transcript
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Episode #499 - Should I Do A Roth Conversion?
Roger: There are a number of things that I think are non-negotiable when putting together your retirement plan if you want to have that confidence to rock retirement.
The majority of things that we commonly talk about, including whether you should do a Roth conversion or not is not one of those non-negotiable things, and that's what we're going to talk about today on the Retirement Answer Man show.
Hey, welcome to the show.
My name is Roger Whitney. If you've listened to the show long enough, you know what these non-negotiables are, right? I hope that you do. You have to work on your vision of what kind of life do you want to create? If have to build a feasible plan of record given the resources that you've accumulated for retirement, and then you have to make that feasible plan really resilient because if you are working to build that life you don't want to get knocked on your butt with the world unfolding. Then yeah, you do want to optimize it. And then in the non-financial realm, there are some non-negotiables. You have to work on building your energy so you can show up and be all that you can be. You have got to work on your relationships. You got to work on your mindset, and you got to work on having passions in your life. These are all the things that really are non-negotiable if you want to rock retirement.
Now, this last month, we've been talking about the Roth opportunity that leads to, should you do a Roth conversion?
We're going to go through a framework to think through that in an organized way. But I'm here to tell you that this is not non-negotiable. Whether you do a Roth conversion or not should not impact Your ability to rock retirement. It may enhance it. You may not know until after the fact, but that definitely falls into the optimization stage.
I actually take issue with many planners and many talking heads that say, if you don't do Roth conversions, you're really hurting yourself in a material way and your ability to rock retirement, and just think that, yes, yes, Roth conversion, Roth conversion, Roth conversion. I take issue with them. I don't think that's intellectually honest in a true planning environment because it does depend on a lot of different things, and it can't just simply be solved by math.
Math is important, but it's only part of the equation of thinking about that and we'll try to build out a framework for you as well as answer your questions today on this topic. Now it's the second week of August. I didn't tell you about the books I read in July, so I'll tell you that quickly.
July was a big travel month, and I focused a lot on not working, not checking in with the office, not reading nonfiction, etc. So, I read four fiction books. Two were written by Neil Stevenson, who wrote Cryptonomincon. Good book. I read it last year. Definitely a really, really good book. I read two more of his books, Seveneves and Reamde, which were science fiction.
Seveneves was about the aftermath of the moon exploding and how that impacted the earth and trying to save humanity by colonizing space. He is an amazing writer. These are long books and I enjoyed it. I'll give it a solid B, not as good as Cryptonomicon. Reamde was again, science fiction, had to do with cryptocurrency and online communities and criminals and mafia.
It was okay. I'll give that a C+. They were fun reads, but nothing that just blew me away. The third book I read, I believe this is nonfiction, but based on life, right, is All Quiet on the Western Front which tells the tale of Paul, a soldier in World War I. I had heard of this book forever; I don't think I read it in high school.
I think they made a Netflix movie on it, haven't seen that. Wonderful book. Anyone in a position of power should read this book about the impact that war has on people, normal people. Not just the physical impact, but the emotional and psychological impact on so many. Great book. No glorification of war.
Fourth book I read, which I'll call it candy, right? I traveled a lot. I was on airplanes for a long time. It was Deadfall by Brad Thor, which is one of those, well, it totally glorifies violence. Totally opposite. Secret agent dude, fighting the terrorists before they blow up the bomb type of thing.
So those are the four books I've read. I'm excited to talk to you in September about the books I'm reading right now. One of them, it's a big book, it's been taking me a while because I've been digesting it so much, is the most tagged and highlighted book that I think I've ever read. It's going to force me to change how I live my life in some material ways, which is a little scary, but it's also really exciting.
So, I'm excited to talk about that book. So those are the books that I read in July. With that, let's move on and talk about a framework for you to think through whether you should do a Roth conversion.
PRACTICAL PLANNING SEGMENT
How should you think about whether you should do a Roth conversion? The typical first step for many is to start to build a spreadsheet or to start to do some modeling in financial planning software. We typically start with math.
One is, if you're thinking about this in depth, you're likely mathematically inclined, so that's a safe place for you and math is extremely important, but the difficulty with math when it comes to dynamic planning or retirement planning is that math works really well in a closed system where everything is known. In retirement planning, almost everything is not known. We don't know what inflation is going to be, what tax rates are going to be, how long you're going to live, what the sequence of returns are going to be, what you're going to need from your life when going forward 5, 10, 20, 30 years, there is so much uncertainty that the utility of math really starts to break down quickly.
So, I would suggest that if you want to consider whether you should do a Roth conversion, don't start with math. Remember that this is the optimization pillar. It can definitely enhance your journey.
So how do you approach it if you don't start with your spreadsheet? I don't know if you've seen a layer deeper on typically how I do these themes, when I want to explore a topic for myself and create or refine my standard operating procedure for how I address something when I'm making these decisions in concert with clients, say, that we work with. I do a theme on it and that helps me think through things in an organized way.
That's why the impetus of doing the Roth opportunity series had to do because it's something everybody talks about. It's a bigger lever in the optimization pillar for sure. But also, I had to refresh my understanding of the five-year rule and all that other gobbledygook.
So, an easy way for me to do that is to do it publicly with you. Through this process, Troy and Scott and my team have been working through what is our protocol or algorithm for deciding whether someone should do a Roth conversion? How do we do that in an organized way? And so, we started off with math, just like you likely do.
And then we went to what we've talked about before, a decision-making structure, and we use the OODA loop. Which comes from the military, specifically aviation. It's an acronym, O O D A, Observe, Orient, Decide, Act. So, we're going to go through an OODA framework for deciding whether you should consider doing a Roth conversion or not.
Now this is nowhere complete for public consumption. This will help you start to build your framework because the key thing you need to do in answering this question for yourself is to think through this in an organized way. That's more important than having the best spreadsheet, is to think in an organized way so you can make a judgment call.
At the end of this, regardless of how fancy your spreadsheet is, it's going to be a judgment call on your end. That's why you need to be thoughtful in the organization of it. One thing I think we underappreciate when we're thinking of making a judgment call is you don't have to decide for the next five, 10 years or 20 years.
You can build out a five- or 10-year Roth conversion model and that's great, it's not necessarily a bad exercise to do, but ultimately it's going to become a year by year decision. So, going through that OODA loop, once you've done this, you've observed, you oriented, you've decided, and you act, and let's say it was to do a Roth conversion, guess what?
You're going to go through that loop again next year, maybe multiple times. That's the whole point. You want to go through that OODA loop really quickly because life is going to change so much that you want to have a fresh thinking based on what you're actually wanting to do and the situation on the ground.
Okay, so let's go through this OODA framework to help you answer the question, should you consider a Roth conversion.
Step one is to observe. Observe where you are now. So, to do that, the first thing you have to have before you even begin this process is you need to have a draft plan of a resilient plan of record.
If you don't have that, you're not going to have much of a framework to observe and then orient and decide. So, if you've listened to the show for a while, you've heard what we said. What do you need to have a draft plan of resilient plan of record? Well, we need to have a vision that is turned into goals. Those are the frequency and the amounts of your base great life spending and your discretionary spending. Then you have to organize your social capital, your human capital, and your financial capital, and do a feasibility study to make sure that that's feasible. Achieving your goal, your vision, is feasible given the resources. So that's a feasible plan of record.
Then you need to go one step further and have a draft of a resilient plan of record, which is essentially cash flow management of how exactly you're going to pay for your life over, say, the first five years of retirement or the next five years of your life. The general ordering that we use is the default ordering, which is you're going to drain your after-tax assets, and then you're going to go to your pretax assets. Pretax IRAs and 401Ks, then you'll go to your tax-free assets. So that ordering in order to pay for your life since you won't have an income. That is your first draft of a resilient plan of record. That has to be table stakes before you even think about doing Roth conversions.
Now, once you've done that, you want to observe a couple things.
One is, are you married or not? If you're not married, then okay, this is a little less complicated. If you are married, that means that you are in joint tax brackets, right? You get to file jointly, which means that you move up the tax brackets a little bit slower. The income levels are a little bit higher.
So, if you are married, we want to observe that, and then if that is the case, you want to do some observation of, well, what's the longevity for both of you? If you're both say 65 right now, are you assuming that both of you are going to live to 90 or 95? Or does one of you have impaired longevity because of a chronic disease or some other condition or simply the state of their health?
We want to observe that here. Why is that? Well, because if one of you is impaired significantly in your potential longevity, that means it's likely that one of you will be single for a longer period of time, and that means you'll go from a joint tax bracket structure to an individual tax bracket structure. That's important to know in this Roth decision that might lean you more towards considering Roth conversions because you know one of you is going to be in a single tax bracket sooner than most.
What else do you need to observe? What is your cash flow going to look like over the next five years? So, either this year or the next five years or the years prior to you needing to do required minimum distributions.
If you have a resilient plan of record draft, you've already built out a cash flow forecast of what your income's going to be year by year, at least for five years. So, you'll very easily be able to say this is roughly the tax bracket I'm going to be in. That's important and we want to observe that.
The next thing you want to observe is what will your projected required minimum distributions be if you execute this draft resilient plan of record. So, if you follow that resilient plan of record draft, you're going to drain your after-tax assets first and let the tax deferred assets grow. You're going to want to do a forecast of what will the required minimum distributions be if I follow that path of deferring taking out of pretax assets as long as possible. The easy way to do that is to have a simple spreadsheet. Take the value of all of your pretax assets today. Apply a, say, 5% growth rate every single year. That will tell you the rough value of your assets at the year that you would begin required minimum distributions you can apply the RMD table to that first year and that will tell you in theory how much you would have to take out in that first year. There are some online calculators that will do that, I think Schwab has one, et cetera.
The reason you want to do this is you want to say, if I follow this traditional path, I'm just building a bigger tax liability and those future RMDs, they may meet the needs that you're forecasting you're going to need, but they may be way over what you need. You're going to have no choice when those required minimum distributions come on, which may force you up higher tax bracket when you're older, when there's a better chance of one of you being single, etc. So, we want to know what those are.
What else do you want to observe? You want to look at your balance sheet, specifically your financial capital, and look at your tax location mix. How much do you have in after tax investments and cash? Those bank accounts, brokerage accounts, joint accounts, etc. What percentage of your assets in those after-tax assets? What percentage is in your pretax assets? IRAs traditional, 401ks traditional, and how much is in your tax-free assets, HSAs, Roths, etc. You want to understand that mix. If you're like most people, you probably have the predominant amount of financial capital or investments in IRAs traditional and 401ks traditional. You may not have a lot of after-tax cash at all. It's important to know that.
Then the last thing that you want to observe, that we're going to talk about here today, because there's a lot of things, is have you met the golden rule? Remember the golden rule is, are you over 59 and a half, and have you had a dollar in a Roth IRA for at least five years?
So you want to observe whether you've met that rule because that makes life a lot easier. If you haven't and you're considering Roth conversions or you're considering Roth as part of your strategy, here is my recommendation to you. Open up a Roth IRA and convert a few dollars into that Roth IRA so you can start that clock.
Now, Troy and I were chatting about this as we're working on our internal framework and we were laughing because here I am, Roger Whitney, super-duper retirement planner. I'm 56 years old and guess what? I don't have a Roth IRA. I've never contributed to one. I've never been able to contribute to one. I started a Roth 401k in my firm so I could contribute to my Roth 401k, but I never got around to setting up that Roth IRA so I could start that clock. So, this is a really easy thing just to not to look at. When I retire, which is going to be forever because I don't want to, if I were to roll my Roth 401k to a Roth IRA, I haven't met the golden rule. Even if I'm over 59 and a half.
I'm going to open up a Roth IRA, get a dollar in there. If you haven't done that, do that. So, you want to observe these things cause that's going to help you understand. the next part of the decision-making process, which is to orient yourself, and right now I've divided these into qualitative and quantitative orientation.
So qualitative, would you prefer to prepay your taxes right now? Some people are adamant. I want to just pay the known amount and be done with it and allow my future self never to have to worry about my tax bill with my retirement assets ever again. That is reasonable. That's a qualitative decision. I just want to pay for it.
I tend to be that way. Even if there's zero interest, if it's installment payment or pay up front. I would rather just pay it up front, so I don't have to think about it again. That's a qualitative thing you want to orient yourself on. Where do you fall on a scale of 1 to 10 in that attitude?
Another thing you want to observe is what is your view on future income tax policy? That will help you determine how aggressively you want to act, and this is not going to be, oh yes, they're going to raise taxes. If I think you've asked the average person, you think they're going to raise income taxes in the future? You're going to get, yeah, of course they are. Take my money. We all probably think taxes are going to go up.
Do you think they're going to specifically raise income taxes? If you believe so, then the fact that you can prepay your tax and neutralize that uncertainty might be of value to you. Now, there are lots of debates of, hey, it doesn't have to be income taxes, right? They could do a VAT value added tax, a consumer tax, et cetera. We don't know what tax policy will be, we think, in terms of income taxes, but yeah.
Another thing you want to orient to is, Are we in a bear market? If we're in a bear market and your pretax assets have had a drawdown, lost money, well, you want to orient that because that might make it a little bit more attractive in your decision to do a Roth conversion and be opportunistic there. So, you want to orient that.
Those are some of the qualitative things and you could easily just go through a blank piece of paper and answer these for yourself as we follow along.
Now, what are some of the quantitative things that you want to orient? Well, if you do a Roth conversion, will paying taxes from after tax assets drain your liquidity?
If you have 2 million in pretax IRAs and you have 50, 000 in savings outside of retirement. If you do a Roth conversion, you may drain all of your after-tax investments or cash. That's why we want to know that asset mix. If you do a Roth conversion, are you still going to have money in your joint accounts?
Another thing you want to orient quantitatively is when you’re worried about income-oriented items such as IRMA or ACA tax credits, taxation of Social Security, long term capital gains rate? Is there something else going on in your plan that if you do a Roth conversion, these things are going to be consequences of that Roth conversion? They're going to come into play.
Then another one is The RMD tax bomb. And that's where you're projecting your required minimum distributions. If you go along with the standard resilient plan of record, are you just creating a huge host of issues for you when you actually get to your required minimum distributions? Because they're going to be so large that you're going to have to take income out. That's going to run you up the tax brackets and going to cause Irma and taxation of social security, et cetera.
This is the most common thing that I. have found I have to orient with in terms of clients is, wow, if we go the standard route, we're really going to be hampered later in life.
I have a client right now who's been a client for a long time. When they became a client, they literally had zero dollars in after tax assets. All of their money was in IRA pretax assets. He was a surgeon. That was the best practice. because of liability concerns, and now they're in their 80s, and they're taking out so much from required minimum distributions that they're always in a high tax bracket, it drives them nuts every year, and there's nothing they can do about it. You want to orient that to see, wow, maybe I should take some money and whether use it to fund your life or do Roth conversions because it's going to help me later on. We call that the RMD tax bomb.
Another thing you want to orient yourself is where are the opportunities where you're going to be in a low tax bracket, and that's looking at the Resilient Plan of Record. Oh wow, this year I'm only going to have 20, 000 in income. I have a lot of opportunities to either take money out of an IRA or do conversions and still be only in the 12 or the 22% tax bracket. You want to orient yourself to that because that's going to tease out the opportunities.
Then lastly, you want to compare alternate strategies. So, you already have this resilient plan of record that has the traditional drawdown strategy. Create a what if, which is essentially a carbon copy of that strategy, that is doing Roth conversions up to a particular tax rate, or that is using the money, strategic withdrawals to fund life, and then through Monte Carlo scenario or through other spreadsheet scenarios, you can compare with that one lever tweaked or that one difference in input to tease out if there is a substantial long term benefit potentially for doing Roth conversions or locking in lower tax brackets. That's why having a standard process is so important so you can create what ifs where you're just tweaking one item to see potential long-term impacts. Doesn't mean that those impacts are valid because there's so many different assumptions in these long-term models, but it can help tease out some meat on the bone in terms of doing Roth conversions or strategic withdrawals.
So that's the orientation stage. Now we get to the D, the decide. Now when we think about Roth conversion strategies, generally we're thinking about multiyear strategies and the potential benefit of doing it over a number of years, and that can be helpful in the Orient stage. But in the Decide stage, you can only decide for this year, so it's like you have this bundle of bananas. In the orient stage, you're thinking about all the things you're going to do with these bananas as they ripen. But when you get to the decide stage, you can only do it with one banana. You have to wait for the other ones to be ripened, right? When you get to the decide stage, even if you built out a 10-year plan that, of doing Roth conversions or whatever, really, you only got one decision to make. Do I do it this year? I want to make sure you remember that perspective because it takes a lot of stress off of you getting it right, because what's going to happen is next year, another banana is going to be ripe. You're going to go back through the OODA loop. Your plan would have changed because your life's going to change, markets and your dreams and your goals and etc. You'll go through the OODA loop and then you'll decide for that year. So, take some pressure off of yourself.
When you decide, you want to decide, Will I do one this year? How much will I do? Why am I doing that amount? How will I pay the tax, and what would that tax bill be? Or what would that tax bill be and how will I pay the tax? So, let's use an example. Will I do it this year? Yes. How much will I do? I'm going to do 80, 000 because I have almost no income and I can get close to the top of the 12% bracket. So, the why is I'm trying to fill up the tax bracket and only pay 12% tax.
How much will the tax be? Well, you can do the calculation. Let's, for simplicity purposes, let's say if I do 80, 000 and I'm in the 12% tax bracket, I'm going to pay about 9, 600 in taxes. Now, that's simple math. Tax brackets are graded, so it's actually a little less than that, but you get the point. Also, when you're looking at what you're going to pay in tax, if you have ACA, Affordable Care Act, healthcare subsidy, you want to factor in that you're going to have probably a higher premium. How much? You can do this. This is where math comes into play. Just so you understand what it is.
Why you're making the decision, even once you know that tax amount, you want to log why you're making the decision. Yeah, I ACA premium. I'm going to pay 9, 600 in tax, but you know what? I'm still at a really good tax bracket. It's going to lower my RMDs. I'm going to lock it in and I'm not going to have to worry about that amount for the future. You want to know what that why is and then you want to log that decision with your rationale and then schedule when you're going to think about the next banana or when you're going to think about the next conversion so you can go through the OODA loop again.
Why is logging that decision and rationale so important? Because two or three years from now, let's assume you never did another Roth conversion. Maybe you forgot to go through the OODA loop, you went on to other stuff, you just never thought about it again. You're going to look back two, three years and say, why the heck did I do that Roth conversion? What was I thinking? They did away with the tax code and now they're a flat tax or they have a VAT tax. What was I thinking there? That was bad advice. You want to log your rationale. So, you can remind yourself why you did it.
Now where that has manifested itself recently is with three-year fixed annuities.
So if we go back to two years when interest rates were zero, and we were building resilient plans and trying to pre fund life, One lever that we had was using a three year fixed annuity, whereas when interest rates were like zero, you could get two and a half, three percent in a three year fixed annuity, acted sort of like a three year bond type of structure, and that was like mana from heaven relative to where interest rates now. Here we are two years later, and you look and you say, oh, I have that three year annuity at two and a half percent. I can get five percent in a nine-month T bill. What the heck was I thinking? Why did they recommend that? You have got to remind yourself the rationale, because you are making decisions with the data you have at that moment.
So that's the decide stage, and then you act, which is execute, execute, execute, and you go through the process of executing the decision, and then you log when you're going to look at the next one.
That is a reasonable framework for deciding whether to do a Roth conversion. Now, you can get as detailed as you want on any spreadsheets that you create, but ultimately, it's going to come down to a judgment call, and rarely is it ever going to be a slam dunk, yes, which is the truth for almost all decisions that we make. That's why you want to go through this type of structure.
So that's the structure I would recommend. We're fleshing this out internally because we do a lot of this just as practice, but we're fleshing it out from a process standpoint. My internal process is as I flesh that out as a process for us, then I create it as a decision pod in the club, so it can be like an off the shelf, let me think through that in an organized way.
So hopefully that has given you some help. We'll continue to answer your Roth questions, and with that, let's move on and just ask her some of your other questions.
LISTENER QUESTIONS
So, if you have a question for the show, you can go to askroger.me. You can type in your question. You can leave an audio question and we'll do our best to help you on the show.
JEFFREY APPRECIATED THE "HOW" OF ROTH CONVERSIONS
So, our first question is really a comment, which is from Jeffrey and Jeffrey said,
"Hey, this week's podcast was very helpful.
I appreciate that. You covered the "how" to start a conversion to a Roth. I've heard many other discussions on the theory and the benefits and Roth conversions, but nothing on the procedural way of starting the process. Thanks for the valuable content."
You're welcome, Jeffrey. And I think we need to do more of the how do I actually do this mechanically?
We'll try to focus more there as well, Jeffrey.
A COMMENT ON THE PRO RATA RULE
Our next question is related to the Pro Rata rule, and actually, I think it's just some feedback as well from Brian.
Brian said,
"Last week's episode, it was the first time Roth conversions with Pro Rata impacts have been explained to me in a manner my dense head could understand.
Thank you so much for doing that. P.S. If you're ever in the Shenandoah Valley, check out the single-track scene. We have some of the best mountain biking in the country."
Well, thanks, Brian. You're referring to episode four, nine, five on the rules for Roth contributions, and you'll get an example of the pro rata rule.
I have never been to Shenandoah Valley. Want to check that out.
One thing interesting about mountain biking that I discovered when I was in Switzerland, specifically, it was not the rule, but an exception, if you saw a normal mountain bike. Almost all mountain bikes were electric which is becoming more and more the way here in the U.S. And there's a lot of debate about that in terms of trail stewardship, etc. It got to the point where when somebody came by on a normal mountain bike I would clap and give them kudos for using human energy.
I imagine that mountain biking is going to be like when you see somebody on a single speed rather than a gear bike, they're, Ooh, wow, they're hardcore. I'm guessing it's going to be that way. If you see somebody who's not a non e-bike, you're going to be like, Ooh, wow, they're hardcore. So, this might be my chance to finally be hardcore because I've not done a single speed. So maybe we'll get there anyway.
ON FUNDING THE YEARS BETWEEN RETIREMENT AND PENSION
All right. Next question is Beth on funding the gap years.
Beth says,
"I am 56 and plan to retire no later than age 62. I have a pension that kicks off at 65 and plan to start Social Security at 70. Got a 401k, a Roth 401k with my employer and I'm contributing the maximum to my Roth contributions.
Similar to most in my age group, most of my funds are in pretax assets, and I've been trying to make up ground with Roth contributions over the last year. I have no brokerage accounts. at this time, meaning after tax accounts. My concern is about funding the three years between my retirement and when my pension kicks in.
I know the conventional wisdom is withdrawing from taxable, then pretax, then Roth. But as I mentioned earlier, I have no taxable, and withdrawing such a large amount from my pretax will result in a pretty big tax hit, so I'm trying to decide what strategy to do. Should I scale back my Roth contributions now and start contributing to a brokerage account?
Or should I, in those gap years, withdraw from funds from my pretax to the degree my taxes aren't unreasonable and then ignore conventional wisdom and withdraw from my Roth? I would love any thoughts that you had on my funding my gap years."
The first thing I would say, Beth, is I'm excited for you in that you're 56 and you have, what, 4, 5, 6, years to strategically change how you're doing things in order to help fill those gap years. So, you're a little bit ahead of the game on this than most people. So, I like that you're thinking strategically and that's one of the benefits of being intentional.
So, the key here first is having that resilient plan of record with that default spending option, right? And you can do this, say, starting at age 62 and map out what your expected income is from age 62, I would do it for five years. So through 67. Map out what your expected income is going to be, and you're going to have the pension that would kick in at age 65. You're going to have those three years prior to the pension kicking in. That way you see what your income forecast looks like for those first five years. Then compare it to what your base great life spending is going to be plus your discretionary spending to see how much you're actually going to need. You have zero income at age 62 and you need a hundred grand or 80 grand the first year and a hundred grand the next year and then 60 grand the year after that? Building that cashflow model will help you visualize and plan better. So, step one is to do that.
Step two is to go to the accounts that you have and actually map out a first version of how you're going to pay for it. So, let's assume that you do it all from your pretax IRA and 401k, right? So, if you need a hundred thousand in year one at age 62, you're going to take a hundred-thousand-dollar withdrawal plus the amount that you have to pay for tax. We'll call that 112, 000, I don't know what it is, and put that in there and map it out. The fact that you're taking that big withdrawal, how does that impact maybe your Affordable Care Act? It might increase your insurance premiums. You just have to muscle through some estimates here, and then once you have done that using that normal withdrawal method, then you can do what if scenarios or what if I did take some out of my Roth right now? Yes, it's going to maybe hurt me long term, but it's going to allow me to have lower ACA tax credits. It might lower my required minimum distribution. So, I would go to some of the observe and orient portions of the OODA loop that we just went through.
But practically, what do you do today outside of this long-term planning? If you have gap years that you're going to have to fund, I think it's reasonable to start building after tax assets in order to do that. Yes, that means that you're going to have less going into your Roth as an example, so it's not going to change your tax bill because you're already contributing to your Roth account So it won't change today's tax bill, but what it will do is help you in future tax bills basically at age 62 because you're going to have more options on how you withdraw money.
I don't know enough about your situation to tell you how you should do it, because it depends on, well, how much do you have in your pretax accounts, is it 500, 000 or is it 3 million? Because of that, all of these things work together, but I think it's totally reasonable to start building after tax investments. The main benefit of tax-free growth, or tax deferred growth, is time. Well, you only have six years until you're going to need that money. The time aspect is not that great from a mathematical standpoint.
Now, you could make the argument, Beth, and I think this is reasonable that you just continue to contribute to your Roth. So whatever growth or interest you have is tax free, and then your plan is you do use some or all of that to help fund your life.
So rather than saving after tax assets, you just continue to save in your Roth because once you save in your Roth, you'll be over 59 and a half, and you would have had money in the Roth for over five years, assuming you have a Roth IRA established. So, you would have met the golden rules. So that would be another pivot point where you could just continue to save in your Roth and not worry about the fact that you're drawing money from that.
So actually, as I think about that, that's just as valid as saving after tax assets, and don't get yourself caught up in conventional wisdom. Conventional wisdom is meant for the population. You're not the population. You're Beth, and Beth has her one iteration of a life that she's just trying to figure out. I think the fact that you're doing the Roth is going to give you options for your one iteration when you hit age 62. So don't worry too much about the conventional wisdom.
ON HSA FUNDING STRATEGIES IN THE FINAL YEAR OF WORK
So, our next question comes from Nancy, related to HSA funding strategy.
"Hey Roger, I'm a new listener and I really love your show."
Welcome Nancy, we love new listeners. We love old listeners. You know what? I'm just amazed that anyone listens to me, so that's great.
"I'm going into my last year of teaching before retirement. I have a health savings account, an HSA, and I don't contribute anything extra to it per year. I have been contributing to a 403b for about eight years at the maximum allowable amount.
My question is, is in anticipation of retiring and going on Medicare, should I use my last year paychecks to contribute to my HSA instead of my 403b and walk away with a healthy 20k plus balance in my HSA?"
So, the question is, I'm really close to retirement. This last year, I've been contributing to my 403b, not really to my HSA. Should I go max that out rather than my 403b? The benefits of the HSA are that they're triple tax advantage. You get tax free on the contributions, so you get that deduction. Tax free growth and tax-free withdrawal, assuming it's for qualified medical expenses, and you don't have required minimum distributions.
I would suggest, Nancy, that you focus on the HSA rather than the 403B. Now, if you're getting a match in the 403B, make sure you get the match and whatever free money that you get there, but you're going to get the same tax deduction in the HSA. If you invest that money, you don't have to, but if you invest that money, it will grow tax free rather than tax deferred like your 403b. It's not going to have required minimum distributions like your 403b. As long as you're tracking, you know, the one wrinkle with the HSA, one of the wrinkles is that you have to take money out for qualified medical expenses in order not to have any adverse consequence from a tax policy standpoint.
So, if you contribute to the HSA, you also want to start tracking your medical expenses, even if you're not getting reimbursed for them from the HSA. That way, Three, four, five years from now, you could use those tracked expenses to give yourself a distribution and reimburse yourself for that medical expense because there's no time frame in which you have to do that. So, you want to build up those records. So, if you have 20, 000 in your HSA, you can submit past medical bills and get qualified distribution, so it comes out tax free.
Then in terms of what do you do with the HSA assets? Well, you're going to have to figure that out in your resilient plan of record. But if you do invest in those, you can put those into treasury bills. You could treat it like a long-term tax-free account and build a bigger healthcare bucket or tax free bucket later in life. You could use it to pay premiums prior to Medicare. You have a lot of options. I wouldn't just leave it in the HSA as cash, which is what most of us do, especially if you're not going to reimburse yourself.
I would at least put it into treasury bills, especially now we can get 5% or so, but I think going to the HSA is reasonable. You're going to get the tax deduction. If you want to invest it, you can invest it and it will be tax free assuming you have some qualified expenses to offset against it and you're not going to have required minimum distributions like a 403b.
The only other wrinkle that you want to think about is unlike an IRA or 403B, if you die with the HSA asset, all that money has to come out in a single year. It doesn't have the 10-year frame like a IRA or 403B.
Now let's move on to the Bring It On segment.
BRING IT ON
Today on the Bring It On segment, I want to talk about mindset.
When we were in Europe, we went to Cologne, Germany, which is on the Rhine. The majority of the city was destroyed by World War II bombings, but the cathedral in Cologne was not. They started construction on the cathedral there in 1248, and for 200 years, they worked on building it, and then they halted construction in 1560, a little over 200 years, and then they had off and on again attempts, especially in the 1800s, to complete the cathedral. So it took hundreds of years to build this cathedral. For a period of time, it was the tallest building in the world and has one of the tallest spires in the world.
Massive, massive cathedral, and we're walking around it. And we toured it as part of a walking tour in Cologne and Dirk, our guide is his early fifties was a former professor of ancient history at the University of Cologne and gave us so much perspective on the city, the Roman walls, things that you would never see just walking by.
But when we got into the cathedral and he was starting to paint the picture of obviously the mass of it, the size of it is overwhelming, but the beauty of it is incredible as well. And he started to explain, you got to think about this, the architect, there wasn't an architect for something that takes three, 400 years to build.
There were architects, multiple architects, four, five, six, seven, eight, everybody that worked on this cathedral from the architect to the stone cutter to the craftsman to the laborers, they gave their life building this cathedral knowing that they weren't going to be there to see its completion.
You start to get that kind of perspective about life and commitment. That's pretty incredible now in the times where this was being done It was definitely a glorification of God, but there was a lot of other things. It's a good job. They got to eat. Everybody was eating hand to mouth. It wasn't an easy life, I'm not going to say that it was totally always the most noble thing, but people for hundreds of years worked on this knowing they weren't going to see the result of it, including the architects.
That is some interesting perspective or mindset to take when we think about our lives, at least for me. What are we going to accomplish in this lifetime? I have to get this done. That is a little bit more of the thinking in modern times than in ancient times about what we will do with our life and see done rather than seeing the thread that we are part of that is well beyond us.
So, as I think about the show and the club and the work I’m doing, I am a steward of a thread of trying to help people rock retirement. This will not be complete in my lifetime my work and hopefully I am contributing in some way to the thread that will be carried on by Troy or by others or by Nicole or whomever.
That is an important perspective I think to keep from a mindset standpoint. So, my challenge to you, as you think about your life, rather than think about it as finite, think about what thread are you carrying on. Perhaps it's your mother's or your father's or a friend or a colleague that you respected that you're mentoring others as a result of them or the recipes that you're passing down generationally.
We are but a part of that, and I think if we lose that we're a part of a much bigger tapestry, we lose a lot of the wonderfulness of life. So just want to reset that perspective for you. It helped do that for me. If you're ever in Cologne, check out the cathedral because it's amazing. Now let's go set a smart sprint.
TODAY’S SMART SPRINT SEGMENT
On your marks. Get set,
and we're off to set a smart sprint. One that you can achieve in the next 7 days. To not just rock retirement, but rock life.
Alright, in the next 7 days. I want you to schedule a time to go through an OODA loop to examine how you're going to deal with the Roth opportunity. Replay this episode, go through observing, and then orienting. Make a decision for the banana that's ripe this day, this year, 2023 right now. Make a decision for now, and then explain why you made that decision. Whether it's to contribute to a Roth, or to do a Roth conversion, or whatever it is. Act on that decision, and then don't worry about it.
Then you can revisit this another time but schedule the time that you're going to do that so you can optimize a plan and feel confident in your decision as you walk this journey to create a great life.
CONCLUSION
So good to be back after my trip to Europe. I'll have some insights from that. I have worked really hard to not journal or observe and process my life while on vacation, if that makes sense. I tried to just simply be, and then Shauna had to turn around and go to a wedding right when we got home, so I've been home for actually seven or eight days, and I've been enjoying processing the trip after the fact. That way I didn't get too caught up in processing it while I was well being present with my wife and my friends and all the cool people I met.
Now this show is dedicated to helping you on your journey to rocking retirement. We really are. This is the thread that I am on for the rest of my life.
We're going to try to do that as authentic as possible. We're not going to talk to you about products for money. We're going to tell you about the club, obviously, because we think that's a big component or could be a big component, but we're not going to talk about products for money.
We're going to try to be as intellectually honest as we can, always have curious eyes and always focus and have a bias towards how you actually take a little baby step, take action to create the kind of life that you want. Hope you have a wonderful week. Gosh, I hope it gets a little cooler soon.
The opinions voiced in this podcast are for general information only and not intended to provide specific advice or recommendations for any individual. All performance references are historical and does not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal, tax, or financial advisor before making any decisions.