Show Notes

• (00:55) What to Do About My Outrageous Fee-Heavy 403(b)? (Martin, Miami, FL)
• (05:56) Should I Hedge My Pre-Tax Non-Qualified 415 Excess Plan? (EF, Kansas)
• (14:25) What to Do With My Old TIAA Retirement Plan? (Max, Seattle)
• (24:29) Highly Compensated Employee Rule and Excess 401(k) Contributions (Mike, Castleton, NY)
• (29:16) How Are Employee Stock Purchase Plans Taxed? (Big Cheese/Bob the Tomato)
• (32:26) Cash Balance Plans Pros and Cons for Self-Employed (Brent Money, Bennington, NE)
• (40:52) The Derails

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Transcription

Andi: What should Martin do about his outrageously fee-heavy 403(b) plan? Should EF hedge his pre-tax non-qualified 415 excess plan? What should Max do with his old TIAA plan, and what are the pros and cons of a cash balance plan for self-employed people like Brent Money? What to do with your employer-sponsored retirement plan, that’s today on Your Money, Your Wealth® podcast number 449. Plus, Mike needs Joe and Big Al’s spitball on the highly compensated employee rule and excess 401(k) contributions, and the fellas explain how employee stock purchase plans are taxed for Big Cheese Bob the Tomato. If you’ve got money questions, or want a Retirement Spitball Analysis of your own, visit YourMoneyYourWealth.com and click Ask Joe & Big 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.

What to Do About My Outrageous Fee-Heavy 403(b)? (Martin, Miami, FL)

Joe: We got Martin from Miami. He writes in. “Hey, I drive a 2010 Toyota Camry, my wife, 2012 Toyota Sienna. My drink of choices, little rum and coke, Cuba Libre, Miami, and a little twist of the lemon.” Little Cuba Libre’s with lime.

Al: Oh.

Joe: So I don’t know what a rum and coke with lemon would be called.

Al: Okay. It’s a little twist on that.

Joe: Yeah. “I’m new to the personal finance sphere and discovered my educator 403(b) with Corebridge has a weighted expense charge of 1.6%. I contribute $1000 per month and have an account balance of $200,000 of a 70/30 stock/bond mix. I’m 53, earn around $170,000, will work at least 6 more years and receive a net pension around $94,000 annually. My wife will continue to work and provide a net income of $36,000 a year. Once she retires, she will receive a pension of $12,000. We spend about $100,000 per year, which will go down once the two kids finish college and leave the nest egg. Fingers crossed. We have two Vanguard Roth IRAs with a balance of $37,000. We maxed out and recently opened up a Vanguard’s brokerage account, and the balance of that is $6000. We contribute $750 per month. My question is, what should I do about those outrageous fees in my 403(b)? Stop contributing and move the $1000 per month to the brokerage account or is there any another recommendation?” We don’t give recommendations here.

Al: We spitball.

Joe: “When I retire, I look forward to rolling my 403(b) into an IRA, working part time earning $24,000 annually. Thank you for your help.” So.

Al: Okay, got it. 403(b), which is great. You can contribute pre-tax, get a tax deduction.

Joe: So, he’s an educator. So, is he-?

Al: Yep. He’s got a good pension.

Joe: Great pension.

Al: Wife’s got a good pension.

Joe: I’m not sure. Is he public school? Is it college?

Al: Didn’t say.

Joe: So, a couple things. 1.6%. Is that outrageous?

Al: It’s high, but it’s, that’s not end of the world.

Joe: It’s not 3%. No, don’t stop. What I would do is I would switch to Roth and I would look to see if there’s a new plan.
If you are working for a public school system or maybe it’s a community college or something like that, most of the time, with the 403(b) plans, there’s a list of providers that you can choose from. So right now, he’s with Cornbridge. Is there a way that he could get another plan? Cornbridge, I’m guessing, is the insurance company, or is that the TPA? I’ve never heard of Cornbridge.

Al: No idea.

Joe: Corebridge.

Al: But he’s got the investments, and they’re with VALIC.

Andi: They provide life insurance, retirement solutions, other financial services.

Joe: Corebridge does?

Andi: Yeah.

Al/Joe: Okay.

Joe: So, maybe that’s the TPA for whatever university he works at. And maybe you stuck there, but 1.6%, I would keep it.

Al: Yeah, I would too. 100%. Because I mean, at the moment, so first of all, your pensions cover your spending, which is great, which is fantastic. I don’t know what kind of cost of living the pensions have and you’re gonna wanna have your own money and you know, you’ve got a good start, but you’re gonna wanna keep adding to it, which you are, which is great. Yeah. Don’t stop right now. I think that’s right Joe. I think look at other options. If the 1.6% is the only option, keep funding it. I mean, it’s an investment, but you’re going to be glad you have.

Joe: Right. Everything costs a little bit of money, you know? And so, but if I could switch to the Roth 403(b), that’s what I would do because he’s going to have pretty large fixed income.

Al: Well, see now that’s a whole ‘nother thing. And that’s a good point because I mean, they’re going to have over $100,000 of fixed income from pensions.

Joe: Right. And so they could be in a, you know, depending on where tax rates go up, they continue to go up. You could be in the 25% bracket. And so I would want to have, you know, those savings in the Roth and I would stop the brokerage account and put everything into the Roth and max out 403(b) out with even at 1.6% because a compounding tax-deferred and tax-free coming out. It’s going to well make up for the 1.6% fees that you’re paying in the overall account.

Al: Yeah. The only tricky thing is they’re in a reasonably high bracket at $170,000 of income and she’s $36,000, but still it’s either 22% or 24%, depending upon their deductions. Which is still lower compared to how it’s going to be. Yeah. Right.

Joe: He’s still young.

Al: That’s right.

Joe: So, yeah.

Al: I like that. I would probably do the same, but I definitely would not stop the 403(b) because of the 1.6%.

Joe: Is there other funds within-?

Al: Yeah, maybe there’s other funds than VALIC.

Joe: Right. Yeah. I don’t know. Give us the plan doc. We’ll take a look at it. But yeah, yeah, don’t stop. Keep it going.

Should I Hedge My Pre-Tax Non-Qualified 415 Excess Plan? (EF, Kansas)

Joe: We got, “Hey, Joe, Big Al, Andi. Joe, EF in Kansas with the question, I think you’ll have as much fun spit balling as I have listening or watching your podcast over the years.” A little E. F.

Al: Yeah. E. F. Hutton.

Joe: And then he’s like pointing it out to me.

Al: Wonder why?

Joe: I don’t know.

Al: Maybe we’ll see as we read.

Joe: I don’t know. Getting pretty excited here, man.

Al: I don’t think I’ve seen you this excited in a couple years.

Joe: Yes. Oh. “Your mixture of CFP®, CPA experience, discussions, with humorous banter, all while Andi keeping you on the line makes your show unique. Some background. 61 year old, retired Lieutenant Colonel.” Oh, salute. Thank you for your service, sir.

Al: Exactly right.

Joe: “USAF A 10 Warthog-“

Al: Warthog?

Andi: Warthog.

Al: Warthog pilot.

Joe: He’s a bad ass. Guaranteed. He’s a bad ass.

Al: I guarantee if he was sitting here, we’d be kind of shaking at our boots.

Joe: Oh, I would pour a cocktail to share with-

Al: Jameson?

Joe: Yeah maybe. Okay, little pilot, combat veteran, Desert Storm, and Iraqi Freedom. You would think 7 tours in the Middle East would make me a heavy drinker, but I just enjoy some sparkling water with lemon and lime and lots of ice. My drive is a Lexus E5 sedan.”

Andi: I think that’s ES.

Joe: Oh, I’m sorry. Yes. What did I say? E5?

Al: Similar.

Andi: Looks similar.

Joe: Oh, I’m thinking military.

Al: It does.

Joe: Right? Military. You know what an E5 is, Andi?

Andi: I do not.

Joe: See? She makes fun of me for saying ES.

Al: Well, yeah.

Joe: “Here’s the unique situation in my current civilian job. I participate in company pre-tax, non-qualified plan called a 415XS. This allows high earners whom exceed the IRS 415C contribution limits of $66,020.23 still capture company money, profit sharing in a pre-tax account. This money has significant IRS constraints. The investment choices and distribution plans are irrevocable. In my case, the money is in VIIX or the S&P 500 and cannot be moved. It will be distributed as a lump sum when I retire September, 2027. The account is currently at about $340,000. Do I, hey, do nothing and ride the ups and downs of the S&P until the day of the retirement and I get what I get? Or two. Hedge the position. Say, one year out, or 6 months out of September 2027, expiration, SPY puts-“ oh, you’re gonna buy SPY puts.

Al: Yeah, right. Getting sophisticated.

Joe: Yes, he is. “The idea would be to buy enough at the money puts to guarantee a value at retirement. The premium spend would be, in effect, fire insurance. If the market rises, I’d be out of the cost of the premiums. If there was a substantial market downturn, I would guarantee I would get no less than the account value at the time of the options purchased, minus the premiums, thus avoiding further downside losses. For example, if I retire in September 2024, I could hedge most of my current account one year out for about $15,000. If I were retiring in March 2024, I could hedge 6 months out for $10,000. Would enjoy hearing your thoughts, I know not advice, about my situation. Cheers. EF.” All right. So he wants a hedge his 415XS plan. It’s got $500,000 in there and he wants to retire in 2027. And it’s like, okay, well, let’s hedge this thing. So he’s going to buy some puts.

Al: Yeah. So the put, you buy a put. So then in that case, if the market goes up, then you just lose the cost of the premiums to buy the put.

Joe: Right. So say it’s $10,000 and you’re putting the stock to someone else.

Al: Right, at a certain amount. And so if it goes down, you could put the price of the put to someone else that they have to buy it. Right. Then you get your price.

Joe: Correct. So you’re going to be down the premium of the put. So that’s the insurance that you’re purchasing to lock in whatever price that SMP or SPY is when he buys the puts. Would you do that?

Al: Well, I would- so first of all, I don’t like answering or spit balling something like this when I don’t know the overall situation.

Joe: There’s nothing. You gotta give me something else, Lieutenant Colonel.

Al: Yeah. It’s like if you told me that, you know what, you’re spending $80,000 a year and your pension is $120,000. It’s like, I don’t care. I mean, just let it roll.

Joe: It doesn’t matter.

Al: Let it roll. Right? But if this is super important to your retirement, yeah, I’d probably do this. Right? So anyway, I don’t know. I don’t know. I don’t have enough information.

Joe: Oh, right. It’s- if this is 100% of his liquid assets and he only has Social Security and he needs to spend X, Y, Z.

Al: Then I would do it.

Joe: Yeah.

Al: Of course.

Joe: Of course. You don’t want to lose this thing. Especially because the sequence of return risk could kill him. Because it’s like, all right, now I’m retiring. I can’t touch it. I can’t move it. And then I’m going to retire and the market, Boom, it’s down 20%, 30%. And it’s like, oh, probably-

Al: Probably should have done it.

Joe: I probably should have done something because a lot of people have other types of plans where they can diversify. So they can buy bonds or cash as they get closer to retirement, they can be more conservative in the overall portfolio. He’s stuck. He can’t. So he picked his choice. If you have to stay with that choice until it’s fully distributed out at his retirement date.

Al: Right. And yeah, it happens all in a lump sum, right? So then there’s taxes on that and you got to factor all that in. But yeah, I mean, the strategy is fine. Basically what the strategy, there’s a cost of doing this, but it does protect your downside.

Joe: Yeah. We do this quite a bit with clients that have high concentrated positions in an individual stock.

Al: Yeah. And they have a lot of gain, so they don’t want to sell it all at one time.

Joe: And so you can put some costless colors on it where you could maintain the market value of that security given high volatility.

Al: Yeah, so what you give up upside and downside. I think that’s what you’re trying to say. And so you kind of lock it in even without selling, right?

Joe: Right.

Al: But the market over time usually goes up. So as a long term strategy, it’s usually not a great idea.

Joe: It’s a terrible strategy long term.

Al: Yeah. Yeah. But, and especially when you’re talking about an asset class like S&P 500. Now, if you’re talking about a single stock, to me, it’s much more important because a single stock, a single company could do great or fail. So there’s a wide variability of returns there. So you might want to lock that in.

Joe: Right. Well, and the reason why we do it with an concentrated position over a short- it could be a couple of years because they’re diversifying out of it.

Al: Yeah. Right.

Joe: And so I’m selling out of this. I’m getting more diversified and I just want to make- and I’m fine locking it in because I know I’m selling it out for the next year or two or depending on where taxes are.

Al: In other words, we have a plan to maybe sell in 3 years, but we sort of want to lock things in now.

Joe: Yeah. Who knows what’s going to happen over 3 years. And I’m fine giving up some of the upside if we can at least protect the downside as we sell this thing out.

Al: Right. Right.

Joe: All right, Lieutenant Colonel. That was great.

Andi: Stocks and bonds, 401(k)s and IRAs – how investment savvy are you? Less than half of Americans have a solid understanding of basic investing terms and concepts, and that lack of financial literacy can be costly. How can you grow your wealth if you don’t know what tools and strategies are available, much less know how to use them to develop a long-term financial plan? Visit the podcast show notes and check out Financial Boot Camp, the latest episode of Your Money, Your Wealth® TV, and you can pick up the free companion guide. From investing basics to retirement plan funding options, Joe and Big Al help to increase your investing IQ on YMYW TV. Click the link in the description of today’s episode in your favorite podcast app, go to the show notes, watch Financial Boot Camp, and download the Investing Basics Guide for free. Then share the show and the free financial resources.

What to Do With My Old TIAA Retirement Plan? (Max, Seattle)

Joe:  Max writes in from Seattle. “I learned a lot, especially learned that people with fat wallets worry a lot about having enough money. They don’t want to lose it.”

Al: That’s a true statement. I would say people with money are more worried than those that don’t seem to have much.

Joe: “But I figure if I listen regularly to rich people talking about money, maybe some of those vibes will stick with me. Big Al invited those with much smaller wallets to write in, so here we go. I’m 45; wife’s 44. We live in Seattle. It’s an expensive place to live, but I’m born and raised here. I’m an artist and she’s a teacher. 14 years ago, basically being at $0 saved after the birth of our only child, I came to the conclusion that the only way I’m ever going to be able to live such that I can make art and take naps, I’m going to have to grow a fat wallet myself. We have made up a lot of ground by regularly saving and reading everything I could on personal finance. My question is about a former tax advantage account with TIAA that I had while I was working in a local community college in my 30s. Stocked away about $7,000 which was employer-matched 100%. 6 years ago I changed jobs to work with a non-profit which has a simple plan. I called TIAA to ask about doing a rollover of those dollars to my IRA and they told me that the money couldn’t be touched until I was 55 years old. I accepted it at the time, but I think they are wrong. Upon further research, I determined this account to be classified as a 401(a), which certainly can be rolled to another tax advantage account anytime. Also, a few years back, I logged into my TIAA account and saw an offer to immediately convert this account to a $500 a month annuity starting at 67 years old. I declined and have just been letting it ride ever since. It’s worth $48,000 today.”

Andi: Not bad for $14,000.

Joe: “My question is, if it were you, would you let this money continue to ride and use it as is intended for regular retirement withdrawal? Should I consider rolling into my simple IRA, Fidelity for Simplicity, reconsider the annuity, or do one of those Roth conversions you both love so much?”

Al: Max, you said my favorite word, Roth. Now I’m listening.

Joe: “which would take a big tax penalty on those dollars. We both work full time jobs and we make $150,000 gross annually. It took years _to toil and promotions_ to get us to the point and we feel _extremely best by this_. We have saved roughly $3,000 a month making Roth contributions to an employer matched savings accounts and building a cash reserve. Our total non-house savings is roughly $220,000 with $53,000 in the simple IRA, $70,000 in Roth, $7,000 in the 403(b) and then $48,000 in that 401(a), $14,000 in taxable investment account and around $20,000 in emergency cash. Rough allocation is 70% stocks. We own a home valued at $1.1 million with a $500,000 mortgage.” This is not a very small wallet, it’s kind of a fat little wallet here.

Al: Max. Very intelligent.

Joe: “It would be great to regularly make art and take naps someday, but with inflation and the mortgage hanging over our heads, I’m kind of feeling like I just will work forever. Bu, if you’d like to spitball for me, have at it. Our daily drivers are a 2017 Nissan Leaf and a Rad Cargo Ebike. I love pilsners in the summer, red wine in the winter, and a Bobby Burns at Christmas. We have Shepard McStog, who is a rescue pup. It has all kinds of anxiety, but we love him anyways. Cheers.”

Max in Seattle, he wants to retire at some point, make some art, take some naps. He’s done a great job. He’s 45 years old. He’s got a few hundred thousand dollars saved, has a really big, nice house in Seattle that’s half paid off.

Al: When we look at fidelity studies on the amount saved by people in their 40s, it’s like a 100,000, maybe. That’s average.

Joe: So, in your 40s, what is it supposed to be? 2 or 3 times annual salary?

Al: I think so. Most people are short based upon what fidelity says you should have. But anyway, a couple hundred thousand dollars with a great mortgage, with equity in the home.

Joe: Half a million dollars in equity.

Al: And you’re only 45. 44. I like it.

Joe: I think he’s doing all right. Saving $3,000 a month, he’s got $220,000.

Al: I did a little math here.

Joe: Well, the wife’s gonna get a pension, right? She’s a school teacher?

Al: Yeah, that’s right. So let’s just start with the savings. $220,000 now. Let’s say $36,000 a year. I just did 6%. I took this out 20 years to 65, just to come up with a number. I get $2 million. $2 million at 4% distribution rate. $80,000. Plus I’ve got another $50,000 of income.

Joe: What was that from?

Al: That’s Social Security. So that’s about $130,000. Then I was trying to figure out, what do they spend? Which would be nice to know, but we don’t know. So I tried to do a little analysis.

Joe: A little back of the envelope.

Al: $150,000 of total income between the two of them. I took out FICA, what I thought taxes were, what I thought savings were. I get $90,000. $90,000 spend in 20 years is like $160,000. So they got $130,000 coming in, $160,000, not quite there, but we don’t know what the wife’s pension is. Maybe that covers it. There’s some things we don’t know, but I don’t think, Max, you’re that far off.

Joe: No, he’s really close. If he can save $3,000 a month, that’s the driver.

Al: That’s the driver.

Joe: Because you got $36,000 of saving on $150,000 gross income. That’s really good.

Al: It’s really good. And so your $200,000 today becomes $2 million. Just keep doing it diligently. And that’s at 6%. You might do better than that.

Joe: And you can’t waver, because I think sometimes what happens is that if you don’t see results right away, that’s when people get frustrated. It’s like, Hey, you know what? I want to make some art and take naps. And so this grind is going to be forever, but it’s discipline. If he can stay disciplined by saving the amount of money in it, let’s say if they get slow raises, or maybe he sells a piece of his art. And if they continue to save diligently and increase that savings a little bit each year as they get raises or cost of living increases or things like that, or they have a young child, maybe a lot of expenses go to the young child as the young child kind of leaves the nest. Maybe you can save a little bit more. There’s all sorts of different levers that they can pull here.

Al: And plus, I took all the expenses and indexed them for inflation, but the mortgage is fixed.

Joe: The mortgages should be gone in 20 years

Al: or close to it.

Joe: So yeah, I think Max is right on. He’s 45. A lot of these people that call in and say, “Hey, I got millions of dollars and blah, blah, blah.” Well, they’re 65, right? Max, you’re going to be writing to us in 20. Well, not Al and I. Maybe the same show, but Al and I are not going to be here. Because we got fat wallets ourselves that we got to spend.

Al: Oh, wait a minute. Wait a minute. Hold on. This is the first time you admitted you got a fat wallet. You just said, you said we’ve got fat wallets. I heard that.

And: So what should Max do with his TIAA plan?

Joe: He’s screwed. Yeah. I mean, he’s locked in.

Al: You can’t roll it?

Joe: I doubt it. But TIAA-CREF is crazy. CREF you can, but if it’s TIAA, it’s an insurance product. I mean, they probably have a good rate. I’m not talking negatively about TIAA, just for the record, but it is very challenging to get money out of those products. He might be able to take out 10% per year, but to take the whole thing in a 401(a) plan, depending on the plan doc, maybe it’s right that he can take the money out at 55, but I’m sure if he calls back and talks to someone else, they might be able to tell him, we can roll this into an IRA to do an annuity. So yeah, when he turns 67, he’s going to get an annuity for life on the thing, or he could take the money out and roll it at 55. I still don’t think he’ll be able to get all of it out.

Al: You don’t think so?

Joe: I don’t know.

Al: Well, I would try.

Joe: I have no idea. With my experience of 25 years in this business, looking at moving money from TIAA-CREF into an IRA from whatever plan it’s in… You can move the CREF component because those are like stock mutual funds. 100% liquidity there. TIAA, forget about it. I would have to look at the statement. There’s so many things I don’t know.

Al: We don’t know the doc. But if you can do it, roll it to an IRA. Not a SEP IRA. Not a Roth. Just go right to an IRA.

Joe: Or look at the rate that you’re getting from TIAA. It might be a good rate. Just keep it there. Who cares? It’s a fixed rate. It’s guaranteed. So, that might be just fine and that would be your bond equivalent and you can take on other risks somewhere else.

Al: Agreed.

Highly Compensated Employee Rule and Excess 401(k) Contributions (Mike, Castleton, NY)

Joe: We got Mike from Castleton, New York. “Joe and Al, please close your eyes. Picture driving down rural New York State.”

Al: Okay, I’m there.

Joe: “In a 2018 Chrysler Pacifica minivan. No animals unless you count my two toddlers, Murphy and Millie, chilling in their car seats. I drink non alcoholic seltzers.” Oh, I wonder what that tastes like.

Al: You never tried one?

Al: I don’t even know if they made such a thing.

Joe: “But can put back…”

Andi: “But can put back some dark stouts in the evening”

Al: He does the non alcoholic thing while he’s driving. That’s sensible.

Joe: He’s got kids in the back. “Last year’s my wife’s company _failed_ the highly compensated employee check and she met 2 of the 3 criteria to make her a highly compensated employee. She made over $135,000 and was at the top of the 20% of salaries at the company. Much of this was due to bonuses. Unfortunately, her HR and Fidelity directed us to remove the excess funds from her 401(k) plan as they exceeded the limit based on the HCE rules. This year, we will be well under the $150,000 limit, but I think she would still be at the top 20%. Does this rule still apply? Her HR sent out a notice to all of last year’s HCEs, and it made us think we should cut back on our 401(k) so we don’t have to take out the funds again. What do you guys think? Thank you so much, and great job keeping the guys in line, Andi.”

Al: Do we get out of line sometimes?

Joe: Never.

Andi: What should Max do with his TIAA?

Al: Oh yeah, well thank you, you did help us on that one. I would say we get out of line fairly often, but we have fun doing it. So highly compensated employees. Here’s the concept. The concept is you have a 401(k) and if you’re considered a highly compensated employee, there’s all these tests to see how much you can actually contribute into your plan, but you don’t know that till after the year’s over. So you’ve contributed a certain amount and then you find out you could only contribute a lower amount. And so the IRS makes you take the money back and out of the plan and you have to pay taxes on it. So that’s why this is important.

Joe: And the reason for that is that because they don’t want these plans to just benefit the people that make a ton of money because then they get a larger tax benefit. So let’s say the people that are not necessarily highly compensated compared to whatever they’re looking at. So $150,000 is highly compensated. If you’re not part of that top 20% and you’re not compensated or you’re not participating in the plan, then it favors the highly compensated more so they don’t necessarily like that. They want a fair playing field.

Al: So, this is kind of a benefits question, which we’re not necessarily experts

Joe: Not even close.

Al: But I will tell you what I think, I think what I’ve heard is that you have to be over $150,000 for 2023 and be in the top 20%, not one or the other. That’s my understanding. I think it’s an and. And so I don’t think, Mike, that your wife would be highly compensated this year. However, for our benefits people that listen to this podcast, if you have a different opinion, let us know.

Joe: Are they fully funding the plan? I don’t know that. Maybe you start with… go Roth IRAs and brokerage accounts. It’s still going to be alright.

Al: Agreed.

Joe: Don’t stop saving. If you can’t go into the 401(k), save it somewhere else.

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How Are Employee Stock Purchase Plans Taxed? (Big Cheese/Bob the Tomato)

Joe: “First things first, you can call me big cheese.”

Al: Big cheese. Okay.

Joe: “Or something fun like Bob the tomato.”

Al: That’s kind of fun. I guess.

Joe: “Beer equals Big Lake Brewing – Hazen Blue is good. Whiskey and Bourbon equals a little Pappy Van Winkle, but never actually had it because it’s expensive. So normally, Jefferson’s Motion or Knob Creek. A little 9 year. Now for the fun part, we got an ESPP plan, and how is it taxed? Offering date and purchase date are the same. Have to hold it for 1 year. Lots of info about qualifying and disqualifying dispositions online. What does this mean? I want to sell after one year, taking advantage of the 50% discount on purchase price. Might use a donor advised fund to avoid any capital gains, but curious if I need to hold for 2 years to avoid it being a disqualified disposition. Any spitballing would be appreciated as long as the spitball doesn’t end up in my bourbon.”

Al: I’m clear on that, Bob.

Joe: Look at Bob the Tomatoes. Spicy, funny guy there. You want to take a stab at this?

Al: Yeah. ESPP plan. So Employee Stock Purchase Plan. What these are is certain companies, generally public companies, maybe always public companies. I’m not really sure, but they will offer this plan that allows you to buy company stock at a 15% discount. And oftentimes it’s even better than that, because when you buy the stock, there’s a look back period, maybe in that same quarter, or it depends upon the plan itself, where you can actually buy it cheaper than that. So you’re getting stock at a discount. Which is good. And the basic rules are this, you have to sell 2 years after the offer date and 1 year after the purchase date. I think Bob is saying these are the same date. Basically right on the surface, it would say you have to wait 2 years for the offering date. But then this is one of the most complicated areas of tax law that I can imagine, ESPP. And it’s somewhat plan specific. But the basic rules are this, if it qualifies for this 12 month after purchase date, 24 months after offering data. In other words, if you sell it after those dates, then you get preferential tax treatment, which basically means the discount part is ordinary income, but all the other gain part is capital gain. When it’s a disqualifying distribution, then you may have a lot more ordinary income. In the case where those two dates are the same, which is kind of unusual, there may not be any difference, but check this out with your own CPA, with the plan specific. I’ll just tell you right now, it’s complicated.

Joe: Thanks Bob the Tomato.

Cash Balance Plans Pros and Cons for Self-Employed (Brent Money, Bennington, NE)

Joe: Got Brent Money?

Andi: That’s what he said his name is.

Al: I like it.

Joe: From Bennington…

Andi: I believe that’s Nebraska.

Joe: I think you’re right. I never heard of Bennington.

Al: Me neither. But yeah, I think it’s Nebraska too.

Joe: Yeah, that’s Nebraska.

Andi: Oh, it’s got a population of 2,026. That’s why we haven’t heard of it.

Joe: “Hey gang, hope you’re all well. Would you two discuss the advantages and disadvantages of cash balance plans for self employed pensions? My CPA friend of mine told me he actually utilizes the cash balance plan for himself. I’m 34 years old and have a high income. I’m self-employed and don’t have any deductions for my business. He said I can max out my solo 401(k) $61,000 employee and employer portion, and also max out a cash balance plan and deduct it from my taxable income. He said the contribution limit is based on my income and age. I used some calculators online and it said I could contribute as much as $80,000 and deduct it. However, I’m skeptical because I’ve never heard of a cash balance plan. I’ve never heard of someone using one. It sounds like administrative costs are high, but worth it if the plan is kept for a long time. Is it as good as it sounds? Why haven’t more people heard of it? Can you guys share your knowledge, expertise? Can the money contributed to the plan be invested in mutual funds? Can all contributions and potential growth be rolled into an IRA down the road? Are there any scary IRS pitfalls I’m missing? Thank you so much.” He’s talking about a little defined benefit plan.

Al: So a cash balance plan is a type of defined benefit plan. Defined benefit plans in general, you can invest in anything you want to. Cash balance plans tend to be more restrictive in terms of fixed income.

Joe: Let’s take a really simple approach to this. So there’s two different types of retirement plans that you can set up. A defined contribution plan is a 401(k) plan. The contributions are defined by the IRS.

Al: They’re limited to whatever the maximum is.

Joe: A defined benefit plan is defined by the benefit that you’re trying to set up. So you’re trying to set up a pension plan for yourself. Like the big companies that have a pension plan that has actuarial tables, you work for the company for 30 years, you get the gold watch, and then you get 40%, 60%, 70% of your income for the rest of your life. That’s what a defined benefit plan is. If I’m self-employed, I can set up a defined benefit plan for myself. So you look at it and you say, how much money do I want this plan to become to create a certain income stream once I retire? The older you are, the more money that you can stock away. So Al and I have set up these plans for people in their 60s and they could put several hundred thousand away.

Al: Correct.

Joe: So he’s in his 30’s because he has several years until a normal retirement age defined by the IRS is that he’s not going to be able to fund it with several hundred thousand, but he’s still going to be able to fund it to a pretty good amount. And I think he ran some calculations here and it’s $80,000.

Al: That’s exactly right. In other words, the IRS defines the benefit, not the contribution. So it’s a little bit of a different way to think about it.

Joe: The benefit is like 200 and some odd thousand dollars at retirement or what that would be the pension. So you’re trying to build up this nest egg by the time you’re retired to get you to this maximum amount.

Al: That’s right. If you’re starting this at age 60, you have less years to fund it. So that’s why you can put $200,000 or $300,000 or more into these plans and fully deduct it. If you’re in your thirties, it’s a lot lower number, but you can do that in addition to a 401(k). So that’s true.

Joe: You set up a 401(k) plan for yourself and then you can have an employer match and then you can set up another defined benefit plan that kind of piggybacks alongside this plan. They’re expensive. Here’s the con. So the pro is that you can stock a ton of money away and then you can have huge tax benefits from that today. The con is that they want you to continue to fund these things. Some people set them up just for a quick tax deduction. Hey, I’m gonna set it up for 1 or 2 years and then, oh, something happened. The IRS doesn’t really care for that. They want you to fund it for several years.

Al: They want it to be a permanent plan, which means at least 5 years and probably more.

Joe: A 401(k) plan is discretionary

Al: Every year you can fund it or not.

Joe: And you can fund it to whatever dollar figure up to the maximum amount. Defined benefit plan, not so much. They’re going to say, Hey, Brent $80,000. Next year, you got to fund it $80,000 or $90,000 or $100,000 or whatever the calculation, the third party administrator is going to do each year. So you’re going to have to come up with those dollars every single year to fund this plan. Can you use mutual funds, stocks, bonds, everything else? Yeah, it depends on how you want to set up the plan. Work with a third party administrator. It’s going to cost you a few thousand dollars to set up. It’s going to cost you probably another $1,500 or more just to have an administrator look at your overall situation to find out what your funding limits are. So, yeah, they’re more complicated. But at the end of the day, can you roll it into an IRA? The answer is yes.

Al: Two more quick things. A cash balance plan, as I was saying, is a type of a defined benefit plan. That may or may not be the right answer for you because the investments are a little bit more limited. That’s the first thing I want to say. And the second thing is you don’t hear much about these plans because most companies stop doing them because they’re too expensive. They went to 401(k)s and made the employees fund their own contribution. And so with a defined benefit plan, the company funded everything. So that’s why for most companies, it’s just too expensive. They’re completely valid. You just don’t hear much about it.

Joe: And he’s self employed and his CPA buddy goes, Hey, you want to save some more money in taxes? This is a good way to do it. But at the end of the day, Brent, here’s what’s going to happen. If you want to continue to fund this thing, just think about it, that you’re funding this by $100,000 or more. Each year, you’re 30 some odd years old, you’re going to have a giant retirement account and those taxes will come out eventually. It sounds like Brent makes a lot of money. That’s why he calls himself Brent Money. Just think about an overall strategy, long term. If I’m looking at saving money today in taxes, when taxes are all time lows, these dollars might come out at a little bit higher tax rates, so just kind of be balanced. Maybe your 401(k) goes Roth if you’re going to set up this defined benefit plan.

Al: Yeah, I think that’s a good way to think about it. One more quick thing too is if the investments are too strong, based upon the assumptions, you may have an overfunded plan and that’s a big problem. So just be aware, that’s the pitfall.

Joe: Yeah, they’re just complex, that’s all. But they’re great plans if you’re using them appropriately. Appreciate everyone’s emails. We got a whole bunch. I know we didn’t even get to most of them. That’s it for us. Thank you all. We’ll see you next time. Show’s called Your Money, Your Wealth®.

Andi: Minus signs and drinking again in the Derails, plus, Joe reading and spelling with his little ones, so stick around.

Help new listeners find YMYW by telling your friends about the show, and by leaving your honest reviews and ratings for Your Money, Your Wealth in Apple Podcasts, and any other podcast app that accepts them.

Your Money, Your Wealth® is presented by Pure Financial Advisors. Click the “Get An Assessment” button in the podcast show notes at YourMoneyYourWealth.com or call 888-994-6257 to schedule your free financial assessment, in person at one of our seven offices around the country, including four offices in Southern California, plus Chicago, Denver, and Seattle, or online, a time and date convenient for you, no matter where you are. Chances are, one of the experienced financial professionals at Pure will be able to identify strategies that’ll help you create a more successful retirement.

Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.

The Derails

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