Show Notes

• (00:53) Police Educator Retirement and Mortgage Spitball Analysis (Tim, Holliston, MA)
• (09:42) ESOP to Roth Conversion and 5% Withdrawals in Early Retirement? (Mike)
• (20:18) Self-Employed Retirement Spitball Analysis (Heather)
• (30:42) Pension and Social Security Spitball Analysis (David)
• (37:11) How Much Should You Have in an Emergency Fund? (James, Detroit, MI)
• (42:01) Ramsey vs. Edelman vs YMYW: 15 or 30 Year Mortgage? Cash or Credit? (Daniel, Camp Lejeune, NC)
• (49:26) Comment: Social Security File & Suspend, Restricted Application (Shweta)

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Transcription

Retirement spitball analyses today on Your Money, Your Wealth® podcast 372 with a spitball for a police officer turning teacher, a self-employed small business owner, an early retiree with an employee stock ownership plan wanting to do Roth Conversions and withdraw 5 or 6% in retirement, and a pension and Social Security spitball analysis. Plus, how many months of expenses should you save in your emergency fund? Also, you may know where Ric Edelman and Dave Ramsey stand on 15 vs. 30 year mortgages and using cash vs. credit, but what does YMYW think? Visit YourMoneyYourWealth.com and click Ask Joe and Big Al On Air to send in your money questions as an email or a priority voice message. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, filling in for Joe Anderson, Kyle Stacey, CFP®, and Big Al Clopine, CPA.

Police Educator Retirement and Mortgage Spitball Analysis (Tim, Holliston, MA)

Al: So, Andi, we have Tim from Holliston, Massachusetts.

Andi: You got it. He says, “Hello again Joe, Big Al, and Andi. First, thank you for answering my question back in show 324 regarding a taxable brokerage account versus a 457(b) deferred comp plan. A brief summary about us: I’m a police officer, 38. My wife, who is 30, works in finance and investing as a data steward. Our gross annual income is roughly $240,000 a year between our two incomes and non-taxable VA disability. He’s an Iraq War veteran.” Thank you very much, Tim. “Our previously mentioned tax free gift from my in-laws is now going into an _eyelit_ rather than an annual gift directly to us. My wife is maxing out her Roth 401(k) through her employer, and we back door the maximum in each of our Roth IRAs. I have a pension through the police department that will pay 50% at age 55, which is when I plan on stepping away from policing but not retiring entirely. I have a Masters in Education and was previously a high school teacher looking to combine both teaching and experience in law enforcement to teach at a police academy as the years and mileage on my body increase. Now to get to my question.” That made me think of the movie Police Academy. I hope that’s not what Tim ends up doing. “My wife and I recently purchased a home in May of 2021 with 20% down and a fixed 30-year loan of $520,000 at 2.99%. Taking into consideration my age, being a disabled vet and my job carrying a higher rate of injury, my wife and I are looking to have the ability to pay off the house in 15 years while taking advantage of historically low mortgage rates. We’re using our brokerage account as our early mortgage payoff account, contributing $250 a week into four Index ETFs. Broad Value, Mid Cap, and Small Cap with a 40/20/20/20 allocation, respectively. Given a 7% annual expected rate of growth, the balance of this brokerage account should grow to match the principal balance remaining at the 15 year mark of the mortgage amortization. I’m not suggesting cashing out the brokerage account at that time and dealing with a large tax bill just to pay off a low rate mortgage, but rather have the peace of mind to know that if a scenario were to happen where I can no longer work, the balance on our home would not cause a crisis event.”

Al: Let’s stop there. Let’s address that, and then he’s got a few more questions. So I think the idea, Tim, is you’re thinking of retiring at age 55. You’re 38, you’re going to set up a savings account, or I should say, an investment account outside of your retirement account that will grow at a 7% rate of return sufficient enough to pay off your mortgage should you decide to, which is not a bad idea at all. I think it’s a great idea. And you’re continuing to pay the mortgage as a 30 year, which is fine. Some people decide to go ahead and pay more on the mortgage each month to turn it into a 15 year. That’s obviously an advantage, too. But as you’ve already mentioned, the loan rate’s 2.99%, which is a good rate relative to what you could earn potentially with investments. And you’re targeting 7%, which may or may not happen. So here’s the pluses and minuses in that versus just turning this into a 15 year mortgage by paying more each month if you want to. And the main disadvantage is the risk. There’s no guarantee that it’s going to go up 7% per year annualized for the next 17 years. And I guess the other part is just thinking about the market. The market has done rather well the last 12 years, and so will it continue at this rate? Hard to say. A lot of experts don’t necessarily think so. But if you look at the areas of the market that have done exceptionally well in the last decade, it’s mostly in the US. International stocks have not done as well. Emerging market stocks, which are companies in countries that are emerging, like India, Brazil, to name a couple, they have not done as well. And there’s something called reversion to the mean, where these different asset classes, foreign asset classes will probably at some point outperform. So looking at your allocation, I like the idea that it’s all stock, but I think you’re missing out on international and emerging markets.
And if it were me at your age, I probably would have at least 30% of my portfolio in international emerging markets. You could do more, you could do less. 20% to 50% would be reasonable.

Kyle: I would agree with that. Emerging markets, especially for someone so young, that asset class tends to be pretty volatile but you’re compensated with a higher rate of return over time.

Al: So you might think about your allocation. The concept is fine. And I also agree with you, in 15 years or 17 years from now, having the ability to pay off the mortgage is great. You may not want to because if you truly do earn a 7% rate of return, you might want to keep that going. And then you got a mortgage that’s 3%, roughly. So you’ve got that arbitrage. Again, though, it’s the risk. We don’t really know what the market is going to do. So think about that. So I guess with that, Andi, go ahead and continue.

Andi: He continues, “my thoughts are to slowly tax gain harvest those long term gains 15 to 17 years from now as I step away from policing and have a reduction in my income. I also like that this money can be utilized as a second emergency fund aside from cash in our savings rather than having to take out a HELOC and pay the bank to essentially borrow our own money. I’m sure there is more info you could always use in these sorts of questions and conversations, but does this plan seem feasible considering our low mortgage rate and average annual returns of the market? Are there any potential issues I’m missing aside from gradually shifting or investing to include a tax free bond/fixed income ETFs to reduce the risk over time? Should our allocation be different right now given a 15 to 17 year window of growth? By the way, we have our first child on the way. He’s due on Easter Sunday.” Congratulations. “I have a question regarding the Atma versus 529 and all the facets surrounding that decision, but I’ll save that for a later show.
The three of you keep me smiling, laughing and informed as I stand in the cold New England weather on a police detail. Thank you for all you do. I’ve been sharing the YMYW podcast with my coworkers.” Wow, that’s cool. Thank you, Tim.

Al: Yes, thank you, Tim. We already touched on having a sinking fund to pay off that mortgage. We’re good with that. We think that’s a good idea. Only disadvantage potentially is the risk in the market, what is actually going to happen. The second point about an emergency fund. I love that, too, because when you think about an emergency fund, I would say you probably want 3 to 6 months in cash, just available in cash. But I really would encourage most of you to have more than that. And anything above that can potentially be invested. It’s not necessarily an emergency fund per se, but investments, liquid investments can be converted to cash within a couple of days. And that’s not a bad way to go.

Kyle: I would say with the emergency fund, you almost have to know yourself a little bit, understand that you might want some of that emergency cash. It’s a little bit tougher to access, kind of like having a lid or a lock on the cookie jar, so to speak. So it’s not so easy just to sweep it into the checking account.

Al: You mean have a CD or something like that?

Kyle: Yeah, maybe a CD or something that’s a little bit more of a pain to try to access.

Al: Yeah, and I think you’re right when you said it depends upon the person and the discipline, because a lot of people that try to set up an emergency fund, an emergency happens every week. It doesn’t last very long. So, I think the plan is fine. Like we talked about, I think you could potentially reallocate to include international. I like the plan. I also like the idea of not necessarily paying off the mortgage in 15 to 17 years, but at least you got that option.

Kyle: The other thing, too, he mentioned tax gain harvesting. Someone so young, with such a long time horizon, he might be able to tax loss harvest over the next 10, 15 years, and he could potentially build up a pretty large capital loss carry forward. Instead of having to pay a gain to pay off the mortgage, he might have some capital losses to offset any sort of gains. And then he can free up the cash without having to worry about the taxes.

Al: I agree with that. Tax loss harvesting is when you have an asset class that goes down, you sell it, you record a loss on your tax return. That loss is available basically for the rest of your life, as well as $3,000 per year for ordinary income. So that can be a good way to go. So, Tim, great question.

ESOP to Roth Conversion and 5% Withdrawals in Early Retirement? (Mike)

Andi: Mike has a retirement spitball question. He says, “Hello, guys. I’m 49 and have worked for a convenience store chain for 30 years in New York. They have an ESOP that matches 12% of our salary as a contribution. It doesn’t allow us to add any funds to it. Over the years, the average appreciation is about 15%. Two years ago it was over 20% and last year it was 33%. I have about $840,000 in the plan. I would have more, but I lost $130,000 about 6 years ago during a divorce. I make $70,000 a year. I only have about $15,000 from a Roth and crypto. I have $75,000 left to pay off on the house. I would like to retire in 6 years or less. Everyone else says to diversify, but I feel like it’s still a strong growing business with no debt. I would like to maintain the same income during retirement. What are your thoughts about a 5% or 6% withdrawal rate and a conversion to a Roth? Mike”

Al: I get three questions here. One is to diversify or not diversify, whether 5% or 6% withdrawal rate is going to work, and conversion to a Roth. So in terms of diversifying or not, I would say in general, diversification is safer. It’s a sure bet. But in terms of making more money or losing more money, concentration of your risk is better. Now, the fact that this company has done rather well the last several years and you have a good feeling that it’s going to continue, I might say just let that ride, personally. But there’s a risk. If the company turns around, you’re going to see that the wealth that you have there could not totally evaporate, but it could go down a lot more than the market as a whole. So there’s the pros and cons. But I think if you’re in a company that’s doing well, that has done well, you think it’s going to continue to do well? I’m okay with a little concentration there.

Kyle: Yeah. You’ve got to understand the range of outcomes here. It sounds like a pretty high upside, and then we don’t know what the relative downside is. He’s probably got more information about the company’s work there. He’s been there. He’s seen the people. It could be a pretty good spot for him.

Andi: So he said he would like to maintain the same income during retirement. And what are your thoughts about a 5% or 6% withdrawal rate? And what are your thoughts on a conversion to a Roth?

Al: And so Mike is 49. Did he say when he’s going to retire?

Andi: He said he would like to retire in less than 6 years.

Al: Less than 6 years. Okay, cool. So that means you’re probably going to retire around age 55. Kyle, what do you think about withdrawal rates at age 55?

Kyle: It seems a little high, but it sounds like he’s got some sort of guaranteed rate of return here of 15%, so he can double it if he wanted, I guess.

Al: He was talking about his ESOP, which is an Employee Stock Ownership Plan in a company which generally is in a retirement account. I guess not always, but that’s where I’ve seen it. And the company has done rather well. And I think we kind of tackled whether he should diversify or stay concentrated. And my feeling is if you’re bullish on the company and you’re going to retire within a few years, maybe you want to stay concentrated, maybe you diversify some, but generally stay concentrated so you can enjoy the wealth. But the risk, of course, is it could go down. You could lose a lot of money. So that’s always the risk there. But then if you want to retire at 55 and you want a 5% or 6% withdrawal rate, you probably have heard us talk about the 4% withdrawal rate, the distribution rate, which is designed for a couple or individual at age 65. That’s where this came about, 30 plus years ago. Interest rates are a little higher than they were, and even 4% is suspect given the interest rates, rates of return on fixed income. 5% or 6% is awfully high. I would say you could probably do 5% if you’re 70 years old or 75. If you’re in your late 70s, you could probably do 6%, but not at 55. That’s going to put way too much strain on your portfolio. So I would say 55, probably a better number is a 3% distribution rate.

Kyle: Maybe even 2% to 3% is probably where he wants to be.

Al: Agreed. I think 3% might be as high as you want to go.

Kyle: There’s a ton of other factors in there, too. How’s his health? Does he think he’s got 30, 40 years to live? And then you can kind of gradually increase the distribution rate over time.

Al: That’s a good point. So, if you’re single and you have impaired life expectancy, you might want to live it up a little bit more. And I’m okay with that. But there’s a risk there, and that is what if you lived a lot longer than you thought.

Kyle: Planning would be a lot easier if we all knew our mortality.

Al: Which we don’t really get that, do we?

Kyle: Would you want to know?

Al: No. I don’t know.

Kyle: I don’t think so either.

Al: Unless it’s a big number. But even still, when you approach that, it’s like, oh, okay… This is my last holiday.

Kyle: I don’t know what I want to do with that information.

Al: So the second question was, should he consider a conversion to a Roth IRA? How would you answer that one, Kyle?

Kyle: If he’s still working, it depends on what his bracket is. It also sounds like this ESOP’s done pretty well. If it’s going to continue to grow, he might end up with a $2 or $3 million balance. And then if he’s only spending, what is he spending? $75,000? His RMD alone on that, presuming it’s in a retirement account, might be $120,000 by the time he gets there. It’s going to depend on the distribution rate, how much it actually grows. But if you look traditionally, if he’s going to have a sustainable distribution rate, maybe that 2% to 3% and it’s growing at 4%, 5% or 6%, that little Delta is going to continue to grow the account until he gets to the RMD age.

Al: By the way, when we talk about a distribution rate, in this case, we’re saying 2% or 3%. If you’re 65, maybe 4%, at 70, maybe 5%. These are absolute rules of thumb. Please do not take this to the bank. This is kind of a starting point to do financial planning, to figure out if that’s the right number for you. And there’s a lot of factors here and you just mentioned, one, which is impaired life expectancy. You can do a higher distribution rate. Your investment strategy. If you’re 100% in CDs and cash, you better do a really low distribution rate because you want your earnings and growth to be higher than the distribution rate. And the reason is because of inflation. In other words, you want your account to grow. So if you’re taking 4% out or 3% out, whatever it is, it’s a higher number each year because inflation keeps on going each and every year.

Kyle: Kind of like the back of the envelope would be maybe spitball. And maybe 4% is what you’re pulling. But if it’s growing at 6% or 7%, that Delta of 2% or 3% is there, like you said, to combat tax, inflation, one off expenses.

Al: Now, in terms of a conversion, Mike, we don’t have near enough information because as Kyle said, we don’t know what your salary is. We don’t know what your tax bracket is. We don’t know what it’s going to look like upon retirement.

Andi: Actually, he does tell us that he makes $70,000 a year. So we have his income. But a lot of the other information we still need.

Al: Yeah, we still need it. But I would suggest at $75,000, you’re going to be in the 22% bracket. It just depends upon what this ESOP plan, which is probably a retirement plan, is going to grow to you, what your future required minimum distributions are going to be. But I think the general rule would be when you retire at age 55, if in fact, your income is a little bit lower, maybe that’s a better time to do it. On the other hand, tax rates are lower now than they will become in 2026. So that might put it in favor of doing conversions right now. But you gotta do some calculations here. You have to figure out the tax rate you’re in now versus the tax rate you’re going to be in the future, what your retirement account is going to grow to so you can look at what your requirement distributions are, and then you could essentially come up with the answer. And I will tell you this, being a CPA, when you go to your accountant, I would say the majority of accountants would tell you not to do a Roth conversion. And the reason is because they’re looking at one year at a time. In other words, if they’re trying to save your taxes for the year they’re doing, why would they want you to do a Roth conversion? Because you’re going to pay more taxes. On the other hand, when you start looking at 20-30 years of tax returns, future tax returns all at once, you might make a completely different decision. For example, if you’re in a low bracket now versus what you’re going to be in the future, then you would want to do a Roth conversion now, even though it’s going to cause more tax right now. So it’s a hard question to answer without enough information. And even with more information, you would need to run tax projections, and not just the tax projection for this year, but tax projections for future years, given what we know and what tax brackets are going to be. And then, of course, it’s probably going to all be wrong anyway because tax rates change all the time, and so it’s hard to know with certainty. Anyway, Mike, I hope that helps a little bit.

21% of Americans have no emergency savings, 4 out of 5 parents wish they learned more about money as a kid, and 59% of parents are uncomfortable talking to their kids about money. This might be why  32% of teens can’t identify the difference between a credit card and a debit card and 46% of teens don’t know what a 401(k) is. That’s all according to the ChooseFI Foundation. April is Financial Literacy Month, an effort to highlight the need for more financial education for both adults and kids. These stats are why it’s so important to have basic financial skills like managing money, budgeting, and investing. Visit the podcast show notes at YourMoneyYourWealth.com to watch brand new videos on financial literacy, and to download our guide to Cracking the Financial Code at Any Age – it’s got financial strategies and actions to take in your 20’s, 30’s, 40’s and 50’s to overcome any previous missteps and set yourself up for a more successful retirement. Just click the link in the description of today’s episode in your podcast app to go to the show notes, access all these free financial literacy resources, and don’t forget to share them to celebrate financial literacy month! 

Self-Employed Retirement Spitball Analysis (Heather)

Al: Andi, we’ve got a question from Heather.

Andi: We do. She says, “Hi, Andi, Big Al, and Joe, I appreciate you taking the time to read my questions and possibly do some spitballing. I discovered your podcast last year and now I’m hooked. I’ve been a listener to some older episodes and in the process, I think you have saved me from making a tax mistake for 2021. So thank you. It might be time for a new CPA. I’m self employed and have always had a SEP IRA. A few years ago I figured out I was getting raked over the coals in fees from a CFP® I was working with. Now I’m trying to manage things myself, and I’m still learning. I recently discovered solo 401(k)’s and Roth 401(k)’s, which seemed like a much better option than my SEP since I don’t have employees. I called my CPA to confirm I could contribute both SEP and SOLO 401(k) for 2021, and he said I could. After listening to podcast 344, I started trying to figure out how to do the Mega backdoor Roth (the Megatron), especially since you discuss taking advantage of the current QBI deduction. In my research, I discovered that my CPA might be incorrect and that I’m not able to have both a solo 401(k) and 5305 Sep.”

Al: I’ll chime in there. Your CPA was wrong. You cannot have a SEP IRA and a SOLO 401(k) in the same year. To do a SEP IRA, it has to be your only pension plan. So that one’s easy. So what else do we got?

Andi: “As a result of this discovery, I now have a ton of questions. If you could spitball some of this stuff I’m trying to figure out, it would make me so happy. I would like to do the Megatron backdoor Roth for 2021 if possible. If not, I’d like to for 2022. My account provider, ETrade, offers both Solo 401(k) and Roth 401(k). They changed their solo 401(k) plan in 2021 to offer non deductible employee contributions. I’ve already contributed $19,500 to the Roth 401(k) for 2021, which I believe is the employee side. Would I need some kind of TPA or other additional plan documents in order to Megatron on the solo side? My CPA said that since I’m self employed, that I don’t, but I’m not feeling confident that he knows what he’s doing. I set up the account in 2021, but didn’t submit their updated paperwork to take advantage of the after tax option until a couple of weeks ago. Would that be an issue? If I’m allowed to do it so it looks like those would be entirely employee contributions instead of employer?

Al: All right, we’ll stop there. There’s a lot there. I will say this. The rules used to be that you have to set up a Solo 401(k), safe harbor, regular 401(k) by December 31 of the tax year that you’re in. And with the Secure Act, it was changed slightly. You could actually now set up the 401(k) after the fact, actually all the way to the due date of the business returns, which would be October 15th if you’re a sole proprietor and you don’t have an entity. However, that’s only good for the employer contributions. The employee contributions require you to have set up the plan before or by December 31, and you have to basically elect that you can do deferrals, which is part of a normal plan anyway. So nothing special there. You’d be out of luck for a SOLO 401(k) with the employee portion, which would include the $19,500 that you can contribute as well as you wouldn’t be able to do the after tax money because that’s an employee contribution. So you couldn’t do that for 2021. You could make the employer contribution, which is 25% of your profits, which, by the way, is the same as the SEP IRA. So if it’s easier to just do the SEP IRA for 2021 because you’re going to get the same deduction either way, 25% of your profits, then that would be a way to go there. But she would want to set up the 401(k) for 2022 so you could do those employee contributions.

Kyle: It looks like she did do the contribution for 2021. I think she was more looking at the employer side. My thought is all these 401(k)’s are a little different unless you actually buy, build one out, and hire a TPA to do it. Etrade is probably going to be her best bet, potentially, because if they have the after tax component, I don’t know if the prototype allows for that, but most 401(k) plans don’t even allow a Roth anymore. She can do the Roth. That’s great.

Al: Yeah. If ETrade offers the Roth component as well as the after tax component.

Kyle: And she’s got the cash to do it.

Al: Then that’s a great way to go. And I guess maybe we should talk just briefly about the aftertax component. Mega backdoor Roth, or Megatron, is what we call it sometimes on the show. What is that, Kyle?

Kyle: Essentially, some 401(k) plans have 3 components to it. There’s the pre-tax portion where you’re able to defer income before you pay taxes on it. There’s a Roth component potentially, where you pay the taxes up front and you put the money in. But there’s a third option that not many people know about, and it’s after-tax or post-tax. Sometimes they call it different stuff, but essentially it’s excess employee contributions. And as long as those contributions do not exceed the IRS limit, those are monies that can go into the 401(k) plan. You don’t get a tax benefit for it today. But the good news is that a lot of times the plan will allow those after-tax contributions to be moved out of the plan into a Roth IRA. So it’s kind of like supercharging or Megalodon or all these fancy names.

Andi: Megalodon! That’s a new one.

Kyle: Fancy names.

Al: So it’s kind of like a way to do a giant Roth contribution, in a sense. But of course, your plan has to allow that. And so whether it allows it in plan or whether it allows an in service withdrawal, so you can send it to a Roth IRA, it would have to do that. All right, Andi, why don’t we continue?

Andi: She says, “do you think it would be smart to roll a solo into a Roth 401(k) or Roth IRA?
Is there any benefit for one over the other? If I did it over to a Roth IRA, would that help to avoid the 5500 form that needs to be filed once the account reaches $250,000?

Al: Well, the advantage of rolling to a Roth 401(k) or Roth IRA is that all future growth income principle is tax-free. You do pay tax on what you convert. That’s called a Roth conversion. I assume if you’re talking about the traditional 401(k). If you’re talking about the money that’s already in the 401(k), yes. If you could roll that out to Roth IRA and keep your total account below $250,000, you could potentially avoid the annual filing of the 5500. So that can work.

Andi: She continues, “I file a Schedule C, and my 1099 was $144,000 for 2021, and I have one rental property. If I had enough deductions for my Magi to reach $125,000, I was hoping to contribute $6,000 to a regular Roth IRA. I already did, since I thought I could contribute pre-tax dollars to my SEP account to help lower the MAGI (Modified Adjusted Gross Income). I may have made a mistake with my SEP account for 2019. I had opened an additional SEP account because I had a Vanguard managed account and I was trying to avoid paying more fees. Is it okay to have more than one SEP account for the same business? I can’t seem to find a clear answer online, and I may have opened a third account in 2021 because I didn’t enjoy the funding process with the second provider. Oops. If I did make a mistake, will I have to correct it on my 2019 and 2020 tax returns, or is that something that I could ignore and hope for the best?”

Al: I’ll try to tackle that one. There’s no limit on the number of SEP IRA accounts you have, and I guess if you funded more than one in a particular year, you’d have to aggregate them together. It could be no more than 25% of your profits. So, no, I don’t see a mistake here. Other than that’s a lot of paperwork.

Kyle: A lot of statements.

Al: To try to keep track of, but I think you’re okay.

Andi: Al, do you remember the question we got from somebody who had opened an IRA every time they wanted to make a contribution to their account? So they had 200 IRAs. That’s what this was starting to remind me of. A little different. She says, “I think I can still pull the money out that I contributed to 2021 to the Sep. Or could another option be to open a prototype SEP and roll everything into that? If not, going forward if I wanted to do a mix of pretax and after-tax contributions, E-Trade said that I can have more than one solo account with the same plan name and sequence number. If I need to pay for planned documents, do you think it would be worth the cost considering the mega might not be around much longer?”

Kyle: There’s a lot in that.

Al: I’m going to take it simply. If you’ve already contributed 2021 to the step, I would just keep that in there because the solo 401(k), that’s all you’re going to be able to do anyway, which is the 25% of profits, which is the same as the Sep. So I’d probably stick with the SEP for 2021. 2022, I would make sure you get the 401(k) in place so you can do those employee contributions as well. So you can get a lot more in.

Kyle: And the other thing with the Sep, too, is you can’t do Roth Sep. There’s no Roth Sep. If she wants to do pre tax or she wants to do a Roth 401(k) contribution, and then the employer side is going to be the deferred, she can do that.

Andi: And then I’ll just wrap it up, she says, “thanks for helping educate people like me that don’t know what we’re doing. It’s so nice to be able to receive knowledge on both investing and tax scenarios from one source. I love the banter between you all. It helps keep me laughing. I personally think Joe sounds more confident than arrogant.” We’ll make sure to convey that to him if he ever comes back. She says, “I don’t have any fur babies. I drive a 2015 Maserati Ghibli and enjoy drinking Moscow Mules with Tito’s Vodka.” That’s Heather in Irvine, California. Thank you, Heather.

Al: Yes, thank you. There’s a lot there, and hopefully we helped you out a bit.

Pension and Social Security Spitball Analysis (David)

Andi: David says, “Dear Joe, Al, and Andi, My wife will have a CalSTRS pension of approximately $3,000 a month. My Social Security at 67 is projected to be $2,900 and about $2,000 at $62. We have $1.5 million IRA and half a million in a brokerage account. Since she will be subject to the windfall elimination provision, she will not be able to claim much of a spousal benefit. I believe she can just get the minimum $200 and the rest is lost because of WEP. In looking at the long run, I think it would be better for me to claim Social Security at 62 rather than use the IRA/brokerage to live on, thus allowing the IRA/brokerage to grow as much as possible in case I die before she does. Because if I delay Social Security until 67 or even 70, the government pension offset will restrict her from getting much of a survivor or Social Security benefit. Am I looking at this correctly? Her pension and my Social Security at 62 would cover our living expenses easily. We have no debts. We live comfortably on $40,000 a year now. We both retired last year, me at 60, and her at 58. We are using the brokerage account to cover expenses while we wait to turn on pension and Social Security. We have a daily driver of a Lexus NX200 and a Ford F350 Dually for towing a fifth wheel. We drink Diet Coke, David.” Thank you, David. We don’t often get people who are just Diet Coke or milk drinkers, but it does happen occasionally.

Al: Sure it does. And I think that’s fantastic. So I guess the question really is referring to when David should take Social Security. There’s something called the windfall elimination provision and the government pension offset. Do you want to take a crack at what those are?

Kyle: Yeah, those are two different portions of Social Security where essentially people who do not pay into Social Security but have a pension. But if they have worked in a previous job where they did pay in the Social Security, they may have a benefit. But the idea is they don’t want you to double dip or they don’t want you getting Social Security and a pension in which you get more income. So with windfall elimination, you will actually reduce your Social Security benefit if you are eligible to take one. So I think the maximum is like $440 or something a month.
Whereas with government offset provision or GPO, that’s more around if you inherit a pension, like a survivor benefit or something and you are already receiving a pension again, you can’t double dip. So there’s a formula. I think it’s like two thirds of the benefit. If two thirds of Social Security is greater, the pension is greater. It’s some weird convoluted calculation.

Al: It’s very complicated how they compute it. I would say, at least from what I know it sounds like it’s an egregious provision, but it’s actually meant there to be fair so that people don’t double dip. And I think the way that they compute it actually does make a certain amount of sense. But the point is if you have a government pension and you have a job where you paid into Social Security, you’re not going to get all your Social Security benefit. So that’s the problem. And then if you pass away, your spouse, if he or she has the government pension, then that’s when the government pension offset comes in where as a survivor, you don’t receive the full benefit either. So I think the question is should you take it at 62 versus 67 or 70…without running a Social Security analysis, which I think will give you a more definitive answer, I think your thinking is correct, David, because the reason why you would wait to take the greater benefit is for you receiving a greater benefit and your spouse receiving a greater benefit. And it seems you’ll both be subject to these provisions where you wouldn’t receive that greater benefit. So maybe you think about taking it earlier. What do you think, Kyle?

Kyle: Yes, I think in a perfect world, everyone would love to delay it as long as they can. Sometimes that’s just not the reality. To kind of play Devil’s advocate, it might make sense for him to actually try and delay it because it sounds like if he’s got $2,000, he can take it at 62, he’s got… looks like $2 million liquid. He might be able to bridge the gap.

Al: He can bridge the gap, but he’s wondering whether he should. So maybe another way to think about it is if your spouse has a much longer life expectancy than you, then it probably doesn’t make sense to delay it. Take it earlier. However, if it’s reversed, if you believe you’re going to be receiving the benefit and your spouse isn’t, then you go back to the break even calculations of around age 80. Maybe think about it that way.

Kyle: I would agree with that.

Al: We have this thing called the Social Security Analyzer. I’m going to make this offer, Andi, for anyone listening that would like us to run their Social Security Analyzer. Email us, and you can tell them how, and we’ll run that for you at no cost.

Andi: The email address is info@purefinancial.com. Super easy to remember info@purefinancial.com for your Social Security Analyzer.

Al: To give you an idea – and I’m in the business, I had our planning Department run it for me. It’s just too complicated to try to think because there’s so many, it’s so complicated, depending upon the books you read or the people you listen to, there’s like 568 combinations of ways to take Social Security. And it’s like, how do you know which one to do? It’s very difficult.

Kyle: Yes. And then you start getting into the realm of sometimes you can even pay it back and pay back the benefit you got if you did it within a year. And sometimes people didn’t know. There’s all kinds of different weird, esoteric ways of claiming Social Security.

Al: And now the rules changed. I believe it was at the end of 2015 where we have these new deeming rules and the old restricted applications and file and suspend, you can’t do that anymore unless you were born before January 1st, 1954, I think. So there was grandfathering in. But anyway, it’s complicated. If you want, we will run that analysis for you at no charge. And what did you say, info@purefinancial.com?

Andi: Yes. You can email info@purefinancial.com, or you can also call (888) 994-6257.

How Much Should You Have in an Emergency Fund? (James, Detroit, MI)

Al: We’ve got James from Detroit, Michigan.

Andi: James says, “Hello click and Clack Brothers. Just kidding. Longtime listener and first time asking a question. For someone who is retired, currently 53, retired at age 48.” Congratulations, James. “With a predictable income, withdrawal from 72(t) and rental income, what is the ideal emergency cash reserve in months? The biggest risk for cash reserve is unemployment, and that is not a factor. I understand that there are other factors to consider. Medical, car and home repairs and other events. By the way, I drive a 2022 Subaru Outback Wilderness, traded a 2014 vehicle about a year ago. This resulted in $16 of monthly depreciation for the time that I own the car. What a strange world we live in. Keep up the great work. Best regards, James.” Thank you, James.

Al: Yeah. Thank you. Well, good for you. So you bought a car and it basically only costs you $16 a month. That’s pretty good.

Kyle: What a world.

Al: So your question is about emergency funds, and I would say my quick answer is anywhere between 3 months and 2 years, which isn’t very helpful. But there’s variables to consider in that. And I think part of it is the stability of your income and what your needs might be. For example, one extreme would be husband and wife are retired. They’ve got great government pensions that cover more than they would ever want to spend. You’re fine with 3 months. I’m fine with that. Then you got an independent contractor that works in the construction trade. Jobs are plentiful, then they’re not. They’re plentiful, then they’re not. You might need a year or 2 given potential recessions and housing booms and busts. So those are kind of a couple of different extremes. I think, James, in your case, you’re talking about a predictable income, but I might question that a little bit because your two sources of predictable income can be variable. So 72(t) election is based upon your IRA balance, which can fluctuate, and rental income that can fluctuate a lot depending on vacancies and repairs. Kyle, why don’t you start with the 72(t). What is that and how does that work?

Kyle: Essentially, 72(t) is a way for people who retire prior to 59.5 to get access to cash in their retirement account. And these can be set up a bunch of different ways. But essentially it’s either 5 years or the longer of 59.5. So it’s a way to get sort of fixed income. It’s not as simple as just allocating the cash with what you think you’re going to need over those 5, 6, 7 years. There’s a lot of formulas, actuarial tables that need to be going into it. But that money is invested. If he gets a bad market in that portfolio is not set up appropriately and he doesn’t have an emergency fund, the 72(t) might not work out.

Al: For those that want to retire before 59.5, of course, you have to pay taxes on the money you withdraw, but you don’t have to pay that early withdrawal penalty, which is 10% federal in California. I know you’re in Michigan. In California, there’s another 2.5% percent penalty on top of that. I’m not sure about Michigan. So the 72(t) basically gets you out of the penalty, which is totally cool. But if it’s invested and your accounts fluctuate, you could have more or less depending upon what the market is doing. And remember, we’ve just had an 11, 12 year Bull run. It’s a little bit volatile right now. What will the next 5-10 years do for you? Hard to say. Hard to say. We just don’t know. So that may not be as predictable as you would think. And then rental income, that can be all over the place. And I can say that from experience because I’ve had rentals since 1986. Rental property income is not necessarily stable. So, James, I’m going to just spitball here. Based upon what you told me, I would say you’re going to need a minimum of six months, maybe even a year. That would be my suggestion.

Kyle: Yeah. I think that’s that’s a good number.

Al: And you might even want to keep that in cash in the portfolio, again, just with emergency funds. I think you want it to be liquid, but you don’t want it necessarily easily accessible in the sense that you can just swipe it from a savings through a checking account. And I think the other thing is the 72(t) election. It’s not like you can just say, well, I need more money this month. It’s a fixed periodic payment. It’s not like you’re 59 and a half and you can take whatever you want. So it’s very inflexible. So with lower balances, it would be less.

Ramsey vs. Edelman vs YMYW: 15 or 30 Year Mortgage? Cash or Credit? (Daniel, Camp Lejeune, NC)

Andi: The next one is from Daniel, who is in Camp Lejeune, North Carolina. He says, “Dear Big Al and Joe, I love your show. I’m currently serving active duty in the USMC (United States Marine Corps). I live in the barracks on base. I was wondering what your thoughts were on a home mortgage. Dave Ramsey says to have a 15 year mortgage and pay it off sooner, whereas Ric Edelman says to have a 30 year mortgage to help save on your federal taxes and invest it. And also, what are your thoughts on having a credit score? Dave Ramsey says pay cash and Ric Edelman says to have a credit card. Love to hear back from you guys. Thank you.” Thank you, Daniel.

Al: Great question. And two very smart people, Dave Ramsey and Ric Edelman, have very different ideas on both of these concepts. Why don’t we start with the mortgage? Kyle, why don’t you take a crack at this?

Kyle: I think some of this is personal preference, too. But you go to a 15 year mortgage, the payments is going to be a little bit larger. It’s not going to leave you with as much excess cash, whereas if you have a 30 year mortgage, maybe the payment is going to be a little bit lower. You won’t get as good of a rate as the 15 year, but you might be a little bit more flush with cash. The challenge that we see sometimes is people don’t take the extra cash and invest it. They spend it.

Al: That’s exactly right. I think both approaches are good, to be honest. I did a 15 year mortgage because I was getting closer to retiring and I wanted the house to be paid off if I could. And that’s actually how it worked out. So that worked out pretty good. The thing about a 30 year mortgage is on paper, that’s generally going to work out better than a 15 year mortgage, because in a low interest rate environment, like, let’s say the interest rate is 3% right now. And if you look at a globally diversified portfolio over the long term, you could probably earn 6% or 7%, even 8%. So if you’re paying out 3% and making between 6% and 8%, you’re going to do better actually having a 30 year mortgage, which is exactly why Ric Edelman says that. The problem is, Kyle, what you just said, which is only a certain amount of people will actually save that money and invest it. Most of us tend to spend it. If there’s money in the checking account, we tend to spend it. And I would say even couples where one of the spouses is very frugal, if the other one is not probably the non frugal one, there’ll be a lot of debates and so forth. But when you do a 15 year mortgage, it’s a forced payment. It’s a forced reduction of principal. You’re going to save interest over the term. You’re going to lose that arbitrage. Arbitrage is the difference between what you’re paying and what you’re making. So both answers are fine. Both answers are good. Both answers are right depending upon how you want to look at it. I’ve always had a 30 year mortgage until the last one that I got. I got a 15 as I got close to retirement. That’s what I did. So that’s just personal preference. I like the 15 year mortgage. You get a slightly better interest rate and you get that thing paid off, you’re kind of forced to pay it off sooner. We have a lot of people that are retired and they have a 15 year, and they want to retire, but they can’t afford the payments. So believe it or not, we sometimes tell people that retire get a 30 year because if they’re house rich and cash poor, having a lower payment structure will actually help them to retire than a shorter pay off term. It just depends.

Kyle: Like you said, that the cash flow in retirement is really King. You want to make sure that you can manage the distributions out of whatever retirement accounts or liquidity that you have. And so making sure that that payment is affordable and it’s not going to burn through the portfolio in 15 years.

Al: And the other thing we see is like someone would retire, maybe they’ve got a mortgage of $100,000 and they have $100,000 in their savings account and they pay it off, and then they’ve got no extra cash if something goes wrong with like a house repair or medical bill or car repair or whatever. So that’s not a great idea either.

Kyle: Yeah. Sometimes sleeping at wealth feels good, but you also want to make sure financially you’ve got a little bit of liquidity there.

Al: Like you said, cash is King and important. So what about the second question? Dave Ramsey says pay everything in cash. Ric Edelman says have a credit card.

Kyle: Kind of different flavors here. You could even probably throw in a third pundit, too. Kiyosaki. Rich Dad, Poor Dad. He just wants to leverage the debt and use as much debt as possible, whereas you got Ramsey and both are successful. They both have different strategies and ideas. But I kind of like the middle ground there with Edelman and kind of like the sweet spot. Little bit of both.

Al: I would say the FICO score. And I like Dave Ramsey a lot. I think he’s very smart and very bright. I think FICO scores are very important, and I think it is good to have a credit card. Here’s what I would recommend, though, is use the credit card, maybe get mileage, but pay it off every single month. So that’s the key there. If you have a credit card and you’re not able to pay it off every month, then you’re probably better off going to a debit card and just having it withdrawn from your checking account. Once you’re done, you’re done. You can’t spend anymore. And if you look at Dave Ramsey’s, a lot of his listeners, they’re people that have had financial difficulties. And so he’s being real strong with them, saying don’t use the credit cards because so many people get into trouble with them. So again, it depends upon the person. It depends upon you, your ability to handle this appropriately. I like debit cards just because it forces you to use your own cash. But then you don’t necessarily build up the FICO score as well.

Kyle: The other thing, too, with debit cards versus credit cards is sometimes if you get fraudulent charges and you use the debit card, you’re kind of out of luck. The bank’s not going to give you the cash backward. You have a credit card. It’s traceable. You can dispute the charges. Every once in a while that comes up.

Al: Yeah, it does come up. And banks are different. Some banks reimburse and some may be a little bit less so.

Kyle: Maybe I’m talking from personal experience here.

Andi: I’m with you, Kyle. I’ve gone through the same thing.

Al: I guess those are our thoughts. I think it’s a good question. I think the mortgage is based upon your own personal preference. I kind of like the 15 year because it forces you to pay it off. But if you really can’t afford it or you’re close to retirement and you do a 15 year and then you don’t have enough resources to pay that payment, that wasn’t a great idea. So think about that. Credit card versus debit card or cash. Cash is actually the best way. A lot of places don’t even accept cash anymore. After COVID.

Kyle: It’s kind of funny. You want to keep a little bit of cash and you couldn’t use anything at the grocery store and no one would take it.

Al: I have very little cash in my wallet. I use my credit card, which I pay off every month, and I got a prescription and it was $0.38.

Andi: You had to put it on your credit card?

Al: I could have, but I don’t want change of $0.62. What am I going to do with it? Anyway, those are our thoughts. Daniel, good question. What do we got, Andi?

Comment: Social Security File & Suspend, Restricted Application (Shweta)

Andi: Our final one for today is actually a comment that we received about episode number 369 and so the comment is from Schweta, but she is commenting on Karen’s question. Karen had said, “originally I thought I was doing everything right, working to 70 and putting off Social Security until I was 70. I finally got there and applied on my 70th birthday. In reviewing my application, the Social Security reviewer realized that I was married for 30 years and divorced for over two, and turned 66 in March. I qualified for Spousal benefits starting March 2018 through when I take my larger benefits at age 70, I was told that they would only do a 6 month look back from my application dated November 2021. Don’t they owe me that money? If I hadn’t paid taxes for 4 years, they would still expect me to pay. Is there any way I can get that money? With all the rule changes in 2015, I got totally confused. Thanks for your help.” And so Al, do you want to summarize how you answered that question for Karen?

Al: Yes. The first part is when you file for benefits, you can get 6 months and that’s it. So there’s no way to go back any more than that. And that’s just the way it is. So sorry about that, Karen. That’s just the way it works. Joe and I spent a little bit of time talking about how this is a strategy that cannot be used anymore because it basically was abolished in 2015. However, there was some grandfathered rules for those that were aged 62 at that date. And what we didn’t remember off the top of our head was exactly what the date was and who qualified. So I think Schweta actually helped us out. So why don’t you read her response?

Andi: That’s where Schweta came in. She emailed me directly and she said, “hey, Andi. Karen writes in regarding missing out on her spousal benefits at her full retirement age of 66. Since she is now 70 and was born in 1952, she did get grandfathered into filing a restricted application. This provision did expire; however, it is still applicable to those born before January 1, 1954. “You can use a restricted application to claim a spousal benefit while letting your benefit continue to grow if you were born on or before January 1, 1954, and if you are currently married or you are divorced and eligible for a benefit on an ex spouse’s record.”” Thank you, Schweta, for filling us in on that.

Al: Yeah, that was helpful. Joe and I, of course, knew that we just didn’t have that at our fingertips at that particular moment. But so maybe to summarize, there used to be this thing called file and suspend and restricted application. You want to take a stab at that, Kyle?

Kyle: Yeah. Essentially, there used to be a cool strategy pre 2015 where one spouse would be able to claim on the other spouse’s benefit without the actual spouse taking their benefit.
So you’d be able to take it and let yours just continue to grow, and then eventually you could claim yours and get more money. It was a way to kind of get a little bit more out of the system.

Al: And I think to be able to do that, you had to be full retirement age and your spouse had to be collecting. Or if they weren’t collecting, they would have to file and suspend to basically get them into the system so that you could take the spousal benefit and let your benefit grow all the way to age 70. So it was a nice benefit that couples did. It was taken away at the end of 2015, but it was grandfathered in. So in this particular case, Karen at age 70, she was born in 1952. So if you were born December 31 of 1953, that was the last day that you could have been born and still do the strategy. So I guess the point is it’s still available.

Kyle: For very few people, I would imagine.

Al: Yeah, very few people. But it is still available if you were born prior to December 31 of 1953. So there’s a way to go ahead and take your spousal benefits and let your benefit grow. This will be basically gone in another couple of years. Schweta, thanks for bringing that to our attention with the exact dates. Nowadays, you still can take a spousal benefit, but you don’t necessarily want to. The way it works currently is there’s something called the deeming rule which means that if you’re taking a spousal benefit, it’s deemed that you’re taking your own benefit first. And then if the spousal benefit is greater then you’ll get that little extra. So you will get the spousal benefit amount. But it’s as if you’re already claiming. So in other words once you start claiming, you’re not delaying Social Security anymore and you’re going to have a lower amount for life. So anyway, just be aware of that. Social Security is a tricky thing.

Andi: Snd if you have more questions, definitely send them into us. Visit yourmoneyyourwealth.com and click Ask Joe and Big Al on air. At some point we may have to change that to Ask Kyle and Big Al on air and we will get those questions answered for you here on Your Money, Your Wealth®. So, Kyle, what did you think of your experience on the podcast?

Kyle: Hey, I think I did okay.

Andi: If you do say so yourself, pat yourself on the back.

Al: I think it was great to have you. I think that the proof will be in the pudding. We’ll see the response that we get. Kyle. It was fun doing it with you. It was actually fun to do it with someone other than Joe because then I could answer questions without worrying about getting my head chopped off. That was good. But anyway, so we’re going to wrap this up here now. But it was pleasure to have you. And Andi, of course, having you read questions definitely helped me a lot.

Andi: It’s a little different that way, isn’t it?

Al: I don’t particularly enjoy reading the questions and then answering. Joe seems to be okay with that. But anyway, appreciate everyone’s help here today and for all you out there, we’re going to call it good. You’ve listened to another episode of Your Money, Your Wealth®.

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