Is a Backdoor Roth IRA Worth the Hassle?

00:00:00.000 | I'm here with Duncan, as we are each week. We get a lot of questions from people. A lot

00:00:25.120 | more tax questions this week, so we're going to break back on Bill Sweet. We've actually

00:00:28.940 | got a lot of follow-up questions, if you remember. Our email here is askthecompoundshow@gmail.com.

00:00:33.400 | Today's show is sponsored by Liftoff, our automated investing platform, powered by Betterment.

00:00:37.960 | Duncan, one of the cool things about Liftoff, I was looking at the asset allocation for

00:00:41.960 | my kids. When I started their accounts, it signed up. I said, "Go aggressive," and I

00:00:45.880 | think it gave me like a 90/10 split. I thought about this recently. I was looking at it,

00:00:50.800 | and I said, "You know what? This doesn't make any sense. They need to be 100% in stock.

00:00:53.100 | Let's make a change." One of the cool behavioral nudges that they have on their system is,

00:00:57.860 | you go to make an allocation change. Before you do it, it says, "Wait, wait, wait. Let's

00:01:01.440 | think about this. What are the tax implications?" Because this is a taxable account. I like

00:01:05.120 | how they just give you that little nudge. I'm not going to name any names. Some other

00:01:08.300 | platforms would like you to make those changes no matter what. They pop champagne bottles

00:01:14.640 | and confetti every time you make a trade. Liftoff and Betterment are not like that.

00:01:19.680 | They want you to be thoughtful about making changes you propose. If you want to check

00:01:23.000 | it out, talk to one of our advisors. Take a look. Liftoffinvest.com. All right. Let's

00:01:30.320 | do it. First question.

00:01:31.840 | Okay. Wow. Diving right in. I got nothing. I was in Miami this week.

00:01:38.800 | I thought you were going to have some jokes or something you came back from Miami with.

00:01:43.760 | Nothing?

00:01:44.760 | The only joke on me is, there's a lot of money there. How's that?

00:01:50.760 | Seems like it.

00:01:51.760 | Yes. No.

00:01:52.760 | I hear everyone always says, when you talk about Miami, everyone says something about

00:01:56.440 | Brickell. Should I say an obligatory, "Oh, did you go to Brickell?"

00:02:01.260 | That's the Brooklyn of Miami, I guess?

00:02:03.280 | I have no idea. I've never been.

00:02:05.400 | It makes me question my life decisions every time I go somewhere warm when I come back

00:02:08.600 | and there's snow on the ground and it's 14 degrees, but there's trade-offs here. One

00:02:14.320 | of these days, Miami is going to be wiped off the map by a hurricane. This is a trade-off

00:02:17.120 | you make.

00:02:18.120 | That's the give and take, right.

00:02:19.120 | Yeah.

00:02:20.120 | All right.

00:02:21.120 | Let's do it.

00:02:22.120 | Up first, I've just come across your blog post from 2016 called "Deconstructing 30-Year

00:02:26.800 | Stock Market Returns." Thank you for that. It was about exactly what I was looking for,

00:02:33.480 | and I wonder if you've updated your findings since then. Also, have you run the analysis

00:02:37.520 | for other time periods? 10-year and 20-year rolling averages would also be interesting.

00:02:41.880 | So, we're digging deep, going back in your library.

00:02:44.800 | Yeah. So, Matthew McConaughey did his book tour a couple of years ago. Someone asked

00:02:49.120 | him about his writing process, and he said, "I don't write to remember. I write to forget."

00:02:54.160 | I guess it's kind of the way -- so, he's like, "I want to journal so I know how I'm feeling

00:02:57.900 | at any particular moment, and I can kind of go back and see where I was at that time."

00:03:01.520 | I guess I feel kind of the same way about blogging. I never thought I would compare

00:03:04.880 | myself to Matthew McConaughey, but here we are. All right, all right, all right. I'm

00:03:09.520 | not going to do it.

00:03:10.520 | So, I've written a lot of blog posts, and I kind of forgot about this one. So, I looked

00:03:14.160 | back at it. It was in 2016. John, pull up the blog post if you can. Maybe we didn't

00:03:20.160 | have that. So, what I did at the time was, I looked at the data on rolling 30-year annual

00:03:26.040 | returns for the stock market. I have data going back to 1926 from our friends at Dimensional

00:03:30.840 | Fund Advisors, and their Returns 2.0 database. So, I'm happy to update this one, because

00:03:35.160 | it's been a while. 2016 was a while ago. So, I'm happy to do the 10- and 20-year numbers

00:03:39.440 | too, right? Because this is kind of my thing. I like looking at long-run data for the stock

00:03:42.720 | market, provide that context. So, let's look at the 10-year numbers, John. So, this is

00:03:46.240 | rolling 10-year returns, 1926 through January 2023. The best 10-year return of all time,

00:03:53.160 | these are using monthly returns, a little more than 21% per year for 10 years, ending

00:03:57.520 | in 1959. That's a total return of 600%, call it. Pretty good. Worst 10-year return, the

00:04:04.000 | 10 years ending August 1939. The stock market was down 5% per year almost. That's a total

00:04:08.800 | return of a loss of about 40%. The 1930s were no joke, obviously. You still can see, though,

00:04:14.240 | even in the 10-year return numbers, a decade is a long time to invest. There's still a

00:04:19.160 | lot of variation in here, right? Between really great and really poor numbers. Let's look

00:04:24.040 | at the 20-year returns, see if that does a little better. Alright, 20-year returns. Now,

00:04:27.240 | we're looking a little better, because there's nothing in the red here. There has been no

00:04:31.040 | 20-year period in the U.S. stock market with losses, right? So, these dates at the bottom

00:04:35.880 | are the ending dates, right? Best 20-year return, a little more than 18%. That was at

00:04:41.600 | the peak of the market in early 2000, right? Starting in the early 1980s through March

00:04:46.640 | of 2000, 18% per year. Pretty good. Worst 20-year return, a little less than 2% per

00:04:53.080 | year. That's the 20 years ending in the summer of 1949. Makes sense, because you're talking

00:04:58.480 | about the Great Depression and World War II. So, if you have really poor returns, that

00:05:02.200 | seems like the time that would make sense. But again, no times where you had a 20-year

00:05:05.840 | period with a loss. That's pretty good. Alright, last one, 30-year. This is one of my favorite

00:05:10.720 | all-time long-term charts. You can see, the variation is compressed here. Best 30-year

00:05:15.760 | return since 1926, almost 15% per year. It's the 30 years ending in 1968, which kind of

00:05:21.800 | makes sense, because it coincides. The start of that period was when the worst 10-year

00:05:26.120 | return ended in 1939. So, you go from the worst 10-year return to the best 30-year return.

00:05:31.160 | Not bad. Now, here's one of my favorite long-term stats about the market. Worst 30-year return

00:05:36.200 | of all time, 7.8% per year, starting in September 1929. So, you top-tick the Great Depression.

00:05:41.200 | John, you can do a chart off here. Duncan, that 7.8% per year over 30 years. Maybe I've

00:05:45.780 | shared this with you before. Wait, that's the worst? The worst annual return. What's

00:05:49.680 | that on a total return basis over 30 years? So, the worst total return you've ever experienced

00:05:55.800 | in the U.S. stock market over 30 years? I don't know. All right. 850%, including dividends.

00:06:04.000 | So, that's the worst 30-year return you've ever got. Obviously, usual caveats apply here.

00:06:09.480 | I didn't take taxes into account, or fees, or any of that stuff. Out of the way. But

00:06:15.520 | still, that's pretty darn good, right? I take that. I mean, you had to live through that

00:06:20.360 | time period. You had to live through the Great Depression, and World War II, and all this

00:06:23.440 | other bad stuff going on. Deflation, all this stuff. The most recent 30-year return through

00:06:29.040 | January 2023. Gain of 9.8% annually. 20-year return through then, 10.3%. 10 years was 12.7%.

00:06:36.320 | Pretty good numbers if you ask me, right? I don't know what long-term returns will be

00:06:40.480 | in the future. In a recent show, I argued they could be lower. It wouldn't surprise

00:06:45.560 | me. But in that 2016 PETA, I looked at three non-overlapping 30-year periods. Because these

00:06:50.840 | are rolling, so some of them aren't going to have the same returns, right? So, you think,

00:06:53.560 | what if we just broke them in and they're not overlapping at all? So, I looked at like

00:06:56.440 | 1926-1955, 1956-1985, 1986-2015. And the respective returns were like 10.7%, 9.6%, and 10% for

00:07:07.640 | those 30-year returns, right? And all of these periods had really nasty stuff going on. So,

00:07:13.120 | again, the '30s to the '50s had the Great Depression, stock market crash of more than

00:07:17.560 | 80%, World War II, Korean War, four recessions. The next 30-year period had Civil Rights Movement,

00:07:22.600 | the Vietnam War, one president was assassinated, one president was forced to resign, oil price

00:07:27.240 | shock, double-digit inflation, huge interest rates, six recessions. And that '86-2015 period

00:07:33.180 | had Black Monday, 1987, saving and loans crisis, Desert Storm, 9/11, Iraq-Afghanistan Wars,

00:07:39.680 | Great Financial Crisis, and three recessions, right? You can point to really bad stuff in

00:07:42.860 | all those periods. Just think about what's transpired since then, since I wrote this

00:07:45.800 | in 2016. We had an insurrection at the Capitol, a global pandemic, oil prices went below zero,

00:07:50.480 | inflation at 40-year highs, all that stuff. Returns have still been pretty good, right?

00:07:54.560 | So, obviously we're not going to be promised anything going forward. I don't know what's

00:07:58.600 | going to happen in the future. But it's hard to look at these numbers and not be optimistic

00:08:02.680 | about the future. I think if you're betting against human progress, do so at your own

00:08:05.640 | peril. That's my general take.

00:08:07.320 | Yeah, well said.

00:08:08.480 | And I think we're all going to have, even if you're approaching retirement, we've talked

00:08:12.320 | about this in the past, you could still have a 20- or 30-year period ahead of you. As always,

00:08:17.960 | I think the long run almost always wins. Undefeated.

00:08:20.340 | And that's why we weather up so much, right? Just kidding, just kidding. Definitely don't

00:08:28.520 | do that.

00:08:29.520 | All right, let's do another one.

00:08:30.520 | Okay, up next we have a question from --

00:08:31.960 | Oh, wait, hang on, before we get to this. Someone in the comments said you wanted Miami

00:08:34.640 | take. Someone asked, "How many Miami vices did Ben have?" I think before we got in here

00:08:37.680 | I said I had three, by the pool, right?

00:08:40.360 | That's the best poolside drink there is.

00:08:42.840 | Can you drink one anywhere else? I mean, it pretty much has to be by a pool, right?

00:08:46.000 | You have to have sun and you have to have -- yeah, it's the when in Rome thing, when

00:08:49.560 | in Miami, you have to do it.

00:08:50.560 | Like, I can't go in a cellar bar in Brooklyn and get a Miami vice.

00:08:54.000 | No, no, no. If you're ordering a drink from a guy with a mustache and high-waisted pants,

00:08:59.360 | then no, you can't order Miami vice.

00:09:01.080 | Right, right. And suspenders, yeah.

00:09:02.800 | Next one.

00:09:03.800 | Okay. Up next we have a question from Will, a young viewer, a student. I'd love to see

00:09:09.240 | that. We love to see that we have students watching. Huge fan of the show. I'm a finance

00:09:13.140 | student at Michigan State and I have a question about bonds. I know the bond market is on

00:09:17.200 | fire right now and I'm wondering how to get in. Listening to your channel has truly paid

00:09:20.880 | dividends towards my education and I recommend it to anyone trying to break into finance.

00:09:25.440 | That second part was immaterial but I left it in because we like compliments.

00:09:28.840 | Yeah, we'll take it. Not to brag. Will, good for you for paying attention to this stuff

00:09:32.400 | when you were in college. I'm not even sure I realized the stock market existed until

00:09:36.520 | I was maybe a senior in college and I had to figure out what I want to do with my life.

00:09:40.280 | I couldn't have told you what a bond was. None of that. I was more interested in extracurriculars,

00:09:44.480 | which explains the Miami vices. I have to say, this is the first time we've ever heard

00:09:48.160 | anyone clamoring to get into the bond market, right? And I guess with interest rates much

00:09:53.900 | higher now and more interest in fixed income, I thought it would be a good idea, especially

00:09:57.120 | for someone like Will, but our regular listeners too, let's do a good bond primer for everyone.

00:10:01.240 | I want to look at the different risks of investing in bonds. So first one is interest rate risk.

00:10:07.280 | So this one, one of those important things to understand about bonds, bond prices and

00:10:10.800 | interest rates are inversely related, right? When rates move up, bond prices go down. When

00:10:15.360 | rates fall, bond prices rise. This makes sense when you consider if you have a 5% bond that

00:10:19.760 | you're holding, Duncan, and rates go to 4%, your bond should be worth more. If rates go

00:10:24.020 | to 6%, your bond should be worth less. The other important factor to understand about

00:10:27.880 | interest rates is that bonds typically provide a good estimate, the starting yields typically

00:10:32.260 | provide a good estimate of your long-term return on bonds. John, do a chart on here

00:10:35.720 | of the five-year Treasuries. This is the starting yield of the blue line. Orange line is your

00:10:41.360 | subsequent five-year annual return. Those are pretty close, right? The correlation between

00:10:46.000 | the starting yield and the ensuing five-year return is 0.92. So that's a strong to quite

00:10:50.980 | strong relationship. Now, it may seem obvious that a five-year bond would have a yield that

00:10:56.000 | the starting yield matches its five-year return, but this works for other maturities, too.

00:10:58.800 | I've done this for five-year, seven-year, ten-year. Pick a return over the long-term.

00:11:03.260 | You're starting to yield on bonds. Less some sort of default/credit risk, which we're going

00:11:08.020 | to get into, and that's kind of where you end up. So, duration risk is probably the

00:11:12.080 | next thing. So, duration is a good proxy for how sensitive your bonds are to changes in

00:11:17.000 | rates. It's a number that's expressed in years because it basically tells you how long it'll

00:11:20.480 | take to get your whole money back, right? Principal plus the yield. So, it's a little

00:11:25.200 | less than the maturity. The good rule of thumb here is, the longer your maturity, the higher

00:11:29.400 | your duration, and thus the more volatility you experience to changes in rates. So, the

00:11:33.560 | other rule of thumb is, the decent approximation is, your duration will tell you how much your

00:11:37.860 | bond will move relative to a 1% moving interest rate. So, let's say you have a bond with a

00:11:42.200 | duration of 3.5 years. If rates go up 1%, you should expect your bond to drop 3.5%.

00:11:47.400 | If rates go down 1%, you should expect your bond to gain 3.5%, right? Those numbers aren't

00:11:54.080 | precise because there's this thing called convexity where bonds tend to lose less money

00:11:57.880 | than they gain.

00:11:58.880 | Yes, convexity.

00:11:59.880 | Yeah, sorry, close enough. The other one is, we talk a lot about government bonds. We won't

00:12:05.820 | even get into convexity, Duncan. It's not worth it. Credit risk is the other one. So, if you

00:12:11.520 | have corporate bonds or mortgage bonds or asset-backed bonds, you could have a downgrade.

00:12:15.920 | Why do bonds drop on a credit downgrade? Most likely it's because a lot of times they're

00:12:19.500 | just sold. Institutional buyers or ETFs or mutual funds can't hold them anymore because

00:12:23.800 | of their investment mandates. So, if you had a corporate bond that went from a high credit

00:12:28.120 | rating that was quality credit to high yield, a lot of ETFs and institutional investors

00:12:33.000 | probably can't hold those anymore if they have a mandate that they can't hold high-yield

00:12:35.520 | bonds. So, default risk is the next one. The long-term default risk for a high-yield junk

00:12:41.680 | bond is 3-4%. You can't really take your yield and high yield and say, "I'm going to get

00:12:45.600 | that going forward." You have to kind of lop off some for default. Obviously, that number

00:12:48.760 | is different depending on the economic environment that we're in, but you should take that number

00:12:51.960 | into account when having those expectations. Finally, the last one is inflation risk. This

00:12:56.360 | is the biggie. So, I looked at the numbers before for long-term bonds. This is just to

00:13:00.600 | illustrate a point here. From 1946 to 1980, long-term government bonds in the U.S. returned

00:13:04.640 | about 2% per year nominally. Not bad considering rates went from like 2% to 15% in this timeframe.

00:13:10.680 | So, people really worry about interest rates rising. That wasn't really that big of a deal,

00:13:15.440 | but inflation was almost 4.5% over this period. So, that means you lagged bigly on a real

00:13:19.200 | basis. How bad? Duncan, I'm not going to make you guess again. On an inflation-adjusted

00:13:23.040 | basis, long-term bonds were down 60% from 1946 to 1980. You just got crushed by inflation.

00:13:28.800 | This is an extreme example, but it goes to show you that, again, rising rates aren't

00:13:32.840 | as big of a deal for investors as high inflation or rising inflation. Rising rates, eventually,

00:13:38.080 | you pick up those higher yields, and that'll kind of help you a little bit. That's what's

00:13:41.680 | happening now. You had a really bad year, but now rates are higher, so investors are

00:13:44.960 | in a better place for bonds. So, listen, as a young person in college, I'm not sure you

00:13:49.340 | really need to worry about missing out on the bond market by any means. Bonds are still

00:13:52.800 | far more boring than the stock market. I mean, at least you can earn some higher yield, but

00:13:56.880 | if I was a young person, I'd be far more concerned with the stock market, because bonds can help

00:14:00.240 | with short-term, intermediate-term goals, but the stock market is still your best bet

00:14:03.780 | against hedging inflation. So, I'd still pay more attention to the stock market if I'm

00:14:07.440 | a young person. If you want to understand the bond market more, I'm sure you'll learn

00:14:10.200 | about it a little bit. But that was Ben's primary on bonds. How'd I do?

00:14:14.720 | That was good. I'm not going to lie, though. You still lost me a little bit there. Bonds

00:14:18.780 | are one of the most confusing topics to me as a non-finance person.

00:14:20.880 | What's the confusing part to you? Tell me the confusing part to you.

00:14:23.440 | Just like when you're saying, "If rates go up by this much, then it means that you're

00:14:28.560 | going to go down by the percent." It loses me as soon as I start hearing about that.

00:14:34.080 | Okay. So, if your duration is 10 and rates go up 1%, 1% is the key here, right? If rates

00:14:40.960 | go up 1%, you're going to go down 10% if your duration is 10. If rates go down 1%, you're

00:14:45.360 | going to go up 10%. Now, if rates go down 50 basis points, you're going to go up 5%.

00:14:51.920 | If rates go up 50 basis points, you're going to go down. See? That's the relationship.

00:14:54.820 | It's not exactly one-to-one, but it's pretty darn close.

00:14:58.200 | I got it.

00:14:59.200 | So, the longer your maturity, that makes sense that you have more volatility to changes in

00:15:03.560 | rates because there's so much more that can happen in that time frame. Rates can change

00:15:06.760 | more. Inflation can change more. Economic growth can change more. And so, it makes sense

00:15:10.960 | that shorter-term bonds have a lower duration than longer-term bonds.

00:15:13.760 | Right, right. Yeah, that makes sense.

00:15:17.080 | So, Oatly has a duration of 974, give or take.

00:15:23.800 | Yeah, sure. It's looking good year-to-date. I think so, maybe.

00:15:28.640 | Let's do another question.

00:15:30.640 | Okay. Up next, we have a question from Dave. Have any of the Rihls tax bills -- and for

00:15:37.160 | those of you that are listening and are new to the show, these are people bills, not tax

00:15:42.120 | bills -- but have any of the Rihls tax bills encountered an online calculator for determining

00:15:47.520 | the RMDs, Required Minimum Distribution Rate, for a non-spousal IRA beneficiary, so-called

00:15:54.740 | inherited IRAs? I'd sure like access to one. It would help, I think, if the IRS updated

00:16:01.840 | Notice 2022-53 in the form of a proposed or, better yet, a final regulation so that taxpayers

00:16:09.840 | know if they will have a penalty tax if they don't take an RMD in 2023.

00:16:15.040 | This is from Dave. Dave went deep here. We're going to bring over our tax bills. We have

00:16:21.040 | a high concentration of bills in our tax department. Here's Mr. Bill Sweet. Bill, a lot of jargon

00:16:26.720 | going on here. I don't know where you want to start. Dave is locked in here. The IRS

00:16:33.880 | regulation notice, that's a first, so way to go, Dave. Dave is in the chat right now,

00:16:40.820 | I think.

00:16:41.820 | It goes right to the tax code. It's beautiful.

00:16:44.280 | So help me sort out this mess here. What's going on here?

00:16:47.960 | Yeah, so I came in late to the back show because I was working on some ribs, Duncan. I grew

00:16:52.600 | these from a pig and they are delicious. I got to tell you that. But John said, "Bill,

00:16:57.480 | your light's coming in hot," but it's not because Dave is coming in hot, citing IRS

00:17:02.040 | notices here. That was beautiful. The backstory here, the IRS changed the rules on us, right?

00:17:06.880 | Really Congress did, excuse me. The old rules, Ben, used to be, what? You needed to take

00:17:11.280 | an IRA distribution within five years for an inherited IRA, right, if you inherit your

00:17:15.800 | uncle, your dad's IRA. But the old rule also allowed you to do what over your lifetime?

00:17:20.240 | Do you remember? The good old days? Nothing? All right, stretch IRAs. So stretch IRAs.

00:17:26.800 | Stretch, okay.

00:17:27.800 | Yeah, do you remember the stretch IRA?

00:17:28.800 | Right, right, stretch Armstrong.

00:17:29.800 | Stretch Armstrong. Okay, cool, cool, cool. So what Dave's referring to is the IRS when

00:17:33.600 | they rolled out-

00:17:34.600 | We needed a crickets thing there.

00:17:36.360 | Dave knew what I was talking about. When the IRS rolled out the Secure Act, they moved

00:17:40.800 | the RMD age up, which was great. But then they said, "Look, there's no more RMDs for

00:17:44.380 | inherited IRAs, but you need to take them all within 10 years," right? So now there's

00:17:48.240 | this 10-year window for anybody who inherits an IRA after 2020, and that includes this

00:17:53.800 | year. There was a gigantic freak-out from the people. They were like, "What about the

00:17:57.120 | kids and what about this?" The IRS came out, they changed the rules again, allowed eligible

00:18:03.080 | designated beneficiaries. And then last year, but still for the 10 years, they said, "No

00:18:07.840 | RMDs required. Don't worry about it, guys. Everybody's cool." But then last year, the

00:18:12.520 | IRS said, "Guess what? We researched the tax law a little bit more, and there are actually

00:18:18.100 | RMDs due for these 10-year RMDs, inherited IRAs, for a certain class of folks, for somebody

00:18:23.700 | who died after they started their RMD during their life time." This is a giant confusing

00:18:29.820 | mess.

00:18:30.820 | And it's kind of crazy that they don't just grandfather people into the old rules and

00:18:33.400 | say the new rules are going to start in five years or something.

00:18:36.340 | Yeah. Well, I guess they did, because if you inherited an IRA three years ago, you still

00:18:40.220 | are playing by the old rules. But what Dave's getting at, this is a mess. And his question

00:18:44.500 | is, "How do I sort this out?" I would go to a trusted custodian. I think that ultimately

00:18:49.660 | is the place to go. WeCustody, Bennett, at Schwab, at TD, at Fidelity, these are trusted

00:18:54.460 | third parties. They're the best in the business. I find Schwab's calculator to be very, very

00:18:58.860 | useful. We don't need to do a segment here on the differences of the rules, but basically

00:19:02.860 | they ask you a bunch of questions about your age, how old was the person you inherited

00:19:06.460 | the IRA from, when did they die, what type of IRA it is. You spit that all out, and it'll

00:19:10.380 | tell you, "Here's your RMD for this year. This is what you should do." Or, "There's

00:19:14.580 | no RMD required until year 10." I find Schwab's calculator to be roughly the best, and I would

00:19:19.780 | encourage anybody else to check it out and use it.

00:19:23.140 | Once again, we have job security for you, because it's a mess, right?

00:19:28.780 | Yeah. People...

00:19:29.780 | Trying to understand this stuff.

00:19:30.780 | Like I've said before, people hate paying taxes more than they like making money, Ben.

00:19:34.060 | And I think ultimately, if you understand nothing about what I just said, and you're

00:19:37.500 | dealing with an inherited IRA, you're right. This is a perfect advertisement, Dave, for

00:19:41.740 | the services of a certified financial planner. Ritholtz Wealth are among them. Just make

00:19:45.460 | sure they're an investment fiduciary, they're not a life insurance salesman, and they're

00:19:48.460 | trying to help you solve this problem.

00:19:49.940 | I don't know. Dave knows the IRS tax codes. Maybe he's going to find it on the calculator

00:19:53.100 | and do it himself.

00:19:54.320 | Can I comment, though, on his last part, which is, why haven't they finalized this? It is

00:19:58.620 | insane. And this, unfortunately, is the world we live in of below competence all of a sudden.

00:20:03.660 | But yes, just putting an IRS notice out saying, "Hey, you actually might be subject to RMDs.

00:20:08.940 | Sorry we didn't tell you for two years. You probably need to do something for the end

00:20:12.300 | of the year," and not even making that guidance final, I think this is a problem of governance.

00:20:16.740 | And I'm with Dave. It's a mess, and God save us all.

00:20:20.140 | Duncan, what was harder to understand, this one or the bond stuff?

00:20:24.300 | This one.

00:20:25.300 | I hope so.

00:20:26.300 | I mean, they both involve a lot of convexity.

00:20:30.020 | Convexity. Maybe I should show up to the meeting on time, right? So I'd be better prepared.

00:20:34.100 | But Dave, good luck to you. Send us an email if we can give you a hand.

00:20:37.020 | All right, next one.

00:20:38.020 | Thanks, Dave. Dave's always in the chat and always writing in good questions, so I'm glad

00:20:42.180 | we got to use one.

00:20:43.180 | Big ups to Dave.

00:20:44.180 | OK, so up next-- and I made my screen larger, so now I can actually read, so I won't stumble

00:20:48.940 | over this one as much, hopefully.

00:20:51.060 | All right, this question is from Sam. Do you think a backdoor Roth IRA is worth it? Assume

00:20:56.460 | that other tax-advantaged vehicles are maxed out and no traditional IRAs, so not concerned

00:21:01.020 | about the pro-rata rule. No idea what that means. I think if everything is maxed out

00:21:05.660 | and a higher earner wants to save more, options are backdoor Roth or brokerage account. Personally,

00:21:10.640 | I feel like buying index ETFs in a brokerage account would be way easier, but not sure

00:21:15.160 | how to quantify the benefit of a backdoor Roth. So, your favorite topic here, backdoor

00:21:19.400 | Roth.

00:21:19.900 | Bill does like Roth IRAs. I'm kind of with Sam here on a lot of stuff. My first question

00:21:25.220 | is always, is it worth it? Is it worth the hassle and the paperwork? And even if I could

00:21:31.620 | make 25 basis points more per year over the long term, is it just easier for me to just

00:21:36.540 | take the easy route and stick it in index funds in a taxable account and call it a day?

00:21:41.580 | Bill, what say you?

00:21:42.580 | It's a great question. Sam, a very strong name. I named my firstborn son Sam, so I'm

00:21:47.140 | a big, big fan. My question for Sam is, do you like tax-free distributions? Is that something

00:21:53.540 | that would appeal to you? And I think the thought process is, if you have $6,500 to

00:21:58.900 | invest, and that's what we're talking about here, that's the IRA contribution limit for

00:22:03.180 | this year, would you rather get that back after it's grown? Rule of seven, $6,000 grows

00:22:08.740 | to $12,000 over 10 years, $24,000 over 20 years, $48,000 over 30 years. I mean, we're

00:22:14.740 | not talking about small bits of money if we're dealing with a 30-year, 40-year timeline.

00:22:19.940 | Do you want all of that investment gain, that $40,000 of gain, to come to you tax-free?

00:22:24.740 | Or do you want to pay tax on it? And that's the question. Is it worth it or not? So to

00:22:29.180 | quantify it, it's probably worth about $8,400 of tax. And so again, that is more than your

00:22:35.060 | initial contribution, assuming that you get a 7%, 8% return over the next 30 years. Do

00:22:40.400 | I think it's worth it? I think so. But like everything else, there's pros and cons. One

00:22:44.820 | of my famous charts here, there are pros and cons.

00:22:47.340 | I know, Duncan's already spit his water out all over. He's getting it right every time.

00:22:51.420 | Ultimately, there are pros and cons, right? So do you like tax-free distributions? We

00:22:54.860 | just talked about that. The cons of a taxable brokerage account are tax, tax, and tax. Tax

00:23:00.240 | number one, you have to pay tax every time a dividend hits that account, right? And Ben,

00:23:05.420 | where are yields today versus where they were two, three years ago, right? I mean, they're

00:23:08.940 | not nothing.

00:23:09.940 | We're probably talking, yeah, 2% dividend, maybe a little less.

00:23:11.660 | Yeah, OK for dividends. But maybe you have a balance of fixed income, like you can get

00:23:15.820 | 4%, maybe 5% from a short-term treasury right now. Ultimately, you're going to give back

00:23:19.900 | about a third of that to taxes right along the way. And that decreases the compounding

00:23:23.540 | effect of your gains.

00:23:25.300 | Second tax, like I discussed, about $8,000. Assuming you wait for 30 years, you're going

00:23:28.740 | to pay $8,000 in income tax from a brokerage account versus nothing from a tax-free Roth

00:23:33.620 | IRA distribution. And finally, there's the tax on rebalancing. And that's a significant

00:23:39.300 | effect. If I move from a 60/40 to a 40/60 or whatever it is in an IRA, nothing happens

00:23:44.380 | tax-wise. It's only in the distribution that gets taxed.

00:23:47.420 | If I have a brokerage asset, Ben, if I don't pick my mutual fund wisely, if I want to move

00:23:51.700 | from mutual funds or ETFs, I need to eat that tax along the way with a brokerage account.

00:23:55.920 | So my question to you, Sam, do you want to pay tax on the gains or don't you? And the

00:24:00.180 | trade-off there is flexibility, right? For a Roth IRA, you really can't mess with it

00:24:03.540 | until you're 59 and 1/2.

00:24:06.180 | If we did the cage match between you and Nick Majulie, Nick has said-- he's made the argument

00:24:09.720 | before that you shouldn't max out your 401(k) because a brokerage account gives more flexibility

00:24:14.500 | if you're going to buy and hold a low-cost index fund.

00:24:16.980 | If, and if is a key question. And if you don't rebalance along the way, and if you don't

00:24:22.160 | like tax-free distributions, I don't think it's an either/or. I think it's a how much,

00:24:27.020 | right? And ultimately, what you want to have in your 60s and your 70s or 80s is diversification.

00:24:31.800 | You want tax diversification.

00:24:32.800 | And if this person is already maxing out retirement vehicles, they obviously like-- they like

00:24:37.900 | to have tax-deferred accounts, right? So they-- you'd think it would maybe would make sense

00:24:42.060 | for them.

00:24:43.060 | Yep. Exactly.

00:24:44.060 | Do you think-- do people like have a little party when they turn 59 and 1/2 because they

00:24:46.900 | can access this?

00:24:47.900 | I mean, I did for my dad.

00:24:48.900 | This is funny. It seems like my children who are eight years and younger, they still like

00:24:53.580 | to like kind of like celebrate their half birthday. Like, "Hey, I'm 5 and 1/2 now."

00:24:57.920 | So the only other time you do that is when you turn 59 and 1/2, I guess.

00:25:00.780 | Yeah, it's a big deal, Duncan. Yeah, you get the penalty and you get tax-free Roth distributions.

00:25:05.600 | Why wouldn't you want that, Sam? I say go for it.

00:25:08.300 | It's like when a young person talks about their, like, six-month anniversary or something,

00:25:11.260 | you know? And you're like, "Oh, that's--"

00:25:12.820 | Or dating.

00:25:13.820 | Sweet.

00:25:14.820 | You know, those cute little couples you're dating.

00:25:15.820 | Call me in 10 years.

00:25:16.820 | Yeah.

00:25:17.820 | All right.

00:25:18.820 | Exactly.

00:25:19.820 | Last question.

00:25:20.820 | Last but not least, we have a question from Eric. I really like this question a lot, and

00:25:22.540 | I'm curious to hear the answers.

00:25:23.900 | I just wanted to let Bill know, we've received multiple questions on this. This was the best

00:25:27.140 | one, but we've seen a lot of questions on this.

00:25:28.460 | Oh, OK. Let's do it.

00:25:29.460 | Right. Yeah. Yeah.

00:25:30.460 | OK. So Eric writes, "I have two follow-up questions regarding the Roth 401(k) employer

00:25:34.940 | match topic you discussed a few weeks ago. How do taxes work on this portion? Say your

00:25:39.380 | employer matched 5% of your salary of $100,000. Would that mean that you end up with $5,000

00:25:43.700 | in your 401(k) as a Roth amount, or would that $5,000 be subject to income tax and leave

00:25:49.020 | you with less? Number two, do you need to contribute to your 401(k) as a Roth contribution

00:25:55.540 | in order to have your employer match be Roth?"

00:25:57.900 | OK, so just a reminder, we talked about this a few weeks ago with Bill, that now you have

00:26:02.620 | the ability to not only have a Roth 401(k), but get your company match in that 401(k)

00:26:08.620 | in the form of a Roth. I didn't know how this worked before, that if you had a Roth 401(k),

00:26:12.900 | you put your money in the Roth, but then your match with the company would be in a traditional

00:26:17.500 | 401(k). Now, this year, it's changed, right? So, all right, Bill, I didn't think about

00:26:21.060 | the tax implications on me. Explain to me how this works.

00:26:23.180 | Yeah. And may I cope on my side? I made a mistake on the last program. I was thinking

00:26:27.260 | in my head about FICA income tax. A 5% matching Roth IRA contribution is going to be taxable

00:26:33.660 | income in the year that you receive it, right? That gets dumped into your account. But again,

00:26:38.140 | one last famous chart, so don't confuse. The question is, do you want to pay tax now or

00:26:42.260 | do you want to pay tax later, right? And so, it's the same dynamic.

00:26:45.660 | The addition to Bill's Roth IRA tattoo on the back is going to say, it's like a dragon

00:26:49.620 | tail. It's going to be like, "Do you like tax-free distributions?"

00:26:52.460 | Yeah. Well, that is the question. So, yeah, so then that matching contribution, it is

00:26:57.580 | taxable in the year received. What does not get taxed, though, is on FICA. You do not

00:27:02.020 | have to pay employment taxes on the matching contribution to a Roth 401(k) or a traditional

00:27:09.060 | 401(k). So, that was a mistake I made last time. No, yes, there is income tax on the

00:27:13.260 | contribution. There is no FICA. And so, that creates a level playing field. And again,

00:27:18.700 | the question is, where's my tax rate going to be now versus where's my tax rate going

00:27:22.540 | to be in distribution? It's different for everybody. I think, while young, matching

00:27:26.660 | Roth contribution sounds absolutely peachy. So, this is essentially kind of like a backdoor

00:27:32.980 | Roth that you're doing in your 401(k), right? Yeah. Yeah, exactly. And so, their second

00:27:37.340 | question was, where is it? I forget. Oh, yeah. Do you need to contribute on a Roth in order

00:27:44.460 | to get the matching Roth? God's honest answer is, we don't know. Also, you contribute to

00:27:49.940 | a traditional, but then your match is in a Roth. Correct. Can you mix and match? Can

00:27:52.980 | you flip the switch? That's what I would want. Yeah, I mean, it sounds super cool, right?

00:27:56.220 | Best of both worlds. The honest answer is, we don't know. And the reason that we don't

00:27:59.420 | know is, the law just changed in December, right, for this year. It said immediately

00:28:04.120 | on passing the law December 27th, custodians, most custodians haven't rolled out the program

00:28:08.820 | on how to actually handle this. There's no IRS guidance that I'm aware of. Our custodian

00:28:12.740 | has not updated our plan. And I don't believe that Fidelity or anyone else has. So ultimately,

00:28:17.220 | this is something, these are answers that are coming. I would direct that question to

00:28:20.100 | your custodian. And it's very possible that they might interpret the rules a little bit

00:28:23.680 | differently than another plan. But again, I think it's awesome to have different choices.

00:28:30.020 | Ultimately, Congress wins because they're getting the taxable income now, right? And

00:28:34.140 | we have a massive budget hole. So why wouldn't you want to tax that income now? And you as

00:28:37.940 | an investor, you can pick and choose based on your situation. And again, I think for

00:28:42.060 | young people with a long time period to compound, it's very difficult.

00:28:45.900 | That's a good point about Congress getting the tax dollars now. I see people a lot of

00:28:49.460 | times over the years have asked me, don't you think eventually they're going to come

00:28:51.700 | after Roths? But no, the tax has already been paid. They already got it up front. They got

00:28:57.500 | it down payment.

00:28:58.500 | But what if they could tax it again?

00:29:00.100 | Right. So it is very possible. But I think it's rational just to plan on the tax code

00:29:04.820 | more or less staying the same, right? Yeah, it'd be catastrophic if Canada invaded and

00:29:10.820 | took over the U.S. and said, no more taxes at all. Like, great. Like you can go to these

00:29:14.580 | hypothetical rules.

00:29:15.580 | The tradeoff there is we get more Tim Hortons though.

00:29:18.240 | And maple syrup, Molsons.

00:29:19.240 | Yeah, you get ham sandwiches with donuts.

00:29:22.460 | Fim du Monde, just a classic. But back to Roth, I just think the more dollars you can

00:29:27.380 | cram into long-term compounding tax-free money, why would you not take that option early in

00:29:33.540 | your career and then switch that later on as you make more and more money in your career?

00:29:37.820 | Bill, you sold me.

00:29:38.820 | Great. I think I did about two years ago.

00:29:41.060 | I have one follow-up. For our Capitol Hill audience watching, what's your pitch? What

00:29:45.580 | would you ask them to do to make all this easier?

00:29:48.540 | Oh, we talked about it on the last show. TSP, open this thing to the masses. Like, why are

00:29:53.540 | 401(k)s tied to employers? I don't want my employer making my investment decisions for

00:29:58.260 | me.

00:29:59.260 | Give us one limit. Make it $60,000 or whatever you're going to make it. It includes HSAs.

00:30:03.020 | It includes 529s. It includes 401(k). Put it all in the same bucket. Make it easy.

00:30:07.700 | I actually kind of like having Bill Sweet make my investment decisions for me.

00:30:13.180 | Flattery will get you everywhere. But yeah, TSP for the masses. The program exists. It's

00:30:17.620 | fantastic. And why not just make those contributions to payroll the same way you pay your payroll

00:30:21.580 | tax? You don't have to think about it, right? Wouldn't that be awesome?

00:30:24.060 | Perfect. I think Bill's other job security here on this show is we get an endless amount

00:30:29.260 | of Roth IRA questions every week. Honestly, taxes are taking over our inbox just along

00:30:33.820 | with bonds.

00:30:34.820 | Keep them coming.

00:30:35.820 | Because Duncan, I got a question from the stream here. People want to know, is the Fed

00:30:38.780 | shirt coming back? I got my Fed godfather shirt. People want to know if it's coming

00:30:42.220 | back to the store.

00:30:43.820 | Maybe if there's enough demand. I think Josh said that we might bring it back when they

00:30:47.100 | cut. But if you want to see it before then, let us know.

00:30:53.580 | Quick announcement here. No show next week. I'll be out of town because apparently spring

00:30:56.800 | break is not enough. Our kids now have to have a winter break. Or a mid-winter break.

00:31:00.300 | Get out of here.

00:31:01.300 | Yeah, so we're going somewhere.

00:31:02.300 | Send them to school.

00:31:03.300 | I know. So we're going somewhere.

00:31:04.300 | That's the American mind.

00:31:06.020 | Leave us a review. Leave us a question. Thank you to everyone for tuning in live. Remember,

00:31:11.740 | YouTube, you can leave us a comment or a question. Email us, askthecompoundshow@gmail.com. And

00:31:17.380 | we will see you next time.

00:31:18.380 | See you, everyone.

00:31:19.380 | Roth IRA for life.

00:31:20.260 | [Music]

00:31:40.660 | (music fades)

00:31:43.160 | you

Is a Backdoor Roth IRA Worth the Hassle? | Portfolio Rescue 63

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