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Published On

May 28, 2019

Travis Shakespeare, Director and Executive Producer of Playing with FIRE, talks about making the first-ever documentary about the Financial Independence / Retire Early or FIRE movement. Plus, Joe and Big Al answer your rental real estate investing questions and clear up some confusion around Roth 401(k) income limits and contributions versus conversions.

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Show Notes

(00:45) Travis Shakespeare, Director & Executive Producer, Playing with FIRE
(11:03) Travis Shakespeare, Director & Executive Producer, Playing with FIRE (part 2)
(24:35) Should I Sell My Rental, Pass Ownership to My Son, or Move Back In?
(29:51) What Should I Do With My Home in ABQ?
(34:18) Real Estate as an Inflation Hedge
(39:28) Roth 401(k) Income Restrictions and Contributions vs. Conversions (video)

Transcription

Travis Shakespeare is the Senior Vice President of Unscripted Programming for BBC Studios in Los Angeles and develops shows you might know like the Emmy-award winning Life Below Zero, as well as Port Protection, and Top Gear. Today on Your Money, Your Wealth®, we’ll hear about how he caught FIRE and became the director and executive producer of Playing With FIRE, the first-ever documentary about the financial independence/retire early movement. Plus, Joe and Big Al answer your questions and comments about rental real estate and they clear up some confusion around Roth 401(k) income limits and contributions versus conversions. I’m producer Andi Last, and here with our guest, Travis Shakespeare, are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

00:45 – Travis Shakespeare, Director & Executive Producer, Playing with FIRE

Joe: Travis, welcome to the show.

Travis: Hey guys. Thanks for having me.

Joe: Man, you’ve done a lot of different things. I mean, you were on Top Gear. That is one of the best shows in the world. And what the hell are you doing on Your Money, Your Wealth®? (laughs)

Al: (laughs) That’s the main question we want to ask you.

Travis: I got a random email and whenever a financial advisor sends me an email, I always respond. (laughs)

Joe: (laughs) I think that is… you know what, I’ll hold that thought. It usually goes straight to the delete box. Playing with FIRE. So you go to Top Gear and then all of a sudden you’re thinking, “there’s this FIRE movement – financial independence, retire early. And you’re thinking, “hey, there’s something to this.” So what, you hate your job so much that you’re thinking let me start saving some money? So you could be part of the FIRE movement? Or you’re just intrigued with how all these individuals are really taking control of their financial lives?

Travis: OK. Well, that’s a lot of questions. (laughs)

Al: So we have 30 minutes.

Travis: (laughs) Okay. I’ll tell you how it all started, which was that when I turned 40 years old I was still in $40,000 of student loan debt. I had credit card debt, and I had no savings account. I had started my career in TV at that point, and I managed to save up $5,000. And I went into Charles Schwab to a physical branch and I said, “I’d like to invest $5,000 because I’m ready to start investing.” And the guy said, “Why don’t you come back when you’ve got 50?”

Al: Wow, really?

Travis: Yeah. And I thought, “Oh my God, I am so broke that they won’t even take my money.” It was a massive wake up call. So I started a search for myself to try to educate myself. I came up through the arts. So I thought that I was just going to win the lottery or an Oscar or something and just become magically wealthy overnight. And when you turned 40 and that hasn’t happened yet, you’re looking at the bottom of your beer bottle going, “I wonder if I had something wrong here?”

Al: (laughs) It was such a great plan.

Travis: Yeah exactly. So not a great planner. And I started trying to educate myself and I started reading a bunch of really complicated investment books that I didn’t really fully understand, I wasn’t a math guy, and I panicked. I just didn’t know what to do. But I ran a couple of financial calculators, I saw that my retirement was terribly off track. Right about then is when I came across two things: One was MrMoneyMustache.com and the other was Early Retirement Extreme, which was a book by Jacob Fisker, a guy who retired on something like $300,000 in his portfolio. I mean, this guy was, when he says extreme, he meant extreme. But it was really fascinating because being a struggling artist I kind of knew how to live like that even though I didn’t want to. And I thought, “oh, well if I just systematized this maybe I’ll be able to catch up.” And so I started my own journey in financial literacy. And that led me to going to something called a chautauqua with the FIRE community down in Ecuador where we spent a week talking about money, talking about investing, talking about values. And I came out of it feeling like a changed man. And I emailed everybody that was there and I said, “hey if I make a documentary about this will you guys be in it?” And they said, “Sure!” And the rest is history. (laughs)

Joe: A chautauqua?

Travis: A chautauqua, Yeah. I think it’s a native word for like a gathering where you kind of hang out and discuss in deep, deep stuff.

Joe: So as an artist it’s either boom and bust, I would imagine. It’s like you get a little bit of a hit and then all of a sudden it goes dark for a little bit, and then you get a little… So the income fluctuation is probably fairly volatile. And so at 40 it’s like, “Okay well wait a minute, I gotta get a little bit more control over this.” But it’s still in the occupation that you’re in, it’s hard to see that the flow is not coming in and then all of a sudden you hit and then you’ve got to pay back everything that you’ve kind of borrowed to get you to the next point. What were some of the key takeaways that you got from all of this, just to now to get you to the point where you’re at?

Travis: Well one of the key takeaways, of course, it was too late for me, but that I really understand now is that time is your friend when it comes to investing and the earlier – even if you’re only putting $20 away at 22 years old, that’s better than where I was at. Because every 10 years you basically have to save twice as much money to get to the same place.

Al: Yeah. Let me ask you about the documentary because from what I’ve read about you, you had this idea of doing a documentary for a while but it wasn’t really until you met the couple by the name of Scott and Taylor that you decided to kind of make this real. So tell us about how all that happened.

Travis: Yeah that’s right. So my day job is I’m an executive for BBC Studios in Los Angeles. And so I’m a career television producer at this point, and I had decided to do the documentary and I sort of dreamed up the mood board, and I had cast all of the experts, and I had it all sort of figured out in my head. But what I didn’t have was an organic driver for the story, which I knew that I would have to find. And right at that moment when I started looking for that person, I got waylaid by my day job to make a new version of Top Gear for the United States. And that just took me into a black hole for over a year in production. And when I started to reemerge, I heard Scott on the ChooseFI podcast and I was like, “oh no, this guy’s going to do my movie!” And I freaked out! I was like, “I’m so mad!” But then I calmed down and I thought, “why don’t I just call this guy, because he’s really interesting and his story is interesting and maybe there’s something here.” And so we ended up meeting and having dinner because I was traveling through Seattle where he was with his wife, and we just met and just completely hit it off and I realized that they had the perfect organic driver for this story, which was basically that they were a high, very high spending couple who had been living in Coronado, living the Instagram life, spending every single dime that they made. They were doing well, but they were spending everything that they made – and then they had a kid. And they realized that they were selling their time and kind of like wage slaves if you will, to support this lifestyle. And in the meantime, not even being able to spend any time with their own child. And so they sat down and had a long talk about it and they decided to change their lives and see what they could do with regard to their own financial literacy and changing the way that they approach consumption, basically.

Al: And Scott wrote the book called Playing with FIRE. Had he already done that by the time you met him or was he working on it?

Travis: So Scott’s a very industrious guy. Like, he’s kind of unbelievable. And he already had the book in the pipeline when I met him. I met him about maybe about six weeks, two months into their journey. The funny thing was he decided to put himself in a documentary and just make a film, and he had done some documentary shorts. But to put yourself in a movie and then produce it and make it, it’s really really, difficult. So when I came along and said, “I’d love to direct this,” he was kind of relieved I think.

Al: Yeah. I had a chance to listen to the entire book. I was just so engrossed in the story. So the concept, of course, is spend a lot less than what you’re making, save as much as you can, be intentional on what you’re spending and all that sort of thing. But to hear his actual experiences – his jubilation of doing this at the start, but the problems of getting Taylor kind of onboard, but the pitfalls and the despair and “what have we done” and all this stuff that I would imagine, probably it’s a pretty common experience that people go through.

Travis: Well I would think so, but I don’t think a lot of people in our society put themselves through a social experiment like that. Most people are perfectly willing to swallow the line that we’re all given every day from advertising and marketing that the whole point of living is buying things. And that is not the point of life. And that’s what the FIRE community directly questions. And I think it’s really kind of brilliant. A lot of the philosophy that I’ve noticed in the FIRE movement I can trace all the way back to Thoreau. Thoreau was a guy who gave up a life of consumption for a life of simplicity in order to investigate what was valuable in his life. And you see that sort of with the Puritans, and there’s a lot of other strains. But I think that we’ve kind of gotten into a place in our world where the marketing and the consumption model is no longer in question. It’s just how we do things. And we see that there are major consequences by just swallowing that pill – like climate change, overconsumption, oil crisis. I’m not trying to sound too lefty about it, but I mean, there are direct consequences in that regard. There are also direct consequences to our lives. So every time we choose to spend everything we make means that we are now required to spend all of our time gathering more resources in order to buy more things. It seems simple when you say it like that but we don’t really question that.

So what do you think of the financial independence/retire early movement? Is a life of simplicity in your future or do you think the potential pitfalls outweigh the benefits? More on that with Travis Shakespeare momentarily – in the meantime, click Ask Joe and Al On Air at YourMoneyYourWealth.com to share your FIRE thoughts with the fellas, and share this podcast episode via email or social media to continue the FIRE conversation out in the wild. Watch the trailer for Playing With FIRE, read the transcript of this interview, and find links to the Playing With FIRE website in the podcast show notes at YourMoneyYourWealth.com. Now, more with Travis Shakespeare.

11:03 – Travis Shakespeare, Director & Executive Producer, Playing with FIRE (part 2)

Joe: With the research and every one that you’ve interviewed to make this documentary – and I recognize all the names and everyone that’s in your film because we’ve either had them on the show or I read their books or I follow their blogs – and they were very successful in following their own path to become financially independent at a very young age. However, I think on the other side of the coin, people want to be financially independent, but they might not do the math appropriately? And they might leave a very well-paying job thinking that they found this independence only to realize that they might go flat broke in a very few short years – or live a life of extreme frugality that they weren’t necessarily anticipating. I love the movement. I’m all for it. But then there’s also I think – are there some pitfalls that we’re not necessarily seeing? Because I think we only might talk to the people that were successful at doing it?

Andi: Well, and are we taking into account the longevity and how long you’re going to live in that early retirement and all of that?

Travis: OK. Lots of questions in there too. (laughs)

Joe: Travis I ask 55 questions at once! (laughs)

Travis: Do you really? (laughs)

Al: He really does. This could go all day. (laughs)

Travis: (laughs) …and I also had eggs for breakfast.

Al: (laughs) Good to know.

Travis: OK so let’s just talk about pitfalls. So first of all, ironically, I haven’t met anybody who’s failed at pursuing FIRE as prescribed by the FIRE movement – which is an interesting point. I think that the people that practice extreme frugality and are willing to sacrifice by saving enough money for, let’s say, 10 years to retire early – and I get what you’re saying, for 40 to 50 years of retirement – those people are really special kinds of people. They’re not your average person. So given that, the math that they use does bake in longevity and flexibility. So we don’t know what the failure rate is so far. There are a lot of people – like Vicki Robin for instance – who retired at 24 years old and is still kickin’. And she’s fine, and doing very well. So I think if you have the right mindset it is completely possible. That said, I have come to the conclusion in making this film that pursuing financial independence / retire early is not necessarily for everyone anyway. For one thing, a lot of people can’t imagine what they would do when they stop working. Now, the FIRE movement will tell you that they don’t just retire and go sit on the beach and drink mimosas all day. I mean, they do that for the first like six to 12 months. And then they start something else – a business, a book, they start writing books, they paint – they find things to occupy their time. And I think of it a little bit kind of like the British agricultural aristocracy, who lived out a passive income with agriculture for centuries in England. And those were the writers and the painters and the aristocrats and the politicians and that’s what they did with their lives – so they didn’t not work. That’s not the point. I do hear what you’re saying about what happens if you miscalculate.

Andi: Or if the market doesn’t behave as you expect it to either.

Travis: I mean they do have contingency plans for all of these things in their calculations. They have a certain amount of cash in reserve to ride out the average bear market, which is something like 18 months. They also have the opportunity to go back to work. A lot of them, even though they say that they’re retired, they’re willing to go back to work, or work part-time, or do what it takes to be flexible to make sure that they can carry out their intention. But there are two things that I think are the most valuable that I got from making the film, which is, first of all, to consider what you value in life. And that includes your time, and how you spend it is extremely important. And it’s not given enough credence in our society. The other thing is that you don’t have to become financially independent to benefit from being financially savvy and being financially literate because there’s a statistic that says something like half of American families don’t have $400 in savings or something – you guys probably know that statistic, right?

Joe: Yeah it’s pretty abysmal. Two-thirds has $1,000.

Travis: Yeah. Over half of the boomers have no money saved for retirement. Like, that’s insane.

Joe: Yeah, the median balance of a retirement account of someone 55 plus is $14,500.

Travis: I mean, it’s really insane. And if you think about that from a societal point of view, who’s going to pay for these people to retire? I mean, they will exit the workforce and who’s going to pay for that? So, just from a social responsibility standpoint, that’s kind of outrageous if you think about it that way. And I feel bad for the millennials in that regard because they’re the ones that are going to have to pay for it.

Joe: Yeah without question. I mean it’s either going to be higher taxes there’s going to be more – all sorts of different types of programs.

Al: Yeah, a lot lower standard of living or they’re moving back in with their kids or – whatever.

Travis: Yeah. So it’s a mess. OK. So – questioning what you value in life, number one, and number two, using the tools of the FIRE community, you can achieve a lot of things besides just becoming retired early or financially independent for all time. For instance, you can have enough money in the bank that if your car craps out on you, you can get it repaired and not go into a major crisis. You can save a month worth of your income and have some liberty around your financial obligations. If you can save a year of your own income, that liberates your spirit and your mind to begin considering other options. You could take a year off as a sabbatical. You can go back to school and study something that will help you to make more money as you go forward. Or you can make stronger demands at your job. You can go to your boss and without fear be like, “hey, I’d like to shape my career like this” or “this part of my job isn’t working out for me. Can we talk about changing that?” And not be afraid that you’re gonna get fired and never be able to pay for your car payment.

Joe: If you just take a little bit from each of these individuals, you can catapult yourself in such a better financial situation – even if your overall goal is not to save 95% of my income and do 16 side hustles and sleep two hours a night so I can reach this goal. You can tone that thing way down and you’re still going to be probably 60, 70, 80, 90% better, financially, than most of the population.

Travis: 100%.

Joe: One last question for you. Who’s your favorite person in the film? I know they’re probably like your kids. But was there a particular story or a particular individual that was most compelling to you?

Travis: OK, you’re the first person to ask me that. And I have to say it’s Taylor, Scott’s wife. She came to the film with such emotional openness and vulnerability, and she allowed me to capture her real journey in a way that is extremely compelling and I think very relatable to everybody that sees the film. I mean, she’s clearly the standout star, to tell you the truth.

Andi: We’re all going to feel like Taylor – we’re all going to be going, “no, I don’t want to give up all the things that I like in my life!”

Al: Yes she didn’t want to give up her BMW, that took a while, and she wanted to get the house in Bend…

Joe: What, do you want to give away the movie, Al?

Andi: Yeah, really.

Al: No it’s the book. It’s already out.

Joe: I got a follow-up question, and I promise it’ll be the last of the thousand questions I’ve asked you today Travis. (laughs)

Al: Is it a multi-question?

Joe: It’s 14 questions in one. (laughs) As you were doing your research, I think you started out by saying, “hey, I’m 40 years old, have $5,000, no one wants to help me – the big brokerage firms, so I got to get this stuff done on my own. Mr. Money Mustache, you started following him, and then probably other financial blogs and reading financial books. When you were reading these blogs and finding your financial path and then you met them in real life, was there – and you don’t have to name names. Was there anyone you’re like, “yeah, you’re full of it, you’re not coming on,” or were surprised when you actually met them versus the learnings that you might have learned from them?

Travis: (laughs) I gotta think about that, that’s a really deep question. It just also occurred to me that I probably threw Schwab under the bus when I told that story…

Joe: Oh Schwab sucks, we don’t like Chuck. (laughs)

Travis: It wasn’t Schwab as a company. It was like one guy that worked there.

Joe: Yeah. His name was Carl Mitchell. I know what branch he’s in. (laughs)

Travis: (laughs) Listen, the people that I’ve met in the FIRE community, especially the core – I would say the core founding group, because there are a lot of people who come along since the movement started gaining steam and started writing their own stories and stuff, so I haven’t met everybody. But that core group are really, truly, remarkable people. They’re kind of renegade in their attitudes to the way our lives are constructed. And I have a lot of gratitude to them, to tell you the truth. There are definitely some kind of… wacky characters? In the FIRE community? They’re unusual people. First all, a lot of them are like computer nerds and engineers and so they’re very, very, left-brained and they can tear up a spreadsheet like nobody’s business. And so they kind of have that engineering nerdy quality that’s kind of endearing, I think. But very different from the highly emotional, crazy people that I deal with every day in Hollywood.

Al: You got both extremes.

Travis: Exactly.

Andi: So the cool thing is the fact that this film is going to be premiering here in San Diego on Saturday, June 1st and it’s already sold out. Then the showing in San Francisco is sold out, the showing in London is sold out, from there they continue on to D.C., Detroit, Seattle, New York City, Atlanta, and Travis, I understand people can actually book screenings of their own as well?

Travis: Yeah. If you go to our website, which is PlayngWithFIRE.co, we have an organization that will allow anybody to mount a screening in their local community. So it’s kind of a grassroots option – if you can get 70 people to agree to buy a ticket this organization will mount a screening. What we’re trying to go to would the big cities ourselves and do Q & As and appear with some of the cast and things like that in the major cities. But even the smaller communities are starting to mount screenings as well.

Andi: It’s truly a grassroots effort and it’s very exciting and I am excited that I’m going to be at the San Diego screening. Looking forward to seeing you and the guys from ChooseFi and Scott and Taylor and the whole crew will be there at the Lyceum Theater in San Diego.

Travis: Yay. Yeah, that’s gonna be awesome. I’m really glad you’re able to come. I did make this movie for people who are financially illiterate like I was, and I’m really grateful that you guys are helping to spread the word because I’m looking to start a financial literacy revolution in this country. I really – I really worry for the kids that work for me and stuff. It’s just crushing what they’re going to have to deal with.

Joe: Yeah. It’s like save as much as you can as early as you can and let’s hope for the best. So check it out – PlayngWithFIRE.co. That’s Travis Shakespeare folks. Thanks so much, Travis, for tolerating this awful program. (laughs)

Al: All these layered questions? (laughs)

Joe: He’s probably like, “Oh my God.” (laughs)

Al: “This is the first time I ever had to go through this.” (laughs)

Travis: It was a little agonizing, but you guys are charming enough, I could take it. (laughs)

Al: At least you’re honest. (laughs)

Travis: I should just say to you that we’re going to start pre-sales of the film on TVOD, Vimeo, iTunes, and all that stuff as well. So if you’re interested, go to the website and the information will be there as well.

Joe: Awesome. PlayingWithFIRE.co. That’s Travis Shakespeare, folks.

Big Al is so excited about Playing With FIRE that I’ve decided to give him my second ticket rather than taking my husband to the sold-out show, so listen to the podcast next week to hear all about it – and make sure you follow us on Facebook or Twitter to see pictures! Find all the links you need in the podcast show notes at YourMoneyYourWealth.com. You know, whether financial independence and early retirement are in your future or if you’re planning a more traditional retirement, the fact is, how you spend your time when you’re done with the 9 to 5 is just as critical as making sure you’ve got enough money. So while you’re in the podcast show notes at YourMoneyYourWealth.com, download one of our most popular free resources, the Retirement Lifestyles Guide, for some ideas on making the most of your retirement, or early retirement. You’ll see the banner right there at the top of the podcast show notes page at YourMoneyYourWealth.com. Now, let’s get to your money questions and comments. Scroll all the way down and click Ask Joe And Al On Air at YourMoneyYourWealth.com to send in yours.

24:35 – Should I Sell My Rental, Pass Ownership to My Son, or Move Back In?

Joe: So Greg writes in. He’s from – L.A. Los Angeles California, just right up the street. “I own a property in SoCal” – that’s what I’m guessing what S. California means. “I’m close to 64, yo.”

Al: (laughs) Years old. Yo!

Joe: Hey yo, I’m close to 64.

Al: Years old.

Joe: Oh that’s what that means?

Al: I think so.

Joe: “And I’m considering various options for this property. Its current status: rental unit.” Okay… “Number one: sell, number two: pass ownership to my son. Three: moving back in.”

Andi: The end. (laughs)

Joe: (laughs) The end. Greg.

Al: So which one’s better. (laughs) Well, he’s 64, yo. And he’s considering various options for this property. I don’t know what the hell Greg are you writing us and did you fall asleep? He forgot to ask a question.

Al: But I will address all three with the premise, and the premise is Greg, do you need this property for your retirement? If so, don’t give it to your son. In other words, if you need a place to live, then live in it. Make sure you’re covered first before you start thinking about giving this away. But I can address all three. If you sell it, then it looks like you say “moving back in.” So I guess it was your residence at one point – so I don’t know when you did that. If it was recent and if you sell it and you happened to live in it two out of the last five years even though you haven’t lived in it for a while, then if you’re single you get a $250,000 gain exclusion. If you’re married it’s a $500,000 exclusion.

Joe: You would have to pay depreciation recapture?

Al: Correct. You’d have to pay depreciation recapture, which basically means when you buy a rental property, you figure out how much is land, how much is building, and the building part you get to slowly write off as an expense over 27 and a half years for residential property. And so to the extent that, even if you have this exclusion because you qualify for two out of the last five years, you still have to pay tax on depreciation recapture. In other words, the tax deductions that you took before now are income and you have to pay tax on them. So that’s one way to think about this.

Joe: But Greg if you had not lived in it or if it was past five years ago, then you look at what the cost basis is, what the game is, and then you would pay income tax on that or capital gains tax.

Al: Yeah. Let’s say you bought the property for $200,000 and the depreciation that you already took, that you wrote off, was $50,000. So now your tax basis is $150,000. And let’s say you sell it for $450,000 – so then there’s a $300,000 capital gain. Some of that, $50,000 of that, is depreciation recapture, which is taxed at either your tax rate or 25% – and the other part is long term capital gain, which can be taxed at 0, 15% or 20% depending upon your tax bracket.

Joe: Is it your tax rate or 25%, whatever is higher?

Al: Whatever is lower, actually. There’s a little break.

Joe: California, they have different rules when it comes to the 121 exclusion?

Al: No, same rules. So you get the same exclusion in California. So that’s if you’re trying to sell it, and so either you lived in it two have the last five years or you didn’t. If you pass the ownership to your son, great, but now it’s no longer your asset. So it’s no longer part of your retirement. If you don’t need it and your son needs it and you want to do that, great. But what happens when you do that is your original cost basis transfers over to your son, and if he sells it, then he’ll have to pay the capital gains. Now, if he lives in it two out of five years, then he can do the same exclusion – $250,000 single, $500,000 married. But yeah, you’d only do that if you don’t really need it.

Joe: And then also that would be a gift. So you would have to just look out for gift tax return and things like that.

Al: Yeah, correct. So right now you can give $15,000 to any recipient per year. And if it’s more than that, you file a gift tax return. You don’t actually pay taxes. What happens is you reduce your exclusion – your estate tax exclusion when you pass away. And I guess the third one, moving back in, great if you want to – I mean, we don’t know., there are no other details.

Andi: Yeah he doesn’t give us any idea how come he doesn’t want to keep it as a rental unit either.

Joe: Well he just owns a property in SoCal, yo. (laughs)

Al: (laughs) So yeah, those are a few choices, I guess.

Joe: All right Greg. Hopefully, that helps. For future reference, a little bit more detail.

Al: Yeah. And actually write us a question (laughs) because we’ll just answer whatever we feel like.

Andi: You mean don’t just make a statement with no question on the end of it, Al? (Laughs)

Al: Yes. Yeah. Like I like to do?

29:51 – What Should I Do With My Home in ABQ?

Joe: We got Karen from Oceanside, California. She writes in. “Hello Joe and Big Al, I trust your judgment.” Thank you, Karen. “I have a second home I bought new in 2007 in Albuquerque, New Mexico with approximately $70,000 of equity. For the past 12 years, I’ve rented to family members and never claimed the home as a rental. My daughter is now moving out of my ABQ home to California.” Albuquerque home. So maybe she goes to KFC in ABQ. “So I do not want to hassle renting it out to tenants. However, I do have a reputable property management company to fall back on there. So the question is since the new tax law has a $12,000 standard deduction for single and my previous itemized deductions for that home ran under $12,000, I don’t see the benefit of keeping the house. Appreciation values are very low and slow there. I don’t risk capital gains selling. With the current rents there if I calculated correctly, I would only profit about 64 bucks per month after all expenses are paid including if I were to start paying for a property management company. So I’m estimating netting out about $58,000 selling the home. I could maybe invest that towards something else as long as it’s not too risky, or put the money in the bank for emergencies since my savings is only $6,000. I’m sustaining monthly just fine with my pension and military health insurance for life, and now that I turned 65 Medicare. I own my very updated and renovated mobile home and planning on dying in it.” Okay.

Andi: Hopefully not literally.

Joe: Well maybe I don’t know. She’s debt free “aside from my ABQ” – that stands for Albuquerque – “home of $131,000 loan. Is your opinion to keep the house or sell it?” Well, what is 64×12? Can I see your calculator sir?

Andi: $768.

Joe: Okay. $768 divided into $58,000.

Al: No that’s the equity. The loan is…

Joe: Well yeah, that would be right. She’s netting 64 bucks a month. The equity is 58 grand.

Al: Yeah you’re right. You’re correct. (laughs) So that’s a 1% cash on cash.

Joe: Okay. 1% cash on cash.

Al: 1.3.

Joe: And then you get probably maybe another 1% appreciation.

Al: Yeah. Could be. In her experience, she has not received appreciation, but she bought in 2007 which was the height of the market before the Great Recession, which was the worst crash we’ve had since the Great Depression, and in some areas worse for real estate, the Great Recession was worse than the Great Depression. So I would say Albuquerque, historically, has appreciated, maybe not in the period of time where you’ve owned it, but I’m not sure that’s a correct premise. But the cash flow is only 1%. So that’s not very good. That’s not going to do much for you your retirement. Now, the ability to sell without paying taxes, that just simply means you’re going to sell it for roughly what you bought it for because you only pay taxes on gain. And there’s $58,000 of equity. I would probably be inclined to sell it. And she mentions she’s got emergency funds of only $6,000. I think that’s a little bit light. So to have that extra flexibility, having the capital in retirement, you’re not really giving up much cash flow. There’s no taxation to sell, you don’t even really want the property. Yeah, I think you sell it.

Joe: Absolutely. Yep. You sell it. You cash out Karen, and then you just put that right there in your old savings account.

Al: Yeah. Don’t be too aggressive with it.

Joe: Yeah. You don’t need to invest it I don’t think. If she’s living comfortably with her pension, she’s got military health insurance. You’re chillin’, you’re gonna die in your home in good ol’ Oceanside. Yeah, I would sell the ABQ home.

Al: Yeah, so we’re in agreement.

34:18 – Real Estate as a Hedge Against Inflation

Joe: We got Rob from Santa Clarita, California: “YMYW TV season 5 episode 15.”

Al: Wow. It was entitled, “Get Real with Real Estate.”

Joe: Thank you for the clarification, Rob. “I loved it but I have one comment. There didn’t seem to be any mention that it is a great hedge against inflation. So even if I’m getting slightly less than 1%, with write-offs for depreciation maybe over 1%, real estate generally rises with inflation so it can keep you well ahead of the game. I understand that that is very illiquid but I was just pointing out another positive.” Rob, cool. Thanks for watching YMYW TV season 5 episode 15.

Al: Yeah, and Rob I agree with you. I think the real estate is a good hedge for inflation, although it’s local. It depends upon the area. Now if you’re in Santa Clarita, and if your properties are in California, California properties have tended over time to appreciate more than some other areas. And in fact in excess of inflation. Certain parts of the country, inflation at best is kind of… But it is an inflation hedge and I think when you’re investing in California, it’s not so much for cash flow because the prices are so high that you can’t charge enough rents to get a good cash flow. In other parts of the country like Texas it’s a little bit different where the properties, they’re cheap enough where you can charge enough for rent to make a good cash flow. That’s not really the case in California. But what does tend to happen in California over time is the appreciation factor – and that’s how people create wealth in California. But when they get to retirement age, to try to turn that into a cash flow, they tend to need to do something with the property because the cash flow is not that great. Meaning they sell it…

Joe: But most people don’t though.

Al: They don’t because they don’t understand they’ve got this big asset that’s not really producing.

Joe: Right. Let’s say they’ve got a $700,000 asset and maybe it’s getting $15,000 net cash flow and they’re like, “Well hey this is great it’s $15,000 bucks.”

Al: Yeah and it’s like a 2%.

Joe: Yeah. On $700,000 it’s not all that great.

Al: Right. And so what I tell folks is when you’ve done that, and just understand what you’re doing, you’re building your net worth and if it’s for you and your retirement then you need to cash it in somehow. You don’t necessarily have to sell it. You can do a 1031 exchange into a different kind of property that has better cash flow. You can do a charitable remainder trust, you can do all kinds of things to sell it and create a better cash flow. But the thing is, if you collect, in your example, that $15,000 per year, well great. I mean that’s a good income, but it’s only 2%. And yet you’re asset maybe is growing at 5% or more. It just depends upon the cycle and the market. If you want to enjoy that, you’re going to have to monetize that somehow by a sale or exchange or something like that. Otherwise, basically what you’re doing is you’re making your kids or your beneficiaries wealthy because when you pass away there’s a step up in basis. They get to enjoy all that net worth and profit, and then they get to live the life that you actually built. If that’s your goal, great. But for most of the folks that we talk to, it’s like, “well I built this for us in our retirement.” Well then you have to kind of look at other options.

Joe: Yeah, and that’s a sticky subject too because it’s like, there’s such a weird emotional attachment to real estate than it is to a mutual fund.

Al: Right. And particularly if you’ve done well in real estate and you don’t really trust the stock market. It’s like, “why would I ever do anything differently? Because the stock market, it seems like gambling.”

Joe: So I think the goal is looking at what is the goal for the asset. Is it for income is it for growth? And then I think in California what you were just alluding to is that I think real estate is a really good asset class more for growth.

Al: Yeah, in most areas. Certainly in the bigger towns. Now if you’re out in the middle of nowhere in… Needles, let’s just say. (laughs) Or Weed and some of these towns that are out there, maybe there’s not quite as much appreciation. Just guessing. I don’t know that for a fact. I’m probably wrong, Needles is probably the fastest growing. (laughs)

Check out the Your Money, Your Wealth TV episode Rob was talking about, Get Real About Real Estate in Retirement, in the podcast show notes at YourMoneyYourWealth.com. And if rental real estate is part of your retirement or early retirement plan, I’ll also throw in the link so you can download the 10 Tips for Real Estate Investors guide for free. We’ve got time now for one more email question – actually this one is a comment. You can send either to the fellas just by clicking “Ask Joe and Al On Air” at YourMoneyYourWealth.com and recording a voice message that we’ll play in the podcast, or you can do it the old fashioned way and send an email.

39:28 – Roth 401(k) Income Restrictions and Contributions vs. Conversions

Joe: Okay, we got Marcos, he’s from Kansas City Missouri. “Thanks for all the education that you provide on your podcast. It’s quite entertaining as well.” Thanks, Marcos. “I’m a new listener and was listening to an older podcast episode 215.” Oh, episode 215, that was a pretty good one. It’s probably on real estate. “The question asked by a listener related to Roth conversions. Comments were made regarding Roth 401(k), Roth IRA, and income restrictions were mentioned. Listeners like myself may have assumed that income limits apply to both Roth IRA and 401(k), however, Roth 401(k) has no income limits, unlike the Roth IRA. This perception could deter someone from contributing to the Roth 401(k) thinking that they made too much. Thanks for your time.” Marcos, God bless you. My point exactly, Al. These stupid retirement plans with all these stupid rules!

Al: Let’s get them coordinated so we don’t have – every single different account has different rules.

Joe: Roth IRA, you have income restrictions – if you make too much money you cannot put money directly into a Roth IRA. It’s about $200,000 if you’re married, $140,000 if you’re single. That’s on the top end of it. If you make more than that you cannot contribute to a Roth IRA unless you do a backdoor Roth. But how about if I have a 401(k) plan? No problem. Oh, you make $200,000? Who cares!

Al: You put $19,000 in, $25,000 if you’re 50 and older. Wait a minute, my neighbor can’t do one and I can do $25,000?

Joe: I thought I made too much money? Well, you do for the Roth IRA. You never said 401(k). Totally different thing. Marcos, I’m glad you mentioned that because I think Al and I get lazy a lot of times because there are so many different rules with so many different plans. And then we make the assumption that everyone understands what the hell we’re talking about. Because we do zero prep for the show. (laughs)

Al: (laughs) If we did more prep we’d be tight.

Joe: When we talk about Roths, some people will tune out right away because they’re like, “No, I don’t qualify. That’s not for me.” But anyone can open up a Roth IRA, you can convert into it if you have a retirement account, there are no income restrictions for conversions. But there are income restrictions for contributions to Roth IRA. There is no income restriction for Roth 401(k) contributions. Stupid.

Al: Yes. So let’s go a little slower. So Roth IRAs, no 401(k) Roth. This is a Roth IRA. Yeah, there’s the income limitations, Joe, that you just mentioned. But a Roth 401(k), which essentially is virtually the same thing except you do it through your pay, through your employer. There are no income limitations there. You could make a million dollars, it doesn’t matter. You can max it out. And right now that’s $19,000 unless you’re 50 and older, and then it’s $25,000. So it doesn’t matter how much you make or how much your spouse makes or if your spouse is in a retirement plan or not. None of these things matter.

Joe: Unless you’re a highly compensated employee with a top-heavy 401(k) plan. It’s bull- it’s BS. (laughs)

Al: Oh no, now you’re going deep. You’re right, you’re right. And so in that particular case you could theoretically make the full contribution and after year end when you’re third party administrator runs all these actuarial calculations, they got six people in the back office with glasses and computers and they come up with this: “Oh, you did $3,000 too much” and you’d have to take that back and call it income the following year. (laughs) It’s like why did they do this?

Joe: (laughs) I don’t know. But you’re right. When I teach these retirement planning courses, we talk about Roth IRA conversions, and then it’s like OK well here, let’s say that your tax bracket is X and you can go to the top of that bracket, which is Y. And I say you can convert this much and let’s just assume that’s like $25,000. And then people would be like, “well, I thought you can only put $7,000, $6,000 in the Roth.” Well no, that’s a contribution. “Well, I make too much money.” Well no that’s a contribution, I’m talking about a conversion. And then it’s like, “well what’s a conversion again?” Well no, it’s taking money from a retirement account and putting it into the Roth – you pay tax on it.

Al: Yeah. Well, the two words sound similar – contribution, conversion. I could see where it’d be confusing.

Joe: But the problem, and I think when Marcos is telling us is helping us out. If you can explain things a little bit more – Marcos probably tuned out, but he’s smart. He knew the rules and he understood what we’re talking about. But he’s like, “the average Joe probably shut your show off.”

Al: Right. (laughs) Well, he Googled it to find out the real answer.

Joe: Or it’s like this is a really good option for a lot of people but they automatically might tune it out because they don’t understand the rules or they might have heard the rules of saying, “oh, I don’t qualify for a Roth because I make too much money.”

Al: Yeah, how many times have we’ve been that people come into our office and we talk about a Roth conversion and the person or the couple will say, “well, my accountant says I don’t qualify.” And then we have to say, “no, that’s a contribution.” And then we have to explain. So a contribution is taking some of your money from your savings and checking account, outside of retirement, and you contribute it to a Roth IRA. That’s one way to get money to a Roth. Another way is to convert it. Now that’s totally different. That’s taking money that’s already in a retirement account that you got a tax deduction – usually, maybe not always – and you convert that. And when you convert it, if you got a tax deduction, you then you have to pay tax on that conversion amount because that’s what it would be when you take it out at retirement anyway. And then we get the thing about, well I’m not 59 and a half yet so I can’t convert.” No, a conversion, it doesn’t mean like you’re putting the money in your pocket, you’re just changing from one kind of retirement account to another kind of retirement account. You simply pay the tax, there’s no penalty, but you can do it at any age whether you’re working or not.

Joe: So if I understand this correctly Al, if I make a contribution, that means it’s after tax, already paid tax on it. And so I put $6,500 or $7,000 into my Roth IRA. It’s after-tax, already paid tax on the dollars, it goes into the Roth, it grows tax-free. A conversion is let’s say if I converted $7,000, I convert it and I pay the tax on the $7,000, and then now it’s in the Roth IRA. Tax-wise there’s no difference. Right?

Al: Right.

Joe: So why is a conversion legal with no income limitations, and there are income limitations on contributions?

Al: Makes no sense.

Joe: It doesn’t make any sense whatsoever.

Al: And I guess it used to be closer because it used to be you could only do a conversion if your income was below $100,000, then they took that rule away and it’s like, “OK well that’s nice that you took that role away, then let’s coordinate the rules so they make sense.” Because they set up these rules that might have made sense way back when. And then they take limitations away to where it makes no sense whatsoever.

Joe: So there should not be an income limitation whatsoever on a Roth IRA contribution.

Al: If we want to do the SECURE Pension Act, we should say anyone can do a Roth contribution – anyone.

Joe: Anyone. All right, we’ll see you guys next week. The show is called Your Money, Your Wealth®.

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Stick around to the very end for this week’s Derails and check out the video of Joe getting worked up in that last discussion in the podcast show notes at YourMoneyYourWealth.com, along with the trailer and links for the Playing With FIRE documentary so you can schedule your own screening and stoke your own FIRE. Special thanks to our guest today, the ever-so-well read and aptly named Playing With FIRE director and executive producer, Travis Shakespeare.

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