RPF0507-Friday_QA
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00:00:30.000 | It's a new year, it's Friday, and that means it's time for Friday Q&A.
00:00:36.000 | [Music]
00:00:52.000 | Welcome to Radical Personal Finance, the show dedicated to providing you with the knowledge,
00:00:56.000 | skills, insight, and encouragement you need to live a rich and meaningful life now while
00:01:00.000 | building a plan for financial freedom in 10 years or less. My name is Joshua, and I am
00:01:04.000 | your host. And on Fridays here at Radical Personal Finance, we do a live Q&A.
00:01:09.000 | We've got callers waiting on the phone line. You can go there, and anything that you want
00:01:13.000 | to talk about, we talk about.
00:01:15.000 | [Music]
00:01:24.000 | If you would like to join for a Friday Q&A call like today's in the future, I would love
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00:01:58.000 | Today, we go first to Shiv in the state of Washington. Shiv, welcome to Radical Personal
00:02:03.000 | Finance. How can I serve you today?
00:02:05.000 | Hey, Joshua. Firstly, happy New Year to you and all the listeners. I'm a long-time
00:02:11.000 | listener and first-time caller. I really appreciate all the work that you do. My question
00:02:17.000 | is related to home affordability. We got serious about buying a home a couple of months
00:02:23.000 | back, and at that point, I used some online calculators to see how much home I can afford
00:02:29.000 | based on my salary and the surplus for down payment. I got multiple numbers based on
00:02:35.000 | different tests like income test, cash test, or debt test, and then I picked the lowest
00:02:40.000 | number from that and started hunting homes. After going through the process of searching
00:02:46.000 | and putting offers for a couple of homes, we realized that the kind of homes that we
00:02:51.000 | like are a bit expensive, and on top of that, there is bidding war going on, which does
00:02:57.000 | not help. I want to buy a home that my family will like, my wife will like, and at the same
00:03:04.000 | time, I don't want to commit a financial mistake. When I look at my income and surplus,
00:03:10.000 | I think I can afford a costlier home than the standard guidelines. When I say standard
00:03:15.000 | guidelines, I mean 20% down payment and mortgage payment not more than 28%, that kind of stuff.
00:03:23.000 | But I want to know your opinion on how much stretch beyond these guidelines one can make
00:03:30.000 | without committing a financial mistake.
00:03:32.000 | What's your household annual income?
00:03:35.000 | 120K.
00:03:37.000 | Are you the sole income earner of your household, or does your wife also earn an income?
00:03:42.000 | I'm the sole income earner.
00:03:44.000 | Okay. Do you have, run me through your assets real quick, do you have some savings, emergency
00:03:52.000 | funds, and cash that is saved for the purpose of buying a house?
00:03:56.000 | Yes, so I have around 100K of cash. I also have around 200K in stocks, which I can use.
00:04:04.000 | Those are outside of my 401K.
00:04:06.000 | And how much is in your 401K?
00:04:08.000 | Around 150.
00:04:10.000 | Okay. Do you owe anybody any money? Do you have any debts right now?
00:04:13.000 | No, no.
00:04:15.000 | And so you have about 150,000 in your 401K, which you're contributing to. You have 200,000
00:04:21.000 | in stocks that you could sell. You have about 100,000 in cash. And outside of those savings
00:04:27.000 | and investment assets, do you have any other major assets?
00:04:31.000 | Not here in the US.
00:04:34.000 | Okay, great. And you don't have any debts. So what price range of house are you considering purchasing?
00:04:42.000 | I was thinking somewhere around 500K, but with a single family home, three bedrooms, and all in our area,
00:04:51.000 | I'll have to go, you know, like more than an hour of commute from my work to get home in that price range.
00:04:59.000 | I don't want to.
00:05:01.000 | Right, hold on. So if you paid, if you bought a house for $400,000, you would be able to purchase a single
00:05:08.000 | family home in your local market, but that would come with a one-hour commute?
00:05:14.000 | Yes, and it's not 400,000. It's more than 500,000.
00:05:19.000 | More than 500,000?
00:05:21.000 | Yes.
00:05:22.000 | Okay, so greater than 500,000. And right now you and your wife are renting an apartment or renting a house?
00:05:32.000 | Yes, we are renting.
00:05:34.000 | And how much is your monthly rent currently?
00:05:37.000 | It's 1,400 plus some utilities, so around 1,500 per month.
00:05:44.000 | If you bought the $500,000 house, how much would you estimate your monthly payment to be on your principal,
00:05:52.000 | interest, taxes, and insurance?
00:05:55.000 | I think it is going to be in the range of 2,700 to 3,000.
00:05:59.000 | Okay. If you were to buy something closer, have you shopped for something closer to your work?
00:06:08.000 | Yes, I have, but I can't afford it. There are only condos available in that price range, and we don't want to buy condos.
00:06:18.000 | We want something which is like a detached home with a small backyard for our son to play and all that.
00:06:26.000 | You have one child currently?
00:06:28.000 | Yes.
00:06:29.000 | And how old is he?
00:06:30.000 | Eight.
00:06:38.000 | So it's a hard question to answer, and here is the way that I would look at it.
00:06:43.000 | So with regard to the affordability of the house, if your monthly payments are $3,000 per month
00:06:53.000 | and your monthly income is gross of about $10,000 per month, I don't think that would be necessarily unaffordable,
00:07:02.000 | especially if you avoided any other form of debt.
00:07:07.000 | If you look at the way that people come up with these ratios and they say – from a calculation of a percentage of income,
00:07:14.000 | et cetera, and you look at it, you'll see that number one, there's not really any science to most of it.
00:07:20.000 | It's just primarily a matter of someone saying, "Well, this kind of works out," and you do have to account for all of your expenses.
00:07:31.000 | But if you can avoid other debts, then I don't think it's necessarily unsafe for you to have a $3,000 a month mortgage payment
00:07:40.000 | with a $10,000 a month gross income.
00:07:43.000 | I don't think it's unsafe.
00:07:45.000 | Now, if you started to add to that student loan payments, if you started to add to that a couple of car payments,
00:07:52.000 | now all of a sudden you start to have your fixed expenses to be very high and you start to run into a much more dangerous territory
00:08:00.000 | with regard to your ability to maintain your budget if times got tough.
00:08:07.000 | But if you have no debt and you have a $10,000 a month income, even if times got tough, if you went through –
00:08:16.000 | you had a 20 percent pay cut or something like that because your company that you work for got into financial trouble
00:08:22.000 | or even if you lost your job, it's not an insane number.
00:08:27.000 | Now, it certainly is a high number but that's due to where you live.
00:08:31.000 | The fact that you have to pay in excess of $500,000 to get a single family home and that's an hour outside of your job
00:08:39.000 | is simply a sign of where you live.
00:08:43.000 | So on the basis of affordability, would it be stupid to buy such a house?
00:08:49.000 | I don't think it would be stupid to buy such a house.
00:08:52.000 | I don't think it's necessarily dangerous.
00:08:54.000 | As long as you don't have a lot of other debts and I think of course you should be careful because usually with purchasing a house,
00:09:05.000 | especially a single family house, it comes with all kinds of new expenses which you'll have the opportunity to enjoy when you go through that.
00:09:13.000 | So make sure you set some cash aside and continue to be frugal.
00:09:16.000 | But everything about the sound of your voice and your calculation sounds to me like you're approaching it very carefully.
00:09:21.000 | Now the bigger question is, is it the best thing to do at this point in time?
00:09:25.000 | That's what I would say is a bigger question.
00:09:28.000 | And I can empathize very much with that struggle.
00:09:34.000 | So with regard to your employment situation, how long have you worked for the company that you work for and does it seem stable at this point?
00:09:41.000 | Oh yeah, I'm in tech and I have been with my current company for five years.
00:09:45.000 | It's doing good.
00:09:47.000 | Do you expect your income to stay about the same, increase a little or increase dramatically in the future?
00:09:53.000 | Increase a little but not dramatically I think.
00:09:57.000 | Have you pursued other opportunities in tech that are in cheaper cost of living areas?
00:10:03.000 | No, not really.
00:10:07.000 | I like the company and I like the city, town I live in right now.
00:10:13.000 | I haven't.
00:10:17.000 | I have talked to my wife about it and we are like, if we want to change jobs, we'll change within Seattle.
00:10:23.000 | So Seattle is the place I'm living right now.
00:10:26.000 | You might know the illicit prices here.
00:10:29.000 | Yeah, definitely.
00:10:30.000 | And so you intend to stay in Seattle.
00:10:33.000 | It fits your goals, it fits your culture, and so you intend to stay in Seattle.
00:10:38.000 | Right.
00:10:40.000 | If you were to, when you and your wife talk about purchasing a single family house and moving out of the apartment that you live in now,
00:10:47.000 | what are the biggest benefits that you're hoping to achieve?
00:10:52.000 | So one thing is we have family visiting from India or we have friends, so we need a place for them to stay.
00:11:03.000 | So that's why we need a bigger place.
00:11:05.000 | Plus, for our kid, we want a kind of small backyard.
00:11:10.000 | I think the place we have right now is kind of limited.
00:11:15.000 | My wife tends to do all these sort of activities and games with him, and she cannot enjoy all those things in our current apartment.
00:11:27.000 | So she would like to have some more space where she can do different activities with him, through which he learns, and all that kind of stuff.
00:11:38.000 | Do you think that you and your wife may have more children in the future?
00:11:44.000 | Not likely.
00:11:46.000 | I think one is in a forest.
00:11:49.000 | So how frequently does your family come from India, and how long do they stay with you?
00:11:55.000 | So my brother lives in Vancouver, which is about two hours or three hours from Seattle, and we keep visiting every two months.
00:12:07.000 | And my family from India comes once a year.
00:12:13.000 | How long does your brother visit every two months?
00:12:18.000 | It's just over a weekend, so it's like two, three days.
00:12:22.000 | And how long does your family come from India?
00:12:24.000 | If they come, they'll be for more than a month.
00:12:31.000 | Okay.
00:12:33.000 | Well, so I can empathize very much with the desire to change your living circumstances from an apartment to a house.
00:12:47.000 | In fact, I, in my family, we are currently in that situation where we live in a smaller apartment.
00:12:56.000 | It's not a high-rise apartment.
00:12:58.000 | It's a duplex apartment.
00:12:59.000 | We have a small yard and a small outdoor space, but we moved in.
00:13:03.000 | It's in a lower-income community, and we moved here to save money temporarily while I transitioned to a new business.
00:13:13.000 | And certainly, when you have children who start to reach a certain age, you start to really get to the point where it would be really nice to have a little bit more space.
00:13:25.000 | There is a reason why most people, when they start to have children, look to the suburbs with much more interest than they do when they don't have children.
00:13:34.000 | We have three young children, and definitely, it's nice to have a place that has a backyard.
00:13:39.000 | And you can say, "Children, go outside," and you can supervise through the window, but you don't have to hear them when they reach that busy time of day, about 4 o'clock, and they just need to be sent outside.
00:13:51.000 | That said, your wife has one child, and your son is 3 years old.
00:13:57.000 | And so I think that pressure is much smaller with one child who's 3 years old than it is with, say, 3 or 4 children who are 6 and 7 and 8, when they start to be much more rambunctious.
00:14:12.000 | And I think you should think carefully about spending money just to get a little extra patch of grass for one child who's 3 years old.
00:14:22.000 | Now, my biggest concern is not financially, because I think you could work out the finances.
00:14:27.000 | My biggest concern would be the cost to you of adding a 2-hour daily commute to go to work and back, and that cost on your family.
00:14:36.000 | In my mind, that would be essentially non-negotiable, because if you could--how close do you live right now to your job?
00:14:45.000 | Just 4 miles, so even with the traffic situation, it's 30 minutes. Without traffic, it is 10 minutes.
00:14:52.000 | If I were in your shoes, to me, that would be the non-negotiable lifestyle choice, because I'm sure that--
00:15:01.000 | If I can--
00:15:02.000 | What's that?
00:15:03.000 | If I can convince my wife that we should move.
00:15:07.000 | Right, but think about this, okay?
00:15:10.000 | Do a survey--you're a researcher--do a survey of how much time most children who live in the type of neighborhood that you're describing spend outside in their backyard.
00:15:22.000 | Individual children, one child, how much time they play outside by themselves.
00:15:27.000 | Well, I would imagine that it's actually not very much, especially if you're in Seattle, where you have cold winters and you have lots of rainy days.
00:15:34.000 | You have to wait for a bright day, and if your son is an only child, it's unlikely that he's going to spend a lot of time playing by himself in the backyard.
00:15:43.000 | Most children, especially at 3 and 4, don't love to play alone, so that means that your wife is going to be the playmate, or he's going to be with somebody else.
00:15:50.000 | And if your wife is going to be outside with him anyway, is it really that much more convenient to go in the backyard, where you don't have any play equipment,
00:15:59.000 | or is it a little bit more convenient to say, "Let's go on down to the local park and let's make this our afternoon excursion," because she's going to be going and playing with him anyway.
00:16:07.000 | It's very different if you have 3 or 4 children and you say, "Hey, go outside and use the swing set," and they're outside and they can amuse themselves together for a couple of hours.
00:16:15.000 | That's different than having one child.
00:16:18.000 | And I would look at the cost to you as a father of having--adding a two-hour daily commute, and I would calculate it this way.
00:16:26.000 | If you live 4 miles from your office, you can do that on your bicycle most of the time, and that gives you an extra hour and a half with your child.
00:16:34.000 | So whether you're home for an extra hour in the morning or you're home for an extra hour in the evening, if you take that and the benefits of that,
00:16:41.000 | even just to load them up and you take them to the park in the afternoon, I frequently--that's often how I handle it for my family.
00:16:49.000 | With 3 young children in the house, it gets very, very wearing on a stay-at-home mom to handle 3 small children all day long,
00:16:57.000 | and there reaches a point in time around 4 o'clock in the afternoon when she's ready to be done.
00:17:03.000 | And so one of the things that I frequently will do is I'll load up the children at 4 o'clock, 4.30 in the afternoon, and I'll take them to the park and get them out of the house.
00:17:10.000 | She gets a break.
00:17:11.000 | The kids get to get outside, release some steam, get their wiggles out, get some energy, play in the sunshine, and it really works out well.
00:17:18.000 | So if I were you, I would stay living where I'm living, and then I would just say, in terms of the outdoor play,
00:17:25.000 | "Honey, if you can take him to the park in the morning 3 or 4 days a week, and then I take him to the local park in the afternoon when I get home from work,
00:17:32.000 | that would be a much better lifestyle for you than sitting in traffic an hour every single morning and sitting in traffic an hour every single afternoon."
00:17:41.000 | To me, it's a lifestyle decision, not an affordability decision.
00:17:46.000 | That makes perfect sense.
00:17:49.000 | Actually, I have kind of thought about that, but I kind of convinced myself that, "Okay, I can take an hour of commute because we should buy a home."
00:18:01.000 | The other reason behind that is the way prices are going up right now in our area, it feels that if we stop for more time without buying a home,
00:18:11.000 | then we won't be able to afford anything, even within one hour of commute.
00:18:18.000 | It will be like, "Just move out of this place, and move out of the town," and we don't want to do that.
00:18:24.000 | So the emotion of it, there are two aspects to consider, and here's kind of just my thinking on housing.
00:18:33.000 | It is very common to get yourself in a situation where you are scared of prices are always going to go up and we're not going to be able to afford to buy in the future.
00:18:46.000 | I am quite confident that will not happen, and here's why.
00:18:51.000 | It simply won't happen because the price of housing is always driven by wages.
00:18:58.000 | The price of housing is driven by wages.
00:19:00.000 | Now, there can be longer-term changes.
00:19:04.000 | So, for example, it used to be that downtown New York City used to be you could live as a working man, swinging a hammer.
00:19:11.000 | A plumber could afford to buy an apartment and live in downtown Manhattan.
00:19:15.000 | Well, that's all been pushed out, and that's entirely changed, and the poor people, the low-income earners have been pushed out of the city center,
00:19:24.000 | and the wealthy, high-income elite have taken over the city center.
00:19:28.000 | But in general, there still has to be someone to change the pipes, and so there has to be some affordability to housing.
00:19:35.000 | So, housing is always tied to wages.
00:19:37.000 | The only thing that on an ongoing basis can allow housing prices to increase over time is if wages also increase because housing is directly tied to the affordability of housing.
00:19:50.000 | So, in time, things will change, and the local governments have to make changes.
00:19:54.000 | What you see when you see the parts of the country that are the most expensive, you see that all of the low-income earners have been pushed out of the inner city, have been pushed out of the city center, and that causes major problems.
00:20:09.000 | And you're starting, I think, finally, a few decades too late, that cities are starting to finally see some changes, and they're starting to loosen up some of the regulations.
00:20:18.000 | They're starting to relax some building codes to try to allow builders to build new housing to meet some of the problems with demand.
00:20:25.000 | So, in the long term, I don't think it's possible for the price of housing to just always go up and up and up and be unaffordable.
00:20:32.000 | It's possible in the short term because many people feel that fear, but in the longer term, it's not possible.
00:20:39.000 | So, yes, prices could go up, but if I were in your shoes, I would look and I would be willing to pay more in order to have the shorter commute just simply for the sake of my lifestyle.
00:20:53.000 | If the place that you live is truly not affordable, and it's truly not, then you should seriously consider looking at some other place to live.
00:21:05.000 | Even if you love Seattle and you say, "I'm willing to pay it," well, just go into it knowing that you'd be willing to pay it in the cost of the commute or in the cost of the standard of living.
00:21:13.000 | But there are jobs and tech all over the place, and the only way that a place like Seattle in the big picture is going to have lower housing costs is when people start to move, and they move to other places which have cheaper housing costs.
00:21:28.000 | Let me speak quickly about the family in India and family visiting.
00:21:33.000 | So, culturally, it's very valuable, culturally, for you to be able to host your family, and I affirm that.
00:21:41.000 | I think that's fantastic.
00:21:43.000 | I love the cultural ethic of families being together.
00:21:48.000 | If you were to go to India and stay with family, you take your wife and your child and you go to India and you stay with family, you would not expect your Indian family to double the size of their house just so that they could host you for your one-month visit.
00:22:07.000 | If you go and visit your family in India, if all they have the ability to do is to lay down a simple mat for you to sleep on in the living room, to push the couch back and lay down a simple mat, you would be thankful that you can visit with your family.
00:22:21.000 | And it's the same for them coming to you.
00:22:23.000 | Now, of course, since you're in the United States, you're earning a higher income, and you want to provide the nicer things for your family.
00:22:31.000 | But you can't let this desire to support your family cause you to put yourself in a situation where your finances are hurt and, frankly, your lifestyle is hurt.
00:22:41.000 | That two-hour-a-day spent in the car really doesn't work.
00:22:44.000 | So, here are some suggestions for you.
00:22:46.000 | Number one, be willing to adjust and be willing to continue to recognize that just the ability for you to provide a place on the floor with your family or a couch for them is perfectly adequate.
00:23:01.000 | You can do a few things.
00:23:03.000 | If you spend a little bit of money, you can buy a very nice inflatable bed.
00:23:07.000 | And maybe it's the type of thing that if your parents are coming, you and your wife, while your parents are in town, you give them your bedroom and you and your wife move to the living room on an inflatable bed.
00:23:15.000 | Is it comfortable?
00:23:16.000 | Not really, but it's a whole lot more comfortable than spending two hours a day in the car so that you can go back and forth and sit in traffic.
00:23:24.000 | So, consider being willing to put them into simpler accommodations.
00:23:29.000 | Number two, if you run the numbers on it and you just simply calculate the cost of the insurance on your new house, which will be a pure cost, or the cost of the interest payment, or the cost of the real estate taxes on a new house compared to where you're living right now.
00:23:43.000 | Calculate that number and recognize that that's money you'll never get back from living in a house.
00:23:49.000 | It's just pure cost.
00:23:51.000 | If you take that and you rent a very nice Airbnb in the building that's nearby your house for the times when your parents visit from India or your family visits from India and you rent for a month, even if you rent it for them, you'll still be way ahead financially.
00:24:09.000 | You'd be ahead even if you just got them a room at the local hotel.
00:24:14.000 | Now, that probably wouldn't give you the benefits you're looking for of being together, of your son being able to interact with your family members when he first wakes up in the morning and at night, etc.
00:24:27.000 | That's really good to have.
00:24:51.000 | That got me thinking in that direction.
00:24:56.000 | I think the primary reason we were looking for is not just for family, but for the kid and making resources available for him to play and all that.
00:25:08.000 | But I also agree that going to a park is also an option in that case.
00:25:15.000 | So, thanks so much for all.
00:25:17.000 | Absolutely.
00:25:19.000 | In summary, I affirm, number one, I don't think the house that you're considering is unaffordable.
00:25:24.000 | I don't think you should consider this on the basis of affordability.
00:25:27.000 | You should calculate what you're giving up, what the opportunity cost is that you're giving up.
00:25:32.000 | You won't come out, based upon what you're telling me, if your current monthly rental cost is about $1,500 a month and your new monthly mortgage cost would be about $3,000 a month, I don't think you'll come out ahead by buying a house.
00:25:51.000 | And the reasons for that is simply that I would guess that about $1,500 a month of your new mortgage payment cost would be based exclusively on taxes and insurance, which is not money that's going to grow.
00:26:06.000 | You're not building equity when you're paying taxes and insurance.
00:26:08.000 | You're just simply paying taxes and insurance.
00:26:11.000 | Go back and listen. If you've never listened, go back and listen to the series that I did on should you buy a house, renting versus owning, and calculate the actual costs of that for you.
00:26:24.000 | And I think that if you calculate that and you also calculate the things that you don't know as far as how much your expenses will be in fixing things that you don't currently have to fix, making repairs, new roof, all that stuff, you will come out behind financially speaking with buying that single family house versus your current rental cost.
00:26:47.000 | It may still be the better thing to do if it gives you a lifestyle improvement.
00:26:53.000 | We don't make every decision in life based upon what's going to be the best financial move.
00:26:57.000 | If we did, you and your wife would be sleeping on the floor of your office taking a shower in the company bathroom with pouring water over your head if that were the case, but you're not.
00:27:08.000 | So it may be worth it to get it from a lifestyle perspective, but financially you're going to come out behind in the scenario you're describing.
00:27:16.000 | But I don't think it's unaffordable.
00:27:18.000 | I just think you should carefully consider the cost of that two-hour commute.
00:27:23.000 | And if I were you, I would wait another year or two until I could save or find something that were closer to my work so that I could have more space for my family to host guests, better space for my son to play, and still be able to be closer to work.
00:27:38.000 | Right. Just one point if we have time on that rent aspect.
00:27:44.000 | So the rent that I have is really a deal right now within the area because everywhere else surrounding the rents are north of $2,500.
00:27:55.000 | It's just my place. The landlady just doesn't care about it, and that's why I've got a deal.
00:28:00.000 | I don't know how long it is going to be, but if she pays us rent or if we just think of changing the apartment to a different one, I'm going to pay in the range of $2,500.
00:28:13.000 | So I would just say stay living where you're living as long as you can handle it.
00:28:17.000 | Try to adjust a few things.
00:28:20.000 | For example, if you're willing to pay more money to move outside of town, maybe what you should do is it would be cheaper for you to say to your wife, "Let's designate a little bit more money in our budget towards activities for our son.
00:28:35.000 | Maybe let's go ahead and join the local gymnastics club, or let's go ahead and spend some money to take the weekends and every third weekend, let's plan a trip to the country every third weekend."
00:28:49.000 | Take some of the extra money in your budget and go ahead and spend it on that need in your family without committing yourself to a house.
00:28:56.000 | If your landlady were to raise your rent to $2,500, then your considerations would change, and you would make a fresh decision at that point.
00:29:07.000 | And now buying the house, financially speaking, looks much more attractive.
00:29:12.000 | I think the lifestyle cost is still too high.
00:29:15.000 | Your son needs you to be there together with him.
00:29:17.000 | He doesn't need 250 feet of grass in backyard.
00:29:21.000 | Children in Seattle, Washington, three- and four-year-old little boys who are only children in Seattle, Washington, I would bet you five bucks on this.
00:29:32.000 | They don't spend more than a cumulative of an hour to two hours per week on average through the winter and everything.
00:29:40.000 | Your son would not spend more than an hour and a half outside per week on average to use that backyard.
00:29:47.000 | For you to spend an extra eight to ten hours a week sitting in traffic so that your son could have a backyard that he could play in for average an hour and a half a week by the time you take winter, rainy days, all that stuff out, I think that would be a bad lifestyle move.
00:30:04.000 | But it would change the consideration if, financially speaking, it would change the consideration if your landlady changed the rent.
00:30:12.000 | Tanya in Maryland, welcome to Radical Personal Finance.
00:30:15.000 | How can I serve you today, please?
00:30:17.000 | Thank you, Joshua.
00:30:19.000 | Well, first of all, Happy New Year, and thank you for all you do for all of us hungry for practical information.
00:30:26.000 | And I hope that 2018 will be successful and satisfying for you and your family.
00:30:32.000 | And I loved the answer to the previous question.
00:30:36.000 | I am totally agreeing with everything you said.
00:30:39.000 | I had to overcommit before.
00:30:41.000 | It was awful.
00:30:43.000 | So my question is about retirement plans that allow for after-tax non-ROF.
00:30:49.000 | And just to give you a quick background, first of all, I'm a business owner.
00:30:54.000 | I have no employment.
00:31:01.000 | I have an option to do backdoor ROF conversions when I need to.
00:31:04.000 | Tanya, hold on one second.
00:31:06.000 | Your phone just dropped out right after you said, "I'm a business owner."
00:31:09.000 | So please start again.
00:31:10.000 | You said, "I'm a business owner," and go from there.
00:31:14.000 | Sure.
00:31:15.000 | Let me try again.
00:31:16.000 | So I'm a business owner.
00:31:17.000 | I don't have any employees or partners.
00:31:20.000 | So just right now, I'll see sole proprietorship.
00:31:23.000 | And I have money to put into retirement beyond just $18,000.
00:31:30.000 | And I also have an option to do backdoor ROF conversions.
00:31:36.000 | So these are the things that I am able to do.
00:31:39.000 | And my goal is try to use the opportunity to do mega backdoor ROF.
00:31:48.000 | And for that, I understand that I need to contribute after-tax non-ROF money.
00:31:55.000 | And my question is, how would you go about trying to set up a retirement plan like this?
00:32:07.000 | As I understand, there are only roughly 8% of retirement plans in the U.S. which allow after-tax non-ROF.
00:32:14.000 | But as a business owner, I suspect I have many more options compared to if I were a W-2 employee.
00:32:25.000 | Well, the way that I would go about it is I would start by calling the advisors that you currently have on your plan.
00:32:32.000 | Do you currently have a solo 401(k) established in your business or some kind of qualified retirement plan established?
00:32:39.000 | I have a solo 401(k) and I called Vanguard, which I have, and they do not allow for this after-tax non-ROF.
00:32:49.000 | Right. The short answer to the question is that to do the – so for the sake of the audience, very quickly, let me explain what it is that we're talking about using the term mega backdoor ROF.
00:33:04.000 | Most people believe that the contribution limits to a 401(k) are about $17,000 per year. I think it's $18,000 per year.
00:33:15.000 | Hopefully, I'm getting my recollection on the current number is right.
00:33:20.000 | And that is true because if you were to join a large company and say, "How much money can I contribute to my 401(k) plan?"
00:33:27.000 | The answer is – if you're under the age of 50, the answer is about $18,000 per year. That's what you can contribute and have deducted out of – contribute to the plan on a pre-tax basis.
00:33:39.000 | However, that's not the only standard of contribution that can be calculated in 401(k) plans.
00:33:46.000 | The plan can actually accept more money than that if the plan sponsor sets the plan up appropriately.
00:33:53.000 | The obvious example would be that if your company matches you on your contribution to the account, and let's say you put in $18,000 and they give you a 50% match and they put in $9,000, you've now contributed – more money has been contributed to the plan than the $18,000 limit.
00:34:13.000 | And so that second way of calculating the limits comes out to a little bit in excess of $50,000 per year that can be put into a 401(k) plan.
00:34:21.000 | So, in theory, you could contribute $18,000 per year to the account. In theory, your employer could make additional contributions.
00:34:31.000 | Let's say that your employer contributed $10,000 per year to the account. That would bring you up to $28,000 going into the account.
00:34:40.000 | And in theory, if the limit were $50,000 – it's actually a little bit higher – that would leave about $22,000 available if the plan sponsor would allow the money to go in.
00:34:49.000 | And so what you can actually do is you can set it up so that you have a pre-tax contribution to the account of your $18,000.
00:34:57.000 | Then you have your employer match. And then if the plan sponsor provides, then you can provide for – you can put an additional after-tax contribution to the 401(k).
00:35:08.000 | This would go up to the $53,000 limit.
00:35:11.000 | So, if the plan documents are written appropriately, then this can be a huge opportunity.
00:35:19.000 | The benefit, then, of having the money segregated as an after-tax contribution in a 401(k) is that, in theory, when you leave that company, you can convert your after-tax contribution directly into a Roth IRA.
00:35:37.000 | And since you've already paid the tax on the money, then you don't have to pay any additional tax when you just roll it over.
00:35:44.000 | You just simply can convert it over to a Roth IRA.
00:35:47.000 | And what you've done effectively is you've built a Roth IRA that has – instead of limiting you to $5,500 per year – has allowed you to put maybe $20,000 or $30,000 into the account, which is obviously a huge, huge opportunity.
00:36:05.000 | When that money could then grow with all the benefits of a Roth, no taxation.
00:36:10.000 | As the money grows, no taxation.
00:36:12.000 | When you take it out for retirement, all the other benefits of a Roth IRA.
00:36:15.000 | So, that is a mega backdoor Roth.
00:36:18.000 | At the moment, to the best of my knowledge, it is available – it is possible.
00:36:23.000 | However, I expect the tax laws to change.
00:36:26.000 | This did not change in the recent tax overhaul legislation in the United States, but I do expect it to change in the future.
00:36:34.000 | Because – well, I expect it to change in the future.
00:36:37.000 | The challenge practically is finding a – it's one thing to construct this in theory.
00:36:43.000 | It's another thing to do it in practice.
00:36:45.000 | Because many companies don't actually offer in their plan documents – the plan sponsor doesn't offer the option for you to make after-tax contributions to the 401(k).
00:36:55.000 | In addition, it's my understanding – I have never done this for myself.
00:37:00.000 | It's my understanding that it's much more challenging to find a sponsor in the solo 401(k) marketplace that provides the service and to find a sponsor.
00:37:12.000 | And then, Tanya, what you're telling me is that your plan – you're working with Vanguard to run your solo 401(k).
00:37:19.000 | And in working with Vanguard, they're telling you that they're not going to allow you to do that in your solo 401(k).
00:37:24.000 | Is that accurate?
00:37:25.000 | That's accurate. Yes.
00:37:27.000 | So, have you looked for another plan sponsor that would help you to set this up in a solo 401(k) and would allow the after-tax contribution?
00:37:37.000 | I started looking and just basically researching what people write about.
00:37:43.000 | And the only thing that I know so far is that large brokerages do not offer it and that there are specialized – I don't know how you call them – but companies that provide retirement plans that do that.
00:38:02.000 | However, and I have not researched a specific company or called a specific company, but what I gathered from people who use those is that they are most likely more expensive and they have limited funds to invest in.
00:38:22.000 | So, essentially, the downside could be that you will be stuck with the investment options they have paying some kind of fees that they ask you to pay.
00:38:34.000 | So, that could be a wash in the end.
00:38:37.000 | But I have not researched a specific company yet.
00:38:41.000 | So, here's how I'd approach it.
00:38:44.000 | I would doubt that most of the – and it's my understanding that most of the solo 401(k) providers, what they're basically doing is they're providing a package document.
00:38:53.000 | And this is why a company like Vanguard won't do it.
00:38:58.000 | They're using a boilerplate document that's saying, "Okay, you have an individual business. You want to establish a solo 401(k)."
00:39:04.000 | Well, in that context, I'll go ahead and I'll give you the – here's our plan document.
00:39:09.000 | I used to use this when I was a financial advisor.
00:39:12.000 | I used to use this frequently with business owners for setting up a SEP IRA, a SEP, Simplified Employee Pension Program, a SEP IRA.
00:39:20.000 | The SEP IRA is the accountant and financial advisor's favorite backpocket tool because it's easy to set up.
00:39:28.000 | It's very simple.
00:39:30.000 | It's going to keep a boilerplate document that the business owner just simply signs and it allows contributions after the close of the tax year.
00:39:42.000 | So, if I'm meeting with somebody in February and they have a big tax bill for the previous year, well, at least we can sit down and calculate how much could go into the SEP IRA and they can write that check in February or March and lower their tax bill for the previous calendar year.
00:39:56.000 | That's different than a 401(k).
00:39:58.000 | The contributions need to be made before the end of the calendar year.
00:40:02.000 | So, if you're doing – as we record, this is January of 2018.
00:40:06.000 | It's too late to do any planning for 2017, but a business owner could make a contribution to a SEP IRA in the same way that an individual can contribute to a traditional or Roth IRA during 2018 for 2017 as long as they do it before the April 15th deadline.
00:40:24.000 | But because these are boilerplate documents, a company like Vanguard or any of the companies doesn't want to get into the idea of saying, "Hey, let's set these things up for you with really interesting ways."
00:40:36.000 | So, my guess is how I would approach it if I were you, if I were really committed to this, if it's really going to benefit you and serve you, I would go ahead and I would research the process of setting the plan up myself.
00:40:48.000 | You can individually have the plan documents written for you by an advisor.
00:40:52.000 | You can contact a company that works as a third-party administrator for the plans.
00:40:58.000 | I would go ahead and work through that process of setting it up.
00:41:02.000 | And instead of using the boilerplate approach from Vanguard, I would custom write or have written documents with a third-party administrator and go ahead and establish it in the plan that's appropriate to my company.
00:41:16.000 | It's hard for me to believe that somebody out there is not offering – a TPA is not out there marketing this to small business owners.
00:41:24.000 | So, a little bit of web searching would be in order.
00:41:28.000 | But you should be able to do it.
00:41:30.000 | There's no technical reason why it's not possible.
00:41:32.000 | It's just going to be a matter of either finding somebody who will sell you the documents, who has the expertise of doing it – that will probably cost you a couple thousand bucks – and/or going ahead and setting it up yourself using the services of a third-party administrator as you need to and going ahead and establishing a new plan for your business.
00:41:52.000 | Once you have that new plan, you've set up the appropriate documentation, the appropriate trust, then you could just go back to Vanguard and have them be the custodian of the account.
00:42:00.000 | But instead of using their boilerplate solo 401(k), you'll be using your customized documents governing your new plan with the segregated accounts.
00:42:10.000 | That's how I would approach it.
00:42:12.000 | That's very helpful.
00:42:15.000 | I think that I will do more research and I was suspecting that I will have to do lots of things on my own with this.
00:42:24.000 | It's probably a good thing.
00:42:28.000 | Technically, I have a – let's see.
00:42:31.000 | What am I?
00:42:32.000 | A registered employee benefits consultant.
00:42:33.000 | So I went through this when I was studying for that particular designation.
00:42:38.000 | Technically, this would be something where if an info product does not yet exist, some of listeners who are nerds on the details of this, you should go through and establish an info product that you sell for business owners like Tanya to go ahead and guide them through the process.
00:42:58.000 | And if any of you are working with a TPA or consultancy, you should go ahead and set this up because I've seen – in the last year, I've seen articles all over the place on the mega backdoor Roth.
00:43:09.000 | And as long as it's still available in the tax code, I think there are a lot of people looking for information.
00:43:16.000 | Tanya said you had two questions.
00:43:18.000 | Let me go on.
00:43:19.000 | I've got one more caller in Hawaii.
00:43:20.000 | Let me go on and handle this next caller and then I'll come back to you, Tanya, in a few minutes for your second question.
00:43:26.000 | Got a caller calling in from Hawaii.
00:43:28.000 | What's your name, please?
00:43:29.000 | And let me know how I can serve you today.
00:43:30.000 | Hi.
00:43:31.000 | This is Laura.
00:43:32.000 | And sadly, I had to relocate to Southern California.
00:43:36.000 | Oh, so sad that you moved from Hawaii to Southern California.
00:43:39.000 | I know.
00:43:41.000 | I'm trying to move back.
00:43:42.000 | So I work in an industry where it's possible to work both as a 1099 contractor or as a W-2 wage employee.
00:43:52.000 | And with the new tax legislation, specifically the part that includes the reduced corporate tax rate to 21%, I think I'm trying to compare the tax benefits of taking work as a contractor, as a 1099 contractor versus the W-2 wage employee.
00:44:12.000 | How much money are you?
00:44:13.000 | And I make –
00:44:14.000 | Oh, yeah.
00:44:15.000 | How much money are you?
00:44:16.000 | It's like in the realm of $65,000 a year.
00:44:18.000 | And is your household income higher than that?
00:44:21.000 | Yeah, it is through some other supplementary income.
00:44:28.000 | In excess of $100,000?
00:44:30.000 | No.
00:44:31.000 | Okay.
00:44:32.000 | No.
00:44:33.000 | You don't need to go through and calculate it.
00:44:36.000 | It's going to be simpler for you.
00:44:38.000 | You can calculate it and I can answer the question.
00:44:40.000 | But you're not going to be affected by the new tax cut and jobs act in terms of that change.
00:44:45.000 | Because with an annual income under $100,000, in effect, you're not going to be facing much of an effect from any changes of income taxation.
00:44:57.000 | Your tax rate, the tax bracket that you are in is going to be so far below the 20% number by the time you take your standard deductions, by the time you just do all the normal stuff.
00:45:09.000 | There shouldn't be any need for it.
00:45:11.000 | The big cost for many people with regard to going 1099, in general, my advice is take the W-2.
00:45:19.000 | But you need something compelling to you to think that you should go the 1099.
00:45:25.000 | So is your company, have they made you a specific offer?
00:45:28.000 | If you go W-2, we'll give you this amount or if you go 1099, we'll get this other amount?
00:45:32.000 | No.
00:45:34.000 | I'm sort of at a crossroads on a personal stance.
00:45:38.000 | I had the LLC, it was formed in Honolulu.
00:45:42.000 | So I have a single member LLC that's 8, 10 years old and that I do run some 1099 business through that.
00:45:53.000 | And I'm kind of wondering if I should just pursue that exclusively.
00:45:58.000 | It just seems like the corporate tax rate is so low that it seems like – I feel like there's this secret code.
00:46:10.000 | I'm like, well, maybe the suckers are the ones earning personal income because the personal income keeps getting hit over and over and over again.
00:46:19.000 | And I'm like, well, maybe the secret to winning is really running all the income through an LLC.
00:46:26.000 | But maybe it doesn't matter at this level.
00:46:29.000 | I mean I'd like to think I'm going to be over $100,000 in a few years.
00:46:33.000 | Yeah.
00:46:35.000 | So theoretically.
00:46:36.000 | When your income starts to go up and this is not a – this is more just a practical matter, not a matter of a specific number.
00:46:47.000 | But let me talk you through it.
00:46:50.000 | So first of all, the number one thing that your company, the company that you're providing services for needs to worry about is are you a legitimate contractor or are you a legitimate employee?
00:47:04.000 | And this is a big deal for the company for whom you're providing services because the IRS definition of who is a contractor and who is an employee is pretty clear.
00:47:14.000 | And the IRS doesn't care how much money you're making.
00:47:17.000 | They're caring about your duties.
00:47:19.000 | So the simple thing would be do you have other clients other than the company that you're providing services for, how much of your time is spent with that company, et cetera.
00:47:26.000 | But that's not your problem.
00:47:27.000 | That's their problem.
00:47:28.000 | But in general, if they need to be – they're the ones – they shouldn't really be offering it to you and saying, "Well, Laura, you can work for us in either of these scenarios.
00:47:37.000 | Which do you pick?"
00:47:38.000 | They should be sitting down and saying, "Laura, you're a contractor," or "Laura, you're an employee."
00:47:43.000 | And to cover themselves, that's important for them to do.
00:47:48.000 | From your perspective, you need to look at it in terms of the totality of the benefits that you're getting.
00:47:55.000 | One big reason for you to consider working as a W-2 employee is to have access to any group benefits that the company offers.
00:48:03.000 | And in general, this is going to be a better move for you because most companies are going to provide some kind of benefits program.
00:48:11.000 | And so in general, that's going to be a good thing for you to join, to be able to get access to a group health insurance policy, to get access to a group 401(k) plan, to get access to group disability insurance, things like that, vacation time.
00:48:25.000 | That's going to be usually a benefit for you.
00:48:28.000 | Now, not all companies have good benefit programs.
00:48:30.000 | And you could make an argument that sometimes you're actually better off setting up your own benefits programs.
00:48:35.000 | That's true to a point.
00:48:36.000 | But it's much more challenging for you as an individual, especially when you're making about $65,000, much more challenging for you to go and set up all those things as an individual than it is just for you to join their group program.
00:48:50.000 | Now, on the flip side, there may be benefits for you as a contractor that would be so valuable it would supersede your willingness to work as a W-2 employee.
00:48:59.000 | You said, "Hey, I'd like to go back to Hawaii."
00:49:01.000 | Well, maybe the company would be happy to have you working for them as a contractor, and that would allow you to go back to Hawaii.
00:49:07.000 | But if you were an employee, then they would say, "No, sorry, Laura.
00:49:11.000 | We want you here in Southern California."
00:49:13.000 | If I were in a job where they said, "You've got to be here at this office this number of hours per week, and if you do that, then we'll give you as an employee," or you can go ahead and work with us as a contractor.
00:49:25.000 | And if you do that, you can be on the road, you can live wherever you want to live, and we just want you back here for a quarterly meeting.
00:49:31.000 | Because of the benefit of flexibility, I would be very tempted to go in the direction of working as a contractor, and frequently this is the case.
00:49:39.000 | It doesn't have to be the case.
00:49:40.000 | There's no reason why you can't work for the company you work for remotely as an employee, but frequently the company will say, "Well, if you're going to do that, we'll pay you on a contract basis."
00:49:51.000 | So think about it as it affects your life.
00:49:53.000 | Now, from a tax perspective, there's really going to be – there's not going to be – let's clarify.
00:50:06.000 | So first of all, let's just say you're simply working and paying taxes as a self-employed person.
00:50:12.000 | Ignore the LLC because you can set up your taxation in the LLC to be working as a self-employed sole proprietor or as an S corporation or as a C corporation.
00:50:23.000 | That's not going to be necessarily important.
00:50:27.000 | As a self-employed person, you're going to pay self-employment tax.
00:50:31.000 | And the biggest thing that I see people do, the mistake they make, is they take on the role of working as a contractor, and what they give up is the fact that their employer is going to pay for the employer section of the employment taxes, which is about 7.65% of the income.
00:50:48.000 | So in that context, you're giving up on a $65,000 income.
00:50:55.000 | That's a $5,000 per year question.
00:50:58.000 | So if they're going to pay you as a contractor, they should be paying you much in excess of $5,000 per year more for you to work in that scenario.
00:51:09.000 | Secondly, sometimes you can have – come into the question of, well, are there things that I can deduct if I run my own company?
00:51:18.000 | For example, could I deduct the mileage on my car, other business expenses?
00:51:21.000 | Travel to Hawaii.
00:51:22.000 | There you go.
00:51:23.000 | Is it possible?
00:51:24.000 | It's possible. In general, the rules on a lot of that stuff are pretty tight.
00:51:28.000 | And there's no reason with most of the benefits – so for example, travel back and forth between California and Hawaii.
00:51:33.000 | If the company desires for you to work for them and to work in Hawaii, they can go ahead and they can set that up.
00:51:40.000 | If it's done for the benefit of the employer, they can go ahead and set that up and they can provide you with a housing expense, and they can deduct that as something for them.
00:51:50.000 | So if they're willing to work for you, you can do it on either side.
00:51:53.000 | You've got to be a pretty valuable employee for the company to jump through hoops and set things up like that for you.
00:51:59.000 | But if you're just working for yourself, all of a sudden, there's not going to be – you're really not going to get that much benefit for most people.
00:52:06.000 | If you're going to work from Hawaii but you're going to work from your house, you can only deduct your office, your home office expense if you're working as a contractor, and what's actually your home office.
00:52:15.000 | You can't deduct your whole house.
00:52:17.000 | And by the time – and that's why I said at the level of income that you're at right now, it's really not going to make a benefit for you one way or the other.
00:52:26.000 | It's going to be a whole lot of record-keeping, a whole lot of hassle that unless you said, "Hey, I'm going to $300,000 a year," then it's just not going to be worth the hassle.
00:52:38.000 | If they'll take you as an employee, stay as an employee, if they won't but you get to have the benefit of moving back to Hawaii, then go ahead and move to a contractor status or stay on your contractor status.
00:52:49.000 | Okay. All right. Sweet. Thanks. Super helpful.
00:52:52.000 | Good. My pleasure.
00:52:54.000 | Yeah.
00:52:55.000 | All right. Back to Tanya and Meryl. And Tanya, you had one more question for me. I got time to take it. Go ahead, please.
00:53:02.000 | Sure. Thanks, Joshua.
00:53:04.000 | My second question was about knowing what you know about running a business and a new tax code.
00:53:12.000 | I know it's still fresh, but what are the considerations that you would recommend sole proprietors to think about in 2018 when they want to figure out whether they should go S-corp taxation route or sole proprietorship?
00:53:30.000 | And I know that there are standards considerations, for example, how much money you make and the difference between the wage that you will set up and then the dividends and payroll and so on.
00:53:45.000 | But there are also things like pass-through deductions that are new and other things that could be new.
00:53:51.000 | So in general, what do you think people should research to they still have time until March 15th to do so?
00:54:01.000 | I am not yet clear on the specific impact of some of the pass-through qualified business income and the new deduction that was allowed.
00:54:19.000 | I'm not clear enough on it to comment on it.
00:54:25.000 | The new Tax Cut and Jobs Act just passed before the end of last year is – I've still been wrestling with it, trying to make sure I understand, make sure the impact.
00:54:36.000 | And it's been very hard for me to see the practical impact.
00:54:39.000 | So my answer at the moment is going to simply be I don't know.
00:54:43.000 | But I will try if I can. It is on my list to do a more deep dive from the financial planning impact of it and as I can understand more fully what has changed and the new planning opportunities.
00:54:56.000 | So much has changed that there's going to be a lot of new planning opportunities.
00:55:00.000 | And I'm not a primary planner.
00:55:02.000 | I'm not a tax attorney who's sitting and reading the code and then – I'm not the person who's sitting and reading the code and saying, "Well, here's what I can apply."
00:55:13.000 | I'm a secondary planner where I'm waiting for the experts who do that and then publish documents on it.
00:55:20.000 | I consume their documents and their publishing and I try to articulate it to a more layperson number.
00:55:27.000 | And as that comes out and as I can more fully understand the practical impact, I'll try to cover that in the future.
00:55:32.000 | But my answer for today is I don't know.
00:55:34.000 | That's no problem. Thank you, Joshua.
00:55:38.000 | You're welcome. My pleasure.
00:55:39.000 | Thank you for calling in. I appreciate it.
00:55:42.000 | I wish I were brilliant enough to be able to do that but I'm not.
00:55:46.000 | Thank you all so much for calling in for today's Q&A show.
00:55:49.000 | Happy New Year, everybody.
00:55:51.000 | We'll be back with you next week with some solo shows and then next week plan to do a Q&A show as well.
00:55:57.000 | If you'd like to join for a Q&A show during 2018, I would love to have you do that.
00:56:02.000 | Today's show, we had three callers.
00:56:04.000 | If you want to just chat with me about anything, I'll do my best.
00:56:06.000 | This is your best way to have access to me and I love doing them and the audience really enjoys hearing them.
00:56:13.000 | And I'd love to have – I love this diversity of questions.
00:56:16.000 | You can talk with me about anything you want.
00:56:18.000 | So please go to RadicalPersonalFinance.com/patron.
00:56:21.000 | RadicalPersonalFinance.com/patron.
00:56:24.000 | Sign up to support the show there.
00:56:25.000 | I'll be doing a lot more promoting of that this year.
00:56:29.000 | RadicalPersonalFinance.com/patron.
00:56:31.000 | Thank you to those of you who have directly contributed to the show.
00:56:34.000 | It's filled with gratitude for you and I thank you for your support for me and for my efforts here at Radical Personal Finance.
00:56:43.000 | You all have a great weekend.
00:56:44.000 | I'll be back with you next week.
00:56:45.000 | [Music]
00:56:52.000 | This show is part of the Radical Life Media network of podcasts and resources.
00:56:58.000 | Find out more at RadicalLifeMedia.com.