: It is very important. It’s paid in full too. 2016 little Ford Fusion. You drive it around.
Al: I can imagine Maverick loves it.
Joe: Oh Maverick. I wonder if he’s a fan of Top Gun.
Al: I would think so.
Joe: I have a Maverick driver.
Al: What’s that? Oh, a driver.
Andi: Golf club.
Joe: It’s a golf club.
Andi: I don’t even play golf and I knew that’s was a driver was.
Joe: Thank you Andi.
Al: I was thinking of the Maverick the dog driving the car.
Andi: That was my first thought too.
Joe: Oh. No. No I have a driver and his name is Maverick. And he drives me around. And he’s not a dog.
Al: Got it. Thank you for clarifying.
Joe: Got it. “Maverick gets the front seat Joe. We’ll have to be in the back.” No problem. I like sitting in the back seat.
Al: Back seat’s ok? With your long legs?
Joe: Very comfortable in the back.
Al: Medium-size legs.
Joe: I prefer sitting in the back. Sometimes I just sit in the back because I feel like they’re my chauffeur.
Al: Got it. You like to feel important.
Joe: I do.
Andi: Johnny and Maverick are driving you around now.
Joe: And then now everyone just thinks I’m in an Uber. I go on a date. She drives. I sit in the back.
Al: Got it. Okay. Does your date sit in the back too when you drive?
Joe: No, she’s driving.
Al: No, but when you drive, does she?
Joe: I don’t drive.
Al: You don’t drive.
Al: You insist. If you wanna go out with me, you’re driving. And I’m sitting in the back seat and I’m not going to tip.
Joe: Pick me up. Might bring a little roadie with me.
Al: Got it. And you are single.
Andi: Imagine that.
Joe: Now you got that visual?
Al: I do. I’m with you now.
Joe: “Thank you all very much for putting on a great educational, entertaining podcast about financial help. It is much needed in our society and something I am trying to spread info to all my friends. Your podcast makes my job a lot easier. My question is about a second retirement account possibilities. A little info. 26, single, and own my own business, S Corp., 100% owner and also an employee.” Well congratulations there Johnny G. He’s in the 22% tax bracket, Big Al.
Joe: “My business offers a Simple IRA plan with a 3% match to myself and my two part-time employees. I max out the Simple IRA, Roth IRA and HSA every year. I’m starting a second business with a friend of mine. She is 25, single, works a regular 9 to 5 and also in the 22% tax bracket and maxes out her 401(k), Roth IRA and HSA every year. With our new business we will not need any employees, just the two of us. We’re trying to figure out if there’s a retirement plan that we both could contribute to based on other contributions that we make. I can’t find enough info and would like to be able to contribute to a SEP or a Solo 401(k) depending on the limits, will still make sense with our other contributions.” So the gist of this- Thanks, Johnny G – he’s got a small business; has a Simple plan has a couple of part-time employees.
Al: Maxing out that plan.
Joe: And he’s like I need to save some more money and I have another side hustle on the way. He’s got a little female friend, 25 years old, same age. Wonder if there’s a romance budding there potentially.
Al: It’s possible.
Joe: And so he’s like with his other business can we- what can we do? Can we save some more money?
Al: Well it’s a good question and so first off you can have another pension plan in another business. However you got to be mindful of the contribution limits. Because in some cases they get added together. For example, if you set up a 401(k)- guess you couldn’t really set up a Solo K and the new business unless they get married. So you might want to get married, Johnny G. But you could set up a Safe Harbor. But your friend who’s already maxing out her 401(k) couldn’t add any more. Because you only get one 401(k) amount per year, that’s $19,500 at your age; $26,000 if you’re 50 and older. So you only get one. Now you Johnny could put more in because you could put in $13,500 into a Simple so you could put in another $6000 into a 401(k). So it would work for you Johnny, but not for your friend.
Joe: So what you’re saying because he’s maxing out the Simple plan and the max contribution for a Simple plan is roughly what, $13,000?
Al: It’s $13,500.
Joe: So if he set up a 401(k) plan, he couldn’t put the full $19,000 in?
Al: No, because they get added together for that purpose of the total contribution of $19,500.
Joe: How about- and then a Simple IRA is an IRA. So he couldn’t necessarily set up a SEP? Or could he?
Al: He could do a SEP. See that would work for both of them. So you could set up a SEP and then it’s 25% of your profits if you’re a sole proprietorship or 25% of your salary if you’re an S Corp. So that could work potentially. You just can’t have two contribution plans. And I know this gets confusing because you can do a Roth contribution or an IRA contribution that doesn’t count towards the 401(k) or the Simple IRA. But a Simple IRA and a 401(k) have the same limit of $19,500 if you’ve already maxed out your Simple which is $13,500. You wouldn’t have another plan like that in your company but you could be working for another company which is exactly what he’s saying.
Joe: What other ideas can we throw at Johnny here? So he’s got a business, it’s just him and he’s got two part-time employees. He’s got a Simple plan. He’s set up a Simple plan because it’s simple. Hence the name. He doesn’t have to match that much for the part-time employees; they’re probably not making a ton of money.
Al: Probably not and it’s inexpensive to have that kind of plan and as opposed to a Safe Harbor 401(k), which is pretty expensive.
Joe: Could he exempt those employees from a- could he set up a Solo 401(k) because he has two part-time employees? I wonder if he could discriminate.
Al: Well if they work- under the old law, if they worked less than 1000 hours then he could still do a Simple. Now it’s 500 hours. If people work 500 hours for three consecutive years they have to be added to the 401(k), with the new SECURE Act.
Joe: With the MEP rules?
Al: So he could do that. He could switch to potentially a Solo 401(k) in his business and add the other $6000 that way. And then in the business-
Joe: But I’m thinking let’s say if he did a Solo 401(k), he put $19,500 in the Solo 401(k), then he could set up a SEP IRA with him and his lady friend.
Al: That’s right.
Joe: And then do 20% on there and then that would have a max contribution of roughly $54,000.
Al: Total, yeah. I think it includes the $19,500. And plus-
Joe: It would. The $19,500 and then add another-
Al: -plus the employer match on top of that. But still yeah it’s a big number. In other words, the SEP allows both of them to actually get more. It’s 25% of their profits or salary.
Joe: So I think what Johnny needs to evaluate here is that, how many more businesses is he going to start? How much money is he going to make in each of these different businesses? And then he would want to design a plan that’s appropriate for each business given the profitability of the business to max out as much as he can if that’s his desired goal.
Al: One other thing I should mention because people get tripped up on this is if you’ve got a control group or an affiliated company, then the IRS looks at you as a single entity, even though you’re more than one entity. And I’ll explain both. The control group means that 80% of the ownership is similar. Now in this case it wouldn’t be because Johnny owns 100% of his one business and presumably he’ll own 50% of the second business so that’s OK. But if there’s an affiliated group; in other words if the companies are interrelated; if they’re supporting each other-
Joe: He’s got a supply company that supplies all of his distribution company.
Al: That’s right or he sets up a separate marketing company that does the marketing – whatever. So that’s would be an affiliated company. And in that case it’s treated as one company for purposes of a retirement plan. So you couldn’t discriminate against employees and things like that. Doctors tried to get away with that one years ago. They took maybe their eye doctor business and separated the eyeglasses sales business and those two are intertwined. And they tried to have the employees in one but not the other and so they have a big fat pension plan in one.
Joe: So the doctor’s got his own business and all the other rank and file is in another business so I’m gonna set up a defined benefit plan and shelter-
Al: Actually more common in the old days Joe, was a doctor would have all this profit so he’d set up this little medical consulting business with no employees. And he basically transferred all the profit from company A to B-
Joe: – or she.
Al: -or she. It could be she. You’re right. Sorry. Sexist. Have to keep me honest.
Joe: Well good. Johnny, congrats on the success. Just thinking about Maverick, chillin’ in the Ford Fusion. Appreciate the visual. I think it makes the listening experience a lot more pleasurable.
Al: Well we can sort of imagine it. You know he’s got a black 2016 Ford Fusion. He’s got Maverick the dog sitting in the front seat.
Joe: What’s your picture of Maverick? What kind of dog do you think Maverick is?
Andi: German Shepherd.
Andi: German shepherd.
Joe: German Shepherd? OK. I was going to say the same thing, Andi.
Andi: His name’s Maverick. That’s a German Shepherd kind of dog name.
Joe: A German Shepherd or maybe a black Lab.
Al: I was thinking Lab too.
Joe: Yeah. I know- it’s like a-
Al: It would have to be black.
Andi: It’s not gonna be a Pomeranian.
Joe: All right cool. Thanks a lot Johnny.
Believe it or not, there are still a few more Derails at the end of today’s episode so stick around if you just haven’t had enough.
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