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Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 153 out of 715 RIA’s nationwide by total assets under management by [...]

Alan Clopine
ABOUT Alan

Alan Clopine is the CFO & Chairman of the Board of Pure Financial Advisors. He has been an executive leader of the Company for over a decade. As CFO he is responsible for the financial operations of the company as well as investor relations. Alan joined the firm in 2008, about one year after it [...]

Andi Last
ABOUT Andi

Andi Last brings nearly 30 years of broadcasting, media, and marketing experience to Pure Financial Advisors. She is the producer of the Your Money, Your Wealth® podcast and radio show, and moderator for the firm's digital events. Prior to joining Pure, Andi was Media Operations Manager for a San Diego-based financial services firm with a [...]

Published On
August 16, 2022

Setting up your saving and investing strategies when you’re in your 30s can put you on a good path to meeting your retirement goals. Joe and Big Al revisit their financial spitballing over the last couple of years specifically for savers and investors in their 30s and even 20s, some of whom want to retire early.

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Show Notes

  • (01:25) I’m 35. Where Should I Invest Long-Term Besides the S&P 500? (David, MO – from episode 324)
  • (05:28) I’m 27. Are My Investments Too Diversified? (Wyatt, Fargo, ND – from episode 352)
  • (14:47) I’m 24, Self-Employed, in VTSAX. Retirement Strategies? The Solo 401(k) & Roth (Preston, AL – from episode 355)
  • (18:35) I’m 31, Retiring Early at 57. Should I Save to Roth 401(k) or Pre-Tax? (Jayme, Pinehurst, NC – from episode 384)
  • (23:53) I’m 32. Did I Make a Backdoor Roth Mistake? + Roth IRA vs Roth 401(k) (Mike – from episode 293)
  • (28:15) I’m 30, Keeping Income Low for the Earned Income Tax Credit. Should I Contribute to Roth? (Nick, Omaha, NE – from episode 304)
  • (34:38) I’m 37 and Want to Retire Early at 45. Will Taxes Destroy Us? (Andre, Bavaria, Germany – from episode 365)

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Transcription

Help us make Your Money, Your Wealth your top retirement podcast. Answer 17 questions in the 5th annual YMYW Podcast Survey and you’ll be in the running to win a $100 Amazon e-gift card! Click the link in the description of today’s episode in your podcast app to go to the show notes and access the survey and the secret password. US residents only, no purchase necessary, survey and giveaway close and winner chosen at 4pm Pacific time on August 31st, 2022. 

Setting up your saving and investing strategies when you’re in your 30s puts you on a good path to meeting your retirement goals. Today on Your Money, Your Wealth® podcast 391, we’re revisiting Joe and Big Al’s spitballing over the last couple years, specifically for YMYW listeners in their 30s, and even 20s, some of whom want to retire early. Though the market has been rollercoastery in the last few months, the fellas’ general suggestions remain the same, because if you’re a regular YMYW listener, you know that the financial plan you create today should be able to stand up to market uncertainty. If you’d like a retirement spitball of your own, or to send in your money questions or comments, visit YourMoneyYourWealth.com and click Ask Joe & Al On Air. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

I’m 35. Where Should I Invest Long-Term Besides the S&P 500? (David, MO)

Joe: David from Missouri writes in, “Yo Joe, Andi, and Al. Little recap here from David. He’s married; gross income of $300,000; maxing out both 401(k)s, $19,500 each; maxing out the backdoor Roth, $6000 each; has two rental properties in Missouri; and he’s also maxing out an HSA health plan, $7100. He’s also got two cats. But I’m sure Andi has already found them on Google. You kind of spying on David from Missouri?

Andi: That’s what you’ve got him thinking.

Joe: I guarantee you probably know what his cats’ names are because it’s right here. It’s Knight and Wade.  Do you still hack Facebook accounts, Andi?

Andi: I do not. I gave that up a long time ago.

Joe: Really?

Andi: Yeah. It just doesn’t pay as well.

Joe: “I’m sure you noticed, but I didn’t list the impressive Kia Optima Hybrid, it’s because it’s gone. Joining the big boys in the non-qual zone with a brand new Tesla.” Wow.

Al: Model S, that’s the good one.

Joe: What’s he got a Model S for? Back to “joining the big boys in the non-qual zone.” What’s a non-qual zone? What the hell is this all about, Al?

Al: Not sure.

Joe: “Al mentioned that some markets aren’t high like the S&P 500 is reported right now. I’m purchasing mutual funds in my brokerage account and have only been targeting S&P funds. Are there other sectors or areas I should be investing in if I want to let them sit for the long-term, 20 or 30 years? Which areas should I be investing in or what are low right now? You’re all great. I look forward to the show each week.” Thank you. He wants us to expand two times a week there Al.

Al: Yeah, I gather that. So I guess since he’s commenting on my comment, I will answer. First of all, I’m really not a market timer, so I’m not the best person to ask what’s low, what’s high, the price-to-earnings ratios, the keep ratios, all that. I’m a long-term investor. I’ll put it that way. So I like to invest in a globally diversified portfolio. And so S&P 500 is a great asset class, but there’s others, too, like small companies in the US and value companies in the US, mid-sized companies. S&P tends to be more large growth. There could be some large value in there, too, but larger companies. I like international as well because they tend to go up and zig and zag at different times than the domestic market. I like emerging markets because-

Joe: You like everything. It’s like you’re-

Al: Oh, pile it on man. Pile it on.

Joe: – like you’re in an ice cream shop. Oh, I like chocolate. I like strawberry.

Al: But I will say – so going back to my original comment. The S&P 500 has done rather well the last several years and certain other asset classes have not done as well, like small companies, value companies. Now in the last 6 to 9 months, that’s turned around a little bit. We’ve actually seen some improvement in those segments. I wouldn’t look at it in terms of trying to get the cheapest buy. What’s on sale right now? I would look at getting a diversified portfolio and then let it ride for 20, 30 years, rebalance as appropriate, and just enjoy the ride.

Joe: Sure. David, targeting S&P, that’s fine. You got 20 or 30 years. You’ve got to think longer term, in a sense, is that you buy high today. Do you think it’s still going to be high for 20 or 30 years from now? It doesn’t matter what the price is today.

Al: It doesn’t really matter. And like I said, that’s one asset class. There’s lots of good ones.

Joe: There’s all sorts of good ones. And there’s bad ones.

Al: I named a few.

Joe: Good ones. You have a good asset class? I don’t know if they’re good or bad. They’re asset classes.

I’m 27. Are My Investments Too Diversified? (Wyatt, Fargo, ND)

Joe: We got Wyatt, writes in from North Dakota.

Al: I like the name Wyatt.

Joe: Wyatt Earp.

Al: Yeah.

Joe: I wonder how many times he hears that.

Al: Daily.

Joe: “Hi, Andi, Big Al and Joe. I’m a big fan of your podcast and look forward to new episodes each week. I’m a longtime listener, first-time caller. I have a question that I haven’t heard covered in your previous shows. Is there a point where you become too diversified in your portfolio?” So over diversification Wyatt’s worried about. “Twenty seven years old from the frozen tundra up in Fargo, North Dakota.” My brother-in-law is from Fargo, North Dakota.

Al: Oh, really? Wow. OK.

Joe: Our new hire, Dominic, is from Fargo.

Al: Yeah, there you go.

Joe: Just keep it in the Midwest. “I drive a 2004 Chevy Silverado and prefer bourbon and an old fashion, but can never turn down a cold Busch latte. My question revolves around being too diversified in my portfolios while I’m still at a younger age. I feel like I’m going against the adage of concentration creates wealth, diversification preserves it. My portfolio breakdown is as follows: my allocation is 100% in equities. You can disclose these amounts on your show, if you want.”

OK. He’s got a 401(k) of about $50,000, and he has an S&P 500 2060 target date fund, large cap growth fund, small cap index fund, total international fund. He’s got a Roth IRA. Same thing. Large cap, got a couple of bucks in individual stocks and small cap, then large cap international. Then he’s got a bridge account, non-qualified brokerage. It’s called a bridge account, I guess.

Al: Yeah.

Joe: So again, he’s fully diversified.

Al: He’s got probably eight positions on a $4,500 account. That might be a bit much.

Joe: It could be.

Al: To try to keep track of all that.

Joe: And then he’s got another brokerage account and he’s got a couple of funds there. “I know there’s a lot of information within this question, but would really appreciate your thoughts on this topic. Looking forward to future episodes, as always. All the best, Wyatt from Fargo.” Cool. Thanks Wyatt. OK, over diversification, so he does have a point. The best investment in the world is in individual stock.

Andi: I thought it was an investment you make in yourself?

Joe: It could be that too.

Al: That too. But besides that. The best investment you could ever make is in an individual stock, IF you pick the right stock. That’s the hard part, because that’s concentration.

Joe: Or, an investment you make in yourself and you build a very successful business, and then you sell it.

Al: Yeah, that works, too.

Joe: But those are highly concentrated.

Al: Yeah. And in many cases, that fails because you are concentrated. But see, that’s the thing about concentration of your assets. If they do well, you make a lot. Or, you could lose it all. It just depends if you pick the right one.

Joe: Do I feel that Wyatt is overly diversified? I think overly diversified is probably not the right answer, but I think it’s too over the top.

Al: Too many funds.

Joe: A lot of funds. There’s a lot of overlap here. It’s not over diversified, there’s overlap.

Al: I think the idea of 100% allocation towards equities at age 27, I’m all for that. As long as you understand it’s going to go down, it’s going to go up. But over the long term, you’re going to do better having all stocks. So I like that. I think, Wyatt, you have more different funds than you need. But the fact that you’re hitting on all the major asset classes, as long as these are low cost index type funds or ETFs, you’re on the right track. And here’s how I think about concentration, instead of trying to pick the next Google, which is almost impossible. Concentration happens when you buy a property, or when you start a business, or you’re working in a successful business and you get stock options. To me, that’s where concentration really works well. To try to find the next gold mine stock is almost impossible.

Andi: Isn’t this also where asset location would come in? He’s kind of equally diversified across both his 401(k) and his Roth IRA and his brokerage, wouldn’t it make more sense to have his more volatile assets in the Roth IRA?

Joe: It could, but he’s 27. So as you get older and you need the money from the portfolio, then that’s when we would probably look at asset location a little bit. But he’s 100% stocks. So there’s more bonds in the portfolio than you would probably look at that, but you’re right, Andi. If this was me, I would have three funds. I would have a total U.S. stock market fund. I would have a total international stock market fund. And I would have a small cap value fund, if I wanted to stay 100% equity.

Al: Yeah, and I might add a fourth one. Emerging market. Just a little bit. And then if I didn’t want to be 100% equities, then I might have 10% bonds or 20% or whatever, just to try to temper the downturns.

Joe: Because you’re overlap city here. Because you’ve got the S&P 500 index fund and then you’ve got a large cap growth fund. If you look at the large cap growth fund and you look at the S&P 500 index fund, I would imagine most of the stocks that are in the large cap growth fund are in the S&P 500.

Al: It’s almost the same. Now, there is a target date fund, which actually will have some fixed income. Not very much, but some.

Joe: But the target date funds, you should only use one fund. If you have a target date fund, that’s the fund. You picked that, you don’t select any other fund.

Al: It’s not a diversification, is what you’re saying.

Joe: The fund is diversified itself.

Al: Agreed. So, I would get rid of that one. But you could do this in three or four or five different funds and call it good.

Joe: Going back to the target date fund, people will go like, “hey, I got a 2060 fund, I got a 2040 fund and I have 2070 fund, I’m diversified.” No, it’s not a diversification.

Al: That means you’re retiring 3 times.

Joe: Don’t you just want to retire once?

Al: I might retire in 2025, it might be 2035, it might be 2045.

Joe: No, it’s not diverse. If you want to retire in 2060, and you want to use a target date fund, then 100% of your assets go into the 2060 target date fund.

Al: Yeah. The way I think of target date funds is that’s what you do when you don’t know what you’re doing. You just pick, I want to retire in 2060, boom, I put all my assets in there. Someone else figures it out.

Joe: Yeah, and they work fine. But where they don’t work out great is when you start needing to create income from the portfolio. Because you might want to sell certain funds that are up or down, tax loss, harvest, manage it and things…

Al: Especially if you have money outside of retirement accounts.

Joe: Right. But, I think for our friend Wyatt, there’s nothing truly wrong with what you’re doing, it’s just a ton of overlap and it’s kind of overkill. Especially this bridge account. I don’t know what a bridge account is. I know it’s a non-qualified brokerage account, but it sounds almost like an emergency fund. That should be cash or money market. You shouldn’t have individual stocks in a bridge account. What would you call it?

Al: A bridge account? Well, like I said, there’s like eight positions in this $4,500 account. So that means each position is $200-$300.

Joe: Yeah, he’s got individual stocks, too at 12%. So I don’t know how many stocks he’s got, what’s 12% of $4,000? You might have some penny stocks.

Al: Maybe. Maybe that’s his concentration, that one of those might hit.

Joe: Hopefully, that helps. But thanks for your email.

Decisions you make today will affect your financial security for years to come, so make sure you’re on the right track. Crack the Financial Code at Any Age with strategies and actions to take now that will help you overcome any previous missteps and set you up for a more successful retirement. This is the companion guide to the YMYW TV episode on the same topic, and both are waiting for you in the podcast show notes at YourMoneyYourWealth.com. Just click the link in the description of today’s episode in your podcast app to get there. Spread the love and share the knowledge! Click the share button in the show notes and send the YMYW podcast and free financial resources to your friends, family and colleagues!

I’m 24, Self-Employed, in VTSAX. Retirement Strategies? The Solo 401(k) & Roth (Preston, AL – from episode 355

Joe: We got Preston from Alabama. He writes in, “I’m currently 24 years old, I’m getting married in June and my fiancee is 22. We’re in the process of setting up retirement accounts. We are self-employed, so we’re setting up our own accounts. My plan as of now, is to open up two separate Roth IRAs with plans to max them out every single year. Along with that, I want to have one or two accounts that offer a tax benefit. I just finished reading A Simple Path to Wealth. I’ve done my research in considering opening up a Vanguard account and contributing to the VTSAX with a percentage of my salary each month. I was curious to know what else I should be doing and how to set up for the most successful moving forward? I appreciate the advice you can offer.” How to set up for the most successful…

Al: For the most successful retirement savings plan?

Joe: Most successful life? Most successful marriage moving forward?

Al: Well, first of all, VTSAX is the Vanguard Total Stock Market Fund.

Joe: We did a show on that one.

Al: In fact, I recommended that fund to both of my kids.

Joe: Really? I own that fund. OK, Preston, 22 years old here. You’re self-employed. So it’s kind of funny, “well, I’m self-employed, so I’m setting up my own account. I’m going to set up a Roth IRA.” Well, if you’re self-employed, you can do something a little bit different.

Al: You can. You might want to set up a self-employed Solo 401(k), then you can put more in if you have years where there’s more profit than just the $6,000 for the Roth.

Joe: So you and your wife are both self-employed, so I would set up a Solo 401(k) for you and your wife. I would make sure that the Solo 401(k) has a Roth provision in it, so you could put up to $19,500 for both of you because you’re under 50, you’re 22 and 24, and you can put those in your own qualified plan. Unless you have multiple employees. But I’m guessing you don’t because you said you work on your own, you’re going to do this on your own.

Al: Yeah, that’s what I’m assuming, too. And if $6,000 is your number, then that’s what you can put into the Solo 401(k), but it just gives you the flexibility to put a lot more, and we completely agree it should be a Roth IRA. The principal reasons for that is you think about decades and decades of tax free growth, what that’s going to be worth later on. And secondly, thinking about if you’re 24 and 22 years of age, likely your income will go up, so you’re in a low bracket right now, which is the best time, absolutely, to take advantage of the Roth.

Joe: Yeah, without question. And then you can set up a brokerage account. What we like to look at is tax diversification. As your self-employment income increases, then you might go with the pre-tax component of your 401(k) plan. Or you might just stick with a Roth. You could do a Roth 401(k), and then you can also do a Roth IRA. So you can double dip here a little bit. You can really maximize the amount of money that you’re putting in tax free. If you want to save more than that, then we would recommend going into a brokerage account because there you’re going to be taxed at capital gains rates. So I think you’re doing a good job. You’re doing your research, you’re reading books, calling this stupid show. Yeah, I like it. Thanks, Preston. Good luck.

I’m 31, Retiring Early at 57. Should I Save to Roth 401(k) or Pre-Tax? (Jayme, Pinehurst, NC)

Joe: All right, we got Jayme from Pinehurst, North Carolina. “Hello, Andi, Joe, and Big Al. Enjoy the podcast. Good banter while on the road for Big Brown.”

Al: UPS.

Joe: Yeah, Big Brown. “I drive a 2014 Honda Accord and enjoy a few cold Modelos while hitting the links on the weekends.”

Andi: Drinking my beer and playing your sport.

Joe: Yeah, I could throw down a couple of Modelos. Hit the links. “I’m 31 yo. Wife is 29 yo. We both make around $100,000, $120,000 a year. As of last year, we maxed out the 401(k) pre-tax and Roth IRAs with extra money going into brokerage accounts. If I’m planning on retiring with Big Brown and receive a pension at 47, just about $4000 a month, should I be doing more Roth in my 401(k) or pre-tax, bring down the adjusted gross income with a baby girl that’s one year old? Only debt is 20-year mortgage, $198,000 with 18 years left at 2.65%. 401(k) is already 50/50 Roth and pre-tax. Roth IRA is $40,000. Brokerage is $60,000. Love the pod. Got a lot of guys tuning in every Tuesday.”

Al: All right.

Joe: Boom.

Al: Glad to hear it.

Andi: Excellent. Thank you, Jayme. Thank you for sharing the podcast.
Just like I say every week.

Joe: Big Brown. Okay.

Andi: And by the way, Jayme’s pension was going to be at 57, not 47.

Joe: Oh, 57. All right. So what’s the question? More Roth? What do you think?

Al: So he wants to- should he be doing more Roth in his 401(k) or pre-tax to bring down the adjusted gross income? That’s a pretty easy one. More Roth.

Joe: Yep. I mean, he’s young, 31, 29.

Al: Here’s the reason why, Jayme. It’s because your young, your salary will probably go up over time. Tax rates, tax brackets right now are kind- are near all-time lows, and you’re probably going to be making more money as you go. So get as much in a Roth now. When you’re making higher salaries-

Joe: They’re making $200,000. So it’s not chump change here, Big Al. I know you got a big wallet.

Al: Okay, let me explain-

Joe: – driving the Big Brown. Maybe someday, someday you’ll start making some real money like I do.

Al: I can’t sit on that wall for 8 hours a day. No, let me explain. Man oh man. I don’t care if you’re making $200,000 or whatever. So $200,000 for a married couple-

Joe: You’re in the 24% tax bracket.

Al: Which is a pretty good bracket. And I’m just guesstimating that the salaries for both of them-

Joe: – will probably go up over time.

Al: Not only will the salaries go up, but the tax rates are going up. So I’m thinking now is a great time to do Roth, especially because the market’s down. So you want to get as much in as you can, make your investments and have that growth on the rebound.

Joe: I agree with that 100%. Another thing, Jayme, is this. You’re not going to remember the tax deduction. You just won’t. You know what I mean? It’s like you’re going to save a few bucks a month from your paycheck if you went pre-tax versus Roth, right? So you’re going to have a little bit less take home. But once you do it, after a couple of weeks, you’re going to get used to spending your take-home.
And then 20, 30 years, 15 years, whenever you want to retire, you’re going to have a giant pot of money that’s tax-free. You know what I mean? You’re going to be like, damn, I’m so glad that I wrote in.

Al: Now, on the other hand, if you find out with the new baby girl, it’s a little more expensive than you thought, like, you can only afford one diaper a week, and you need more than that. Then you kind of switch over a little bit.

Joe: Yeah. But you’re going to have a pension. You will have Social Security. You’re going to have a lot of some good fixed income that will already be a floor that could be a fairly decent rate. So then every additional dollar that you’re going to be pulling out of your 401(k)s and IRAs and everything else is going to be taxed at ordinary income. If you start now with Roth to get the compounding effects of tax-free dollars at 30 years old over the next 20, 25 years, it’s going to be significant. And all of that is exempt from tax.

Al: Yeah. And one other key point, I think is, if you’re getting a pension of $4000 a month, and I don’t know what that will be when you’re 57, it’s going to be higher. But just right now, that’s about $50,000 a year. You multiply that by 25, that’s equivalent to having an IRA of a $1,250,000, because that would be a 4% distribution rate. So you’re already going to have $1,200,000ish. Right. I mean, equivalent in a pension plan. So you kind of want to get as much in the Roth as you can.

Joe: Right. To say it another way, for those of us that don’t have a pension, I need to save at least $1,200,000, $1,200,000 saved to create the income that your pension is going to give.

Al: Yes. That’s a good way to say it.

Joe: So if you think about what that pension is really worth, it’s million, right. It’s $1,000,000.

Al: $1,000,000+. Right.

Joe: All right, thanks for the call, and let’s hit the links. I would love to play Pinehurst.

I’m 32. Did I Make a Backdoor Roth Mistake? + Roth IRA vs Roth 401(k) (Mike)

Joe: Go to YourMoneyYourWealth.com if you’ve got a question like Mike did from Washington D.C. “Hi there. I’m 32 years old, paid off all my student loans, around $80,000 to $90,000, and have just over $300,000 in overall liquid and retirement savings.” Killin’ the game. Mike, 32 Al, he’s saved $300,000 and paid off another $100,000, That’s $400,000.

Al: Yeah. That is amazing Mike.

Joe: That’s what happens when you listen to Your Money, Your Wealth®. I mean stuff like that just happens to people. “I’m contributing about 13% to 14% of my 401(k), Roth 401(k) through work, I have a Roth IRA account. In the last few years, I’ve contributed the maximum amount of $6000. But when I put the information doing my taxes they ask me to withdraw that amount because I made over the limit of $183,000 dollars. I am making this contribution through a Backdoor conversion. So I thought I was doing this correctly. What am I doing wrong? What steps do I need to do for this to work? Also, do you recommend not contributing to a Roth IRA and just my total percent of the 401(k)? Any help would be greatly appreciated.” So Mike makes over $183,000. So he’s 32, so- but he’s doing a Backdoor Roth IRA. So he’s doing a non-deductible IRA then converting it. And he’s probably using Turbo Tax. So we kind of answered this question a little bit earlier. I think he’s doing everything correct but he needs the file the dreaded 8606 form and figure out how to do it on his taxes appropriately.

Al: Yeah. Or just contribute to your Roth 401(k). Much simpler. You get the same impact. That’s what I would do.

Joe:  It makes no difference- here’s the difference between a Roth IRA and a Roth 401(k). A Roth 401(k), the biggest difference is that if you have to take a required distribution at age 72 out of a Roth IRA 401(k). Mike is 32. It makes no difference. He’s gonna move the money out of that plan and put it into a Roth IRA to avoid that anyway. If he likes the investments inside his 401(k) then by all means do the Roth 401(k). Right?

Al: Yeah, no makes sense. It’s just it’s simpler. It’s simple- if you have extra money though if you’re not maxing out. Let’s say you are maxing out and you still want to put more money into the Roth then go for it. But if your income- I think the limits this year are what, $193,000 to $203,000, something like that, I believe for the phase-out, give or take. If you’re income is above that, you’ve got to do Backdoor Roth, which means that you shouldn’t have any other IRAs. If you do, it blows this whole thing up. But assuming you have no other IRAs, you can continue to do the Backdoor Roth at any income level. So that would be a way to do that over and above your 401(k).

Joe: It sounds to me then he’s got everything in a Roth 401(k), then he’s got the Roth IRA account, doesn’t have any other IRAs. You make the $6000 a non-deductible IRA contribution, you convert it directly into the Roth IRA.

What’s blowing him up is just how it’s reported on his taxes and sounds like he might be doing his taxes on his own. You just have to file the 8606 form which we talked about a little bit earlier. But you’re doing everything okay Mike. Congratulations actually. You’re doing a phenomenal job.
Spitballing your financial future is one great, especially if you get started early. But if you can get a one-on-one, personalized deep dive into your entire money situation, from an experienced financial professional on Joe and Big Al’s team at Pure Financial Advisors, and it doesn’t obligate you to anything, and it’s FREE, why wouldn’t you? What works best for you and your family is entirely dependent on your time horizon, your current circumstances, your risk tolerance, and your goals, and those are all unique to you. Find out exactly what strategies are going to help you pay less tax and make the most of your investment portfolio for your future – go to YourMoneyYourWealth.com and click Get an Assessment now.

I’m 30, Keeping Income Low for the Earned Income Tax Credit. Should I Contribute to Roth? (Nick, Omaha, NE)

Joe: We have Nick from Omaha, Nebraska writes in. “Currently utilizing my employer’s pre-tax 401(k), 457, HSA plans to control my AGI each year. I contribute as much as necessary to keep my adjusted gross income at or around $25,000 to get the maxed tax credit and refundable child tax credits. Being married with 3 children this scenario gives me no tax liability and actually gives me effective tax rate of negative.” How in the world is Nick living? He’s got 3 kids.

Al: Right and he’s got his taxable income, or AGI below $25,000, which means his taxable income is zero.

Joe: It’s negative.

Al: Yeah.

Andi: Negative 43%.

Al: He must have other money he’s living off of I’m guessing.

Joe: He’s got a little trust- a little trust fund? Ohhhh.

Al: That’s what it would seem like. Yep. Something happened somewhere.

Joe: Yeah we’re not judging. Well maybe a little bit. When we hang up we’ll be like ‘Nick, that lucky-”

Al: Lucky Nick. Good for you Nick.

Joe: “This seems to be the best scenario as it gives me a guaranteed return. However I’m wondering if I should be utilizing my employer’s 401(k) 457 Roth option as well, while I’m in such a low tax bracket. Any help would be greatly appreciated. Context, I’m 30 years old, wife’s 28, married with 3 children. No debt, paid for house and have been contributing to Roth IRA separate from our employer plans for both the wife and I over the years, as well as a taxable account. Love your show, mainly Andi.”

Andi: I know it looks like I added that but honestly Nick did actually include that.

Al: 30, 28, house paid off.

Joe: Yeah.

Al: That’s pretty good.

Joe: Yeah. 30 years old, wife’s 28. You got a paid-off house. I got millions in the bank.

Al: Got lots in the bank.

Joe: I make $25,000-

Al: I’m gaming the system so I get the credit.

Joe: I love it. I love Nick. He’s killing the game.

Al: So he’s- when he’s talking about tax credit, he’s talking about the earned income tax credit which, when you have kids and your income is low enough you actually get a refundable credit. So that’s how he can get a credit of over $10,000 by making zero.

Joe: So he calculated that is that he’s getting a 43% rate of return.

Al: Yeah that’s right. Guaranteed Rate of Return.

Joe: So what does he do? He’s thinking about should I be utilizing the Roth option? So I guess Al, talk to me about the Earned Income Tax Credit. If he then- do you know the thresholds of that tax credit off the top of your head? Al: No, not off the top of my head. But since he brought up $25,000, let’s just use that. So in other words-

Joe: Is it a dollar for dollar or let’s say if I make $26,000- is it pro-rata? Does it kind of-?

Al: Yeah. It’s a pro-rata thing. But if your income is low enough and if you have children all of a sudden some really cool things happen to your tax return. You get- it’s basically like you had additional withholding that you didn’t really have. And so the government pays you. It’s called a refundable credit. It’s the best kind of credit there is. And as one very smart tax advisor who I went to a seminar years ago he said ‘refundable credit equals fraud’. Because when there’s a refundable credit people have a tendency to make up numbers on the return to get free money.

Joe: Got it.

Al: I’m not saying Nick is committing fraud.

Joe: Oh absolutely not.

Al: No. But people do that.

Joe: Sure. Because he’s gonna 401(k), 457 plan that he’s maxing out. So he’s sheltering probably $40,000 a year-

Al: So we can only assume he’s got other money to live off of. And so-

Joe: But he lives in Omaha, Nebraska. I don’t know. $25,000. No mortgage. Three kids.

Al: I’m sure he lives pretty tight.

Joe: Cheerios.

Al: They don’t have shoes.

Joe: Oh, they got boots. They’re probably Sorels. It’s cold there. So would you give up the tax credits to build more tax-free money? I guess is the question.

Al: No. I mean he’s in a sweet position. If you start putting more of your money into the Roth you’re gonna be over that earned income tax credit-

Joe: He’s gonna lose it.

Al: – and your effective rate in the Roth conversion will be like 100% or more.

Joe: So let’s say Nick is saving hypothetically $45,000 into a retirement account. And then so he’s got another $25,000 of income. But then he’s getting an additional $10,000 of income from the government as a refundable credit. So essentially he’s getting another match from the IRS of $10,000. I would take that milk train as long as you can get it.

Al: Yeah. It’s not necessarily what the credit was designed for. But nevertheless, he’s arranged his affairs in such a way to take advantage of it. So there you go. No, I wouldn’t add any more income Nick, you got a sweet deal. Keep that going as long as you can. Eventually, probably your income will be high enough where you can’t pull this off anymore. And then at that point is when I would start doing Roth contributions.

Joe: But we’ve seen people then have millions and millions that with the whole Affordable Care Act-

Al: Yes. We have. Exactly.

Joe: That’ll screw up my subsidies.

Al: I’m not doing a Roth conversion.

Joe: Oh my God, it just-

Al: I remember one person in particular several years ago. This was probably someone that had $3,000,000 or $4,000,000 and they were trying to keep their income below whatever, $35,000, whatever it was to get the full Obamacare Affordable Care Act credit. And you kind of blew up at him. And said ‘dude, this is not what this is for.

Joe: I mean he’s tripping over dollars to pick up pennies. Yeah I kind of lost my-

Al: Yeah.

Joe: We got to lead people to show them the right way to handle their money. And so he wanted to keep a couple of bucks in this Affordable Care- I don’t know.

Al: And he had- he had a lot of money in his 401(k).

Joe: Right. And I was like ‘dude, you’re gonna blow yourself up. I don’t care.’

Al: Trying to save this little credit you get.

Joe: Right. So that just kind of tells us personality.

Al: Anyway, that earned income credit if you can qualify for it, is actually pretty generous.

I’m 37 and Want to Retire Early at 45. Will Taxes Destroy Us? (Andre, Bavaria, Germany)

Joe: We got Andre from Bavaria, Germany.

Andi: You said it right. Well done.

Joe: Bavaria. Have you ever been?

Al: Not to Bavaria, but I’ve been to Germany. I’ve been to Munich.

Joe: What did you do there?

Al: Go to Hofbrau Haus, drink some beer.

Joe: What, a hopper house?

Al: Hofbrau Haus.

Joe: Half browe.

Al: Hofbrau. That’s like their famous beer garden. There’s others, too.

Joe: What’s that celebration?

Andi and Al: OktoberFest.

Al: I was not there during Oktoberfest, but yes, they would do a big one there.

Joe: Got it. “I’m 37 now and will be able to retire from my current job, U.S. Army, at 45 with $70,000 pre-tax retirement income. My wife and I invest $80,000 a year and are on track to have $2 million in our brokerage account by the time I retire.” Thank you for your service, first of all. What is he? He’s 37. He’s going to retire at 45 and he’s going to have $2 million.

Al: Good job.

Joe: Guys legit. “We also have a rental property worth $700,000 that we’re breaking even on, rent wise. I still plan on working after retirement number one, but want to have your “opinion to do” otherwise?” Using the 4% rule, I can take out $80,000 from my brokerage account annually without depleting my portfolio, resulting in $150,000 annual passive income. My wife will likely still work, making about $100,000 a year. How destroyed will we get on taxes if we decide not to work? Let’s take it a step further. What if we pay off a rental property and add $50,000 in annual income from rent? Thanks.” There’s stuff to unpack here.

Al: Yeah, there’s plenty.

Joe: First of all, congratulations Andre from Bavaria, Germany. I don’t think he’s from Bavaria, Germany, if he’s stationed there. He’s in the U.S. Army, saving a ton of money. He’s 37 and wants to retire at 45. This guy is jamming as much money as possible into his brokerage account. He thinks he’s going to have $2 million in a brokerage account. In a brokerage account, you’re subject to capital gains tax which is 0%, it could be 15%. It could be 20%, really, depending on your taxable income and what tax bracket that you’re in. He’s got a rental property. Not sure what the debt is on that, but he’s breaking even on it. If he pays off the debt, then he gets another $50,000 of income. His wife is making $100,000. He’s thinking, I’m going to take 4% out of $2 million is $80,000. Then he’s got another $80,000 brokerage account without depleting my property, resulting in a $150,000 annual passive income.

Al: Yes, I think that’s $70,000 pension plus the $80,000 pulling from the brokerage. I think that’s where he gets $150,000.

Joe: Got it. Okay. Then if the wife still works.

Al: She’ll make another $100,000. Then they would make $250,000 per his math.

Joe: He’s like, how destroyed will we get on taxes if I decide not to work?

Al: If you work, it’ll be worse. I’ll put it that way. If you’re just simply looking at taxes.

Joe: I don’t think he’s going to get destroyed in taxes at all.

Al: I don’t, either. I think he’s a little mixed up. So the $70,000 of pension, Yes, that’s ordinary income.

Joe: Part of that’s going to be a VA pension and that’s tax free.

Al: That’s true, it too could be.

Joe: Have you ever seen someone that has a pension in the military that doesn’t have a portion of that tax rate?

Al: It’s very common.

Joe: Right? Hey I was injured.

Al: Very common. Yup. The $80,000 a year, which is 4% of $2 million, that’s what you’re thinking of pulling out. That’s pulling it out of your brokerage account. You’ve got a tax basis. Let’s say $1 million is what you originally invested and it grew to $2 million. When you pull it out, just being a simple example, then you pull out $80,000.Only $40,000 is taxable. Given that very simple example and that’s capital gains rate. Not the whole $150,000 is going to be taxable. If the wife is working, and that’s another $100,000, that’s ordinary income. What you have here is $70,000 plus $100,000. That’s $170,000 minus the standard deduction, we’ll call it $25,000. So $140,000, $150,000, something like that, before capital gains. That’s in the 22% bracket.
So you fill up the 12% bracket, you’re in the 22% bracket. If you work, then it’s going to push the extra, your salary, into the 24% bracket.

Joe: I think the biggest issue here is that you’re 45 years old. I would not be taking 4% out of my brokerage account at 45 years old.

Al: I wouldn’t either.

Joe: You’re going to deplete the account. The 4% rule does not apply to a 45 year old. It applies to a 70 year old.

Al: Age 65 is where it was first thought of.

Joe: Now we’re even looking at 3% for someone that’s 65. So you’re 45. You want to take 2% out.

Al: 2, 2.5%. 3% would be the upper limit.

Joe: I guarantee he’s probably fairly aggressive because he’s still young and he can go back to work. If the market turns on him and he’s taking 4% out, it’s going to be very hard for him to get caught up. Just because of the simple math, it’s more complex math. If your account is down 25% and then I earn 25% the next year, I’m not whole. You need to earn like 35% just to get you back to square one. If you’re taking out an additional 4% you’re going to have to have a larger rate of return on the rebound just to get your principal or just to get your basis back. Be careful when you start taking distributions. You know you’ve got a great pension. Your wife is going to continue to work. You’ve saved a couple million bucks. I would run the numbers here.

Al: I would say if Andre is going to have that much money by age 45 they’re probably not spending a lot right now anyway.

Joe: He’s probably saving 100% of his income. He’s in Germany.

Al: So in other words, if you have $70,000 for retirement and your wife’s making $100,000 that’s $170,000 just right there. Do you need more than that? I’m thinking no based upon how much is being saved.

Joe: Wow. Do you need more than that? Look at you. Where are you spending your money, Andre?

Al: I’m just saying I don’t think he’s spending near that much right now.

Andi: Hofbrau.

Al: The Hofbrau Haus? I don’t know where Bavaria is compared to Munich.

Joe: Congratulations. The guy is definitely a saver, and I don’t know if he could probably spend that much. Savers have a difficult time spending. I think he’s just spitballing some stuff in the air. And seeing hey, does this make sense? He’s worried about the tax bill. The tax bill is not going to be all that bad, but if he works, how much is it going to be making? If he adds another $100,000 of income on top of

Al: It’ll probably be in the 24% bracket, mostly.

Joe: If your savings are all in a non-retirement account, you’re very tax efficient. If it was all in a retirement account, especially at 45 that thing would probably double by the time he was taking the money out at 60. Then he’s got

Al: $4 million.

_______

Listen to all of the full podcast episodes where these questions originally aired by clicking the link in the description of today’s episode in your podcast app to go to the podcast show notes – they’re all listed right above the episode transcript. Next month we’ll do a spitball roundup for retirement planning in your 40s and 50s – make sure you’re subscribed to the YMYW podcast so you don’t miss a thing. 

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