The Most Optimal Way To Invest For Retirement - Don’t Invest Everything Into Your 401k

00:00:00.000 | Everyone says to max out your retirement accounts, but is that always the best move?

00:00:04.400 | Today I sit down with financial planning expert Michael Kitsis to challenge the traditional advice

00:00:09.140 | and explore why your saving strategy might be holding you back. We cover smarter ways to grow

00:00:13.980 | your wealth, how to think more intentionally about where your money's going, how to access

00:00:17.620 | your retirement accounts early, how to avoid unnecessary taxes, and what people miss when

00:00:22.500 | planning for flexibility or even early retirement. I'm Chris Hutchins. If you enjoy this episode and

00:00:27.320 | want to keep upgrading your life, money and travel, click follow or subscribe.

00:00:30.920 | Michael, everyone says to max out your retirement accounts, but do you think that could actually be

00:00:36.200 | bad advice sometimes? I tend to start from like one step back, which is to say, not just where am I

00:00:44.540 | saving the money, but effectively, what is the opportunity cost of the money? What else can I do

00:00:49.580 | with the money? It's like, okay, I can save in my retirement account. I can put the money aside for

00:00:55.340 | potential to start a new business someday because if I actually go and launch a business someday that is

00:01:00.900 | successful, that is very challenging. A lot of people fail. It helps to have a little bit of a

00:01:05.100 | financial cushion to fail, but a lot of wealth building comes from successfully creating a business,

00:01:10.120 | which I ain't ever going to do unless I have dollars available to do it, which is difficult to

00:01:15.900 | draw out of a retirement account. Or I can do this to go get some class training, certification,

00:01:21.660 | designation, whatever it is in my profession of choice that maybe gets me a little raise. That

00:01:27.220 | if I'm in my twenties is a raise I get as like a new baseline salary for 40 years from here. I mean,

00:01:34.420 | even if I'm in my thirties or forties, like I could have a good 20 something years left in my career.

00:01:40.220 | And I find a lot of us just we drastically underestimate the impact that comes from

00:01:47.780 | taking our savings and trying to use it to advance our career, as opposed to taking our savings and just

00:01:53.420 | kind of yanking it out of my career and putting it in the future retirement savings box. So if I take two

00:02:00.780 | grand and I go get some certification and whatever my profession of choice is, and my boss says,

00:02:09.340 | cool, you finished it. You're probably a little more competitive in the marketplace. We want to retain

00:02:13.540 | you. Like, here's a thousand dollar raise. We're fairly low stakes here. You didn't even get your

00:02:18.340 | money back in a raise yet. Like you're two grand out of pocket. And they gave you a thousand dollar

00:02:23.220 | raise. It's like, well, okay. But for most of us in our careers, salary I earn here is also the salary

00:02:28.900 | base from which I negotiate for my next job. So this not always, but often is like kind of the new

00:02:34.300 | baseline of my income for life, like for a trajectory from here, take another thousand dollars of income,

00:02:40.100 | make that for the next 40 years. That's 40 grand. If I put $2,000 in my IRA, that's two grand. Now,

00:02:47.120 | if I grow two grand by about, you know, like 8% balanced portfolio for the long-term, two grand

00:02:53.360 | actually will grow to 40 grand over about 40 years. If you get long-term rates of return,

00:02:58.880 | return. But if I make an extra thousand dollars a year, I can save and invest that every year. It's

00:03:05.160 | like I get an extra grand for 40 years. I get an extra grand for 39 years. I get an extra grand for

00:03:09.200 | 38 years as I wind that forward. So if I take my $2,000, I put it into my career, I get a thousand

00:03:16.040 | dollar raise. And then I take my extra thousand dollars of earnings and I save that every year for

00:03:21.160 | the next 40 years. And I get the savings and the growth that maps out to about $400,000 at the same

00:03:28.580 | growth rate that I would have gotten by just putting my two grand in my Roth IRA. This isn't perfectly

00:03:33.980 | apples to apples, but we're literally 10 X difference. This is way more than even, okay, there's some tax

00:03:41.700 | benefits to Roth that I don't quite get in the same way. If I'm getting some earnings that themselves are

00:03:46.280 | taxes, wages, it's such a massive difference. I mean, even if you're already in your thirties or

00:03:54.540 | early forties, like you've only got 20 or 25 years left on your career, $1,000 raised for the next 25

00:04:00.140 | years plus growth, it's about 300 grand. Two grand into your Roth for the next 25 years, it's like

00:04:06.200 | $15,000. It's still like a 20 X difference. Ironically, it's actually even more dramatic because

00:04:12.580 | the compounding of the extra earnings favors you more when the time horizon shorter. Starting to

00:04:17.140 | think from that frame, like I could put my money into the market. I can put two grand in and get my

00:04:23.400 | growth, right? 8% a year. I make $160 of growth in the first year, or I put my two grand in and I get a

00:04:30.820 | certification that gets me a raise and I get a thousand dollar raise. It's like getting a 50% dividend

00:04:35.980 | and you get it every year. And that might grow with inflation because salaries usually get COLA

00:04:41.440 | adjustments over time and you can reinvest that money to grow. And so just doing things to make

00:04:47.160 | the human capital bucket bigger grows a lot more than compounding the financial wealth. Now there's

00:04:52.860 | a point where that changes. You get within 10 years of retirement, it is very much how do we harvest the

00:04:57.000 | money out of the human capital and put it into the financial capital so that we can afford to retire.

00:05:01.220 | So like, this is not indefinitely true. It is very specific to time horizon, but for those of us,

00:05:07.280 | there are twenties, thirties, even into our forties, where we might still have a multi-decade time horizon.

00:05:11.600 | We just so underestimate the impact that comes from spending dollars to do things that might get us

00:05:20.480 | raises and promotions and how much it compounds. And frankly, for a lot of people in a lot of industries,

00:05:26.220 | like $2,000 for high quality certification designation, like that is actually more than a

00:05:32.020 | thousand dollar raise. It's not always immediate, but show me the career trajectory of people in your

00:05:37.340 | profession that have more advanced knowledge versus the people that don't, there's usually a pretty big

00:05:42.300 | income gap. The cardiothoracic surgeons make more than the general family practitioner. Forensic

00:05:47.720 | accountant makes more than the generalist CPA. I mean, almost every profession financially rewards

00:05:53.460 | specialization and more deeper advanced knowledge, but it apprised across a really wide range of careers.

00:06:00.900 | And I would say there are some companies that might even pay for this. Like you could be listening to

00:06:04.740 | this and not have to make the trade off. You could take advantage of your advice to add hundreds of

00:06:10.260 | thousands of dollars over your career and potentially do it for free. Whether it's free certification,

00:06:15.700 | company paying for certification, applying for a sponsorship.

00:06:18.820 | Oh, absolutely. And like the challenge I find for a lot of folks is like they stop at the free line.

00:06:24.500 | Yeah. And it seems like the ROI is even easier. The example you gave about business, a lot of wealth

00:06:30.260 | in America is made from business, but it's not quite as clear as get this certification, comp people's

00:06:36.900 | salaries that have it. But certainly you could make a case that if many business owners in America had not

00:06:44.740 | put the money in their business and had instead put it in whatever index fund of choice, they would have a lot

00:06:50.020 | less wealth having never built that business. So I think it's good to open your eyes to

00:06:55.060 | other ways that you can use money to build wealth that isn't just savings.

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00:09:33.220 | What do you think about the kind of liquidity flexibility argument, which is maybe not don't

00:09:40.260 | save, but maybe don't save in a retirement account and instead save in a taxable account?

00:09:46.260 | So in an investment context, we all have different tolerances for risk, right? Some of us buy like the

00:09:52.580 | high-flying stocks and we're all in and some of us buy a diversified index fund. There's not a right or wrong

00:09:56.660 | answer. Just we all like taking different versions of the journey. So to me, there's a similar version

00:10:01.300 | that shows up in human capital, in career capital with kind of the same parameters. So my more

00:10:08.500 | conservative version is I'm going to take the dollars and try to get a certification or designation so I

00:10:14.580 | can get a raise. The slightly more aggressive version is I'm going to build up a reserve of a

00:10:19.460 | couple of months of expenses so that if I get the dream job that would be amazing, but I have to move

00:10:26.100 | halfway across the country, uproot my family, spend the money to move and relocate, go a month without

00:10:31.860 | income while I'm going through the transition. I can take the dream job and do that because I've got some

00:10:38.580 | kind of, I'll call it like a financial transition fund. So stage one is this is like certification

00:10:45.060 | designation, get me a raise money. Bucket number two or like option number two, we're going a little

00:10:49.940 | about riskier is this is the transition fund. This is the flexibility fund. So if I get a cool career

00:10:55.940 | opportunity where I have to take one step back to take two steps forward, I can afford to take one step

00:11:01.780 | back in order to take the two steps forward. The third domain is we're like going out on the

00:11:07.060 | proverbial risk spectrum is I want to be an entrepreneur and start my own business someday.

00:11:11.780 | And if you talk to most entrepreneurs that have done it, we all have like horror stories of how

00:11:17.300 | awful it was and how little money we made for a while or negative money or went into debt or all the

00:11:22.500 | things for every one story of the person that's like, I had an idea. I started my garage with no money

00:11:26.740 | and I turned into a bajillionaire. Most people who try entrepreneurship lose a lot of money for

00:11:31.940 | an extended period of time. So high reward in the risk reward spectrum, like it holds for human capital

00:11:38.100 | the way that it holds for our financial capital. But what that means is, okay, if I've got aspirations

00:11:43.220 | somewhere someday of starting a business, then I need to be able to let even more reserves and I need it

00:11:48.500 | more liquid. So if you're saying you're saying, yeah, like never going to start a business, got to

00:11:55.460 | defense enough emergency fund, I can float the transition, then maybe you don't need any more

00:11:59.540 | liquidity than that. Core emergency fund is sufficient and either power forward with your

00:12:04.500 | retirement accounts or maybe just think about might I want to do a little bit less to retirement if that

00:12:09.300 | would let me do a little bit more towards training certification designation, like something in my

00:12:14.260 | in my career of choice. But again, like the scenario where I spend two grand and get a thousand dollar

00:12:19.060 | raise and like 15 to 20 X my return on my Roth, that's the low return conservative one on this

00:12:25.140 | spectrum because the ones that build businesses successfully tend to build even more significant

00:12:29.540 | wealth that goes along with it. And so all of that to me comes down to, I mean, retirement accounts,

00:12:35.700 | yes, like wonderful tax advantages, long-term saving compounding, all of those things are wonderful and

00:12:41.220 | completely true. And when we're still early in mid-stage in our career, we still live in a realm

00:12:48.340 | where the human capital bucket is a lot larger than the financial capital bucket. And our ability to

00:12:54.820 | impact the human capital bucket, what we can do, what we can earn over the rest of our careers,

00:13:00.020 | is something we actually have a lot more financial impact over than sometimes we give it credit to be.

00:13:05.380 | And when you look at how this averages out over the long run, it takes a remarkably modest raise or new

00:13:11.940 | job promotion to just have like a massive change in financial trajectory in the long term.

00:13:18.340 | Okay. So now I'm going to flip the table and ask you to take the other side, which is for someone who

00:13:22.900 | either has enough savings or has enough extra income that they can put money in multiple places,

00:13:31.220 | but is kind of thinking, gosh, I don't know what the future holds. I'd like flexibility. Does it even

00:13:36.420 | make sense to put money in a retirement account? Make the case for why the tax advantages of a retirement

00:13:42.180 | account might actually outweigh just leaving it in a brokerage account if you didn't end up needing it.

00:13:47.620 | I'd answer this two ways. I mean, the first is it's sort of like a practical reality of the rules. Roth style IRAs,

00:13:56.580 | when you put the dollars in the earnings are subject to taxes and potential penalties if

00:14:02.260 | you take them out early, but your principal, you can get back. You've got liquid. So you do have some

00:14:08.740 | options to get your Roth style dollars back a bit earlier if you want to, which means I've at least got some

00:14:14.820 | partial liquidity options available with Roth style accounts. That aside, we have a natural tendency and proclivity

00:14:24.100 | to keep and hoard more dollars that are available than are necessary. Our banking system is literally

00:14:30.020 | built and predicated on this. Like the whole nature of how the banking system works in the simplest sense

00:14:34.900 | is we put money on deposit that we could withdraw at any time. And then we don't withdraw it for months

00:14:40.660 | or years at a time, which is why banks can pay us a very limited amount for giving us all the liquidity

00:14:45.380 | and then actually lend the money out to someone else for 10 to 30 years and not go bankrupt.

00:14:49.620 | So everything from banking to emergency reserves is all built around the reality that just as human

00:14:57.460 | beings, we have a tendency to desire a little bit more liquidity than we end up needing. So on the one

00:15:02.420 | hand, look, if that's what makes you sleep well at night, please do not go and contribute so much to

00:15:06.580 | your retirement accounts that like you have anxiety and can't sleep. Like keep yourself liquid enough, you can

00:15:10.980 | sleep. But there comes a point where I'm just financially impairing myself by not taking advantage

00:15:18.340 | of opportunities for growth and opportunities for tax preferences, right? If it turns out that I keep

00:15:24.340 | my money liquid all the way throughout and I don't use it for the next five or 10 or 20 years, I just pay

00:15:29.460 | taxes on growth for the next five or 10 or 20 years that I would not have needed to pay if I used a retirement

00:15:33.540 | account. And that can easily be a quarter of my gross return or more depending on what my tax rate is.

00:15:39.620 | It's a huge pile of money that you don't end up getting because you sacrifice to taxes under the

00:15:46.660 | sheer preference of, I was afraid I might need the money and therefore I paid Uncle Sam a huge portion

00:15:52.420 | of the money for the privilege of not using it myself. So figure out what we need. For some of us,

00:15:58.260 | like, look, if your sleep well at night, peace of mind is like, I don't want three months of

00:16:03.780 | an emergency service or I want six months emergency service. I want two years worth. Like, cool. Knock

00:16:08.820 | yourself out with two years. Give yourself permission for two years. At some point, if you're saving and

00:16:12.900 | investing diligently, you're going to end out with more than two years of reserves. Can we at least commit

00:16:17.460 | that once we get to that point, we're going to take the overflow beyond the two years worth and put that

00:16:24.260 | into retirement accounts. And once we get there where we built that reserve, all future money is

00:16:29.300 | now going into retirement accounts. We're not using the reserve. It just kind of sits there as the balance

00:16:33.380 | that we need to sleep well at night and be comfortable. I worry less about any dollar over

00:16:40.340 | three months of savings is a financial waste and you have to get it into your retirement account. I've

00:16:45.700 | sat across from more than enough clients over the years to know that like just that is not a positive

00:16:50.580 | a peace of mind. It just doesn't feel like it's enough money to be comfortable. It's not enough

00:16:54.420 | and make an adjustment. But sometimes we just don't know what the number is because we've never really

00:16:59.300 | scenarioed through like, what would I really need if bad stuff happens and I needed to tap dollars?

00:17:05.540 | And often when we go through that process, we can get to here's what I need. And it might be more than

00:17:10.900 | the traditional advice about emergency savings, but there's some number. And if you're diligently saving,

00:17:17.540 | you will cross that number at some point. So let's worry less about whether one year or two years of

00:17:23.300 | savings is too much if that's your number instead of three to six months and more about like, cool.

00:17:28.420 | So let's get to that number as quickly as we can. And then I know we're going to take everything above

00:17:31.700 | that. Now, can we agree that we've got enough liquidity that we can put this over to retirement

00:17:36.500 | accounts? And maybe if you want to, let's look at Roth style of retirement accounts where we still got

00:17:42.020 | some way to draw principal back if we really need to. You mentioned briefly that you could be giving up

00:17:47.780 | 25% of your long-term return by not putting that money in some sort of tax advantaged account.

00:17:54.100 | We could debate that number for a while because it's based on all kinds of assumptions about

00:17:59.140 | future tax rates and all these kinds of things. Correct.

00:18:01.540 | But at its core, if you hold the money to retirement, you're probably going to be better off

00:18:06.900 | in a retirement account. For some people, they might only have one option. But for a lot of people,

00:18:12.580 | I know, you know, when I had a W-2 job, I had, okay, well, I couldn't put it in a traditional IRA,

00:18:18.420 | but I could put it in a backdoor Roth. I could put money in a 401k pre-tax, or I could put it in a Roth

00:18:24.260 | 401k. As people think through their options, do you have kind of a order priority or any kind of framework

00:18:31.140 | they can use to decide traditional versus Roth, 401k versus IRA? How do I pick where to go

00:18:37.540 | if I've made the decision that I will be investing for retirement?

00:18:40.820 | So beyond just the emergency savings, high debt pay down, mobility fund, just like once we get through

00:18:48.100 | that foundational layer. The next one that typically comes up for us is we're not actually fooling the

00:18:53.780 | retirement accounts yet. We're in health savings accounts. Tax preference accounts typically have

00:18:58.100 | three different ways that the government can incentivize tax benefits. We get a deduction

00:19:02.820 | up front. We get deferred growth while it's in. We get tax free withdrawals. Retirement accounts are

00:19:09.460 | typically two of the three. Choose your flavor. So Roth is no deduction going in, but you get tax deferred

00:19:16.180 | growth and it's tax free at the end. Traditional, you get the other two. Deduction up front and tax

00:19:20.980 | deferred growth, but no tax free at the end. It's actually taxable. So most retirement accounts are two

00:19:25.540 | out of three. HSA's health savings accounts are unique because they're the only three out of three.

00:19:29.860 | It's deductible going in. It's deferred while the dollars are in there and it's tax free when it

00:19:33.220 | comes out, as long as you use it for a qualified expense. So traditionally qualified expenses, my

00:19:39.220 | medical expenses, and I use it accordingly for any, any medical expenses I've got. But if either I'm

00:19:45.140 | relatively healthy or I'm just plowing in the maximum, my HSA enough that I'm actually still saving

00:19:51.300 | more than whatever incremental medical expenses I get, even after my high deductible health plan,

00:19:55.940 | any dollars that are left over, you get to save, you get to grow. And if you get all the way to

00:20:01.620 | retirement without using them in retirement, HSAs essentially convert to like a mini version of a

00:20:09.060 | tax free Roth for medical related expenses. So in retirement, I can still draw my HSA dollars out,

00:20:15.780 | but I can use them for things like Medicare expenses and health expenditures that I have

00:20:21.300 | in retirement of which there tend to be some eventually. So it becomes like a long term super

00:20:26.980 | turbo charged version of a Roth, except it was actually tax deductible going in and tax free coming

00:20:32.900 | out. I can only use it for the sleeve of medical expenses in retirement, but there's actually a lot of

00:20:37.460 | things that crop up that are medical expense or medically related in retirement. And so it runs very

00:20:42.660 | nicely in parallel with other retirement accounts. If I'm only ever going to be able to save in one

00:20:46.980 | thing, if I'm of more financially limited means, HSA is not a good anchor point because you need dollars

00:20:52.980 | for all the other retirement expenses in addition to. But if you've got multiple wealth buckets that

00:20:58.500 | you're building and eventually you're going to save more than the HSA limits and we're going to put

00:21:02.180 | money to multiple places, HSA has actually become the most tax efficient layer in this like foundational

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00:24:27.140 | oh, I'm using my HSA to reimburse my medical expenses. Here's 30 years worth of receipts of

00:24:31.460 | all the medical expenses I've gotten. Therefore, they're tax qualified withdrawals and off I go.

00:24:36.420 | But in retirement, there is a lot of other stuff that tends to come up that I also have opportunities

00:24:45.060 | to use it for. So just in practice, it's pretty hard to not find any medical expenses that are going

00:24:52.820 | to be eligible by the time I get to retirement. Yeah, I don't disagree. I just think if you get

00:24:58.740 | nervous putting all this money in an HSA thinking, what if I ever need it? It's harder to get out. I would

00:25:03.780 | argue that anytime you spend, you don't have to do it every time you buy band-aids at the store,

00:25:08.740 | but maybe every time you spend over $100, just throw the receipt in a place. And that makes it

00:25:14.820 | much more accessible to get your money out. And you don't have to wait until retirement to reimburse

00:25:19.940 | yourself for a medical expense. Correct. You don't have to wait. But if nominally like we're saving for

00:25:25.220 | retirement and we've got enough money to be saving for retirement on an ongoing basis, we're accumulating

00:25:31.540 | some wealth. We tend to have dollars left over in retirement that we're going to use for

00:25:36.500 | retirement once we're done with our working year. So I mean, yes, you can draw it down if it crops up

00:25:42.100 | that you need to earlier, or we can just end out spending more on covering all of our medical expenses

00:25:48.420 | when we get there. I mean, Medicare premiums alone are not trivial. Like you're going to have a couple

00:25:53.300 | thousand dollars a year per person, particularly if you take current Medicare premiums and inflate them by

00:25:58.500 | 20 or 30 years of medical cost inflation of whatever Medicare is. By the time you get there,

00:26:04.020 | you can cover long-term care expenses. There's a lot that crops up. We can give a link in the show

00:26:09.940 | notes just for all the different ways that HSAs can get used in retirement that give you just,

00:26:16.180 | it's the deduction upfront and the tax-free at the ends that, again, I wouldn't have it as my only bucket

00:26:21.940 | for retirement because there's other clearly non-medical, non-health related expenses that crop

00:26:26.580 | up. But for folks that are saving multiple buckets, this is a particularly tax-advantaged one,

00:26:33.940 | a uniquely tax-advantaged one, because it's the only one that really runs on a triple tax-free basis.

00:26:39.460 | Everything else is two out of three.

00:26:41.060 | Now you're only eligible with the right health plan. So let's assume you don't have that health

00:26:46.340 | plan right now. We're not going to go down the path of how to pick health plans. So now let's move on to

00:26:51.700 | the other buckets.

00:26:52.420 | So then we start getting into core retirement accounts, right? For most of us, it tends to be

00:26:57.620 | two dimensions. I've got to go tax versus Roth, and I've got to go employer versus mine. So employer

00:27:05.060 | provided versus my own is really a question of, if it's my own, I get full control. I can invest

00:27:13.060 | whatever I want under God's green earth that I can get an IRA custodian to hold and invest for me. If

00:27:18.660 | I'm using my employer's plan for at least most plans, I'm limited to their menu of options and what they

00:27:24.260 | provide. If you like their menu and it's reasonable cost, that's great. Depending on the plan, not all of

00:27:29.940 | them are the best menu of options or the most reasonable cost. So for some of us, it's just a control

00:27:34.740 | autonomy thing and ability to invest flexibly in a low cost that tends to pull us to individual

00:27:40.100 | retirement accounts. We see people more often go after employer plans, either A, just I want to

00:27:45.700 | capture my match and free money is a beautiful thing. Beyond that, I might be going after the

00:27:50.580 | employer side because they've got things like loan provisions that I want to be able to take advantage

00:27:55.300 | of in the future. And it's nice to have the choice available if that's a version of my emergency

00:28:00.580 | reserves. Not a high fan of it because often emergencies involve layoffs that mean you can't

00:28:05.780 | keep the loan. But sometimes we'll see clients that pursue employer plans because of loan provisions.

00:28:11.620 | Sometimes we'll see them pursue employer plans because we're doing things like mega backdoor

00:28:16.180 | Roth contributions as a way to route the money through the employer plan to do additional Roths. But

00:28:22.660 | most folks we find, the primary reason they end up going employer is simply because they contribute to

00:28:28.820 | their individual account and max out the accounts and want to keep contributing. And so we go individual

00:28:34.340 | retirement account limits first, and then we stack salary deferral contributions to employers on top

00:28:40.660 | because we're just trying to keep stacking up the bucket. So depending on how much disposable dollars

00:28:44.980 | I've got, like first I'm HSA, then I've got my match, then I've got my individual retirement account,

00:28:50.820 | then I've got my employer salary to contributions. And I just keep stacking on layers of tax preference

00:28:56.660 | buckets as far as I can. And so on the personal side, if you have an employer plan, you know,

00:29:01.460 | you're kind of both limited in types and by contribution limits. My belief is that it's become

00:29:09.060 | accepted that the backdoor Roth is an appropriate method. I'm sure you've written a post about all

00:29:14.420 | the nuance of it. I mean, the core works fine. The only even slight debate out there now is just like,

00:29:20.020 | should you wait at all between the contribution and the conversion? There's like a nerdy step

00:29:24.740 | transaction debate that's out there. But do you think you need to? Many people I know wait the next day.

00:29:30.980 | I still do. I still advise some level of waiting period. Now I'm a tax nerd and I'm a conservative tax

00:29:37.940 | nerd. Do I think there's some risk? Yes. Do I think it's tiny? Yes. Do I still want to have to go

00:29:43.860 | through that with the client and defend them in front of the IRS? No. I'm not particularly looking

00:29:49.140 | to get my client's name as like the tax case that determinatively settled this for everybody about

00:29:53.860 | exactly where the IRS draws the line. And this is why I look at the grand scheme of things, you know,

00:29:58.420 | if your money's going to be sitting your Roth for 40 years, if it's only there for 39 or 39 and a half,

00:30:03.300 | you are never going to notice in the grand scheme of things. If you do a Roth contribution,

00:30:07.460 | the IRS comes back and disqualifies it and applies excess contribution penalties,

00:30:10.980 | you are definitely going to notice it. There's so many other ways that we can push the limits and

00:30:14.900 | take risk. It's just not a terribly compelling risk return trade-off scenario relative to a slightly

00:30:22.100 | modest waiting period. And then go get your multi-decade compounding high time horizon

00:30:26.900 | in a Roth account. That's going to be great in the long run, even if you didn't get the first

00:30:30.660 | couple months or years worth of growth. When it comes to, you know, like a traditional pre-tax

00:30:35.380 | contribution and an after-tax Roth contribution, whether it's a 401k or another retirement account,

00:30:41.380 | how do you think people can make that decision? Well, I think about the Roth versus traditional

00:30:47.380 | decision very opportunistically. The math version of this is if your tax rates end up being higher now and

00:30:56.660 | lower in the future, it's better to do the traditional account. If your tax rates are lower

00:31:02.100 | now and higher in the future, it's better to do Roth, which gets down to the remarkably simple rule.

00:31:07.700 | It turns out it's best to pay your taxes whenever the rate's going to be the lowest. And if you do all

00:31:11.540 | the fancy underlying math, that really is what you get to when you do present value, future value,

00:31:15.700 | adjustments, and the rest. So if I think my rates are going to be worse in the future, I may as well do

00:31:20.260 | Roth, get my bill out of the way today at current tax rates. If I think I'm higher tax rates today

00:31:24.660 | and I'm going to be lower in the future, then I do a good old fashioned traditional account,

00:31:28.740 | take my tax deduction up front at my obnoxiously high tax rates, and then take the money out and pay

00:31:33.780 | Uncle Sam his share later when he gets a smaller percentage because my tax rates have gone down.

00:31:39.220 | The further out you are at either extreme, literally like the more tax arbitrage is on the table, the more

00:31:45.380 | difference potential there is between where your tax brackets are now and where they may be in the

00:31:50.500 | future. A lot of the time we talk to folks, right? Like I'm kind of in the middle. I make a good six

00:31:54.340 | figure income, which means a married couple. I'm in the 22 or 24% bracket, roughly rounding almost

00:32:00.740 | anybody between one and 400,000 of income as a married couple is in the 22 or 24% bracket. It's like,

00:32:07.060 | I make pretty good money. I don't think it's really going to be lower bracket than this in the future.

00:32:10.660 | I don't know that I'm going to climb to higher brackets in the future. So I'm not really sure

00:32:13.540 | where it's going to go. And the answer is if you really end out roughly where you are now,

00:32:17.940 | it won't matter. They're the same. You can't really get it wrong is the good news.

00:32:21.940 | The other thing that we find that a lot of folks miss is particularly the traditional bucket. It's not

00:32:28.580 | static. Like we can flip it to Roth at some point in the future. So we have a lot of clients that are

00:32:34.020 | peak earnings years saying, you know, I hate how much I pay in taxes to Uncle Sam,

00:32:37.940 | please do something about this. Like I want to put money into a Roth so I never have to pay taxes on

00:32:42.500 | this growth again. And we point out to them, like, you'd probably be much better off to put the money

00:32:46.820 | into a good old fashioned traditional IRA or 401k. Take your maximum deduction, stick it to Uncle Sam at

00:32:53.460 | the absolute maximum tax rate. And when you retire and your tax breaks come down a little bit,

00:32:58.420 | then let's do giant multi-hundred thousand dollar Roth conversions. So we'll get the money in Roth.

00:33:03.540 | It'll be in Roth by the time you're finishing retirement and leaving money to your kids if

00:33:07.060 | that's what you want to do. But I don't have to make the Roth bucket in my very expensive peak

00:33:11.300 | earnings years. I can make the Roth bucket after my income dials down. And I get that kind of what

00:33:16.020 | often is a valley after my wages stop before Social Security and required minimum distributions and like

00:33:22.580 | begin. So the fact that we get even more of a flexible toggle switch creates additional opportunities

00:33:29.140 | to say, let's be opportunistic around this and really make sure we're loading up on Roth when income years

00:33:36.660 | are low and really loading up on traditional when income years are high. And because our income goes

00:33:41.780 | through fluctuations and life happens, that can change from year to year. Like this year, I did

00:33:47.460 | a big IRA contribution because I had a big income year. And then next year I get laid off. Bad things

00:33:51.940 | happen. And I do a giant Roth conversion of the money I contributed last year because now my tax bracket's

00:33:56.660 | nothing while I'm between jobs. Now that Roth conversion income will count towards your income

00:34:02.740 | for your tax bracket, right? So if you have no income for a year, you can't just convert the entire thing.

00:34:08.180 | Oh, correct. I mean, I'm going to create income and fill my brackets. But if I got no other income

00:34:12.740 | this year, at least I'm starting at zero. So great. Now I can do a Roth conversion of almost $400,000 and

00:34:18.980 | stay in a part of the money in each bracket. So like some 10% money, some 12% money, some 22,

00:34:25.540 | some 24 as I blend through the tax brackets. But I can stop before I get to the 30 plus percent brackets

00:34:32.020 | that hurt a little bit more. Or for our clients who are mere average Americans and not very high

00:34:38.100 | income earning folks, that might simply be, I'm going to convert up to $100,000 and stay in the 12%

00:34:44.260 | bracket. Because if I do that diligently over multiple years, like I could create a million dollar

00:34:49.860 | Roth and never pay more than 10 or 12% in taxes. All I have to do is not contribute all at once and not

00:34:56.420 | convert all at once. I do it in small pieces opportunistically over time.

00:34:59.780 | This episode is brought to you by Gelt. When it comes to building wealth, taxes are such a big

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00:36:08.820 | you can skip the waitlist. Just head to allthehacks.com/Gelt, G-E-L-T. Again,

00:36:15.380 | that's allthehacks.com/G-E-L-T to stop overpaying

00:36:20.980 | on taxes. Thank you so much for being here today. You can find all the links, promo codes, and discounts

00:36:28.180 | from our partners at allthehacks.com/deals. These are brands I love and use, so please consider supporting

00:36:35.780 | those who support us. But if someone is listening to this and has put a lot of money in a pre-tax account

00:36:42.260 | and is taking 18 months off for sabbatical, for a mini retirement, they should absolutely in that window

00:36:50.580 | be thinking about conversions. We've got these seven tax brackets. The more income you earn,

00:36:54.980 | the more money that spills over to the higher tax bracket. So most of us are pretty clear when you're

00:37:00.020 | in high tax brackets, avoid, avoid, avoid, defer, defer, defer. No one wants to pay more dollars in high

00:37:05.620 | brackets than they have to. The part that often gets missed, though, is that because when you have too much

00:37:10.660 | income, it automatically spills over to the next higher brackets. Low income brackets are basically

00:37:15.940 | use it or lose it buckets. The number one problem that we deal with with retirees are folks that come

00:37:20.820 | in in their seventies with giant retirement accounts saying, I'm getting killed on RMDs. Is there anything

00:37:26.260 | you can do? I'm like, yes. Not now. Now it's too late. But like for the past 10 years, when you were so

00:37:32.180 | excited that you were sticking it to Uncle Sam paying 0% in taxes through your sixties, you wasted a

00:37:38.900 | decade of low tax brackets that we could have been doing six figure Roth conversions every year for

00:37:44.100 | a minuscule fraction of the tax bill that you are now facing because all your money is hyper concentrated

00:37:49.700 | into an IRA. Now that doesn't mean it would have been better for you to contribute to a Roth when you

00:37:54.340 | were a doctor in your peak surgery years, then you would have paid 30 something percent and it would

00:37:59.700 | have been even worse. But if I've got low income years, if I don't do the conversion and use up that low

00:38:06.420 | bucket in that year, I can't get it back. I just get a bigger balance in the future and have more

00:38:11.620 | money crammed in the tax brackets in the future, which starts to overflow to higher tax brackets.

00:38:17.300 | So yes, whether it's the years after retirements, before things like social security and required

00:38:23.540 | minimum distributions begin, or it's a time window of laid off job, not doing well business that is not

00:38:30.340 | doing well and has no income or negative income sabbatical year, like low income years are a gift

00:38:36.740 | when you've been building up traditional IRA dollars, because those are the years that you

00:38:41.060 | opportunistically convert, not necessarily the whole thing, but enough to fill the low brackets. And

00:38:46.260 | indirectly, this is why it's so helpful to contribute to the traditional accounts when you're in your peak

00:38:51.780 | income years, because I'm getting my tax deduction at the top rates. And then I'm opportunistically doing my

00:38:57.140 | Roth conversions at much lower rates. Now you said traditional IRA, but you could have easily

00:39:02.340 | had money in a traditional 401k from a previous employer or some other traditional retirement

00:39:07.380 | account, roll it out into an IRA and convert it. Roll it out in plan conversion if the plan allows,

00:39:14.180 | often if we're in sabbatical or between income years, we separated from the employer. So it's easier to

00:39:19.620 | just roll it to an IRA. But yes, converting by whatever means any pre-tax IRA or retirement account

00:39:25.300 | bucket I've got. So I can do an IRA, I can do it 401k, I can move it from the 401k to the IRA and do it

00:39:30.980 | there. And for people who have multiple previous employers and have never really thought about the

00:39:37.220 | fact that they might have like six or seven 401ks stranded out there. Do you have any advice to those

00:39:42.260 | people on whether they should roll it into their current employer, roll it out into an IRA as one

00:39:47.460 | better or worse? I mean, aside from just literally like the costs of the retirement plan, whatever the

00:39:53.940 | plan expenses are, the expenses of the funds that are in the plan versus what you can get your own

00:39:58.900 | individual IRA. There's not a dramatic difference between the two. Most folks I find ultimately just

00:40:06.180 | it's kind of a pain to keep going back to the old employer that you don't still work with. And so

00:40:12.580 | either you're going to keep rolling money to each new employer as you go with this increasingly large

00:40:17.380 | snowball effect, just like the money builds up from each plan with savings, then you get to the next one,

00:40:22.260 | or you just make your own IRA under your own control, pick the investments where you can fully

00:40:27.300 | control the choices and the expenses and just make that your repository that any and all retirement

00:40:33.140 | accounts that you accumulate from employers now and in the future, just when you transition,

00:40:37.860 | you're going to roll it there. So as advisors, we tend to kind of bias towards control and flexibility.

00:40:45.460 | The only counter to that I've heard is if you're thinking about doing recurring every year backdoor

00:40:52.020 | Roth contributions and you roll all your old 401 s into a traditional IRA, I would say it can get

00:40:59.380 | messy, either really understand it or work with someone or skip it.

00:41:03.300 | Yes. Yes. There is a thing out there called the IRA aggregation rule that says if you've got multiple

00:41:08.340 | IRA accounts, when you do Roth conversions, including for a backdoor Roth, you can't just convert the one

00:41:13.860 | account to a Roth. You're technically converting a pro-rata portion of all of your accounts, which means you put a

00:41:20.420 | couple thousand dollars after tax into an account, immediately convert it. And Uncle Sam comes back

00:41:25.220 | and says, well, you didn't convert that account. You converted 1% of all your IRAs. And since 99%

00:41:30.420 | of your IRAs were pre-tax, 99% of your conversion is taxable and you just ate a tax bill on your Roth

00:41:36.180 | conversion that you may not have meant to. So yes, if you're doing systematic backdoors, you need to be

00:41:41.860 | careful about IRA roll-ins, but there are still workarounds to it. Okay. I want to make sure we get to a few topics

00:41:47.220 | before we have to wrap. So one is about any other ways to access your money before the date in which

00:41:55.860 | you stop having penalties. And so one thing that our conversation about Roth conversions brought up was,

00:42:01.780 | well, let's say I have $300,000 that I've strategically converted to a Roth IRA. How does that work in terms of

00:42:09.780 | my ability to access the principal, which had I done that with a traditional 401k, you know, I'd be facing

00:42:16.340 | penalties and fees. Are these Roth conversions effectively a way to access my retirement funds

00:42:21.940 | early? They do end out that way. So under the original framing for retirement accounts,

00:42:26.740 | 59 and a half was never supposed to be a mandatory retirement age. You can't use your money before 59 and a

00:42:33.060 | half. That wasn't actually the intent per se. It wasn't to force you to work until 59 and a half.

00:42:38.980 | It was to make sure that you use the money quote long-term for retirement because they're supposed

00:42:44.420 | to be retirement accounts, IRAs and 401ks. And so from the very start, there was always an intention

00:42:50.980 | to say, but if someone actually retires early, they should be able to get their retirement money early.

00:42:56.260 | Like we don't want to penalize early retirement. We just don't want people to use the money as their

00:43:02.180 | own liquid piggy bank when it's supposed to be long-term money. And we're giving a tax preference

00:43:06.500 | to it to be long-term retirement money. So the question that cropped up originally in Congress was,

00:43:12.340 | how do you figure out whether someone is using their retirement account as like a liquid flexible

00:43:17.300 | piggy bank and how you figure out when someone is just like legitimately early retired and needs to

00:43:22.820 | live off of the money? When you get kind of literal and thinking about like, well, what's the difference

00:43:26.740 | between the two? The difference is people that are just using as a liquid account, like they take some

00:43:32.900 | money, money, or they don't take any of the next year. They take like a big draw withdrawal and need

00:43:36.340 | to fix the roof. They take nothing in the next year because the appliances held up. Like the dollars are

00:43:40.500 | really uneven in amount and timing. Contrast that with what does it look like if you retire early and you

00:43:47.860 | have this retirement account and it's the primary or sole source of your retirement income?

00:43:51.540 | You get a check every month. I got bills to pay every month. So I'm taking money out every month and my

00:43:58.180 | bills are at least usually relatively stable. For most of us, we've got some standard of living.

00:44:02.500 | So I tend to take out money on a regular basis that's pretty similar in amount or what one might

00:44:09.300 | call substantially equal periodic payments, which is literally where the provision in the tax code

00:44:15.460 | came from and the name came from. So what Congress wrote in was a provision that said,

00:44:21.300 | if you are taking money out of your retirement account prior to age 59 and a half,

00:44:26.580 | and your distributions are following a substantially equal periodic payments flow,

00:44:33.140 | we will not penalize them as early withdrawals. You can have your money early. It's still taxable. It is

00:44:39.700 | still a pre-tax IRA. So this is for pre-tax accounts. It is still taxable, but no early withdrawal penalty

00:44:45.060 | attached. Now, over the years, there was some back and forth because as always happens, the creative people

00:44:52.980 | then come up with crazy, screwy ways to try to abuse this. Like I'm going to take substantially equal

00:44:59.300 | periodic payments for like, I need a roof repair. If I take out 20 grand, I get in trouble. So I got it.

00:45:05.140 | I'm going to take out two grand a month for 10 months, and then I'm going to stop after 10 months.

00:45:08.660 | So it kind of looks like substantially equal periodic payments, but they don't actually continue.

00:45:12.740 | So the rule then that got added says, well, okay, if you want to do 72T distributions,

00:45:18.260 | if you want to do substantially equal periodic payments, once you start the payment stream,

00:45:22.340 | it must continue until the later of either age 59 and a half or five years from when the

00:45:28.340 | distribution started. So if I start young, it's until 59 and a half. Like if I start at age 57,

00:45:33.780 | I got to go to age 62. And if I don't continue the series of payments, if I stop them or modify them in

00:45:40.660 | any way, then Congress comes in with the nasty gram and says, okay, you violated your substantially equal

00:45:46.260 | periodic payments, which means your distributions aren't eligible for the early withdrawal penalty. And we're

00:45:51.380 | actually going to retroactively apply early withdrawal penalties to all your prior substantial equal

00:45:56.020 | periodic payments that apparently weren't actually early retirement assets. And we're going to apply

00:46:00.740 | late interest penalties for the fact that you didn't pay the penalty in the original year because you're

00:46:04.260 | paying it now. All of which means once you turn on the 72T spigot, you really don't stop. It is very

00:46:10.580 | harshly penalized if you try to stop it. So then people came in and said, well, like, oh, okay, no problem.

00:46:15.700 | You know, I actually have some other assets, but I really wanted to draw my retirement account down more quickly.

00:46:20.340 | So I'm just going to take like 20% a year for five years. It'll continue for five years.

00:46:25.060 | And I'll just like drill my account down from 56 until 61 because I've got other resources.

00:46:30.020 | So then we got more guidance from the IRS that said, no, no, no, like that's still not within the intent

00:46:34.340 | and purpose of these rules. In order to figure out what a reasonable payment is, there's a series of

00:46:41.140 | formula options that they give you. One is basically, what would I get if I just took my account balance

00:46:46.660 | and divided by my life expectancy? IRS gives you the tables so you don't gain the life expectancy

00:46:51.220 | tables. There's another version that says, what would I draw out if I bought the equivalent of a

00:46:56.020 | commercial rate annuity with this money? That's sort of my payments for life adjusted for mortality risk.

00:47:02.820 | And there's a third version that says, what would I just get if I amortize my current value plus future

00:47:07.620 | growth over my life expectancy? So it's three different formulas. The IRS doesn't really care which one

00:47:13.060 | you use. They just say like, once you pick one, you're expected to stick with one. What it effectively

00:47:17.460 | amounts to is you can use your IRA early for retirement distributions. But once you turn on the spigot,

00:47:26.020 | you have to keep it. And once you pick the method, you're generally limited to stick with the method.

00:47:31.380 | You can do a one time change from annuitization and amortization to life expectancy method if you've

00:47:36.500 | got a problem, but for where you're drawing down the account, you're at risk of depleting it. But if you

00:47:41.380 | really need the money early for retirement and this is how you're affording your retirement lifestyle,

00:47:45.620 | the dollars are available. And the dollars are available enough that in practice, we usually

00:47:51.540 | are doing Roth conversion ladders to free it up where we're doing Roth conversions at high tax rates.

00:47:56.900 | We're simply doing 72T distributions because we can get the money anyways. And now we're getting the money

00:48:02.020 | when you actually early retired, which means your rates are generally lower and it's much more tax

00:48:07.060 | advantageous. Yeah, you're not waiting the five years.

00:48:09.780 | You're not waiting the five years and you're almost by definition like you're taking the money out after

00:48:13.940 | your wages went away. It sounds like for most people, they're probably going to end up at retirement age

00:48:19.540 | with some of their retirement assets still in their account. And so for people who are either almost

00:48:24.660 | there, there, or maybe who are trying to help their parents figure it out. Yeah.

00:48:30.180 | How do you think about taking those distributions? When to take them? Which buckets to take them out of?

00:48:35.540 | So in the retirement research, we call this the account sequencing problem, right? I've got multiple

00:48:40.900 | different types of accounts. Most of us, even if we're just sort of opportunistically doing the things

00:48:46.420 | over time, we end up with basically three different buckets. Like I've got my taxable dollars, bank

00:48:51.940 | accounts, brokerage, et cetera. I've got my tax deferred bucket, pre-tax IRAs and 401Ks. And I've got my tax

00:48:58.740 | free bucket, which is my Roth and maybe my HSA for retirement if I held onto it this long. So

00:49:05.380 | there's a couple of ways I can sequence this. The first says growth at capital gains rates is better

00:49:11.380 | than growth at ordinary income rates. So I'm going to spend my IRA dollars down first and I'm going to

00:49:16.260 | let my investment brokerage accounts grow, right? I'd rather grow the things that get capital gains

00:49:21.140 | rates than the stuff that gets ordinary income out of my IRA. There's a second version of this that says,

00:49:26.020 | no, no, let's flip it around. We're going to spend the brokerage accounts down first because

00:49:30.180 | we can actually do it fairly tax efficiently. It's only capital gains and a lot of it is basis.

00:49:35.060 | And we're going to let the IRA run because tax deferred compounding growth is an amazing thing

00:49:39.060 | when it gets to compound for multiple years. If you've got a 20, 30 plus year retirement time horizon,

00:49:44.980 | draw the brokerage account down first and let the tax deferred run. Generally works better than the

00:49:49.540 | other way around. The caveat is if you've built some pretty significant wealth, it works too well.

00:49:56.340 | You spend down the brokerage account, the pre-tax account continues to grow on a wonderfully,

00:50:00.740 | beautifully tax deferred basis, except it grows so large that it starts pushing you into higher tax

00:50:06.260 | brackets because there's just so much darn money in a pre-tax status that either 100% of your

00:50:12.260 | distributions become ordinary income because now you have to do all your spending from your retirement

00:50:16.500 | account, or you hit required minimum distribution age in your seventies. And now it starts forcing out money

00:50:22.260 | that if you grew a large IRA becomes a very large number and you get vaulted into higher tax brackets.

00:50:28.820 | So you can partially ameliorate that by say, well, what if we do a blend strategy? Like I'm going to take

00:50:35.140 | half my retirement distributions from my brokerage account, and I'm going to take the other half from

00:50:39.780 | my pre-tax IRA. So I'm going to spend my IRA down enough that it doesn't grow huge and knock my tax

00:50:45.860 | rates up higher in the future, but I'm only going to take a partial amount today because I don't want to

00:50:50.100 | knock my tax rates higher today by taking up more from my IRA than I need to. And as it turns out, blended

00:50:55.300 | strategies do better than either of the first two, taking some from each works better than all IRA and

00:51:00.980 | brokerage later. And it works better than all brokerage IRA later because now I'm not hitting high

00:51:06.260 | tax rates now or high tax rates in the future. I'm essentially levelizing my taxes in retirement,

00:51:12.100 | which lets me average out at a lower rate.

00:51:13.860 | The core principle to this is the way we optimize drawdown in retirement is by trying to bring down

00:51:21.620 | the average tax rate that we play throughout retirement. And the way we do that is by

00:51:26.260 | making sure we don't bunch the income up too much at the beginning or bunch the income too much up at

00:51:30.580 | the end. We try to smooth out when the income is occurring so that we can keep it in lower tax

00:51:37.540 | brackets each year and always fill whatever that low tax bracket bucket is each year. If we dribble

00:51:43.460 | dollars out at lower tax rates over time, we can constrain the growth enough that we don't climb

00:51:48.500 | into higher tax rates in the future either. And we just get lower average tax rates for life. And that

00:51:53.300 | turns out to save dollars and increase wealth. Does this change at all? If you realize I'm going to have

00:51:58.260 | too much money, I'm not going to spend it all. I'm going to leave some to my children or other heirs

00:52:03.300 | or charity. Should you do something differently? Yes, potentially. You have a couple of different

00:52:08.580 | scenarios there that actually pop up different outcomes. So it depends a little bit on which ones you're

00:52:12.820 | going after. In the context of charity, the most notable thing for those who are thinking about

00:52:18.900 | charity is that, so we get a tax deduction when we donate to charity. If we die with the money and

00:52:25.060 | leave it to the charity, there's an estate deduction if you are subject to federal estate taxes. When the

00:52:31.060 | charity gets the money, it doesn't owe any income taxes. It's a tax free entity, which means practically

00:52:36.820 | speaking, IRAs are awesome things to leave to a charity. You don't pay the taxes while you're alive because it's

00:52:42.420 | tax deferred and they don't pay the taxes when you die because they're tax free. Which also means I

00:52:47.860 | don't really need to wind down or Roth convert or do other things to make my IRA dollars pay taxes now

00:52:55.220 | on distributions or conversions to make them tax free later. If I'm going to earmark it to the charity,

00:53:00.100 | it's going to be tax free for the charity no matter what. So I don't really need to push on reduce my IRA

00:53:06.420 | strategies beyond maybe making sure I'm not getting crushed by required minimum distributions in my 70s and 80s.

00:53:12.820 | If the account's really compounding a lot, we tend to earmark IRAs to charity first. It's super tax

00:53:18.740 | efficient. Even if I'm just putting some money to charity and the rest of the money to my family,

00:53:24.660 | earmark the IRA to the charity, earmark the other stuff to the family and you end up with much more

00:53:30.020 | net tax wealth to everyone. The charity finishes more, your family finishes with more and Uncle Sam finishes

00:53:34.820 | with less when you put the three pie slices together. If you're leaving the dollars to family,

00:53:40.740 | the situation looks a little bit different because now the whole discussion of, well, what's a better

00:53:48.820 | deal? Like my tax rates now when I might Roth convert or my tax rates in the future when I might take the

00:53:53.620 | money out of the pre-tax account. It's not my rates now versus my rates in the future. It's my rates now

00:53:59.300 | versus my kids' rates or whoever my heirs, whoever my inheritors are, which means now it really depends

00:54:04.900 | on what's going on in the family situation. Sometimes we get scenarios, mom and dad invested heavily into

00:54:11.300 | their children's future. Johnny and Sally are a lawyer and a doctor doing incredibly well for themselves.

00:54:17.780 | Mom and dad only ever accumulated a fairly modest lifestyle for themselves because they put so much in

00:54:22.660 | their kids. And so mom and dad are going to leave a couple hundred thousand dollars to the kids and the

00:54:26.740 | kids make a couple hundred thousand dollars a year. In which case I really like mom and dad to do Roth

00:54:31.940 | conversions at their tax rates and leave the kids some tax-free Roths instead of pushing the money into

00:54:38.100 | their rates. Sometimes it's the other way around though. So mom and dad were the accumulators and wealth

00:54:44.100 | builders and gave their children a lot of financial room and flexibility. And one of them has built a very

00:54:48.820 | high income year and the other two are artists who are dedicated to their craft but do not make a lot

00:54:54.660 | of taxable income. In which case, the best thing I can do is take my high dollar value parents' assets

00:55:01.780 | and leave good old fashioned boring traditional IRAs to these children because their average tax rate is

00:55:08.500 | going to be a whole lot lower than what mom and dads are going to be. Maybe the one high income child is

00:55:12.580 | going to be equal to mom and dad, but the other two are going to be much better off to not Roth convert

00:55:18.340 | this. So either I can leave all of them traditional. If you really want to get into the sophisticated

00:55:23.540 | stuff, I can start doing partial Roth conversions so that I leave a Roth to the high income child and I

00:55:29.460 | leave pre-tax assets to the lower income children. It's very tax efficient. It's really messy in practice

00:55:35.460 | because the accounts grow and move every year. And so suddenly your inheritances are not equal the way

00:55:40.100 | that you might have meant them to be equal amongst the children. So there's some nuances about doing

00:55:44.100 | that and monitoring that so you don't create family strife down the road. But the kind of Roth versus

00:55:48.660 | traditional conversation now effectively becomes what's mom and dad's tax rates and what are the kids

00:55:53.940 | tax rates. And I still get to the same principle, which is I want to pay the bill with whoever's got

00:55:58.260 | the more favorable tax bracket. So if the kids are more favorable, let's give them a good old fashioned

00:56:02.020 | pre-tax IRA and 401k. And if the kids are financially higher income than their parents, then I want to do as much

00:56:08.740 | Roth as I can. Now, not necessarily everything at once because then parents go into the top tax bracket

00:56:13.380 | and we have not helped the situation, but I might at least winnow down partial Roth conversions to set

00:56:19.220 | this up for higher income children. And just in general, that also comes up even as part of the

00:56:24.820 | strategy when we're spending down our own dollars in retirement. I mean, as I highlighted earlier,

00:56:28.900 | the kind of the blended strategies work better than spend all the brokerage first and let the IRA run or

00:56:34.420 | spend all the IRA first and let the brokerage run. The slightly more efficient version though is I don't

00:56:40.020 | take part of the money out of my brokerage account and part of the money out of my IRA because I'm still

00:56:43.940 | depleting a tax-preferenced account earlier than I needed to. The most optimal one is I take all the

00:56:51.060 | money out of my brokerage account, but I don't leave my income really low. I do partial Roth conversions to

00:56:57.060 | fill my income during the low income years while I'm spending my brokerage account that usually has

00:57:02.820 | limited tax impact. There's a lot of basis there. The rest is mostly capital gains so I can fill up a lot

00:57:09.220 | of ordinary income very favorably. And so I might spend, depending on how many mixture of dollars,

00:57:15.060 | I might spend the first one, three, five, seven, 10 years spending down a brokerage account very tax

00:57:20.580 | efficiently and doing systematic partial Roth conversions from IRA to Roth so that by the time

00:57:25.860 | I get five to 10 years into retirement and I'm running low on brokerage account dollars, now I've

00:57:30.900 | got a big IRA and a big Roth that I made a very favorable tax rates because I converted them not

00:57:35.940 | while I was working but during the low income years at the beginning of retirement. And now in the second

00:57:40.580 | half of retirement, I can take a blended withdrawal from my IRA and my Roth and continue to stay in low tax

00:57:46.580 | brackets all the way through. Wouldn't that taxable brokerage account have gotten stepped up to the

00:57:51.460 | children if you left that to them? Yes, the brokerage account gets stepped up if I leave it to them. But

00:57:56.820 | if I'm winding down the brokerage account so I can systematically create tax-free Roth assets,

00:58:01.860 | I'm generally doing better for them. It's tax-free anyways. And practically speaking, like, yes,

00:58:08.180 | my capital gains get a step up in basis, but there's two caveats to it. The first is most of us don't

00:58:13.940 | generate 100% of our return from capital gains. We get those pesky things called dividends, which from

00:58:19.140 | an investment perspective can be very appealing. From a tax perspective means a portion of your growth

00:58:24.340 | is dividends that would have been totally tax-free in your Roth and you have to pay taxes to Uncle Sam

00:58:28.580 | every year when you own a brokerage account. And although investment styles and circumstances vary,

00:58:35.220 | a lot of us don't actually literally hold the same thing for like 20, 30 years in retirement. At some

00:58:41.460 | point, investment circumstances change, investment vehicles change, right? 30 years ago, we barely

00:58:45.940 | had ETFs. Now we kind of use them a lot. I don't know what the hot investment vehicle of 2055 is going

00:58:50.900 | to be. So I struggle a little bit with sort of banking on the, well, I'm just going to hold this

00:58:56.020 | for 30 years and wait for step up in basis. Because I'm like, are you really sure you're not going to

00:59:00.820 | want to like change that once in 30 years? I mean, heck, if it grows well, you're going to have a

00:59:05.380 | rebalancing problem and you're going to have to rebalance out of it, which is going to start

00:59:08.660 | triggering some capital gains. If it does badly, you're going to want to sell it,

00:59:11.940 | which is going to trigger capital gains on whatever you've got left after the losses.

00:59:15.540 | So it's one thing if the retirees or the parents are older, are sadly just our time horizon is not as

00:59:22.100 | long. We're now like, okay, then I'm really focused on capital gains, step up in basis planning. But for

00:59:28.500 | sort of like the generic retiree situation, right? 50 or 60 something year old couple in pretty good health,

00:59:35.140 | that's enjoying life and wants to live a long and vivacious retirement, even if I've got more

00:59:39.620 | wealth than I need, unless there's a really specialized scenario, like I've had this stock

00:59:45.140 | I inherited from grandpa, I'm going to hold it for another 50 years for my children. And we're just,

00:59:48.820 | this is like sacred family assets and we never sell them. I just, I get a little bit wary about

00:59:54.420 | banking on step up in basis for ultra long-term time periods. A because I still get tax drag from

00:59:59.940 | dividends, no matter what. And it's non-trivial over time. And a lot of us don't really hold one

01:00:05.460 | thing for 20 or 30 years. A few of us do. If that's really you, you know, you and you be you.

01:00:10.020 | That makes sense. And for anyone who doesn't know, like the concept is that death, if you pass on

01:00:14.900 | something, the basis steps up. So the child, if they sold it right after would not have to pay capital

01:00:20.740 | gains tax. But it only works on brokerage or regular taxable account assets. You don't get a step up on

01:00:26.660 | Roth. You don't get a step up on, well, Roth tax for anyways, but you don't get a step up on traditional

01:00:30.260 | IRAs, only brokerage account assets. Okay. This has been great. I know we've gone right up to your limit.

01:00:36.660 | So if people want to go deeper on either these topics or maybe go deeper and actually get someone

01:00:42.580 | to help walk them through this process, because they were like, that's awesome. Whether it's me,

01:00:46.820 | the retiree or my parents, where do you want to send people in both those scenarios?

01:00:50.900 | Oh, well, so look, I just, if you want to nerd on more of this, like kitsis.com is our site.

01:00:55.540 | Our primary audience is financial advisors. You'll get the over the shoulder look at what the financial

01:00:59.620 | advisors read. That's our primary business is doing training and education for financial advisors,

01:01:04.740 | but the content's online. If you're looking on the advisor end, I wear a couple of different

01:01:09.140 | hats in the advisory world. Like I'm also head of planning strategy for a national wealth management

01:01:14.180 | firm called Focus Partners Wealth. So we do a lot of work with retirees who have reached the point where

01:01:20.100 | they're trying to figure out what to do with all the dollars and how to make the transition. And just,

01:01:23.540 | we implement all the tax sensitive stuff we've been talking about here in practice with clients.

01:01:28.100 | This all comes from practice. I'm also a co-founder with, for an organization called XY Planning

01:01:32.900 | Network or XYPN for short, xyplanningnetwork.com. XYPN is a network of advisors that specifically are

01:01:39.380 | focused on working with folks in their thirties, forties and fifties, and primarily build around

01:01:44.020 | subscription fee models. So like no asset requirements. Some of them do subscriptions in

01:01:50.020 | asset center management. Most of them do subscriptions only. So if you just want like pure advice from an

01:01:55.780 | advisor, advice only is kind of the hot term in the industry right now, xyplanningnetwork.com.

01:02:00.820 | And there's a find an advisor page there for just a whole network of advisors that do this,

01:02:06.340 | really focus on folks who are navigating all these financial and career decisions in their thirties,

01:02:10.500 | forties and fifties. Focus Partners Wealth, mostly for folks who are already at the retirement stage.

01:02:15.380 | So many great resources. I've read so many blog posts that you've written. And so whenever I'm like,

01:02:19.860 | Ooh, 72T, how does this work? I'm going to your site. So we're going to link a lot of those in the show notes.

01:02:25.460 | Thank you so much for breaking a lot of this down for everyone. I really appreciate it.

01:02:28.900 | Yeah, my pleasure. Thank you, Chris.

The Most Optimal Way To Invest For Retirement - Don’t Invest Everything Into Your 401k

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