RPF0104-Get_Money_Out_of_Retirement

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00:00:25.440 | I've gotten a lot of questions with all of the early retirement interviews I've played

00:00:29.340 | on this show about how all these people are going to access the money that they have stuffed

00:00:34.660 | away in retirement accounts if they retire before the age of 59 and a half.

00:00:40.400 | After all, aren't they going to have to pay the penalty tax to get their money out?

00:00:43.720 | Today, I'm going to answer that question and give this show a shot.

00:00:48.040 | Whether you're a beginner or an expert on this subject, I think I might have some ideas

00:00:52.520 | that will help you.

00:01:10.360 | Welcome to the Radical Personal Finance Podcast.

00:01:12.660 | My name is Joshua Sheets.

00:01:13.660 | Thank you for being here.

00:01:15.880 | Today is Monday, November 17, 2014.

00:01:19.620 | Today I'm going to tell you why you might not pay the penalty taxes even if you retire

00:01:24.180 | before 59 and a half.

00:01:25.180 | Then I'm going to tell you how to avoid them all if you want to.

00:01:28.620 | I'll give you all the answers for that.

00:01:30.780 | Today's going to save you some money, so stay tuned.

00:01:43.100 | As we wade into the weeds of retirement rules and laws and things like that, I'm going to

00:01:48.900 | ask you to do me a favor.

00:01:50.340 | Give today a shot.

00:01:51.340 | I'm going to try to do this with a minimum of detail, meaning I'm not going to get down

00:01:55.580 | to the technical weeds.

00:01:56.740 | I'm going to try to answer this big picture with just enough detail and then let me know

00:02:01.300 | how I did.

00:02:03.100 | I'm pretty excited about it.

00:02:05.020 | I feel like I can do it.

00:02:06.380 | Two quick announcements as we start.

00:02:07.740 | Number one, as I've been saying for the last week, I wound up deleting all of you who are

00:02:12.100 | subscribed to my show in iTunes.

00:02:14.060 | It was accidental.

00:02:15.060 | Trust me.

00:02:16.060 | That's not something that a podcaster wants to do is delete the majority of their audience

00:02:19.460 | when you work so hard to build an audience.

00:02:21.980 | If you are subscribed to my show in iTunes or even if you're subscribed in many other

00:02:27.180 | podcast apps, many podcast apps actually use iTunes and scrape from iTunes the info, then

00:02:32.860 | please make sure that you are receiving updates on the show in your app after episode 99.

00:02:37.780 | This is when it would have happened.

00:02:39.940 | If you are receiving today, which is episode what?

00:02:42.220 | 103, I think, or 104, something like that.

00:02:45.300 | Then 104.

00:02:46.300 | Then if you're receiving after today, then that's great.

00:02:49.700 | If not, unsubscribe from the show, look in the store or the directory for the show, and

00:02:54.500 | then click subscribe.

00:02:55.740 | If you're not subscribed to the show, why not?

00:02:58.140 | Subscribe.

00:02:59.140 | Number two, for you international listeners, I apologize.

00:03:01.900 | Today's going to be fairly US-centric.

00:03:03.340 | I think there'll be some info in here that you'll benefit from.

00:03:06.100 | About 80% of the audience is based in the US and 20% is international.

00:03:10.500 | The top three, 5% in Canada, 5% in the UK, and 5% in Germany, and then the remaining

00:03:15.540 | 5% scattered around the world.

00:03:17.300 | I thank all of you for listening.

00:03:18.820 | I never in my life imagined I would be speaking to an international audience.

00:03:22.780 | Several of you, especially the Canadians, have emailed me and asked me to do shows on

00:03:27.540 | Canadian personal finance topics.

00:03:29.500 | I would love to do that.

00:03:30.500 | I think it'd be really fun to do.

00:03:32.060 | I don't know a thing about your laws, so I'm going to have to do that in terms of an interview

00:03:36.900 | format.

00:03:37.900 | If you've got somebody that you think would be a great guest on the show to talk about

00:03:41.340 | financial planning from a Canadian perspective, especially if they might know things that

00:03:45.260 | are similar, dissimilar, I'd love to learn about it.

00:03:47.780 | I can do that in an interview format.

00:03:49.940 | If you've got somebody, ask them to email me or you email me for them, joshua@radicalpersonalfinance.com.

00:03:57.020 | Let's get into the show.

00:03:58.580 | We're not going into the weeds today.

00:03:59.780 | I'm going to stay with some big picture concepts, but I'm going to give you enough detail that

00:04:02.900 | this is actually going to be useful.

00:04:04.300 | I've gotten this question several times, and although I have covered it briefly on a previous

00:04:08.660 | show, I think in the show where the guy wrote me and says, "I'm 35 years old.

00:04:12.180 | I got a million bucks.

00:04:13.180 | I hate my job and I don't want to retire," at the end of that show, I put some of this

00:04:17.980 | info in.

00:04:18.980 | The number one response I got on that show, I think it was episode 55, it might have been,

00:04:24.700 | was, "Joshua, you crammed like eight shows into one.

00:04:27.820 | That seems to be my disease."

00:04:29.420 | So I wanted to create a standalone show to answer this question, and that's what we have

00:04:32.460 | today.

00:04:33.460 | I used to be very scared by this question or by this problem, and you probably have

00:04:39.420 | been or are right now.

00:04:42.460 | You know what?

00:04:43.460 | Maybe you should be because when you get into the world of figuring out what are the penalty

00:04:46.580 | taxes and things like that, it just doesn't sound fun, dealing with penalty taxes.

00:04:51.940 | None of us really want to deal with penalties and none of us really want to pay taxes.

00:04:56.220 | One of the big problems in this area is actually the problem of perspective.

00:05:00.740 | Who are we talking about?

00:05:02.100 | So you've heard where this question comes from is if you've listened to my show and

00:05:05.660 | you've heard various early retirees, people planning on retiring at 30, 40, 50 years old,

00:05:11.540 | and you're saying, "But they have all this money in 401(k)s.

00:05:14.020 | What do they do?"

00:05:15.220 | And if you go and listen to mainstream personal finance topics, you find that the standard

00:05:19.500 | advice is don't ever take money out of your retirement accounts early.

00:05:22.540 | You have to wait until 59 and a half.

00:05:24.060 | Why would you ever take money early?

00:05:26.060 | This is especially tough when you listen to radio shows.

00:05:29.940 | So for example, two of my favorites, if you listen to Clark Howard or Dave Ramsey, if

00:05:33.860 | they get a listener, unless they do a lot of probing and find something out, the majority

00:05:37.900 | of the time when people call them up and say, "Hey Clark or Dave, I need to distribute

00:05:42.700 | money from my 401(k), should I take money out of my 401(k) to pay off my credit card

00:05:47.380 | debt?"

00:05:48.380 | Well, the most common answer you'll hear is no, absolutely not.

00:05:51.540 | And here's why.

00:05:52.540 | Here's the math you'll hear.

00:05:54.500 | No Mr. Collar, if you're Ms. Collar, because you're going to pay a 10% penalty tax plus

00:05:59.500 | you're going to pay taxes on the money.

00:06:01.380 | So let's say you're going to pay 30% taxes.

00:06:04.740 | So you've got 30 plus 10, that's 40%.

00:06:07.620 | Practically half your money, you're going to lose half your money to taxes and penalties,

00:06:10.940 | so therefore you shouldn't do it.

00:06:13.300 | Now is that true?

00:06:14.300 | Well, it might be.

00:06:16.300 | I don't know.

00:06:17.300 | I mean going from 40 to 50 is kind of a big deal where we just automatically say half

00:06:20.820 | and I'll tell you I have been guilty of that working with a client who's called me in the

00:06:24.740 | same situation.

00:06:25.740 | I'm like, "Well, you basically lose half your money.

00:06:27.140 | It's half your money."

00:06:28.540 | I've done that myself.

00:06:29.540 | I've done that myself.

00:06:30.540 | So maybe I need to atone for that with today's show.

00:06:34.180 | But there's a big difference between that type of caller and that type of situation

00:06:39.300 | versus somebody who is financially sophisticated and understands the rules and has a plan for

00:06:45.620 | early retirement.

00:06:46.620 | They have a lot of money.

00:06:47.620 | They're saving money.

00:06:48.620 | They're using their retirement accounts as a tool.

00:06:51.380 | And this is a big difference.

00:06:53.020 | And this is one of the reasons it's tough.

00:06:54.660 | If you're used to listening to mainstream financial talk, nothing wrong with that.

00:06:59.540 | That's great.

00:07:00.540 | But you've got to recognize that you probably have a different perspective than maybe what

00:07:04.540 | I talk about on this show.

00:07:06.300 | There's a big difference between saying, "I've got to take my money out to pay off my credit

00:07:08.900 | card debt," when the majority of people that I'm bringing on this show, at least to talk

00:07:13.100 | about early retirement, credit card debt is nowhere near an issue.

00:07:19.340 | It's just not even in the same ballpark.

00:07:21.260 | That's why it's kind of tough for me to answer questions on credit card debt because I just

00:07:24.580 | don't think that much about it.

00:07:26.340 | If you have credit card debt and if you're paying interest on it and it's not deductible

00:07:29.700 | interest, I'm just like, "What are you doing?

00:07:31.460 | Why would you do that?"

00:07:32.780 | So there's a little bit of a different approach to my show versus the other.

00:07:36.900 | So you've got to ask yourself the question, "How sophisticated are you when you're actually

00:07:40.260 | doing this problem?

00:07:41.540 | Do you need help on the fundamentals of finance, the fundamentals of getting out of debt, working

00:07:45.780 | hard, planning a budget, doing that?

00:07:47.820 | Or are you ready to go a little bit deeper?"

00:07:49.180 | If you're sophisticated and if you're deeper, that's where this conversation is going to

00:07:54.020 | go.

00:07:55.020 | If you're dealing with the question of, "Should I take money out of my 401(k) to pay off my

00:07:58.940 | credit card debt?"

00:07:59.940 | The answer is probably not.

00:08:01.340 | Probably not.

00:08:02.340 | It's usually not going to be a good plan.

00:08:03.860 | But you still could calculate it, but that's not the realm that we're talking about today.

00:08:08.980 | If you take all of the emotion out of this answer and you take all of the rules that

00:08:13.460 | you've heard about, "Don't only take money out of your 401(k) if you're going to declare

00:08:17.820 | bankruptcy or escape foreclosure," that's probably a good rule of thumb.

00:08:20.820 | I like rules of thumb.

00:08:22.300 | But it's one thing to have the rule of thumb.

00:08:25.460 | It's another thing to go beyond the rule of thumb and understand it.

00:08:28.140 | If we actually understand it, we basically have two questions that we're trying to figure

00:08:31.780 | out.

00:08:32.780 | Number one is, "What is the cost versus the benefit of paying income taxes now versus

00:08:39.660 | paying them later?"

00:08:41.260 | Number two, "What is the cost versus the benefit of paying the extra 10% penalty tax now or

00:08:47.800 | not paying it later?"

00:08:50.740 | That's it.

00:08:51.740 | So why did I start with all those tax planning shows in the beginning?

00:08:54.660 | Go back and check out the tax series.

00:08:56.060 | It's all there in your feed, freely available.

00:08:58.060 | All we're doing here is adjusting the timing of income.

00:09:01.900 | That's all this is, is a timing strategy.

00:09:04.820 | And you're just saying, "Do I take the timing of income forward or do I push the timing

00:09:08.980 | of income back?

00:09:10.260 | Do I take this deduction now or do I push the deduction back?"

00:09:13.620 | So let's handle the income taxes first.

00:09:17.220 | You are always going to pay income taxes on the money if you're using a retirement account.

00:09:21.100 | You're always going to do it, period.

00:09:23.780 | You're either going to do it now because you're participating in a Roth IRA or a Roth 401(k)

00:09:29.340 | and so you're choosing to pay the income tax now and to avoid it later, or you're going

00:09:35.180 | to pay it later.

00:09:36.300 | If you're participating in a traditional 401(k), a traditional IRA, a simplified employee pension

00:09:42.580 | plan, a SEP, a simple IRA, you're just taking the deduction now.

00:09:46.880 | So all we're doing is we're choosing, "Am I going to pay now or later?

00:09:49.060 | Now or later?

00:09:50.060 | Do I push the tax off, pay it later?

00:09:52.420 | Do I bring the tax forward and pay it now?"

00:09:55.020 | And the answer to that question is pure math.

00:09:56.940 | What's in your best interest?

00:09:57.940 | Well, you have to actually calculate it.

00:09:59.900 | You have to look at your situation.

00:10:00.900 | You have to look at your plans.

00:10:03.220 | Now with regard to the penalty tax, it's still just a timing question.

00:10:08.000 | Do I pay the penalty tax in order to have the money now or do I not pay the penalty

00:10:12.680 | tax later?

00:10:13.900 | Now you would think that would be straightforward, right?

00:10:16.820 | But it's not.

00:10:17.820 | Well, in some ways it is, but it's not.

00:10:19.980 | Here would be an example.

00:10:21.480 | If I tell you that in your 401(k) you're going to average 10% on your money and you're going

00:10:27.700 | to take that 10% on the money and you're going to keep it invested, thus avoiding the 10%

00:10:33.380 | penalty tax now, you're going to get a 10% rate of return annually over the next 30 years.

00:10:38.220 | Or you can go ahead and take the money that you have in there now, pay the 10% penalty

00:10:41.820 | tax and invest the money at 110% rate of return compounded annually for the next 30 years.

00:10:48.220 | Which would you do?

00:10:50.980 | Obviously if I could guarantee it, and of course I can't, but it's just a mental game,

00:10:55.260 | obviously you would take the 110% rate of return because you would make up far in excess

00:10:59.780 | of the cost of the 10% tax.

00:11:02.460 | So therefore all we're doing here is trying to figure out should I pay the 10% penalty

00:11:06.700 | tax or should I not pay the 10% penalty tax?

00:11:10.020 | And there are various ways to answer it.

00:11:11.980 | Do I value the money now or do I value not paying the tax?

00:11:16.060 | It's not a law, it's not a rule, it's not a religion, it's just a matter of when do

00:11:19.780 | I value it?

00:11:20.980 | What's my plan for it?

00:11:22.300 | If you're going to take the money out and that money is just going to go to pay off

00:11:25.420 | credit card debt and you're taking money out and you're paying half the money in taxes

00:11:30.420 | and penalties and fees so that you can pay off credit card debt at a 10% interest or

00:11:34.380 | 15% interest, probably not a good plan.

00:11:37.240 | But if you're taking it out to invest in your business that is guaranteed to be the next

00:11:41.540 | big IPO success, maybe it is a good plan.

00:11:46.060 | There have been plenty of entrepreneurs who have taken early distributions out of their

00:11:49.360 | accounts and made way more than they ever would have had by having the money in their

00:11:54.060 | accounts.

00:11:55.060 | There are many, many businesses that have been started and funded based upon pensions.

00:12:00.460 | There are many businesses, whether that was Colonel Sanders just living on Social Security

00:12:06.740 | while he starts Kentucky Fried Chicken or whether it was JCPenney, either starting JCPenney

00:12:11.780 | or rescuing JCPenney with money from his cash value life insurance policy or people taking

00:12:16.940 | distributions from their 401(k)s to start their dream.

00:12:19.340 | That's fine.

00:12:20.340 | I've got lots of friends that have done that.

00:12:21.860 | So get the emotion out of it and understand what the rules are and then you can coach

00:12:25.220 | yourself or somebody else through it.

00:12:27.420 | And it's basically what do I expect to do better?

00:12:29.980 | That's it.

00:12:31.780 | Now all tax planning is very specific.

00:12:34.060 | You have to look at your situation.

00:12:36.140 | And I'm going to say things in today's show that are going to be absolutely contradictory

00:12:39.900 | to one another.

00:12:40.900 | All you've got to do is just avoid, avoid, avoid, and that's your key.

00:12:43.860 | Now the question is what are you avoiding?

00:12:46.340 | Sometimes we'll choose to pay some taxes in order to avoid paying another one.

00:12:50.880 | So we can avoid the 10% penalty tax, but we might choose to pay it to avoid paying a higher

00:12:57.020 | income tax.

00:12:58.780 | That's basically it.

00:13:00.140 | Same thing with we can avoid the AMT, the alternative minimum tax, by paying a higher

00:13:04.940 | amount of income tax because we choose that the higher income tax is a better deal than

00:13:09.620 | the AMT.

00:13:11.380 | Same thing with we're doing tax planning for this new Medicare tax.

00:13:15.460 | We're just simply avoiding.

00:13:16.900 | So you've got to look at your situation.

00:13:18.940 | And what you need to do is just calculate it out, figure out what the cost is, figure

00:13:22.300 | out what the benefit is, figure out what the plan is, and make that decision.

00:13:28.220 | The key with the early retiree scenarios is that they have flexibility.

00:13:33.700 | And that's what's often missing in mainstream financial advice is there's no flexibility.

00:13:39.540 | If you're stretched to the max with income equaling expenses and no money to pay off

00:13:43.380 | credit cards, there's no flexibility.

00:13:44.860 | You can't take advantage of strategies like we're going to talk about here that the early

00:13:48.380 | retirees have grabbed onto.

00:13:50.220 | So you've got to have flexibility.

00:13:52.140 | Now there are real quick answer, and we're going to get to the four different options

00:13:55.300 | that I'm going to explain to you today.

00:13:56.500 | But there are a bunch of detailed rules and exceptions for each type of account.

00:14:00.620 | I do not want to cover those in today's show because I want to do shows at some point on

00:14:04.980 | about a specific topic.

00:14:06.340 | So the early distribution rules are different for IRAs than they are for 401(k)s.

00:14:10.660 | And they're different for IRAs than they are for Roth IRAs with the exceptions.

00:14:14.620 | So the death exception, the disability, the first-time home purchase, the medical expenses,

00:14:19.380 | the medical insurance premiums during unemployment, the higher education costs.

00:14:23.380 | Some of these exceptions that you can find to paying the 10% penalty, they exist, but

00:14:27.700 | I don't want to cover them today because it just gets us too down in the weeds.

00:14:32.300 | And you've got to figure out, depending on whether you have a Roth or a traditional IRA,

00:14:37.180 | that makes a difference.

00:14:38.180 | And with a Roth, you've got to figure out are we avoiding the 10% penalty tax or are

00:14:41.300 | we also avoiding the income tax on the money.

00:14:44.100 | With 401(k)s, you've got double counting of rules.

00:14:46.500 | So if you've got the Roth rules with a Roth 401(k), you've got your five-year rules that

00:14:51.500 | apply because of the Roth portion, but you've got the challenge of how do I get my in-service

00:14:55.340 | distribution out of a 401(k).

00:14:58.180 | You could take a loan, but the loan has its own issues.

00:15:01.140 | Does your plan offer loans?

00:15:02.700 | So there's all kinds of issues with it.

00:15:05.540 | So I'm not getting into those weeds.

00:15:06.700 | I want to give you four answers, though, to help you organize your thinking, at least

00:15:10.300 | to understand why and how all these early retirees I brought on the show are avoiding

00:15:15.980 | the tax or how they're making rational decisions.

00:15:18.980 | There are four answers to this question, how are they doing it.

00:15:22.300 | And I'm going to give you the four and then we're going to go through them in detail.

00:15:25.860 | Answer number one, they might not need to actually pay the penalty taxes because they

00:15:28.780 | might not need to actually make the distribution from the account.

00:15:33.640 | Even though all the money or most of the money is in a tax-qualified account, they might

00:15:38.380 | not actually need to pay the taxes because they might not actually take the distribution

00:15:42.700 | even though they retired before 59.5.

00:15:44.100 | And I'm going to give you some various scenarios to that.

00:15:47.360 | Answer number two, they might just pay the penalty tax.

00:15:49.980 | It might be cheaper to pay the penalty tax than to pay some other tax or other expense

00:15:55.260 | or other fee than the penalty tax.

00:15:58.180 | And then we're just getting into what's the calculation.

00:16:01.100 | Then number three and four are the well-known options to avoid the 10% penalty.

00:16:06.160 | Option three is the Roth conversion option.

00:16:08.820 | And then option four is the series of substantially equal periodic payments, also known as the

00:16:15.820 | 72(t) rules.

00:16:16.820 | So I'm going to cover three and four, which are the technical ones.

00:16:19.900 | So let's start with number one.

00:16:21.900 | How is it that somebody comes on my show and they have all their money in their 401(k)

00:16:25.060 | and they say, "But I'm going to retire at 35 years old."

00:16:27.340 | What?

00:16:28.340 | Well, here are a few ideas for you.

00:16:34.020 | There could be many reasons why they may or may not actually take money out of the accounts

00:16:41.060 | that are going to be penalized.

00:16:42.260 | And quick other caveat, I'm primarily today talking about avoiding the penalty, not so

00:16:48.980 | much talking about the income tax.

00:16:50.780 | I'm primarily talking about the penalty tax, but the income tax will weave in.

00:16:56.420 | So the first example that comes to mind for me is that most retirees, or at least early

00:17:02.140 | retirees that say they're going to stop and stop spending money, don't—excuse me, stop

00:17:06.340 | making money and thus start spending savings that they have, don't actually ever stop making

00:17:11.300 | money.

00:17:13.140 | Or if they do, it's temporary.

00:17:15.180 | The most recent example I would point to here is my friend Brandon, the mad scientist.

00:17:18.820 | I've had him on the show.

00:17:19.820 | He's back in the first 10 episodes.

00:17:20.820 | He's going to give a great interview.

00:17:22.140 | Brandon is a young guy.

00:17:23.460 | He and his wife have been working on this early retirement plan.

00:17:26.220 | They're retiring in their early 30s, and he's been working on it for a few years.

00:17:30.300 | So his plan, he's hardcore.

00:17:31.780 | I'm going to mention his site later as a great resource for you with really accessible

00:17:35.880 | articles on this.

00:17:36.960 | But he's hardcore with retirement accounts.

00:17:38.820 | Put everything in an IRA, put everything in a 401(k), defer everything, cut all your taxes

00:17:42.740 | across the board, and then pursue a Roth conversion strategy.

00:17:46.300 | So he's super detailed with it.

00:17:47.740 | He's awesome at it.

00:17:49.340 | So he goes in.

00:17:50.340 | He's working his plan, and I'll link to the article where he talks about this in his show—excuse

00:17:53.860 | me, in the show notes for today.

00:17:55.760 | But he's working his plan, and he's planning to quit.

00:17:58.380 | He was working at a university, so he could get a free master's degree there at the university,

00:18:02.460 | saving tons of money, not spending anything.

00:18:05.300 | And he and his wife are planning to move to Scotland.

00:18:08.420 | And so he goes in and he quits his job, per the plan.

00:18:11.900 | He's financially independent.

00:18:12.900 | He's hit his date.

00:18:13.900 | He's gotten all the money.

00:18:14.900 | He goes in and quits his job.

00:18:15.900 | And a few days later, his employer gets in touch with him and says, "Brandon, no, listen,

00:18:19.220 | you were great.

00:18:20.220 | You were really useful to us as an employee.

00:18:22.340 | Would you be willing to keep on working for us, doing what you're doing from wherever

00:18:26.100 | in the world you want to do it?

00:18:27.500 | And in fact, we'll give you a 20% pay raise over and above what you were making."

00:18:30.660 | Huh.

00:18:33.840 | So it seems like at least for now he's accepted it.

00:18:35.420 | Now, will he do that for the rest of his life?

00:18:36.900 | I don't know, and he doesn't know either, I'm sure, unless—maybe it's six months,

00:18:40.420 | maybe it's six years.

00:18:41.420 | He's not at all.

00:18:42.420 | But the point is that this happens a lot of times.

00:18:45.420 | And so people end up making more money after they declare themselves financially independent,

00:18:49.580 | early retired.

00:18:50.580 | Now, some people don't, theoretically.

00:18:52.580 | I haven't been able to find any of them or at least get them on the show.

00:18:55.740 | We're having a thread in the Money Mustache forums where people are like, "Get someone

00:18:58.420 | who's lazy on the show."

00:18:59.420 | I'm like, "I can't find anybody who's lazy, who's willing to make the effort of coming

00:19:03.100 | on my show."

00:19:04.100 | But the point is, Brandon—so he's making 20% more, and even though he's got all this

00:19:08.940 | strategy of how do I get the money out, he's still making more money.

00:19:12.620 | So he doesn't actually need the money.

00:19:13.940 | So he declared himself financially independent, and yet he's still working.

00:19:18.260 | Now, does this violate the whole idea?

00:19:20.780 | No, of course not.

00:19:22.500 | It doesn't.

00:19:23.980 | Because probably the biggest benefit to declaring yourself financially independent is psychological.

00:19:28.140 | It changes your options.

00:19:29.900 | You can do or not do anything you want, which is why even though I'm not in favor personally

00:19:34.060 | for me of never working again, I can't conceive of that being a desirable thing or a good

00:19:40.100 | thing or even something that I would ever even consider.

00:19:45.820 | Yet it's one thing for me to say that from where I sit right now, not financially independent

00:19:50.540 | in my definition, versus if I were financially independent in my definition of it.

00:19:56.500 | So you might still work and earn some money.

00:19:58.620 | I haven't actually—I've hardly ever found anybody in the early retirement space who

00:20:02.780 | hasn't continued working and doing something else, whether that's the ones that are well-known

00:20:07.500 | today, you know, Money Mustache.

00:20:09.380 | He's making more money now than he ever did in his life.

00:20:11.500 | I guarantee it.

00:20:12.500 | His blog is doing great.

00:20:13.820 | He's got all his construction projects.

00:20:15.940 | He could make more if he wanted to.

00:20:17.260 | He's not that into it.

00:20:18.420 | So the point was it's hugely valuable to be financially independent, but it doesn't mean

00:20:22.980 | you actually have to do it.

00:20:25.220 | Jacob Fisker, same thing.

00:20:26.780 | He's working, making money.

00:20:29.020 | I've reached out to other older authors, actually, of other traditional books, and I have found

00:20:33.660 | that many of them, after they wrote their books some number of years later, they just

00:20:37.780 | went on and went back to work.

00:20:39.180 | Now, does that mean everyone—no, of course not.

00:20:41.740 | Not everyone does that.

00:20:42.740 | I think Joe Dominguez, who wrote Your Money or Your Life, to the best of my knowledge,

00:20:46.580 | he spent the rest of his life volunteering, and he donated every dollar he made for the

00:20:50.420 | rest of his life.

00:20:52.060 | Doug Nordman from the financial—what's the military site?

00:20:57.820 | Military Finance or something like that, whatever his site is called, he donates all of his

00:21:01.900 | money that he gets from his book and from his blogging to military charities, and he

00:21:05.460 | just lives off of his retirement savings.

00:21:07.060 | So that's great.

00:21:08.060 | But the point is, he could.

00:21:11.300 | Now, another reason why you might not have the money coming out from a retirement account

00:21:18.340 | early even though you're declaring yourself financially independent is perhaps your spouse

00:21:21.420 | is working.

00:21:22.420 | So the other example, to the best of my knowledge, Brandon is from Mad Scientist.

00:21:27.020 | The plan is for he and his wife to move to Scotland, and I think that she is planning

00:21:30.100 | to continue working.

00:21:31.220 | She's Scottish, and she's either an ophthalmologist or an optometrist doing something with eyes,

00:21:36.820 | and so the plan is for her to continue working.

00:21:39.220 | And so very well, they could live on that income for a family and just keep the money

00:21:45.480 | in retirement accounts.

00:21:46.700 | Same thing, Jacob Lundfisker, when he was writing Early Retirement Extreme, his wife

00:21:52.020 | was still working and earning money.

00:21:54.300 | Now, how they handle that on tax planning doesn't matter to me, whether they handle

00:21:59.180 | their finances separately, whatever.

00:22:01.420 | I don't understand why people in a marriage ever handle their finances separately, but

00:22:06.460 | live your life, do what you want.

00:22:07.620 | I think it doesn't work for me, and I wouldn't do it, and I don't think – anyway, you'd

00:22:12.300 | have to convince me.

00:22:13.300 | I've never found the argument that's convinced me, but if you want to do it, fine.

00:22:16.660 | But so for me, if I chose and declared myself financially independent, if my spouse were

00:22:20.580 | working or vice versa, then we're financially independent because we have the money in the

00:22:26.340 | retirement accounts.

00:22:27.340 | It doesn't mean we actually pull it out, and that's fine.

00:22:31.200 | You might do something like – another option, you might wind up getting an inheritance.

00:22:35.700 | Maybe your parents die and leave you money.

00:22:37.420 | Maybe your Uncle Joe dies and leaves you money.

00:22:39.780 | It happens, and there's no reason then in that situation not to spend it and keep the

00:22:44.780 | money in the retirement accounts.

00:22:46.060 | You might do something like using other assets.

00:22:48.220 | So you might have something like a house, and you might sell the house.

00:22:52.220 | And so for many people, maybe all of their assets are in a house and a 401(k).

00:22:56.940 | That doesn't mean they can't retire early.

00:22:58.460 | It just means they'll probably be selling the house and spending those proceeds or selling

00:23:02.020 | the house and buying a rental house instead and living on that money.

00:23:06.020 | You might have other accounts, or the early retirees might have other accounts that are

00:23:10.140 | deferred but that have less restrictive rules about 59.5 than an IRA or a 401(k).

00:23:17.140 | So the examples that quickly come to mind are deferred comp programs including a 457

00:23:23.020 | plan.

00:23:24.020 | When I was at Northwestern Mutual, I had several retirement accounts and various accounts available

00:23:30.140 | to me.

00:23:31.140 | I had two different pensions that I was eligible to based upon different calculations and formulas,

00:23:36.820 | and I also had two different deferred compensation programs that were available to me.

00:23:40.900 | I had a short-term deferred compensation program and a long-term deferred compensation program.

00:23:46.060 | And basically, it's super simple.

00:23:47.140 | I could just tell Northwestern, "Defer this amount of my income based upon this formula

00:23:53.300 | into this specific year."

00:23:55.080 | So I always plan to use this in my life as part of my—basically to fund my plan of

00:24:01.740 | taking sabbaticals or distributed retirement throughout my life.

00:24:06.180 | I've had the idea of how I would prefer to work, to work in chunks.

00:24:11.340 | So each year, I've been working towards—I haven't hit this every year, but for the last

00:24:15.500 | five years, I've been working to try to work in essentially three-month chunks of time.

00:24:20.660 | So my plan was always to work January, February, March, take April off, work May, June, July,

00:24:26.560 | take August off, work September, October, November, and then take December off.

00:24:30.860 | And I like that from the perspective of it gives me the time to tackle major projects,

00:24:35.140 | and I would wind up working 75% of the time.

00:24:38.060 | And based upon how I like to work, I think that I would actually get more done in that

00:24:42.100 | really focused time and then having the time off on the—of every fourth month.

00:24:47.660 | And I could distribute that into projects.

00:24:49.220 | It would work well with my family.

00:24:51.260 | We could take month-long trips, which to me is an ideal length of time.

00:24:54.500 | It's long enough to feel like I don't have to fit into this silly six-day vacation weird

00:25:00.880 | thing that we US Americans do.

00:25:03.060 | But it's also not quite as big of a deal as setting your life up so that you can leave

00:25:06.940 | for six months.

00:25:08.180 | So that's how I've—even I've approached it for the last few years.

00:25:11.300 | I haven't hit it every year as organized as I would like, but I've always been able to

00:25:15.900 | take at least a month off, often closer to two, depending on how I structured it, every

00:25:20.300 | year for the last basically five years.

00:25:22.340 | And I work harder during the time that I'm here than take my time off.

00:25:25.900 | I also have had the plan of doing sabbaticals.

00:25:27.660 | I never wanted to do this when it was just me.

00:25:30.340 | And at this stage with a young son, I don't want to do this.

00:25:33.020 | But as my son and hopefully—we're hoping to have more kids, then hopefully more kids

00:25:39.860 | get a little bit older, then I plan to take sabbaticals.

00:25:42.180 | I want to take a year off or maybe two years off or a year and a half off.

00:25:46.240 | So I could use something like my deferred compensation programs—and this was actually

00:25:51.060 | my plan—was to basically just defer 20% of my earnings into this account.

00:25:56.660 | And then every fifth year I'd have one year of income sitting there waiting for me.

00:26:01.300 | Now from a tax perspective, this was purely a deferred compensation program with no age

00:26:05.780 | 59 and a half restrictions.

00:26:07.880 | And so I could keep the money there, and every fifth year I would have the same amount of

00:26:12.260 | income that I had in years one through four.

00:26:14.940 | So this was my plan of to use that specific plan to cover myself.

00:26:20.580 | So these programs do still exist.

00:26:22.340 | They're uncommon with small employers, which is why most people don't even think about

00:26:29.140 | this.

00:26:30.140 | We just think 401(k), 401(k), but they're very doable.

00:26:32.500 | Usually it's going to be with either a larger employer or it's going to be an executive

00:26:36.300 | benefit.

00:26:37.300 | So if you're an executive at a large firm, you're going to have access to something like

00:26:40.900 | this or at least it's going to be something that you're going to be talked about.

00:26:44.100 | This is an area of financial planning that is pretty niche.

00:26:48.020 | Most people aren't familiar with it, but you can set these types of deferred comp plans

00:26:50.940 | up.

00:26:51.980 | Or the most common one would be a 457, which is a deferred compensation plan for government

00:26:57.740 | employees and also for nonprofit employees, essentially.

00:27:00.300 | There's differences between the governmental ones and the non-governmental ones.

00:27:02.900 | But basically it just allows you to defer some income into this plan and you could take

00:27:08.380 | it out, but there's no, without the age 59 and a half restriction.

00:27:11.060 | I'm dramatically simplifying, but that's basically how it works.

00:27:13.780 | So if somebody has a 457 plan, if you're a teacher and you have access to a 457 plan,

00:27:17.540 | or if you're a police officer and you have access to a 457 plan, you can use this to

00:27:22.780 | defer the tax now and pay it in the future without dealing with the age 59 and a half

00:27:27.300 | scenario.

00:27:28.700 | You might just have something like a taxable account, a cash savings account, or you might

00:27:32.860 | do something like your, maybe, a scenario that I can think of where you would even,

00:27:37.740 | you declare yourself financially independent even with a bunch of money in retirement accounts

00:27:42.180 | would be, because you can tap the equity on your house and use that to fund your lifestyle.

00:27:48.140 | And many people can do this.

00:27:49.660 | And the key is that usually with early retirees, most of the people who are planning this early

00:27:54.300 | retiree path, their expenses are so low compared to their assets that it's relatively simple

00:27:59.940 | to find some money from somewhere else.

00:28:03.480 | So you could combine these plans.

00:28:05.540 | So you could, for example, you turn 50 years old and you're trying to get yourself from

00:28:09.620 | 50 to 60 and you have a big house, fancy house, well paid for.

00:28:14.500 | You don't need that much money, but you want to stay in the house for five years.

00:28:17.020 | Well, you take the equity out with a home equity loan for the first five years.

00:28:22.140 | Then at 55, you sell the house and you spend down some of the proceeds from that from 55

00:28:26.380 | to 60 and then you start tapping retirement accounts.

00:28:29.220 | Depends on your scenario.

00:28:31.480 | You might have something like a life insurance policy.

00:28:34.580 | With Northwestern Mutual, Northwestern, we did a lot of cash value life insurance.

00:28:38.060 | And so that was always something that oftentimes I would come across a client who has this

00:28:42.380 | really awesome, mature, well-funded life insurance policy.

00:28:46.840 | So a lot of times when you're doing retirement planning, that's a pool of money that we can

00:28:50.980 | pool from.

00:28:52.060 | And if their dad bought it for them and this thing is crazy mature and we've got all these

00:28:55.720 | dividends that we could take out tax-free up to the basis, or maybe we could take out

00:28:59.500 | a loan against it to fund as a funding mechanism to bridge from one account to another.

00:29:05.220 | Just depends on the makeup of the person.

00:29:07.980 | So that would be one example.

00:29:08.980 | They might not need to pay the penalty tax because they don't actually have to take the

00:29:11.580 | distributions because there's other money.

00:29:15.020 | They might be moving to a different country and earning money in a different country.

00:29:18.420 | So you still have the US taxes, but now you're working in Spain or working in Australia,

00:29:25.180 | having fun, making a living.

00:29:27.000 | So the money just sits in the retirement account in the US and what gave you the guts to do

00:29:30.380 | it was the fact that you didn't need the money, you didn't need to pull the money out.

00:29:34.380 | Some people might work on the black market.

00:29:36.860 | Whether that means going around and picking up scrap metal because you think that's fun

00:29:39.860 | or whether that means making birdhouses in your garage and selling that for a couple

00:29:43.740 | thousand bucks a month or coding on the internet and just making your money in Bitcoin or something

00:29:49.540 | like that.

00:29:50.540 | Some people might, because they're financially independent, might just work on the black

00:29:53.060 | market and evade the taxes.

00:29:55.820 | Some people might, for example, barter for housing.

00:29:58.380 | So let's say that I like agriculture.

00:30:01.060 | Well, I could easily have a bunch of money in retirement accounts and I want to go out

00:30:05.060 | and do slow travel around the world, but I just choose to work on wolfing farms, worldwide

00:30:11.500 | opportunities on organic farms, and I choose to work for my living where I lower my lifestyle,

00:30:17.380 | my cost for my lifestyle, so I don't need to take money out of the retirement account.

00:30:21.980 | You could keep the house and rent your own house out while you slow travel.

00:30:24.660 | And for some people, you have a nice fancy house in a desirable place, you can rent that

00:30:29.700 | thing out for two, three thousand bucks a month and that's more than some people will

00:30:33.180 | spend traveling the world.

00:30:35.500 | Or two, three thousand bucks for that plus a severance package or something like that.

00:30:40.620 | That's a lot of money for some people.

00:30:43.300 | And then you might just start a new business that you love with the freedom that you have.

00:30:47.180 | So again, prove to me that you can show me an early retiree that completely quits.

00:30:53.060 | Now I found a few of them online.

00:30:54.060 | I just haven't been able to get anybody to come on the show because the ones who are

00:30:57.540 | actually lazy are too lazy to come on my show, which is fine.

00:31:01.700 | Good for them.

00:31:02.700 | That's awesome.

00:31:04.140 | So in many cases, financial independence or early retirement might just be the mental

00:31:08.380 | freedom knowing that I don't have to work if I don't want to and that can be worth it.

00:31:12.340 | It really can be.

00:31:13.500 | So that's answer one is maybe they're just not actually taking a distribution.

00:31:17.620 | Now that's not probably why you tuned into the show, but I do want to start there because

00:31:20.820 | that is what happens.

00:31:22.180 | That's actually what happens.

00:31:23.860 | Now option two is you might just choose to take the distribution from the retirement

00:31:28.020 | account and pay the penalty tax because it's cheaper than something else.

00:31:32.580 | Oftentimes with tax planning, what we wind up doing is paying one tax in order to avoid

00:31:36.540 | another more expensive tax.

00:31:39.220 | The example that would come to mind off the bat is probably the simplest example would

00:31:43.220 | be the penalty tax if you don't take your required minimum distributions off of a 401(k)

00:31:49.780 | or off of a qualified retirement account.

00:31:52.980 | So you reach age 70 and a half and you have money in a 401(k), the IRS requires you to

00:31:57.860 | take required minimum distributions from that account.

00:32:01.060 | There's a formula that it's based upon, but there are many people who reach that point

00:32:04.860 | in time and they say, "I don't need this money.

00:32:06.300 | I want to keep the money in the account because if I take it out, I'm going to have to pay

00:32:09.660 | the income tax on it."

00:32:11.300 | The problem is that if you don't take your required minimum distributions, then you are

00:32:15.620 | taxed at 50% of what the required minimum distributions would have been.

00:32:20.260 | So you pay a 50% penalty tax.

00:32:22.800 | That's a lot of money.

00:32:23.800 | There's almost nobody that has a tax rate in excess of 50% on retirement distributions.

00:32:28.700 | So basically you choose to take the money out at say perhaps a 20% rate and pay the

00:32:35.140 | 20% income tax now so as to avoid the 50% penalty tax on your required minimum distributions.

00:32:42.700 | Now it could be the other way around.

00:32:44.740 | You might choose to put the money into a retirement account and then take it out to avoid a 20%

00:32:51.900 | income tax and then take it out knowing that you're only going to take it out when you're

00:32:55.820 | paying a 10% penalty tax.

00:32:58.100 | And so therefore paying the 10% penalty tax could conceivably be cheaper.

00:33:03.380 | And there are various reasons why it could be cheaper.

00:33:05.380 | It could be cheaper because it allows you to actually take advantage of something like

00:33:09.200 | an employer match or it could be cheaper just because you've changed what your individual

00:33:14.100 | tax rates and tax base and tax rates are.

00:33:17.620 | So if you had something, I'll make an example.

00:33:19.460 | Let's say that your employer matches you dollar for dollar into a 401(k) up to let's just

00:33:24.820 | make it generous $5,000.

00:33:27.240 | So if you contribute $5,000 of your money to the 401(k) and if your employer contributes

00:33:32.740 | $5,000 of their money to the 401(k), then in that situation you put in five and you

00:33:37.900 | get ten.

00:33:39.100 | Now you've avoided the income taxes.

00:33:41.860 | You're going to be taxed on that later when you pull it out.

00:33:44.740 | But if you take it out, you're going to have to pay the 10% penalty tax.

00:33:47.700 | Well let's run the math.

00:33:48.700 | So $5,000 plus $5,000 equals $10,000.

00:33:52.940 | Now regardless, you're going to have to pay the income tax if we take it out early and

00:33:58.820 | we don't avoid that.

00:33:59.820 | So I'm keeping it purely apples to apples.

00:34:02.620 | Now assume you're going to pay a 20% income tax either on the $5,000 that you go ahead

00:34:06.820 | and take the income or on the $5,000 that you defer into the 401(k) to get the match.

00:34:13.140 | So in your head, you know that you're either going to go ahead and get $4,000 to spend

00:34:16.980 | now or you're going to get $8,000 to spend later.

00:34:21.140 | So let's say that you go ahead and you put your $5,000 into the account.

00:34:26.580 | The employer puts their $5,000 into the account.

00:34:28.660 | You're going to pay $2,000 of income tax when you take it out.

00:34:31.940 | But you're going to pay a 10% penalty tax on the $10,000.

00:34:36.020 | Well that would be a $1,000 penalty tax.

00:34:38.380 | So now the question is would I rather go ahead and take the $4,000 this year in my paycheck

00:34:45.260 | and give up the employer match or would I rather go ahead and put that – it was $5,000

00:34:51.100 | and you paid $1,000 of tax now to get $4,000 in the paycheck.

00:34:54.900 | Or would I rather go ahead and put the $5,000 into the 401(k).

00:34:58.740 | They put their $5,000 in the 401(k) and assuming I'm vested – going based on a vesting

00:35:05.060 | schedule – assuming I'm vested in their contribution, next year I leave and I take

00:35:09.820 | all $10,000 out of the 401(k).

00:35:12.420 | I pay $2,000 of income tax and $1,000 of penalty tax which leaves me with $7,000.

00:35:18.620 | That's a net gain.

00:35:20.780 | So, you might just say, "Well, this is 10%.

00:35:22.620 | I got to pay it."

00:35:23.620 | So, that could be very rational.

00:35:25.900 | Now it could also be rational because you know of something that's going to happen

00:35:29.900 | where you're actually going to change your scenario.

00:35:32.340 | So what comes to mind here is let's say that you're going to change states.

00:35:35.780 | Maybe you're working in a state where you have very high state income tax or even a

00:35:40.020 | local city income tax.

00:35:41.940 | So, if you think of something like New York City and New York State, New York State income

00:35:46.980 | taxes vary depending on what the brackets are.

00:35:49.920 | But around – let's see.

00:35:52.260 | So, I'm looking at tax-rates.org.

00:35:56.700 | So around $154,350 of income for a couple, you get into a 6.65% marginal bracket.

00:36:04.380 | So ignoring deductions and credits, every dollar you earn that's in excess of $155,000,

00:36:10.100 | you're going to pay 6.65% of income tax on that money.

00:36:17.020 | Now if you go to the New York City rates, well, let's see.

00:36:20.260 | So New York City rates look like they range from about 3 to 3.5%.

00:36:24.220 | So let's say as an example that you have 3 to 3.5%.

00:36:28.540 | Let's use 3.5%.

00:36:29.540 | That will make it line up well with the 6.5%.

00:36:32.180 | So now if you have 3.5 plus 6.5, you have 10% income taxes.

00:36:36.660 | So what's the harm of just putting the money into the 401(k) and then moving to Florida

00:36:41.100 | when you quit your job and taking the money out of the 401(k)?

00:36:44.500 | You paid 10% up there and you paid 10% down here of taking it out early.

00:36:49.260 | Now the trick would have been in that situation you can exploit probably an income bracket.

00:36:53.500 | So let's say you go from $300,000 of household income to living on only needing $3,000 a

00:36:58.780 | month because you're doing an early retirement thing and you were saving 90% of your income.

00:37:02.700 | Well in that situation it's pretty simple.

00:37:04.300 | You're not going to pay that much bracket and you're going to have zero income taxes.

00:37:08.340 | So you go from maybe an effective rate of 40% up there to an effective rate of 10% in

00:37:13.740 | Florida because you're just paying the 10% penalty and you're paying 0% state income

00:37:17.580 | taxes and 0% in federal income taxes because you lowered your income needs.

00:37:25.460 | That might be a good reason just to go ahead and pay it.

00:37:29.300 | Another example would be California.

00:37:31.660 | In California, let's see, again, tax-rates.org, excess couples, in excess of $415,000 of income,

00:37:39.660 | the marginal bracket is 11.3%.

00:37:42.300 | That goes up to 13.3% in excess of a million of income.

00:37:45.900 | So you've got an 11% state tax bracket.

00:37:49.720 | If you just simply moved from California to Florida and then took all of your money out

00:37:53.260 | of the account, that theoretically could save you 11.3%.

00:37:58.780 | Now does this actually work in practicality?

00:38:03.340 | No not in that specific way because the brackets, we're talking about a marginal bracket, it's

00:38:08.660 | not quite that neat but it's pretty much the concept.

00:38:11.800 | Now when you combine this with the income tax bracket from going with a lower number,

00:38:16.920 | this is the other one.

00:38:17.920 | So the two big changes, you might change states from a state that charges income taxes to

00:38:21.700 | a state that doesn't or you might also change where you are in the bracket, what your marginal

00:38:26.140 | bracket is.

00:38:27.460 | So if you went from earning $200,000 a year and you're living an early retiree lifestyle

00:38:32.300 | and living on $3,000 a month, $36,000 a year, and then you just went and you started taking

00:38:37.700 | off the money at $36,000 a year, you're going to be paying a much lower, even though it's

00:38:42.220 | coming from retirement accounts, you're going to be paying a much lower income tax bracket

00:38:47.300 | at that money even if you were paying the penalty.

00:38:50.180 | Now you actually have to calculate your specific scenario but this can make a big difference.

00:38:54.420 | Could you go from a 30% marginal bracket to a 0% marginal bracket?

00:38:58.780 | If so then paying 10% instead of 30, paying a 10% penalty instead of the 30% bracket would

00:39:05.740 | be worth it.

00:39:06.780 | So you have to start with looking at your actual scenario, looking at your actual taxes,

00:39:10.940 | your actual rates, the base, the rates in your situation, and then looking at what your

00:39:15.540 | options would be and also what your plans would be.

00:39:17.940 | If you're never going to move from New York City to Florida, don't.

00:39:22.020 | Don't do that plan.

00:39:23.220 | But I can tell you that's one of the big reasons why we have a gazillion New Yorkers down here.

00:39:26.780 | And if you're never going to move from California, don't do that plan.

00:39:29.660 | That's not going to work.

00:39:30.660 | You're going to need to do something else.

00:39:31.820 | But that is one scenario.

00:39:34.100 | So you might be in a lower bracket, you might move to another state, and the other thing

00:39:37.260 | is the tax might not be a big deal because it's just doing it for a few years.

00:39:41.300 | So maybe, and this is often I think also what happens, is that people are going to retire

00:39:46.100 | before 59.5 but they just need money for a few years.

00:39:49.380 | So maybe you're retiring at 50.

00:39:50.860 | Well, if you have a ton of money in investments, maybe by then your investments are growing

00:39:54.700 | by so much that it's far in excess of the 10% you're going to pay to get the money from

00:39:59.380 | 50 to 59.5 and then you're going to take the money out.

00:40:02.380 | Big deal.

00:40:03.380 | So is that mathematically perfect?

00:40:05.420 | No.

00:40:06.420 | But we don't have a crystal ball to know exactly what all of your lifetime plans are when we're

00:40:09.980 | sitting down at 22 years old and making out plans.

00:40:13.900 | So hopefully that's a good intro.

00:40:15.100 | Now we're going to get to the two technical things.

00:40:17.020 | And I'm not going to actually spend a long time, but I wanted to make you aware of those.

00:40:20.940 | Answer one, meaning answer that they don't actually take the distributions, that's one

00:40:24.580 | answer to the question of how do the early retirees do.

00:40:27.180 | Answer two is they might just pay the penalty tax.

00:40:30.020 | But most of the people in the early retiree plan are planning on options three or four.

00:40:35.740 | Option three is called the Roth conversion and option four is a series of substantially

00:40:43.060 | equal periodic payments.

00:40:44.540 | 72T is what it is.

00:40:46.260 | So let's do the Roth conversion.

00:40:47.660 | Here's basically the principle behind it without any technical talk.

00:40:51.100 | When you participate in a Roth IRA, you can always take your contributions to the account

00:40:57.940 | out again without any tax implications one way or the other of any kind.

00:41:04.420 | So if you this year put $5,000 into a Roth IRA and next year you take $5,000 out, regardless

00:41:12.140 | of your age, there are no tax issues whatsoever with that decision, which is why when you're

00:41:21.500 | young this can be a really great move to do is that you fund the Roth IRA and you put

00:41:27.020 | your $5,000 in there.

00:41:28.900 | And even if you just kept the money in cash, you can use it as an emergency fund.

00:41:31.780 | It's no big deal.

00:41:33.020 | Now you have to avoid any kind of penalties or fees that would be imposed by an investment

00:41:38.500 | company.

00:41:39.500 | So let's say that if you were buying loaded mutual funds where you're paying a commission,

00:41:42.940 | you wouldn't get that money out.

00:41:44.580 | Or if you are paying where there's some sort of fee involved, you have to avoid that if

00:41:49.220 | you're going to do this plan.

00:41:50.220 | But you could do that at a bank with probably no fee and just toss the $5,000 in there.

00:41:54.780 | So I would always just use the Roth IRA as just a straight account because you can always

00:41:58.020 | take the money out.

00:41:59.500 | Now if you contribute $5,000 to the Roth IRA and next year you take out $5,001, well the

00:42:07.620 | $5,000 comes to you with no tax implications.

00:42:10.820 | But the $1 of gain will be taxed to you and it might be penalized unless you can avoid

00:42:18.420 | one of the exceptions.

00:42:23.060 | So that's one of the keys.

00:42:24.660 | So essentially what this opens up for people is – and by the way, sorry, here's the

00:42:29.180 | other key – is that on that basis, as long as the money that's in a Roth IRA stays

00:42:34.500 | there for – excuse me, I'm getting tongue-tied here.

00:42:38.220 | So when you put money directly into a Roth IRA, the rules that I just said apply.

00:42:42.820 | However, you can also do this by converting a traditional IRA or a traditional 401(k)

00:42:51.060 | to a Roth IRA.

00:42:53.140 | So the example would be, let's say I have $100,000 in my traditional 401(k) and I convert

00:42:59.380 | that to a Roth IRA.

00:43:02.900 | Now in the year that I convert it, I'm going to pay the income tax on the money.

00:43:08.120 | So I convert it and I pay the income tax.

00:43:11.580 | Now as long as I leave the money alone for five years and then I only take out the amount

00:43:17.020 | that I converted, I can take out that amount that I converted after five years without

00:43:22.940 | paying the penalty tax.

00:43:25.320 | So this is the plan that most of the people that are in this scenario are working on.

00:43:30.580 | So I have $1 million in 401(k)s and this is called a Roth conversion ladder.

00:43:35.740 | So I have $1 million in 401(k)s and assume that I need $10,000 from my portfolio to support

00:43:42.460 | my other forms of income so that I can be financially independent.

00:43:46.240 | So this year I convert $10,000 from my 401(k) to a Roth IRA.

00:43:51.520 | I bring that income forward, because remember this is just a timing strategy, an income

00:43:55.320 | time shifting strategy.

00:43:57.080 | I go ahead and pay that tax on the $10,000 now if there is any.

00:44:01.840 | Then five years from now I take that $10,000 out of the Roth IRA and I spend it.

00:44:06.080 | Now in the meantime it may have actually grown.

00:44:08.640 | So it may have grown from $10,000 to $12,000, which is great.

00:44:11.920 | I still just take my $10,000 out and I leave the $2,000 to grow until after 59 and a half.

00:44:18.800 | Or I take it out and pay the penalties on the $2,000 if it's not for one of the other

00:44:22.960 | exceptions.

00:44:24.560 | So that's it.

00:44:25.560 | So that's what many people are doing.

00:44:28.080 | Pile up a bunch of money in 401(k)s, cover yourself for five years through other sources

00:44:32.500 | of income, and then transition and transfer the money from the traditional 401(k) to a

00:44:36.880 | Roth IRA and then start taking it out.

00:44:39.640 | It's called a Roth conversion ladder.

00:44:41.960 | And it's great.

00:44:42.960 | There's no reason why it can't work.

00:44:44.520 | If you're interested in this strategy, I just explained to you everything you need

00:44:47.920 | to know as far as the basics of it, how it works so you can understand it.

00:44:54.400 | Now there are some tweaks that you can do and some of the tweaks are pretty cool.

00:44:57.820 | So one of the useful things, the two most accessible resources that I would send you

00:45:01.880 | to is our Brandon@MadFientist.com and then Jeremy and Winnie@GoCurryCracker.com.

00:45:09.960 | The reason they're accessible is they're normal people and they don't write in financial

00:45:15.960 | planner speak.

00:45:17.960 | I think you need to learn – it would probably be a good idea if you read the financial planner

00:45:21.680 | speak but it's hard for people who are not used to financial planner speak to get it.

00:45:27.360 | And Brandon and Jeremy, because they're normal people, they write in normal language.

00:45:32.080 | So start there.

00:45:33.080 | Now then go from there.

00:45:34.240 | Go to the financial planner stuff and make sure you get the rules.

00:45:36.800 | But they do everything.

00:45:37.800 | They talk about everything that you need to know.

00:45:40.360 | They're normal guys.

00:45:43.560 | And so start there.

00:45:44.720 | Now the problem with – I mean here's the advantage and disadvantage and here's why

00:45:47.800 | many of the early retirees are doing it.

00:45:49.800 | In order to retire early, you have to learn to live on a much smaller percentage of your

00:45:53.480 | income than most other people.

00:45:55.520 | Does that mean you're used to living a good life on not much money?

00:45:59.120 | Now that means you're willing to continue it also on not much money in retirement.

00:46:03.920 | And so the crazy thing is our tax code penalizes productivity.

00:46:08.280 | So as long as you can suit your lifestyle to not much money, then you can escape the

00:46:13.520 | tax code.

00:46:14.520 | It's crazy.

00:46:15.520 | Excuse me.

00:46:16.520 | To me, I understand but I don't understand.

00:46:19.160 | I think it's stupid how our tax code is set up where it completely penalizes any kind

00:46:23.200 | of productivity and the more productive you are, the more it penalizes you.

00:46:27.460 | So some people just ignore it and press through and a lot of people say, "This is stupid.

00:46:31.600 | Why should I do it?"

00:46:32.740 | So if you can be a slacker and just simply stop being productive, you can stop paying

00:46:38.280 | taxes.

00:46:39.280 | Go read Jeremy's articles on that.

00:46:40.600 | I interviewed him on the show as well, previous episode.

00:46:42.640 | Go look through the archives and see Jeremy from Go Curry Cracker.

00:46:45.440 | He publishes his tax returns online, pays no taxes and lives a slacker lifestyle, which

00:46:49.400 | is awesome.

00:46:50.400 | Good for him.

00:46:51.400 | I just think it's a sheer and utter total waste of talent to have very smart people

00:46:56.280 | like Brandon and Jeremy spending their life energy avoiding taxes.

00:47:00.080 | It's even worse to have a whole army of financial planners expending our life energy to help

00:47:05.840 | people avoid taxes.

00:47:07.400 | I do not get it.

00:47:10.000 | It frustrates me.

00:47:11.000 | I have a difficult time having political conversations about taxes with people because I understand.

00:47:16.060 | Look at the incentives.

00:47:17.120 | Look at the facts.

00:47:18.800 | Look at how just stupid all of the laws are as far as when they're put together.

00:47:23.440 | Don't you realize that people with money have plenty of money to hire guys like me

00:47:27.560 | and guys ten times smarter than me and more well-read than me and gals 20 times smarter

00:47:32.520 | than all of us to find the loopholes and exploit them?

00:47:36.000 | If you're making $3 million a year, a 2% savings on your taxes, that's big money.

00:47:41.800 | Now, if you're making $30,000 a year, that's not a big money, but 2% savings, that's

00:47:46.840 | $60,000 if you're making $3 million a year.

00:47:49.760 | So you have this whole stupid tax code.

00:47:51.640 | It's all cobbled together with this and that and this and that and this and that.

00:47:55.880 | And you got to, anyway, rant over.

00:47:58.120 | But it's just utterly stupid.

00:48:00.000 | I hate spending my life energy helping people avoid taxes, and I think it's despicable

00:48:05.240 | that we're taking some of the smartest people, incredible guys, and it's like, "Why should

00:48:09.640 | I bother to work and pay taxes?"

00:48:13.200 | It's just dumb.

00:48:16.000 | So go look at how Brandon and Jeremy are talking about it, and you'll understand the Roth

00:48:20.000 | conversion scenario.

00:48:22.840 | And there's some good stuff.

00:48:24.200 | So the key is here, you have to actually understand how much you're going to spend.

00:48:28.280 | And this only works, this strategy only works well.

00:48:31.600 | It works okay, but it only works well if you're going to be spending a much lower amount of

00:48:34.960 | money than most other people because all the tax breaks in our tax code are for the poor.

00:48:42.160 | So if you can just simply not make much money, then you can be poor and you can not pay any

00:48:47.320 | taxes.

00:48:48.320 | I'm intentionally not giving you a lot more detail than that because you need to research

00:48:52.320 | this for yourself.

00:48:53.980 | And so start with Brandon and Jeremy's, and then from there, go to the IRS website is

00:48:58.840 | what I would do and start reading their stuff.

00:49:00.700 | If you can deal with IRS-speak or financial planner-speak, that would be a good place

00:49:05.760 | to go.

00:49:06.760 | My hope is that you'll research it.

00:49:08.260 | And I love the early retirement scenario.

00:49:10.720 | One of the things that's so frustrating, and the reason why, one of the things that's frustrating

00:49:15.040 | about traditional financial advice is if I tell a traditional person sitting in my office,

00:49:19.400 | just lower your expenses to $3,000 a month, people look at me like I have two heads.

00:49:24.200 | The standard answer when you're a financial planner, if you ask somebody who's making

00:49:27.280 | $6,000 a month how much they want to retire on, they say $10,000 a month.

00:49:31.200 | And you say, "Are you kidding me?

00:49:34.000 | Do you not get this?"

00:49:35.680 | But that's the standard answer.

00:49:37.080 | Now in the early retirement space, the cool thing is if you ask somebody making $10,000

00:49:40.880 | a month how much they want to retire on, they say $2,000 a month.

00:49:43.840 | So it's pretty cool.

00:49:44.840 | This works really well in the early retirement space.

00:49:46.720 | I hope that helps.

00:49:49.200 | Read the articles.

00:49:50.200 | Pay special attention to the tax rates on dividends and capital gains.

00:49:54.280 | You can do fancy stuff.

00:49:55.600 | Like Brandon has a great article on what he calls the Roth IRA horse race, which is a

00:50:00.920 | cool little technique.

00:50:02.320 | Basically at the beginning of every year, you convert two accounts.

00:50:06.040 | You invest one in stocks, one in bonds.

00:50:08.200 | Whichever one comes out better at the end of the year, you keep.

00:50:10.920 | And the other one, you recharacterize and undo that conversion and then flip it back

00:50:15.840 | before the end of the year.

00:50:17.320 | It's a cool strategy.

00:50:18.320 | Read that.

00:50:19.320 | You can do cool stuff like front-loading your accounts at the beginning of the year and

00:50:21.720 | seeing what ends up being better.

00:50:23.080 | There's all kinds of stuff, but I don't want to go any deeper than today.

00:50:26.160 | So hopefully that helps you to understand the Roth conversion ladder.

00:50:29.920 | Option number four is often referred to as the 72(t) distribution.

00:50:38.360 | You'll see it as 72(t) or SEPP, which stands for substantially equal periodic payments

00:50:44.960 | or often I'll refer to it as a series of substantially equal periodic payments.

00:50:49.160 | So basically this is one of the exceptions to paying the penalty tax.

00:50:53.520 | And so 72(t), section 72(t) of the Internal Revenue Code is where you find all of the

00:50:59.120 | exceptions to paying the penalty tax.

00:51:01.480 | And one of those exceptions is that the 10% additional penalty tax will not apply to a

00:51:06.960 | distribution which is part of a series of substantially equal periodic payments.

00:51:12.960 | Now how is that defined?

00:51:14.160 | Well, it has to be defined in this way.

00:51:17.160 | Number one, these payments cannot be paid any less frequently than annually.

00:51:21.880 | So that's IRS speak for saying it's got to be at least once a year.

00:51:25.680 | Number two, those payments must be paid without changing the amount until the longer of five

00:51:34.480 | years or until you reach age 59 and a half.

00:51:39.100 | So if I'm 30 and I do this, I cannot change the amount coming from the account until at

00:51:45.400 | least 59 and a half.

00:51:47.420 | If you do this at 57, you have to go for at least five years.

00:51:50.440 | So it has to be paid to you without changing the amount of the payment for at least for

00:51:56.640 | the longer of five years or until the payee reaches age 59 and a half.

00:52:02.120 | Next, the distribution has to be based upon the life expectancy of the recipient or the

00:52:09.320 | recipient and their beneficiary.

00:52:11.440 | So it has to be paid to you based upon your actual life expectancy.

00:52:15.720 | And this is the big problem.

00:52:18.120 | It has to be based upon a reasonable rate of interest.

00:52:21.680 | And if applicable, it has to be based upon reasonable mortality assumptions.

00:52:26.760 | Here's the key.

00:52:28.480 | Once you start taking payments, those payments may not be changed.

00:52:33.400 | They may not be increased.

00:52:34.880 | They may not be decreased.

00:52:36.280 | They may not be changed in any way before the age of 59 and a half or the end of five

00:52:43.640 | years, whichever of those is longer.

00:52:47.320 | Make sense?

00:52:48.880 | If the payments are modified in any way, then the 10% penalty tax is applied retroactively

00:52:55.920 | to all payments that are received before 59 and a half.

00:53:00.640 | That's a big deal.

00:53:01.640 | That's a huge deal.

00:53:03.700 | If you change the amount at any age, then the 10% penalty tax has to be paid retroactively.

00:53:10.760 | Now if I do this at age 30, I'm probably going to know that.

00:53:13.840 | But what happens is sometimes somebody will do this at 52.

00:53:16.680 | And let's say they set up a series of payments at 52, and then at 58 they change something.

00:53:20.640 | Because they're like, "I'm almost 59 and a half," and they change the amount somehow.

00:53:25.160 | And if they do that, then they're sunk because then the payments have to actually – they

00:53:32.080 | pay the 10% penalty tax on all the money they receive from 52 to 58.

00:53:36.440 | And the only exception to that is that there is an option one time where they can switch

00:53:42.440 | from what's called the annuity method or the amortization method to the required minimum

00:53:47.280 | distribution method without paying a penalty.

00:53:50.120 | But what that does is it greatly decreases the payout amounts.

00:53:54.000 | And so that could actually help keep the funds for longer, but it reduces the payout amounts,

00:54:00.000 | which usually isn't the goal for early retirees.

00:54:04.400 | Which is – incidentally, this is one of the reasons why this Section 72(t) – and

00:54:08.600 | I'm going to give you some example numbers here in a minute as we wrap up.

00:54:11.080 | But this is why 72(t) is not really of help for most people.

00:54:14.800 | I had a scenario in my practice where I had a client, a wonderful client, and this client

00:54:20.560 | came to me and they had a lot of money in their 401(k).

00:54:23.720 | And when they had a lot of money in their 401(k), they were doing well, the money got

00:54:26.800 | rolled over to my stewardship.

00:54:30.960 | And while it was under my stewardship, the client was doing fine.

00:54:33.600 | They had gotten laid off from a job, but they were receiving – what's that called when

00:54:40.280 | they pay you money?

00:54:41.280 | Unemployment.

00:54:42.280 | They were receiving unemployment, and they were just enjoying their unemployment income.

00:54:47.440 | They weren't looking for work, and they were just enjoying their unemployment.

00:54:50.640 | This was in the time in 2000-whatever, late 2000s, when it was extended, when they kept

00:54:56.080 | extending the unemployment, extending the unemployment.

00:54:57.680 | The client was traveling and just not living a big lifestyle, but just enjoying the unemployment.

00:55:02.320 | So then – and then had some other savings, and then finally the unemployment ran out

00:55:06.520 | after what, it was 99 weeks, I think.

00:55:08.600 | So finally the unemployment ran out.

00:55:10.480 | So they just started to think about getting a job.

00:55:12.720 | So they went and started getting a job and started looking around and trying to figure

00:55:15.520 | out, "Well, what do I do?"

00:55:18.200 | They looked at a few different places and couldn't find a job.

00:55:21.720 | And then they started taking distributions from the retirement accounts.

00:55:25.600 | It started off as small, and it got bigger, and it got bigger, and it was bigger, it was

00:55:30.240 | one, and then four months later it was another, and then it was $10,000, and then it was $40,000,

00:55:34.280 | et cetera.

00:55:35.280 | And this retirement account goes down, down, down, down, down.

00:55:38.560 | The problem was the retirement account – this client was about 50 – but the retirement

00:55:42.960 | account – no, no, excuse me, late 40s – wasn't enough to get them through retirement even.

00:55:47.900 | So they said, "Is there any exception?"

00:55:50.960 | But we go through 72(t), and 72(t) didn't work because they didn't even have enough

00:55:57.760 | money for retirement.

00:55:58.760 | So the whole time though they insisted they were going to get a job.

00:56:01.120 | If they're going to get a job, they're going to get a job.

00:56:03.380 | So I said, "Listen, you could start 72(t), but the problem is the payments are not enough

00:56:07.720 | to fund your whole lifestyle, and if you start at 72(t) you can't change it."

00:56:11.840 | Well, the whole point was they needed to go back to work, and they said they were going

00:56:14.440 | to.

00:56:15.440 | So it just wound up being a tough situation all around, and it was a massive problem.

00:56:19.120 | So 72(t) didn't help.

00:56:21.280 | Looking back in retrospect, if I could have predicted what would have happened, then I

00:56:25.480 | should have.

00:56:26.480 | And that's one of those things where with more maybe wisdom of hindsight, maybe next

00:56:30.080 | time if a client is the type of client who doesn't work for two years because they're

00:56:34.520 | taking unemployment, and then I should have maybe predicted.

00:56:37.040 | But I didn't know they were going to be out of work for five years, and so 72(t) didn't

00:56:41.880 | work.

00:56:42.880 | So they had paid the 10% penalty tax.

00:56:45.520 | So this is just an example, and the key is you have to actually review the rules and

00:56:51.040 | figure out what works in your situation.

00:56:53.540 | Let me give you one calculation, and then I'm done here for today, except I want to

00:56:58.120 | actually talk about one problem or consideration with these approaches.

00:57:02.700 | So if you actually look at the numbers, and the easiest way to look at the numbers is

00:57:08.120 | to just use an online calculator.

00:57:10.000 | I'll put one from Dinkytown here in the show notes that I pulled up.

00:57:14.400 | This is easier than calculating by hand.

00:57:16.320 | And it'll compare the three different amounts, and you can put in your account balance, the

00:57:20.600 | interest rate.

00:57:21.600 | It'll stick that in for your age and the beneficiary's age.

00:57:25.000 | And then you can choose whether you want to do a single life expectancy or a joint life

00:57:29.220 | expectancy or the uniform table.

00:57:31.440 | So if I put in here, let's say that I now am, and it starts at 35, so I can't do it

00:57:36.320 | at 30, but let's say I'm a year old, and I put in here that I'm 35 and my beneficiary

00:57:40.440 | is 35, and I calculate this on a million-dollar portfolio.

00:57:44.560 | This million-dollar portfolio, basically I could get somewhere about $34,000 per year

00:57:49.520 | out of this account.

00:57:50.920 | So in my scenario, if I were 35 years old and I had a million dollars invested, and

00:57:55.200 | I wanted to take out 3.5% every year, which would effectively be what $34,000 would be,

00:58:01.400 | I could use this to actually fund my lifestyle and never have to pay the 10% penalty tax.

00:58:08.000 | I would pay the income tax, but I'd never have to pay the 10% penalty tax if I did that.

00:58:12.320 | Now the problem would be that I can't stop it.

00:58:15.400 | So if at 39 I change my mind and I go back to work, I can't stop this money, otherwise

00:58:20.240 | I have to go back and pay the 10% tax retroactively.

00:58:23.500 | So this is the kind of thing that it could be applicable to an early retirement situation,

00:58:29.440 | but it's probably not.

00:58:30.480 | You have to have enough money, and an early retiree scenario could do it because they

00:58:33.520 | have enough money, but it's probably not because you can't change it.

00:58:37.040 | And for me to go from 35 to 60, 59.5, 60, that's 25 years that I've got to predict

00:58:43.800 | and I can't stop the money.

00:58:45.360 | Now if I'm okay with just keeping the money coming in and getting it out, that's fine.

00:58:48.740 | And so for some people who are trying to say, "I need to cash out my 401(k)," that can

00:58:52.360 | work and that can be fine, but you've got to consider it and count the cost.

00:58:55.880 | So those are the four basic options, and depending on an individual situation, many people will

00:59:01.720 | choose among those options.

00:59:03.880 | Now I want to close with one of these problems.

00:59:06.780 | One problem for you to consider.

00:59:08.920 | Could the laws change?

00:59:11.320 | This is something I rarely see discussed in the early retirement space, but it's a concern

00:59:15.000 | of mine.

00:59:16.640 | Could the laws change?

00:59:19.960 | One thing I've—I haven't gone back and searched all the legislative history, but I do know

00:59:25.800 | this.

00:59:26.800 | Laws change.

00:59:27.800 | And I have an example here that to me is a good example.

00:59:29.760 | I'm going to cover in just a second.

00:59:32.080 | But it's very tough for me to trust the government.

00:59:34.320 | It's very tough for me because the legislators who are designing the law are going to be

00:59:39.640 | swayed by the court of public opinion.

00:59:41.680 | And it's very hard for me sometimes to figure out why certain things are done.

00:59:45.680 | So for example, you could hear the traditional mainstream tax perspective of financial planning—excuse

00:59:53.360 | me, of tax law—would say that the reason that the government gives you a tax incentive

00:59:59.080 | for you to set your money aside until at least the age of 59 and a half is because it's in

01:00:04.000 | the social good and it's in the common good for all of us to care for ourselves for retirement.

01:00:09.440 | So there's going to be a motivation for you to set your money aside.

01:00:13.560 | Well, it might be a motivation if you just stop taxing people on earning money, but set

01:00:18.720 | that aside.

01:00:19.720 | So that might be a motivation.

01:00:20.940 | Now you could flip it around and say, "Well, is there another reason for this?

01:00:25.660 | Is there a motivation for you to keep your money locked up, for example, to keep you

01:00:29.480 | as indentured or enslaved to the working system?

01:00:33.980 | Because if you can't get your money out easily, then now you're forced to keep working."

01:00:39.160 | What's the answer?

01:00:40.160 | I don't know.

01:00:41.160 | I could argue either of them.

01:00:42.960 | I'm generally inclined to say it's in the social common—you know, the common social

01:00:49.120 | good for the common good of all people because tax theory is actually remarkably consistent.

01:00:54.080 | I used to say that tax theory was crazy and inconsistent, and then I actually started

01:00:59.120 | studying it and I found out that tax theory and policy is generally applied pretty consistently

01:01:04.920 | across all the different taxes and is generally applied fairly evenly.

01:01:09.200 | So I'm inclined to go in that direction, but man, I can acknowledge whether intentional

01:01:12.800 | or not the fact that if you keep the money locked up until 59 and a half, it makes it

01:01:16.400 | tough for people to get at it.

01:01:18.280 | Or is it a way of gaining insight into what people have?

01:01:22.120 | Every year, every single one of your retirement accounts gets reported.

01:01:25.040 | The balance gets reported to the government.

01:01:27.140 | So there's no chance for privacy in the retirement accounts.

01:01:31.080 | There's no chance for privacy.

01:01:33.440 | You can't make an investment that the IRS doesn't know about.

01:01:36.160 | They know about all of it.

01:01:38.480 | Now they could also come and you could do it at a brokerage account if you're trading

01:01:41.840 | stocks and they could know about that too.

01:01:43.160 | Sure, they could subpoena that, but it's a whole lot easier if all the papers get sent

01:01:45.640 | to them every year.

01:01:46.720 | So is that the key?

01:01:48.200 | Or was this lobbied by Wall Street?

01:01:49.920 | So it's a lot easier to buy mutual funds and put that money in your 401(k) or in your IRA

01:01:56.480 | than it is for you to do – you can do a self-directed IRA and invest in real estate,

01:02:01.160 | but it's a lot easier to do mutual funds.

01:02:02.520 | So was this a Wall Street issue?

01:02:05.960 | I have no idea.

01:02:07.520 | I have no idea.

01:02:08.520 | I've never found any credible discussion on that one way or the other that was actually

01:02:14.040 | credible.

01:02:15.040 | If you know of something that would go in one way or the other, let me know.

01:02:17.960 | Personally I'm inclined to think it's just social policy because having been involved

01:02:21.560 | in the investment business, I see how this is a factor and legislators feel the need

01:02:26.640 | to get involved.

01:02:28.200 | They don't just stand there and do something is what they say.

01:02:31.320 | I would say don't do something, just stand there.

01:02:34.020 | But another conversation for another day.

01:02:36.280 | So I've been involved enough, but I've also been involved enough to know there's

01:02:40.880 | a lot of industry interest that gets to play.

01:02:42.760 | I was involved a lot in the insurance industry and it really bothers me when you go to meetings

01:02:47.480 | and you go to industry association meetings and you go to company meetings and it's

01:02:52.280 | all about here's what our lobbyist is doing.

01:02:54.760 | Come on.

01:02:55.760 | I don't want to be involved where there's a lobbyist, but I understand why you would

01:02:57.520 | have to.

01:02:58.520 | If I were running a company, guess what?

01:03:00.080 | I would have my lobbyists because you have to protect your shareholders or your policy

01:03:05.440 | owners if you're a mutual insurance company, but I don't like it.

01:03:08.980 | But I've been around enough to know that guess what?

01:03:11.400 | It's the finance industry, it's the investment industry, it's the insurance industry.

01:03:14.720 | I don't like it, but it exists.

01:03:17.080 | So I have no way of knowing that.

01:03:18.600 | But here's the key.

01:03:20.460 | Is there a credible reason to think that your plans might get foiled if you become too heavily

01:03:24.800 | dependent on one of these strategies?

01:03:27.720 | I think you need to be aware of it.

01:03:29.400 | I think you need to be careful.

01:03:31.280 | And I'll give you an example of one fairly recent change that was actually from this

01:03:35.400 | year that from earlier in this year that affected some people.

01:03:40.580 | And the example would be the IRA rollover rules.

01:03:43.320 | And will this happen with conversion rules or something like that?

01:03:46.440 | I don't know, but there's no reason why it couldn't.

01:03:49.640 | And so I personally am careful about pegging everything on one of these strategies.

01:03:55.320 | I would be uncomfortable for me if everything were based upon one of these strategies.

01:04:00.120 | So let me tell you about the IRA rollover rules.

01:04:05.200 | The IRS has various rules that allow people to avoid taxes when they're doing IRA rollovers.

01:04:14.600 | Many of you have done this when you move money from a 401(k) into an IRA.

01:04:19.120 | You left a job.

01:04:20.120 | You rolled the money over from a 401(k) to an IRA.

01:04:23.480 | So the key is that there are different ways to do it.

01:04:28.720 | Most of the time how this is generally practically done is you do what's called a custodian-to-custodian

01:04:34.160 | transfer.

01:04:35.160 | The 401(k) provider sends the money directly to your mutual IRA fund, whoever that happens

01:04:41.800 | to be.

01:04:43.040 | And you never see the money.

01:04:44.360 | Now this is also often done where you receive a check for the money, but it's made out,

01:04:52.880 | for example, it's made out to Fidelity.

01:04:56.720 | So it's made out to Fidelity for the benefit of Joshua J. Sheets.

01:04:59.640 | That's how investment transfers are often done.

01:05:02.120 | That's common.

01:05:03.120 | But the rule is that the money can actually be distributed to you as long as it's put

01:05:06.680 | into an IRA within 60 days.

01:05:09.180 | So I could leave a company and I could receive a 401(k) and that money could be sent to me,

01:05:14.320 | Joshua Sheets, and as long as within 60 days I put that money into an IRA, then in that

01:05:20.200 | scenario I don't have to pay.

01:05:22.200 | It's not actually a distribution.

01:05:23.800 | It's a rollover.

01:05:24.880 | But I can keep the money out of the IRA, and that's the key for 60 days.

01:05:30.960 | Now in order to avoid abuse of the rule, the IRS always said that that was based upon an

01:05:37.720 | account-by-account basis.

01:05:40.520 | So if you had one IRA account and you rolled it – excuse me, you had two IRA accounts

01:05:44.840 | and you rolled one from an IRA at one place to a second IRA, you could still go back to

01:05:49.800 | the other IRA and do that one, and they would have separate 60-day windows.

01:05:54.620 | So you could only do that once every 12 months, but it was on a per-account basis.

01:06:01.000 | So essentially what you could do is because it was treated on an account-by-account basis,

01:06:07.540 | you could set up separate accounts under the IRA rollover and basically chain together

01:06:12.400 | multiple IRA rollovers, one after another.

01:06:15.500 | So you do one, and then 60 days later you do another, you do another, you do another.

01:06:19.700 | Now how does this matter?

01:06:20.700 | Well, let's say you have a million dollars in IRAs, and you're trying to get out $100,000.

01:06:27.100 | It works best if it's for a temporary need, but theoretically it could be prolonged.

01:06:32.700 | It's going to get a little bit cumbersome, but theoretically – this is theory – it

01:06:35.700 | could be prolonged.

01:06:36.700 | So let's say you need $100,000 all of a sudden.

01:06:39.500 | Well what you do is you take – and let's pretend that you had the foresight, and in

01:06:43.780 | my example you had 10 different accounts.

01:06:46.500 | So you have 10 accounts, each having $100,000 in it.

01:06:49.580 | Well you take $100,000 out of IRA 1, and you spend the $100,000.

01:06:56.620 | Then 59 days later, you take IRA 2 and you distribute the money from that, and you put

01:07:02.820 | money from IRA 2 into IRA 1.

01:07:06.300 | And then 59 days later, you do it from IRA 3 to IRA 2, and so on and so on and so on.

01:07:12.280 | So you could see how you could stretch this out.

01:07:14.740 | And you're going to have some issues with taxes, because sometimes those taxes are going

01:07:18.180 | to be withheld.

01:07:19.180 | 20% taxes are going to be withheld, pun of a distribution to you, so you need to avoid

01:07:24.100 | that.

01:07:25.100 | That's law.

01:07:26.100 | Then you also need to make sure it gets done in time.

01:07:27.420 | So there are issues with it, but this is theoretically possible.

01:07:30.620 | And this was always a well-known exception among tax law useful tricks.

01:07:40.100 | Where you would often see this would be, for example, probably the most mainstream application

01:07:45.560 | of this among financial planners would be if you were selling one house and buying another

01:07:49.740 | one.

01:07:50.900 | But you needed some money to do a down payment on the second one while you were waiting for

01:07:53.940 | the first one to close.

01:07:55.560 | So you take the money out of an IRA, you put the down payment on the second house.

01:07:59.360 | If you need to, and it goes for more than 60 days, you do this rollover from one to

01:08:03.620 | the next to make sure the money's not out for 60 days.

01:08:07.220 | And you go ahead and then when you sell the first house, you put the money back in and

01:08:10.260 | you stop the rollover.

01:08:11.260 | That was probably the most common.

01:08:12.900 | It was a little tool in our arsenal of financial planners to come up with money for a down

01:08:17.420 | payment when somebody's trying to come up with money for down payments.

01:08:19.580 | Better than a 401(k) loan.

01:08:21.220 | So that changed.

01:08:24.420 | And it changed earlier this year with a tax court case called Bobrow v. Commissioner.

01:08:32.420 | You can go research this, but Bobrow is spelled B-O-B-R-O-W, Bobrow v. Commissioner.

01:08:38.700 | And basically what happened is this guy Bobrow screwed the thing up.

01:08:43.420 | He basically botched the transfers.

01:08:45.660 | And so he did it, and I think it was 62 days that it took him or 63 days, something like

01:08:51.340 | that.

01:08:52.340 | So he didn't get it done.

01:08:53.700 | He didn't get it done within 60 days.

01:08:55.580 | And he was doing some distributions from IRAs, and it just didn't get done within the 60

01:09:00.220 | days.

01:09:01.220 | So they called him on that.

01:09:02.220 | I think it was 61 days.

01:09:03.220 | They called him on it, and they took him to court.

01:09:06.060 | And they said, "You owe the money for the distribution."

01:09:08.740 | And he fought it.

01:09:09.820 | But the tax court ruled, and this isn't actually what the IRS argued, but what happened is

01:09:14.180 | the tax court didn't rule in favor of the IRS or in favor of Bobrow.

01:09:19.700 | It ruled that the distribution was a taxable distribution because it wasn't done within

01:09:24.860 | 60 days, but it actually interpreted the IRS laws to apply to all of an individual's IRAs

01:09:32.620 | all at once.

01:09:33.620 | So instead of being on an account-by-account basis, which is what the official IRS doctrine

01:09:38.020 | was, including publication in their guidance documents as an example of how it works.

01:09:44.420 | I think it was publication 590.

01:09:47.100 | Yeah, publication 590, where they actually had examples previously of how this was applied

01:09:52.820 | on an account-by-account basis, and the tax court said, "No, this is applied now in

01:09:57.260 | aggregate on all IRAs."

01:10:01.420 | So it's theoretically possible that somebody could have been counting on this rollover,

01:10:05.820 | rollover, rollover plan to get early retirement money out.

01:10:10.060 | I think it would be a lot of hassle.

01:10:11.300 | It's not necessarily easy and straightforward, but it's possible.

01:10:13.740 | And I think it's instructive.

01:10:14.740 | You need to be aware of the example.

01:10:16.580 | And then—this is going to be a finger snap—then, there we go, it worked.

01:10:21.940 | One tax court case, and boom, it's changed.

01:10:24.460 | So the IRS went back, it changed the code, changed the examples, updated publication

01:10:29.500 | 590.

01:10:30.820 | Bo browsed out the money, his plan didn't work, and now we have different rules.

01:10:36.620 | And there's no reason, in my opinion, why rules can't change.

01:10:40.940 | So the Roth conversion ladder, is there any reason why it couldn't change?

01:10:43.460 | I don't think there's any reason why it couldn't change.

01:10:46.160 | You would then have to look and say, "Well, is the doctrine consistent with what's going

01:10:49.380 | on?"

01:10:50.380 | But the problem is that, how do you deal with the winds of public climate?

01:10:55.380 | All this stuff is built in these massive pieces of legislation and it brings sweeping changes.

01:11:00.380 | So I mean, a lot of people hear this information and say, "Well, that's it.

01:11:04.660 | I'm just not even going to play the game."

01:11:05.900 | And I understand it.

01:11:06.900 | I get it.

01:11:07.900 | A lot of people, however, say, "Okay, here, I'm going to play the game."

01:11:10.580 | And most people, what is reality is that most of us wander into this stuff.

01:11:15.140 | You get a job and you wander into your 401(k), you wander into your IRA or your Roth IRA

01:11:19.640 | when your dad tells you to do it, and then years later, you're looking at your situation

01:11:22.760 | saying, "What do I do?"

01:11:23.760 | So my point is that there are various ways around this.

01:11:26.760 | You have to look at it as an individual and say, "What are your assets?

01:11:32.040 | What's your asset makeup?

01:11:33.120 | What are the risks of your situation versus the rewards?

01:11:36.160 | What's the potential savings versus the not?"

01:11:38.640 | And you've got to actually look at your situation.

01:11:40.400 | There's no way that I'm willing at the moment to make up a generalized broad sweeping statement,

01:11:46.700 | but I hope with this information, you can figure out what would be good for you and

01:11:53.520 | you can calculate it.

01:11:54.520 | The key with all these things is you need to actually calculate it for yourself.

01:11:58.360 | So that's it for today's show.

01:12:00.400 | I hope you enjoyed this content.

01:12:02.360 | I hope I hit my goal, so you tell me if you liked it or not.

01:12:07.440 | Check back tomorrow.

01:12:08.440 | I'm releasing an interview with Tammy Strobel from Rowdy Kittens.

01:12:11.240 | We're going to talk about minimalism and how it has helped in her and her husband's financial

01:12:17.720 | planning.

01:12:18.720 | I think you'll enjoy that.

01:12:19.720 | Wednesday, I think I'm going to talk about college planning.

01:12:21.400 | I've got openings for Friday's Q&A.

01:12:24.240 | I would love some feedback on the Q&A.

01:12:26.240 | If you're listening to it, if you're not listening to it, let me know.

01:12:28.800 | I did a two-hour show on Friday with the Q&A thinking that I felt guilty last week when

01:12:34.600 | I cut myself off at an hour.

01:12:35.600 | I wanted to answer the questions, but I know many of you have trouble with those two-hour

01:12:39.040 | shows.

01:12:40.040 | I feel like I did an okay job at answering the questions, but it was long because I did

01:12:43.600 | a lot of questions.

01:12:44.600 | So I'm still trying to figure out the format here and figure out what's helpful and what's

01:12:48.160 | not.

01:12:49.160 | Thank you for those of you so far who have signed up for the membership program for the

01:12:52.720 | Irregulars.

01:12:53.720 | I thank you for it.

01:12:55.320 | It hasn't been – well, I dumped probably 70 percent of the audience right when I launched

01:12:59.720 | it, so a little hard to know.

01:13:01.240 | It hasn't been enough where I can just quit everything I'm doing now, but it's certainly

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01:13:14.840 | That is how I've designed – if you like information like this, it's straightforward,

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01:13:23.400 | It's $10 a month or $100 a year.

01:13:25.120 | Listen, if you don't have the money – I received some feedback from the listeners

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01:13:30.120 | Don't worry about it.

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01:13:34.120 | Apply the concepts and consider it my contribution to your financial independence.

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01:13:41.680 | if you wanted to support it at that point in time.

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01:13:46.480 | So go buy – if you're interested, go to RadicalPersonalFinance.com/membership.

01:13:52.120 | I think that's it for 104.

01:13:58.720 | Anyway, go check out the membership program.

01:14:09.600 | We'll be thrilled to have all of you to join that.

01:14:12.200 | And thank you for listening.

01:14:13.200 | I'll be back with you tomorrow.

01:14:21.200 | Thank you for listening to today's show.

01:14:23.440 | This show is intended to provide entertainment, education, and financial enlightenment.

01:14:31.440 | Your situation is unique and I cannot deliver any actionable advice without knowing anything

01:14:37.740 | about you.

01:14:39.480 | This show is not, and is not intended to be any form of financial advice.

01:14:46.800 | Please, develop a team of professional advisors who you find to be caring, competent, and

01:14:55.160 | trustworthy.

01:14:56.600 | And consult them because they are the ones who can understand your specific needs, your

01:15:02.520 | specific goals, and provide specific answers to your questions.

01:15:08.200 | Hold them accountable for your results.

01:15:10.920 | I've done my absolute best to be clear and accurate in today's show, but I'm one

01:15:15.400 | person and I make mistakes.

01:15:17.480 | If you spot a mistake in something I've said, please come by the show page and comment

01:15:21.920 | so we can all learn together.

01:15:24.440 | Until tomorrow, thanks for being here.

01:15:27.200 | The holidays start here at Ralph's with a variety of options to celebrate traditions

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01:15:32.680 | Whether you're making a traditional roasted turkey or spicy turkey tacos, your go-to shrimp

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