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Episode #506 - Should I Stop Contributing to My Pre-Tax Accounts?
Roger: "The individual who is mistake free is also probably sitting around doing nothing. And that, my friend, is a very big mistake." -John Wooden.
INTRODUCTION
Welcome to the show. Roger Whitney in the house.
This is the show dedicated to helping you not just survive retirement, but to lean in with courage because you're doing the work to rock retirement. Got a good show today. We're going to answer some questions around whether you should stop saving in your 401k, as well as understanding QLACs and IRAs. An audio question on do you use after tax assets in early retirement, is this a sound plan, and a few other questions. In addition to that, we've got Mark Ross coming on to help us get our passions dialed in and what the difference is between a passion and interest.
So, good show today. Got a couple announcements to start though.
The first one is I would like to invite you to join me live online on October 26. At 7 p. m. Central, that's Thursday, or on Saturday at 11 Central, where we're going to hang out and I'm going to walk through how to build the four pillars of a great retirement plan. The scaffolding that you want to have in place to have confidence in your plan. We're going to talk about that. In addition, I'm going to invite you to join the Rock Retirement Club. We're going to open the doors to the clubhouse for about six days. And in the RRC, the Rock Retirement Club, we've compiled everything that you need to build your retirement plan around these four pillars. So, you can have confidence that you can manage your retirement and live the life that you want. So, you can go to livewithroger.com to save your seat.
All right. Second announcement. is next month, which is October, the theme for the month is going to be wisdom for my children.
I don't know about you, but I have two adult children. I've been trying to coach them on money, career, mindset, choosing a spouse or a significant other, et cetera. A lot of times the parents are not the one that is in the best position for them to hear. So, what we're going to do is over the month, we're going to share the collective wisdom of you, me and lots of people in the rock retirement club on what we would tell our younger self or our children about mindset, about retirement, about careers, about health, about saving and investing, etc. Throughout the month, we're going to try to share some collective wisdom that hopefully your adult children or even teenagers can listen to help them build an amazing life. In addition to the collective wisdom, we're going to share a lot of books that we would suggest that you have them read or consume so they can become mature financial adults and create a great life for themselves.
So excited for that. With that said, let's get on with answering your questions.
LISTENER QUESTIONS
Let's get to answering some of your questions on how to rock retirement. If you have a question for the show, go to ask Roger dot M E. You can type in your question. You can leave an audio question. We'll try to get it on the show to help you take a baby step towards rocking retirement.
FUTURE PRE-TAX CONTRIBUTIONS
Our first question comes from Javon wondering about future pretax contributions.
Javon gives us a great fact set here.
"My wife and I are 53. We plan on retiring at age 65. We have 1. 8 million in pretax accounts, and by our simple projections, using a 5 percent annualized return, we estimate it's going to be worth 3. 2 million when we retire at age 65 if we stop contributing now. We have 1. 3 million in personal investments, 800, 000 in a Roth, and our kids’ education is fully funded."
Huzzah! Jevon, you guys obviously have very good income and to your credit, you hopefully have been living a great life and saving. Not everybody does that, that has a great income. So, congratulations to you. Well done.
Javon's question concerns the required minimum distributions. He's concerned that he may pay too much tax, he and his wife, when they turn 62.
" Can you provide a framework to think about how to go about deciding, do I stop pretax contributions, or do I continue?"
So, this is an optimization question.
Now, I'm assuming you already have a vision of what you want your life to look like. You have age 65 as a retirement. I'm assuming you have a feasible plan of record. You're still in the accumulation stage, so it doesn't have to be high resolution because you have, what, 12 years? But you want to start knowing, is this feasible, given the kind of spending lifestyle we want to have?
Then, is it resilient? And right now, because it's so low resolution, you're likely going to be focused on just having an emergency fund and a contingency fund for unexpected expenses that come up.
So, this is an optimization question, meaning that you have this fork in the road. Regardless of what path you go on, Javon, it sounds like you're still going to be saving. If you decide to redirect the funds from pretax accounts to Roth or after-tax accounts, it's not like the savings are going to stop. This is just which fork in the road makes most sense. This is optimization here.
So first off, regarding the required minimum distributions, with the recent tax law change, your required minimum distributions are actually going to start at age 75, not 72.
You have a little bit more time for those to accumulate. Also, it is important to remember that once you reach age 59 and a half, you'll have the option of drawing from those pretax accounts. You'll have from 59 and a half to age 75. That's a pretty large window to either do qualified withdrawals or Roth conversions. You do those now but doing Roth conversions or some combination of those things later on. So, you have a big window when you are later in life to manage this. It's good that you're thinking about it now, but it may not be as critical if you're thinking of doing Roth conversions, etc.
If my assumption is correct, Javon, that you're going to be saving regardless of where you're saving, this is just, do I pay the tax now, or do I defer and build up this larger tax liability later on? That's the central question here. I think for sure you don't stop saving if there is an employer match of some sort. Money is that the employer matches based on your contributions to your 401k or 403b. I would explore whether they have a Roth option in your qualified plan because you could simply continue to save aggressively but just start saving in the Roth option rather than the pretax option. Not everybody has that, but you want to explore whether that's there or not.
The upside to continuing to save in pretax accounts, Javon, is, as you likely know, when you put a dollar in, 100 percent of that dollar is going to work. Whereas, if you save in the Roth option, or you save in the after-tax option, a fraction of that dollar is going to work because you're going to pay taxes on it. Then whatever dollar you're shaving off to not save in the pretax account is essentially going to be the last dollar in, meaning that if you're in the 35 percent tax bracket, only 65 cents of every dollar will actually be going to work for you in after tax or in Roth accounts. Now that can be disconcerting, right?
I faced this decision as well, Javon, in that I felt like I was saving too much in my pretax accounts, and because we added the Roth option to our 401k plan, I could save in a Roth account. I felt very lopsided. You actually seem like you have a very decent mix between those three buckets so bravo to you because that's usually people that have a lot in pretax accounts won't have nearly as much in personal assets or Roth assets. So, it sounds like you've already been thinking.
What I ended up deciding for myself was I was going to begin saving in my Roth account even though I was in a similar tax bracket or one of the higher tax brackets. Now mathematically you can run spreadsheets all day or long. You're not going to get to the correct answer in this case.
At least I have not seen a model where it's, oh yeah, it makes total sense. I decided to contribute to my Roth 401k rather than my pretax 401k because I knew that the employer contribution was going to go in pretax and that will change here in the next few years. So, I was already going to have more money going to pretax from the employer contribution.
I had very little Roth or tax-free assets, and I wanted to have that bucket built up. I had the income to where although it was extremely annoying to pay the tax, I mean it's a significant amount of money, I was able to do that without impacting my life in other ways. So that was the decision I came to.
Now this last tax time when I got a little surprised because I did some calculations wrong, it hurt. So, make sure if you do switch from pretax contributions to after tax or Roth that you calculate your taxes correctly because it can be a big surprise. You put in twenty-five, thirty thousand dollars in a pretax IRA, you're going to pay tax on a good portion of that based on your tax rate. That's a good chunk of change. I was doing this thinking that my future self would thank me for this. Even though I was foregoing the money today, I had enough free cash flow in order to afford the tax and I was going to benefit by having lower required minimum distributions and build up this other tax bucket from a strategic standpoint. So, I had more optionality later on.
Now, where you're going to differ from my equation, I think, Javon, is that you already have a lot of money in Roth and a good amount in personal investment assets. If you look at the personal investment assets for me, primarily it's my business, right? Because that's where most of my money goes from an investment standpoint outside of my savings accounts. You've built up a lot of different buckets.
I would call this dealer's choice. Assuming that you keep saving with these dollars, any one of the pathways, continuing to save pretax, putting it towards personal investments, or if you're able putting it into a Roth option, any one of these pathways is going to continue the positive trajectory that you and your family have created for yourself. So, it's just a judgment call there.
Now, if you decide to stop contributions for any of the accounts, let's say the pretax accounts, let's say you stop pretax contributions and then don't redirect that to some other savings. Let's say you live a little bit longer. If that's a consideration, what I would suggest that you do is make sure that the plan that you have is feasible in the event one of you prematurely dies and you start to need the access to these funds prior to age 65, make sure that you're well-funded for what you want your lifestyle to look like today if one of you were to prematurely die. Now that could include some other life insurance that you have in place. Because if you stop saving, you're going to change that trajectory a little bit. It may not be detrimental to the feasibility of your plan, but you just want to make sure you check that.
The last thing I would suggest. is you're talking about age 65 as your retirement. If you go through a structure to say, what is it we really want as a family? Is it feasible given the resources we have? You have ample resources. You're in the top percentile, right, of wealth. Question your assumption that you work to 65.
I'm not saying change it. I'm saying question it. Money comes and goes. Time just goes. If you want a good book to help, bring that home mindset wise, one of the books I finished, I think I talked about it earlier, no, I'm going to talk about it next week, is 4, 000 Weeks by Oliver. I don't have the book in front of me.
Here it is, Oliver Berkman, Time Management for Mortals. If you have ample resources, I'm not saying stop work, but consider the type of structure you want with your life and see if that is feasible. So, you at least know you have some options because it's easy to be on this train of wealth accumulation and think that we just have to keep staying on that train when we could get on a slower train.
But in terms of where you save. I'm pretty agnostic with you. You got three really good buckets. I do think if it were me, I would probably slow down my pretax savings and redirect it either to personal investments or to Roth investments. Yes, you're only going to have 65 cents of every dollar going to work, assuming you're in the 35 percent tax bracket.
But if you're still working and you can afford to pay for it, you just absorb that and it's annoying. That's going to slow the trajectory of future required minimum distributions. It's going to build more after-tax assets, in this case, or Roth, which are better for giving and better for the distribution phase of your life.
You're going to neutralize tax risk on what your future distributions from your IRA will be. That's what I would do, assuming you can handle the payment, but this is going to be a judgment call for you.
WHAT IS THE OBJECTIVE OF HAVING PREFERRED STOCKS IN A PORTFOLIO?
Our next question comes from Jeb related to preferred stocks. This is again an optimization question.
Already has a vision, already has a feasible plan that's resilient. Now just trying to figure out what investments do I put into whatever layer of the pie cake or allocation that he's implementing.
Jeff says,
"I have preferred stocks in my after-tax account. In general, what is the most likely objective of preferred stocks in a portfolio?
What problem are they solving for?
Thanks, Jeb."
It's a great question. I have not used preferred stocks in some time. The main reason is that the preferred stocks of today are not the preferred stocks that we think of with our grandparents, et cetera. So, they're not your grandparents Oldsmobile as the slogan used to say.
When you look at individual stock issues, you start with common, which is the lowest issuance of stock and then you move up to preferred stocks and there's a whole hierarchy within that. About 15, 20 years ago, the nature, might even be longer than that, the nature of preferred stocks changed, and so Jeb, when you look at these preferred stocks, you'll want to look a little bit deeper as to what they actually are.
Meaning that a preferred stock used to be a plain Jane preferred stock. It had a higher order than the common in terms of payout, etc. The newer version of preferred stocks, just in the last few decades, are really, well, it's easier to explain it this way. What a company would do, let's take ABC Company, what they would do is, establish an entity called ABC preferred one, and they would issue very long-term debt to that ABC entity one, and that entity would issue preferred stock shares for that entity by itself. It's not actually a preferred stock of ABC. It's a preferred stock of an entity that is wholly owned by ABC but has within its box long term debt that ABC issued to the new entity. And then that is what would be the preferred stock and they would receive the income from the long-term debt from the holding within that ABC entity.
That's a little bit different than your grandma's preferred stock.
So, essentially, what role can a preferred stock play in a portfolio? Obviously, they generally pay fairly nice dividends, which are really interest payments coming from the entity that holds the bond, and that's why people are attracted to them. So, what role do they play? They play the role of a long-term bond within a portfolio.
If you own preferred stocks within a portfolio, they're going to act very much like a long-term corporate bond, meaning that they're going to be very sensitive to interest rates going up and down. You're not really going to participate in the economic engine of the company because really what you're receiving are interest payments from the debt that the ABC issued to the entity that they created.
So it's going to act like a long term bond. If you're filling your allocation and you're using preferred stocks, I would put this in the fixed income or bond portion. of your allocation, knowing that it's really long-term bonds within that sleeve of whatever it is you're creating. Jeb, that's how I would look at it.
They can be very volatile, meaning going up and down significantly, when interest rates are moving. That's the role that it would play for. If you're trying to fill that kind of sleeve, that's essentially what you're getting.
CAN A QLACS DISTRIBUTION BE TREATED AS A QUALIFIED CHARITABLE DISTRIBUTION?
Our next question comes from Howard, related to QLACs.
QLACs are Qualified Longevity Annuity Contracts. Which are a strategy that allows you to move money from a qualified plan or IRA to an annuity up to about 200, 000 that will defer the required minimum distributions than have guaranteed payments later in life. It's a structure around that. They have to be structured in a certain way. Howard's question is essentially, can a QLAC's distribution be treated as qualified charitable distributions?
We have this annuity we buy in an IRA, let's say.
When those distributions happen, Howard wants to know, can those be applied as a qualified charitable distribution, meaning that the distribution goes directly to a charity which satisfies required minimum distribution?
We've done some research on this. Howard, my team and I, and it's as clear as mud, and I know in other emails that you've been getting some various answers depending on where you go.
I don't know the answer. We cannot find a definitive answer of whether the QLAC distribution can be treated as a qualified charitable distribution. My judgment is likely not, because a qualified charitable distribution has to go directly from the IRA to the charity in order to bypass required minimum distributions, and when you create a QLAC, you sort of create a sidecar to your IRA or qualified plan that's separate from.
My guess is not, but I wanted to answer it here on the show, as in Roger doesn't know, just in case there's a very geeky person who's researched this issue, Howard, that might share their knowledge with me so I can share it with you and the other listeners.
But in our research, we haven't found anything definitive to say that you can actually do that. So, I wanted to share that answer here and see if anybody has more wisdom on the subject than I.
WHERE SHOULD THESE 34-YEAR-OLDS SAVE?
Our last question for today is related to where should I save? A related question, but by some younger folks.
Charles says,
"I'm 34. My wife is 40.
I know we're not your target audience, but we'd love your help on. Should we save in Roth retirement accounts or traditional retirement accounts? I realize this is a judgment call, but I'm trying to think through balancing taxes now versus later, and there's so many unknown and uncontrollables between now and 2050.
I'm having a hard time figuring it out.
At the moment, I'm contributing Roth to my 401k. My wife is doing traditional to her 403b, which doesn't offer a Roth. Also at the moment, we have roughly 25 percent of our assets in Roth, 75 percent in traditional. Any guidance you can give?"
That's a great question, Charles, and love to have young folks, because all of the things that we talk about actually apply for the most part, at least in longer term planning, but definitely from a strategic standpoint.
You're correct. You're not going to be able to figure this out.
My suggestion. Given your age, you continue to save in Roth IRAs or Roth 401ks. If your wife cannot contribute via her 403b, you could slow hers down and make Roth contributions in a traditional IRA. Definitely get whatever match she's having, but I think it would serve you well to have healthy Roth allocation and healthy after-tax allocation in addition to the traditional pretax accounts that you already have.
You say about 75 percent of your assets are already in traditional. We don't have numbers here. I would continue to focus on the Roth and make sure you also build up some healthy after-tax cash that you can have as a contingency fund as well as Just having after tax investments. I think those three buckets, tax wise, as much as you're comfortable, pay the taxes now to insure yourself, if that's the right word, against all those uncontrollables that you really can't see going forward.
That's going to give you much more optionality as you go. With that said, let's move on and bring on Mark Ross for our Bring It On segment.
BRING IT ON WITH MARK ROSS
Now it's time to focus on the non-financial pillars of retirement. Today, we're going to talk about passions, having passions in your retirement with retirement coach Mark Ross.
Hey, fancy shirt guy, what’s going on? Mark always has these fancy shirts on.
Mark: Yeah, I always wear fancy shirts, it keeps me awake, and thank you so much for the invitation to chat about passions in retirement. One of the pillars under mindset we talk about in the Rock Retirement Club.
Passions and interests, are they the same? That's the topic that I think we can talk about today. Some say they're the same. Some say they're interchangeable. What do you say? Let's talk through this and see where you land. Have a little call to action and see what happens.
Roger: Yeah, for me, passions are projects that I'm working on. They can be personal projects, whether an interest or just, I think they can be the same. I think everybody has to make this decision. For me, the core thing is to have things that you're pursuing to improve yourself or to improve the world around you.
That's what I think of a passion as.
Mark: I would agree. Sometimes those can be, well, for example, passions are not always, we're not going to split hairs here, but passions can involve a deep emotional connection. It's like I love art and I'm committed to that, and I love to dive into it daily in different ways, but I also have interest where I'm just curious and I'll explore and experiment with something, but it may not last very long.
So, it doesn't really necessarily mean it's a passion. They're just various interests. So that's one difference. A nuance between passion and an interest. Passions usually are related to projects and interests. I have an interest in purging my storage unit so I can get rid of it and quit paying for it. But I do not have a passion at all for that.
Roger: What is it about storage units? I've never had one, but that's like an American thing. There was an article, I think, in the Wall Street Journal a few weeks ago about that, but it’s very U.S. centric.
Is this about consumerism or why do you have a storage unit?
Mark: I've never had one until we had in laws who aged and passed away. We were in charge of executorship a whole different retirement topic but some of their remains were too emotional for my wife to let go of them. We have a storage container, but we're past that now and we're emptying it out.
That's why we have a storage container.
Roger: That seems like a very valid use case.
Now, I say this being in a house over 3, 000 square feet with two people and not having a storage unit, but I have attics and I got a bunch of stuff in there that I need to get rid of. So maybe I have my own storage unit. I just have it in my attic.
Mark: You live in a big storage unit and y'all happen to live there too.
Roger: So that's an interest of hey, I want to get this done. It's a fleeting interest whereas a passion is for you. It's art for me. It's I guess exercise or mountain biking or reading. Why are they even important? Why do we care?
Mark: We talk a lot about happy people who have projects and often projects are something that we're passionate about, and that's why we dive into them. But we also can think about things that have interested us for a while and we may experiment with those interests, and they may not go anywhere. But at least we tried. They didn't turn into a passion.
In another episode, we're going to talk about what if I don't have any passions, but that's for another day.
Roger: Okay, I was listening to a podcast the other day and the gentleman studied baboons for a couple decades, and he was a Scientist, professor as well outside of the studying baboons. He talked about certain tribes of baboons when they lived in certain environments where in three hours of the day, they were able to get all the food and nourishment that they needed. Which meant that they had 21 hours of the day for stuff, just random stuff.
That actually is very problematic, especially for humans, and this was the connection he was making, that if you have 21 hours of the day, because the other three are just basic maintenance and food, our minds are very good at tormenting us when we have idle time.
If we don't have passions or interests, we’re going to be in for it, potentially.
Mark: Absolutely. For many of us in this retirement space, whether you're approaching a season of retirement, meaning pulling away from the work you've done for a long time to open up some new horizons, to do some new things that if we don't have some kind of project or passion or interest that pulls us forward, we can get lost in that 21 hours of who knows what, right?
Roger: Exactly. So, I imagine the action today is to make sure you are thinking about these things.
Mark: Yeah, think about these things and think about your core values. If you're familiar with your values, usually the top five, that kind of start pointing towards things that interest you enough. They could turn into passions.
The last thing is that a passion usually has an intense focus. I just started playing the guitar again. Now, am I passionate about that or is it just an interest? So far, I've been disciplined every day to practice. I really enjoy it. I look forward to it. I'm passionate about the sounds coming out of this new guitar I bought.
I would say I lean toward it, it's a passion. If it lasts for a while, I bet it's going to be a passion project that keeps growing. If not, it's just going to be an interest that fleets and flits away. So be flexible and be aware.
If you've heard anything today about a passion or an interest, And the nuance, the nuance doesn't really matter. It's like, what are you going to do with your time? How are you going to move forward and focus on one thing that may be a passion, or maybe you're already into your passion and it's just time to refresh it. So, there you go.
Roger: Great advice.
TODAY'S SMART SPRINT SEGMENT
On your marks, get set,
and we're off to take a little baby step you can take in the next seven days to not just rock retirement, but rock life.
All right, in the next seven days, we're coming up here to the end of the third quarter ending. Hard to believe. So, your action item is to prepare to update your net worth statement for the quarter end.
If you've never created a net worth statement, that's okay. Let's start.
We'll share a link to a worksheet that will help you on your way to creating one and you can get that in our 6-Shot Saturday email. If you like the show, you're going to love 6-Shot Saturday. It's a great resource with summary to answers to the question but also links to resources and links that we talked about on the show. You can sign up for that at rogerwhitney.com or 6shotsaturday.com but I want you to update your net worth statement because this will help you in some of the questions that we were hearing today about where do I have most of my assets, my financial assets? Am I mostly pretax? Am I mostly Roth? Am I mostly after tax? And you can start to identify some rebalance or some imbalances. in where you're saving.
The key here is not to get it perfect. The key here is to be intentional about providing yourself optionality in the future and trying to maximize the tax code to your benefit.
So that's your action item. Let's get started.
CONCLUSION
Are you excited for October? I know I'm excited for October. It's going to be a big, big month. We're going to talk about wisdom for our children and have a lot of things that we want to share to our children, and we're going to collect your thoughts on friends and spouses and money and retirement and career that we can share as wisdom that we've learned because we're so much older that we can share and hopefully this will be a resource to help spur some conversation over the holiday season or they could just listen to on their own.
In our 6-Shot Saturday email, we're putting a form like a Google form where you can share some of your tips. So, make sure to fill that out and we'll try to share that on the show or create a resource.
I'm excited for October. We have a couple hundred people in the Rock Retirement Club coming to Fort Worth for our annual get together, conference, whatever you want to call it. Excited for that.
What else? The heroic book, Areté: Activate Your Heroic Potential, by Brian Johnson is coming out at the end of the month. I'm excited about that. Going to the book launch party. We'll have some freebies related to that. I'm always excited to sit here and chat with you every week.
Be well.
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 do 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.