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Episode #505 - What Is The Ideal Mix Between Before And After Tax Retirement Accounts?
Roger: "Now that I finished Outlive by Peter Atiyah, great book by the way, I've made a really exciting decision. I intend to live forever. So far, so good."
-Steven Wright.
Welcome to the show that is scientifically designed to help you not just survive retirement but have the confidence to lean in because you're doing the work to rock retirement.
I'm going to answer a bunch of your questions on the show today, including what's the right mix of after-tax investments and pretax investments? How do I find an hourly financial planner, what do I do if I only have high fee investment options in my retirement account, and a few more. In addition to that, in our Bring It On segment, we're going to bring on Kevin Lyles, coach of the Rock Retirement Club, to talk about keeping up with the Joneses and the impact that can have on rocking retirement.
So, let's get going.
LISTENER QUESTIONS
If you have a question for me, go to askroger.me and you can type in your question, send me a note or leave an audio question and I'll do my best to get it on the show so we can help you take a baby step on your journey towards rocking retirement.
Now, before we get started with the first question, quick announcement on October 26, and October 28th, we're going to have live online meetups with you and me and many other listeners where we're going to do two things.
We're going to talk about the four pillars that you want to have in place to have a great retirement plan that vision and feasible and resilient and optimized how you can work on those.
Then secondly, we're going to open up enrollment to the Rock Retirement Club for about six days where we've gathered all the resources to help you not just create your plan of record, but also begin your journey of executing that plan.
You can register or learn more at livewithroger.com.
WHAT IS THE IDEAL MIX BETWEEN BEFORE AND AFTER-TAX ACCOUNTS?
All right, let's get to our first question, which comes from Don, short and to the point, Don.
"What is the ideal mix between before and after-tax retirement accounts?"
I'm going to assume, Don, that you mean after-tax investments and pretax retirement investments. So that's the question I'm going to answer here.
On your balance sheet, you have three categories of assets. You have after tax assets. That's like your bank account, your checking account, where you've earned a dollar, you've paid taxes on it, and you're either saving it or investing it or spending it. Then you have your pretax assets. That's going to be your traditional 401k, your traditional IRA where you've earned a dollar. You didn't pay tax on that dollar, and it was invested in an IRA or 401k, and it's been growing, but none of those monies have ever been taxed. Then the third category, which we don't have to include necessarily in this discussion is the tax-free category, which is Roth IRA contributions, where you've earned a dollar, you pay tax on that dollar, you put it into either a Roth IRA, a Roth 401k, and now it's all growing tax free forever. So those are the tax categories that will be on, say, your net worth statement.
Don wants to know, what's the ideal mix between those tax categories? The ideal mix, Don, is one that will give you flexibility during retirement to control how you pay for your life from those investment accounts. There isn't a percentage that really is a rule of thumb. The goal, the intent of the exercise is to have optionality so once you retire, you're not forced to draw from certain accounts because of the tax rules.
So as an example, let's assume you retire at 54. Well, if all of your money or the majority of your assets are in pretax IRAs or 401ks, it's going to be difficult or impossible to take money out of those accounts without having a tax penalty and realizing a lot of income for every dollar you take out of pretax assets because of the rules around those accounts, you have to be 59 and a half, with some exceptions, before you can take money from those accounts.
Those pretax accounts, where you're not paying tax on the dollar you earned and it's all being deferred in a traditional IRA or 401k, is generally how we all have invested because Roths weren't around for a portion of our career and then another time, we didn't realize they were and then 401k Roths or just in the recent five or so years.
So generally, where I'm seeing an issue is we have way too much in pretax assets which means when I pull from those accounts in retirement, I'm going to have taxable income. The ideal mix, Don, is going to be one that will allow you some flexibility to either pull from after tax investments or pretax investments or tax-free investments in order to solve for, obviously, paying for your life, but also solve for other items.
Now, another example would be, let's assume you retire at age 60. If you have the majority of your assets in pretax assets, then if you have to spend 100, 000, You can use some whatever you have in after tax assets, but once you blow through that, you're going to have to pull from your IRA pretax, and that will generate ordinary income, and that could impact the amount you pay on health insurance before Medicare. It might impact IRMA. It might cause you to pay more taxes than you would otherwise, if you could control your taxable income.
What I would suggest that you do is start to map that out, Don. I don't know where you're at in your journey, but the intent here, the ultimate goal is to have flexibility. If you have too much in your pretax account and you realize, wow, when I retire in four years, I'm going to go through my after-tax assets fairly quickly, you may want to start directing some of your savings to after tax investments and slow down the pretax investments. The optimal mix is really going to be specific to you on what gives you flexibility. So, you're not forced to go to the IRA in a pretax fashion in order to pay for your life.
I have an example, in fact, I'm meeting with them in a couple of days of someone much older now, but almost all of their money is in IRAs and 401ks because he was a doctor and they were worried about liability, so qualified plans were advantageous to them. And now they're forced to take out a ton of money in required minimum distributions, even though they don't need it. They hate it every year because it drives them up the tax bracket.
The optimal mix is going to be something that gives you some flexibility there.
WHAT TO DO ABOUT A FEE-HEAVY INVESTMENT ACCOUNT?
Our next question is an audio question on high fee options in a retirement account, in this case a 403b, and this is from Martin.
Martin: Hello, Roger.
I'm new to the personal finance sphere and discovered your podcast about a year ago. Learned a lot. So, I have discovered that my Educator 403b has a weighted expense charge of 1. 6. I contribute about a thousand per month. The balance is 200, 000. I'm 53, earn around 170, 000, and will work for at least 6 years. My net pension amount will be 94, 000 annually. So, my wife will continue to work, and she'll bring in about 36, 000 annually, 36, 000. Once she retires, her pension will be about 12, 000 a year.
So, we spend about 100, 000 per year, which we know will go down once our two college-aged kids complete college and leave the nest. Because we're new to personal finance we have to off IRAs for the balance of 37 K we max those out. Just open a brokerage account, 6, 000 to about 750 a month.
So, my question is, what should I do about the outrageous fee heavy 403B? Should I stop contributing and move the thousand per month to the brokerage account, or is there another recommendation? Of course, when I retire, I look forward to rolling the 403B. into an IRA and also working part time, maybe earning 24 annually.
Thank you for your help.
Roger: It's a great question, Martin. So, what options do you have here?
Well, number one, you talked about, I think the weighted average. So that might be over all of the investment options. So, I'm going to give you a few options that you can pursue. Number one is look at the investment options you have to choose within your 403b, you should have a menu of investment options that you can choose. Each one of those will have its own objective from cash to a hundred percent stocks growth to conservative, and each one will have its own individual internal investment fee and that should be listed within your menu of selection.
So maybe that is the weighted average of all of those. I'm not sure whether that's how they're calculating or not, but maybe you can just choose other investment options or maybe you're already in an option that isn't at that 1. 6 Percent. So, number one is look at the investment options and perhaps they have some less expensive options, maybe some index-based options that can help you lower the cost on that average or whatever you're in right now. So that's number one, look at your investment options and they'll show you the investment options and the fees there.
If you do and you say, man, all of these have a high fee, right? 1. 6 percent on 200, 000 is about 3, 200 a year in fees. That is a dragging performance. A second option could be to talk to your benefits department.
Now that's dealing with the bureaucracy of whatever institution that you're at, but they have a fiduciary responsibility to provide you an investment option menu that controls fees in addition to being options around different investment objectives, and that they fall under ERISA, which is the Department of Labor, I believe.
So they have a responsibility, and I know over the last decade or so, that's become a much bigger thing for 401k and 403p providers. So, you could go to your benefits provider and say, hey man, these fees are really high. Can you add other options that cannot be so high so we can all have more money in our accounts because they're not dragged down by fees?
Third option would be those two avenues are all high fees, they're not going to do anything is you can see if they have what's called an in-service distribution where you can move those monies while you're still working there to an IRA now. Each plan will be different as to whether they allow that or not. So perhaps you could do an in-service distribution to an outside IRA and invest in much lower fee options.
If you're going to lower your savings, I don't know what you're doing from a maxing out perspective, but could you redirect it to your wife's retirement account? Maybe hers has much more reasonable fees.
So, these are some of the avenues I would suggest that you pursue. If you're wanting to lower those fees, cause if you just lower those by a percentage point, that's 2, 000 every year in your pocket that's not being dragged down by fees. I think it's worthwhile pursuing.
FINDING A FINANCIAL PLANNER
Our next question comes from Dean on finding a financial planner.
Dean says,
" Do you have a list of recommended financial advisors who work on an hourly basis rather than on commission? I live in California, but don't necessarily need someone who is in state."
Good question, Dean. I'm going to give you a couple of resources. One is to go to the National Association of Personal Financial Advisors.
They have a search function to filter for planners, financial planners, that work on an hourly structure. So that's going to give you a national database, and then you can filter for other types of qualifications.
The second option is going to be look at Garrett Planning Network, which also has a search engine where you can search by feed type. Some will be local, some will not. I don't think that matters. I think it's finding the right person. Also, Andy Panko at Tenant Financial has a list of advisors that have either a retainer or an hourly fee structure. I think he has some hourly fee structure. That's going to be a much smaller list, but that's one that Andy keeps.
So, I think those are three resources to help you find an hourly planner to solve whatever issue that you're trying to answer.
THE IMPACT ON ENERGY LEVELS
Next. I want to share some feedback from David related to one of our Bring It On segments on energy with Dr. Bobby DuBois.
" On a recent episode, you asked for examples on the tools he describes and the impact on energy, and I thought I'd share my story.
Five years ago, I complained to my doctor about mental fog and issues with memory and concentration. She asked about my sleep and if I snored. My wife had complained about my snoring. She referred me to a sleep specialist for study, and we discovered that I had moderate sleep apnea.
I was fitted with a CPAP. It took me six months to get used to it, but I can tell you it made a huge difference in my energy, focus, and memory. I now regularly sleep seven to eight hours every day. The machine is quiet. My wife loves it because she sleeps better with not storing. I was alarmed when you mentioned that you often sleep in another room because you snore so loudly.
I'm surprised that Dr. Bobby DuBois didn't mention sleep apnea because it affects brain function. By the way, I got a Peloton rowing machine and love it."
Hey, David, what's my handle? It's at Sparty115, I think you can connect with me on Peloton. Anybody can now, I guess. That's cool.
David, I don't really snore loudly. I snore very mildly. It would be useful for me to get a sleep apnea or sleep study, I guess it's called.
I'll be honest with you. I'm a little hesitant to do it because my impression is I don't want to have to wear that machine, the CPAP, which is stupid for me not to be proactive about this. As I've been leaning into my health regimen, I'm going to face the idea that I should go do it if I am not sleeping well so I can be proactive. It's a little bit for right now, I think David, me putting my head in the sand. So, thank you for giving me a poke and maybe some others on the show to be a little bit more proactive and not be so hesitant to do things that might really, really help us, and I'm glad this has for you.
SAVING FOR KID'S EDUCATION
Our next question is around saving for kids education. I haven't answered one of these in a while.
I listen to various financial podcasts and different podcasters and give me different answers to this question. That is not surprising because it depends on the fact set and it's always difficult when you are answering a question in a public forum like this to have a complete fact set because the process should drive the answer.
In addition, everybody's going to have their own opinions. There is no one right path for most everything. So of course, you're going to get different answers because there are different paths available to you.
But your question is,
"Do you think saving for kids college in 529 plans is a good idea? We live in California."
Question two is,
"Or is it better to save the same amount of dollars in my Roth IRA instead of 529?"
Question three.
"If the kids end up with having a large 529 savings, will that prevent him from getting scholarships, or federal aid, or student loans, etc.? Does the SECURE 2. 0 Act affect 529 plans?"
We may not get all of these questions, anonymous listeners, but we'll try to get to a few of them. Where is the best place to save for your child, for education, or your grandchild?
Some of this is going to depend on how old the child is. The younger the child. The better it would be to save in a 529 plan because the dollar that you put in will grow tax free forever. So, if you have an 18-month-old or a 5 year old, you have a pretty long timeline where you can contribute to the 529 and it has the chance to grow over the 5, 10, 20 years before the child is actually going to use the funds. The older the child is, the less attractive 529 plans get it from that tax free growth perspective.
Now you live in California, and this is relevant because that's one of four states that has an income tax and does not offer a deduction for 529. So that leaves you only with the tax-free growth of assets. If you live in other states that have income taxes, you can check. A lot of them will give you a tax deduction on contributions to a 529 plan.
So, as you're thinking through this, where is my child age wise, and what is the time frame that I'm investing for? The younger they are, the better I think 529 plans are to take advantage of that tax free growth.
Now, is it better to invest the same dollar amount, say, in a Roth IRA instead of a 529? Well, in this case with the child, they can't have a Roth IRA unless they have earned income. So, if they have earned income, a Roth IRA would be a good option, but it's going to be limited by the amount of income that they have.
If you're saving for it in your Roth IRA, I would probably not do that. I would probably save in after tax investment accounts in your name, not the child's name, and put it into something that's very efficient and tax wise and low cost. That way, you retain full ownership of the money not in the child's name at all, and it's still very tax efficient.
As far as the implications of having a large 529 on the impact of getting loans, it's possible currently that it may limit your student's ability to get needs based scholarship, but realistically these days so many colleges are offering loans instead of needs-based scholarships, and the cost of college is so high, this is likely not going to be an issue.
Again, if your child is young, these rules are going to change. I think we're going to have a transformation here over the next 10, 15 years in the whole education structure with college.
Hopefully that at least gives you some perspective. There is no best place. I used 529s for my kids, as well as after tax investment accounts. The answer is likely going to be somewhere in between.
HOW TO OPEN A ROTH WITH HIGH-INCOME
Our last question today comes from Alan on opening up a Roth IRA.
Alan says,
"I discovered the podcast recently and is hooked and he's going through the 2022 episodes."
Welcome to the show, Alan.
Alan says,
"I have zero assets in Roth and a big pretax IRA balance.
My wife and I are 58 and I'm hoping to retire at age 62. My income is high, so never thought I was eligible to open a Roth. How do I open a Roth when I have a high income? My 401k doesn't have a Roth option. Do I have to wait until 62 with no regular income to do Roth conversions? I'm confused. How do I do this?"
In your case, Alan, you are a little bit in a pickle.
So, you could open up a Roth, whether you're qualified to make contributions to it or not actually opening up the Roth account. That's easy. You are able to do Roth conversions from your IRA into that Roth IRA at any time that you want and any amount that you do as a conversion is going to be added to your taxable income in the year that you do the conversion.
One thing that we've talked about is the idea of doing a backdoor Roth contribution. Since you don't qualify to make a Roth contribution because you make too much money, if you established a Roth account, you could make an nondeductible IRA contribution, traditional to your IRA, and then convert that amount into your Roth and that's a backdoor way of getting the money in there.
The difficult part with you, and this is why you're in the pickle, is that you say you have a large IRA balance because this means that the Roth backdoor option likely isn't going to be that advantageous to you because it's not going to see that one nondeductible contribution you made. It's going to look at the entire balance of the IRA. So, I think in this case, Alan, opening up a Roth is not really going to be an option for you.
Now in terms of should you wait until 62 and you don't have earned income, you can actually open up the Roth right now and contribute a dollar to it in the way you would do that is you would convert a small amount from your pretax IRA to your Roth IRA and that would start the proverbial five year clock that we talk about from time to time.
So, you could still do that even if you don't plan to do big Roth conversions until 62 or when you get ready to retire. That might still be something that you want to do. I actually would suggest that you do that if you're considering Roth conversions because it's a small amount you could convert from your pretax IRA to the Roth and that will get that clock started, and then down the road, if you decide to do Roth conversions, you're going to be happy you did that.
If you decide not to, it's not that big of harm or foul. So hopefully that helped clarify that for you.
With that, let's take it to the Bring It On segment.
BRING IT ON WITH KEVIN LYLES
Now it's time to bring it on and talk about mindset and how you can improve yours to rock retirement with Mr. Kevin Lyles. Hey, buddy.
Kevin: Hi Roger!
I want to talk about a part of retirement that we don't talk about much, or I've not heard it talked about much, and that is, when you're in retirement, there's no more keeping up with the Joneses.
Roger: Isn't there? Isn't there?
Kevin: No, there shouldn't be. During our careers, I think many of us felt the need to run a race against our peers, right?
We lived in the same neighborhoods, we bought the same cars, we wore the same clothes. We vacationed at the same places. We sent our kids to the same schools. There's so much conformity when we're pursuing a career. We did things that we assumed were expected of us, and we worried about what others might think of us.
But in retirement, one of the freedoms available to us is to be whoever we want to be and live however we want to live without regard to what people are thinking about us.
Roger: Because you don't have to play the political games and the company you're working in or those types of things?
Kevin: Exactly. You're finally free to be your authentic self. Now sometimes, and for me it's true, and I know a lot of others that I've coached, you've got to really dig deep to figure out who that is. Discover not only who you are, but more importantly, probably, who you want to be. Doing that without those societal burdens that I talked about earlier, keeping up with the Joneses, is really a freedom that is wonderful.
Roger: Dude, this is a very, very hard thing because for most of us, and even I think I am, we're conditioned. Comparison does rob us of joy, but we're just conditioned from a societal standpoint to how do we compare to others and especially in the corporate world. You have all the politics and stuff related to that.
Kevin: When I say no more keeping up with the Joneses, it's an aspirational goal that I think we ought to pursue in retirement. We should try to live in accordance with our personal values, not the values of other people. Our employers or the values that we think society has that we need to live up to.
We want to do things that are meaningful to us without regard to how it will appear to others or be perceived by others.
Roger: So, what's an example, whether it's in your life or one that you can think of doing that?
Kevin: Yeah, a big one for me, I was very competitive throughout my career. My career itself, I was in a competitive field. What I'm trying to do, I shouldn't present this as though I'm, I'm a completed work. What I'm trying to do is to not be so competitive, to be more giving of myself.
I think during my career, I tried to stay bottled up for fear of giving away the secret sauce or something and losing my competitive edge. I'm trying to be more giving of myself in retirement. That's one example.
Roger: Do you have a tactic that you use to walk that journey?
Kevin: Yeah, it's a lot of soul searching to decide who do I want to be.
What I'm really trying to do is, the only legacy that is important to me is how my family and friends think of me and how they'll remember me when I'm gone. I try to live the way I want that legacy to be. Like I say, it's an aspirational goal. You never achieve this, obviously. I'm not even very good at it myself, but I'm sure trying.
One thing I have mastered Roger, having things is no longer that important to me. Used to be very important to me that I had the right things. Now I realize I have enough things. That's not an important part. I really think I have achieved that one. I'm no longer about things except new pickleball paddle came out and I had to have it, so maybe I haven't quite graduated.
Roger: One interesting part of that is when you say one of the aspirations, I do want my family and friends to look at me with pride and admiration, right?
Kevin: Right.
Roger: You go a layer deeper on that. This is important, I think. I know it is for me. You have to define, well, who is family and who are friends? Because you can have family that you shouldn't care what they think of you because of their own issues, and you can have friends that way too, so you almost have to define it.
What does the exemplary of people that are hanging around looking at me going, yay, or, ugh.
Kevin: Yeah, good point. Good point. Maybe we need to carry around a list in our pocket. Here's who's important to me today. Are you going to stay on my list?
Roger: My tactic is, because I say I want to play by my own rules and I'm not following the traditional path of my peers in a lot of ways, and I get a lot of FOMO. My tactic is not to be disciplined, but just not to engage in conversations.
I don't read a lot of news. I don't go on social media because when I do, I find I become comparison minded. Yeah, I just don't trust myself not to be able to. That's a good one. That's a good one. It's a hard one. But it'll help us rock retirement.
Kevin: I'll see you next month.
TODAY'S SMART SPRINT SEGMENT
Roger: On your marks, get set
and we're off to take a baby step we can take in the next seven days to not just rock retirement, but rock life.
In the next seven days, I challenge you to check yourself on this idea of comparing yourselves to others. Now we're going to have, well, the plan is in 2024 to have more mini retirement plan lives throughout the year, because we do like to see how we're doing relative to other people.
I think that actually is healthy to a point, but I'm going to challenge you to check yourself a little bit and make sure that you are living by your own rules and creating the life that you want and aren't so worried about what everybody's doing around you.
CONCLUSION
Well, thanks for hanging out with me today.
I'm going to ask a favor here at the end. If you enjoy the show, would you go to your favorite podcast listener app and leave a review of the show? That's going to help other people find the show, so we can build this cadre of people working to rock retirement.
We're dedicated to helping you be proactive, and dialing in you rock and retirement. We're going to try to do it with much integrity and humility and focus on not just talking about things, but actually taking action on things.
I feel honored to walk this journey with you. I hope you have a great week.
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.