Are We Done With High Inflation? | Portfolio Rescue 68

00:00:00.000 | Welcome back to Portfolio Rescue. One of the cool parts about our job as trusted sources

00:00:22.120 | of financial advice is people email us all the time. They give us not to brags about

00:00:26.520 | their financial situation, they have questions, they have problems that come up. They email

00:00:30.520 | us at AskTheCompoundShow@gmail.com. Duncan, what's going on today?

00:00:35.920 | Well, I just wanted to start out today kind of saying that I'm sorry, I guess maybe I

00:00:42.560 | jinxed myself, all the bragging I've done in recent months about my beautiful checking

00:00:47.680 | account that paid 4.27% interest. I got an email yesterday, they're shutting down because

00:00:53.760 | of all the banking turmoil. So, yeah, pour one out for Enzo Bank.

00:00:58.520 | So you're creating your own bank run here?

00:01:02.020 | No, no, no. I mean, they're closing down. They said they're closing down. So yeah, it's

00:01:06.120 | just I felt like I needed to let people know because I kind of bragged a little bit about

00:01:09.600 | it. Like, oh, yeah, why would you have T-bills if you have a checking account that pays you

00:01:14.160 | 4.27%?

00:01:15.160 | Well, I blame Jerome Powell for your banking account shutting down. So where are you gonna

00:01:19.040 | move it now? Just a regular old bank?

00:01:20.280 | So they're recommending a place, I'm not gonna save a name, but it reminds me of the villain

00:01:23.520 | from from Toy Story. The name, it sounds very not legit, but but they pay 5% interest for

00:01:30.320 | the first three months, and then they're offering the 4.27 that Enzo offered. So I'm gonna do

00:01:35.060 | it probably. But um, yeah, they don't sound super legit.

00:01:38.520 | 14% chance you lose all your money, just putting it out there. Okay, let's do a question.

00:01:44.160 | Okay, up first, say we have a question from Michael. My friend recently sent me an article

00:01:48.880 | saying that young people shouldn't save money. The argument is based on the life cycle model.

00:01:53.560 | He argues that in order to maximize happiness out of your income every year, and to avoid

00:01:57.960 | changes in standard of living throughout life, high income earners should not save at a young

00:02:02.360 | age. And instead, it should be made up in the middle ages. Some context not to brag,

00:02:07.680 | I count my blessings for the position I'm in. I'm 24 single and making $252,000 a year.

00:02:13.080 | I've been stocking away. Yeah, not, not bad. I've been stocking away all my money in S&P

00:02:19.200 | index funds with some money saved on the side for potential real estate investments. Should

00:02:23.680 | I start saving less and enjoy the money in my youth more? I would love to buy a Porsche.

00:02:28.600 | But it seems irresponsible given the power of compound interest. Notice I said Porsche.

00:02:32.960 | That's the right way to say it, even though I feel awful every time I say it.

00:02:36.000 | Yeah, I refuse. I say Porsche. This is just a question that's tailor made for me. I just

00:02:41.840 | I there's like five different layers going on here. We got like retirement savings, behavioral

00:02:46.360 | finance, spending money, striking the right balance between like enjoyment now and comfort

00:02:51.200 | in the future. Luxury vehicles. I love this question. Great one, Michael. A lot of people

00:02:56.080 | actually sent me the paper he's referencing when it came out. I read it. I don't agree

00:03:00.200 | with all the conclusions, but I do kind of appreciate the spicy take the authors take

00:03:04.520 | here. Like it's a pretty spicy take. Retirement research papers are generally boring. I'm

00:03:08.960 | a person who enjoys this stuff and I find most of them boring. So here's the main crux

00:03:12.360 | of the argument. This is from the conclusion of the of the article, because a lot of times

00:03:16.280 | you have to like buy these from some financial journal and they just give you the conclusion

00:03:20.760 | of the intro. And that's usually enough. So we argue that under realistic assumptions,

00:03:24.360 | the life cycle model implies that most young people should not save for retirement. That's

00:03:27.960 | the general conclusion. High income workers tend to experience wage growth over their

00:03:31.280 | careers for these workers, maintaining a steady standard of living as possible, therefore

00:03:35.320 | requires spending all income, all young and only starting to save for retirement during

00:03:38.480 | middle age. So I kind of, there are some aspects I kind of agree with here. In theory, in theory,

00:03:44.840 | it does make sense that your income should rise over time. Therefore, enjoy your youth,

00:03:48.880 | put off saving for another day. That's great. And there probably are a handful of people

00:03:52.020 | who are disciplined enough to plan ahead and say, listen, I'm going to make more money

00:03:55.120 | in the future. I'll start saving then, you know, I'm going to enjoy myself from my early

00:03:58.520 | twenties to my early thirties. And then when I make more money and I'm further on in my

00:04:02.440 | career, then I'll start saving. Here's the problem with this idea. It sounds great in

00:04:06.440 | a spreadsheet, you know, in a textbook, as your income grows, you begin to spend more

00:04:11.160 | money and you get used to a new lifestyle, right? You gain responsibilities as you age.

00:04:14.640 | Maybe you get used to some of the finer things in life. And I have a hard time believing

00:04:17.780 | that after 10 to 15 years of that, people can all of a sudden flip a switch and just

00:04:21.880 | go, okay, now I'm going to save because psychologically those new savings are going to feel like a

00:04:26.840 | loss, not a gain at that point. All the behavioral research from Kahneman and all these people

00:04:30.920 | says that losses sting twice as bad as gains make us feel good. So even though you'd technically

00:04:35.960 | be saving money and putting it aside, taking it out of your income at that point is going

00:04:39.200 | to feel like a loss. So it's going to be hard to do. So I think this idea is probably a

00:04:42.480 | pipe dream. Uh, now I understand it's not easy to save as a young person, especially

00:04:46.840 | when you want to enjoy yourself. I went through this. My first job out of college did not

00:04:50.120 | pay very well at all. I still wanted to have some fun and didn't have a ton of discretionary

00:04:53.800 | income. So I started small and I, it was like $50 a month into a target date retirement

00:04:57.280 | fund. Of course, very prudent. Uh, and I made more money. You said, you said your first

00:05:02.560 | investment ever was a CD on animals this week, which just killed me. And number two was a

00:05:07.200 | target date fund in my IRA. Sorry, not all of us can be exciting and invest in options

00:05:12.280 | in YOLO. I've never made a YOLO trade in my life. So $50 a month didn't give me a ton

00:05:19.360 | of capital in my account, even after a couple of years. But as I made more money, I would

00:05:24.760 | save half my raise and spend the other half so I could give myself a little bit of a bump

00:05:28.040 | in standard of living. But the idea was to build up saving habits. And I think those

00:05:32.320 | early savings habits can compound just as much as the compound interest. So I think

00:05:36.040 | getting into those habits, if you can, that, that, that's very helpful. The thing is for

00:05:40.160 | this person, they make a quarter of a million dollars in their twenties. I don't care where

00:05:43.280 | you live. That's a lot of money for someone who's 24. So it's not going to be that hard

00:05:46.760 | to find spare change. So here's what I'm going to do for this person. I would say, pick a

00:05:50.520 | reasonable savings rate. Now I always say I want double digits. So 10 to 20% is fine

00:05:56.180 | for this person. If you want to go splurge for the rest, my answer is unequivocally.

00:06:00.640 | Yes, splurge. You don't know what your future earnings powers are going to be, but if you're

00:06:03.680 | making that much money at age 24, you're in a pretty good place. You obviously don't want

00:06:07.180 | to go overboard. So I think just make sure you're still saving. Then, you know, for a

00:06:12.240 | single person who's young and no responsibilities, you should have plenty of discretionary income,

00:06:16.360 | even if you save 30% of your income or something. However, I'm not a fan of spending a ton of

00:06:22.160 | money on a car. So I would, I would, I recommend this person to do is read happy money by Elizabeth

00:06:28.160 | Dunn and Michael Norton. Put it up there. Yeah. One of my favorite books, it's all about

00:06:31.000 | the science of spending and what actually makes us happy when it comes to expenditure.

00:06:34.380 | So the book lays out five ways that research has shown that spending money can actually

00:06:38.000 | make you happier and not simply give you that short-term dopamine hit. So the five things

00:06:41.820 | are by experiences, not stuff, right? Make it a treat, which is just don't overindulge,

00:06:46.120 | right? It's, it's better when you space things out and don't do them all the time. They say

00:06:49.560 | by time, which is basically paying up for convenience. The fourth one is pay now and

00:06:54.240 | consume later, which is basically avoiding credit card debt. And the fifth one is invest

00:06:57.760 | in others. So charity, picking up tabs for friends, helping others. I think the big one

00:07:01.760 | here for some of their twenties is to buy experiences. So their research shows that

00:07:06.140 | experiences provide way more happiness than material goods in part, because experiences

00:07:10.120 | are more likely to make us feel connected to others. And they have these long lasting

00:07:12.960 | memories that also compound over time. So I would say before you buy that Porsche, not

00:07:18.120 | Porsche Duncan, you know, spend some of that discretionary income on going out more, traveling,

00:07:23.320 | go out to eat, do stuff with your friends on nights and weekends, like do stuff, don't

00:07:27.160 | buy stuff. And you know, when we were young, my wife and I made a concerted effort before

00:07:32.360 | having kids to travel as much as we could, because we knew once the kids came around,

00:07:36.120 | it would be a lot much harder to do. And it's, it's true. It's money well spent. I'm glad

00:07:39.120 | we did it. So I think you get way more bang for your buck by spending on travel and experiences

00:07:43.200 | than a car. Wait until you go through a midlife crisis, then buy the Porsche. Don't do it

00:07:48.240 | in your 20s. That that new car smell is going to wear off very quickly when you get stuck

00:07:53.160 | in a traffic jam, and you realize it's just another car. So I think the memories you make

00:07:57.080 | from going on a bunch of trips in your 20s, traveling, doing stuff with your friends.

00:08:01.080 | That's the kind of stuff that lasts a lifetime, the the new car smell fades away quicker than

00:08:04.840 | that. Yeah, and if you are I love cars. I mean, if you are gonna buy a car, get get

00:08:10.160 | like a Ford GT, or you know, a 1967 GT 40. If you really want to go out, you know, like

00:08:15.280 | get something, you can't just get a Porsche. I'm sorry, you know, like Porsches are cool,

00:08:19.240 | but like, I'd rather get something. Well, yes, at 24, making a huge income. Again, if

00:08:26.160 | you you say you can save a decent amount of your money, max out your 401k. And then with

00:08:30.760 | the rest of it, sure splurge and have a little bit of fun. This is the you're gonna look

00:08:33.880 | back at this time in your life before you have a lot of responsibilities, maybe settle

00:08:36.760 | down with a family, get married or whatever, own a home, you know, pay for all this boring

00:08:41.280 | stuff. Yeah, sure. Have a little fun in your 20s. And if you're still, you know, stocking

00:08:44.840 | some money away, you're gonna be fine food for thought. What if what if they turn having

00:08:49.520 | a fancy sports car into a side hustle and they make money racing it? Maybe they could

00:08:54.640 | blow it up and turn it into NFT. You never know. Right? Okay. Great question, though.

00:08:59.880 | If you want to splurge on a car, don't let me hold you back. But I would think twice

00:09:03.080 | about about doing that. I don't think you're going to look back at buying a Porsche at

00:09:07.400 | 24 and think that was a good idea. Just what do you think? What do you think they do? That's

00:09:10.800 | a pretty, pretty nice salary for a 24 year old. That's got to be software engineer or

00:09:14.840 | something, right? I'm guessing that's that'd be my guess. They're working for Google or

00:09:19.680 | Amazon or some something like that. Right. All right. Let's do another one. Okay. Up

00:09:23.640 | next, we have a question from Ed. When was the last time in history people rushed to

00:09:27.280 | buy government bonds? What are the chances of this leading to the Fed having to lower

00:09:31.200 | interest rates and inflation going even higher? All right. So this is this is the fact that

00:09:36.400 | the last two weeks we had a little bit of a banking crisis. Interest rates dropped

00:09:39.520 | like a rock in some cases. This question is actually relatively easy to answer because

00:09:43.840 | 2022 was the outlier in terms of people not rushing to buy government bonds during a down

00:09:48.360 | stock market. I've used this one before, but it's worth revisiting. John, do a chart on.

00:09:53.320 | This is every year where we've had a down year in the S&P 500 since 1928 with a corresponding

00:09:58.240 | 10 year treasury returns in those years. Look at 2008. 10 year treasuries were up 20 percent

00:10:03.280 | when the stock market got crushed. 2000, 2001, 2002, that was a three year bear market. Every

00:10:08.680 | single one of those years, treasuries did great. People rushed into that flight to safety

00:10:13.080 | to buy bonds. 2022, again, is the outlier where you saw bonds actually cause the stock

00:10:18.200 | market pain. So most of the time when the excrement hits the fan, people rush into the

00:10:24.440 | safety of government bonds. And that's kind of what happened in the last couple of weeks

00:10:26.880 | with the banking crisis. So it's nothing new to see nervous investors leap into the open

00:10:30.940 | arms of U.S. government bonds during a crisis. It's just that, yeah, last year was kind of

00:10:35.320 | an outlier. So the question here is, will the drop in rates from this bank crisis actually

00:10:39.520 | lead to higher inflation? So the idea here is that for bonds, that the relationship is

00:10:44.640 | easy. When bond prices, as rates rise, prices fall. And as rates fall, prices rise. That's

00:10:49.840 | the inverse relationship between bonds and prices. But the relationship between rates

00:10:53.320 | and inflation is not quite so easy. For instance, interest rates went to zero during the 2008

00:10:58.280 | financial crisis and stayed there for almost a decade. They remained low until basically

00:11:02.320 | inflation really had these last couple of years. From 2009 to 2019, the 10-year yield

00:11:09.000 | averaged 2.5%. John, do a chart on here. The 10-year average 2.5%. Inflation over that

00:11:13.600 | time was 1.6% per year on average. We had low rates for well over a decade. That didn't

00:11:20.480 | cause inflation. So I think a lot of what we're thinking through here is, well, if rates

00:11:24.920 | fall, that must mean inflation has to go up. And that's not necessarily how this works.

00:11:28.120 | A lot of it depends on why rates are falling. Now, it seems like right now, sometimes you

00:11:32.440 | don't really know. It could just be that the bond market is confused. But there's two reasons

00:11:36.080 | rates are falling now. One is this banking crisis, right? Because people are worried.

00:11:40.480 | And the second one is the bond market seems to think that means the Fed is going to have

00:11:43.200 | to cut interest rates or stop raising them because of this banking crisis. The Fed obviously

00:11:48.480 | is not. Yesterday, they still raised rates. The bond market says, "I don't believe you."

00:11:52.800 | That's the roundberry. "I don't believe you," right? So I think if the banking crisis leads

00:11:56.400 | to slower loan growth and thus slower economic growth, it would make sense for rates to fall.

00:12:00.800 | But in that case, if economic growth is going to be slower, guess what? Inflation is going

00:12:04.600 | to come down too. So there is no easy relationship. In the textbooks, this is what I learned in

00:12:09.400 | economics class, right? If rates fall, inflation should go up. The last 10 or 15 years really

00:12:15.200 | disproved that. So it's really going to matter why are rates falling. That's going to be

00:12:20.240 | the big thing. So maybe the past couple of weeks could change people's spending habits

00:12:24.120 | and alter the economy. It's a good possibility. I think it's also a confusing time. So I

00:12:28.560 | don't think I'd put too much into two weeks worth of bond market moves. Rates could easily

00:12:32.480 | go back up. They could go down further. Who knows? But it's important to remember that

00:12:36.200 | rates falling in and of themselves don't automatically cause inflation. There's a lot more that goes

00:12:40.520 | into inflation than that. If it was that easy, the Fed would have snuffed inflation out a

00:12:45.000 | long time ago. Because as we've seen, just because the Fed is raising rates doesn't mean

00:12:48.280 | inflation falls right away either. It's not that easy.

00:12:52.120 | Yeah, it looks like I'm doing a poll in the chat. 55% of people are more worried about

00:13:00.920 | inflation than the other option was banking crisis or not worried. People are still kind

00:13:06.480 | of worried about high inflation.

00:13:08.040 | Who knows? Consumers could say, "I don't care that this bank in Silicon Valley failed. I'm

00:13:14.040 | still going to keep spending money." So we could certainly see that. It's like the bond

00:13:19.760 | market versus people in our chat right now. They don't believe it. The bond market seems

00:13:23.280 | to think inflation is over based on where rates are headed. We shall see.

00:13:27.200 | We'll find out.

00:13:28.120 | Let's do another one.

00:13:30.000 | Up next we have a question from Bill. Ben wrote a blog post last week about how so many

00:13:36.080 | rich clients at SVB, Silicon Valley Bank, neglected to manage their cash properly. I

00:13:40.520 | have to admit, I've never really given much thought to cash management before the past

00:13:44.000 | year or so now that we finally have yields greater than 0%. Here's a cash management

00:13:49.760 | and tax question wrapped in one. What is the most tax efficient vehicle to part my cash

00:13:53.680 | in? T-bills, money markets, CDs, munis, that's municipal bonds for those new here, online

00:13:59.720 | savings accounts, or anything else I'm missing?

00:14:03.360 | This is a question from Bill. We only get our answers on tax questions from another

00:14:08.080 | Bill. Let's bring in tax expert extraordinaire Bill Sweet.

00:14:11.840 | Gentlemen, coming to you live from Pine Island, New York. I'm on location today.

00:14:17.920 | I noticed. Where's Pine Island, New York? Tell us what's going on here, Bill.

00:14:22.000 | It's out in the black dirt region in the sticks, but this is where I come from. New York is

00:14:26.800 | not just about skyscrapers and cities. It's a big place. I'm happy to be here and supporting

00:14:31.960 | the local business.

00:14:32.960 | Did your car break down? Why are you outside?

00:14:35.780 | It did. My turbocharger blew up last week coming back from Chicago. I apologize to the

00:14:41.640 | listeners about the wind, but the show must go on, gentlemen. Let's do this.

00:14:45.000 | All right. Personal finance crisis for Bill. He had a run on his car.

00:14:50.600 | Great name, first off. Ultimately, Ben, I love this question because Bill wraps a lot

00:14:55.160 | of things in here. Ultimately, we don't eat our after-tax returns. You know this, Ben.

00:14:59.640 | You know this, Duncan. Ordinary income rates are pretty high, too. As high as 37% plus

00:15:05.000 | a 4% net investment income tax, and up to 12% for the People's Republic of California

00:15:10.000 | if you happen to live out in the West Coast. Brother Bill, do the math. It could be as

00:15:13.680 | high as a 50% tax rate, meaning that you have to be very careful not to give up half of

00:15:18.400 | your interest to taxes.

00:15:19.800 | John, can we chart this on right now? I want to talk about the different flavors of interest

00:15:25.800 | income that Bill brings up. Let's start all the way on the left. Let's talk about online

00:15:29.960 | savings account. Duncan, what was the company that you were in? You were FDIC Insured Savings,

00:15:35.000 | right?

00:15:36.000 | Bernie Madoff Securities.

00:15:37.000 | Yeah.

00:15:38.000 | They were called INSA.

00:15:39.000 | Yeah. Ultimately, there are a lot of banks. If they're FDIC Insured, it may be something

00:15:43.520 | to consider, but they're offering you a pretty high yield. Ultimately, you have to pay tax

00:15:47.080 | on that. You have to pay federal income tax and state income tax. All the way on the left,

00:15:51.280 | on the blue, I'm talking about a 4% pre-tax return that gets cut down to about a 2.53%

00:15:56.520 | after-tax return. That's on your typical, standard, ordinary income interest rate. That's

00:16:02.240 | option A. It's great news because it's always liquid, but at least tax efficient.

00:16:06.400 | Bill, can I just stop you for a second?

00:16:08.160 | Yes, please. Please do.

00:16:09.520 | This is the nicest-looking chart we've ever had on Portfolio Rescue. Usually, you have

00:16:12.920 | these napkin things.

00:16:13.920 | Wow. I know. I thought it was going to be a napkin, but I guess it'd be blowing in the

00:16:16.040 | wind too much.

00:16:17.040 | Do you have an intern we don't know about that you're having create things for you now?

00:16:20.240 | No. I had a lot of time because I was stuck without a car here all morning.

00:16:23.680 | Also, it looks like you're getting some of that black dirt in your eyes from the wind.

00:16:26.640 | Are you going to make it?

00:16:27.640 | Yeah. I don't know. The storm is coming, so I think we've got to get moving. John, let's

00:16:31.920 | bring that chart. Let's focus on the red now. Let's say that you move out to the tax-efficient

00:16:35.960 | scale. You move to a one-month U.S. Treasury. If you buy a 30-day bond that's U.S. Treasury

00:16:41.240 | backed, that's not state income taxable, so you get a bit of a tax-efficient boost there

00:16:45.120 | in that you're not going to remit any taxes to the state's tax agencies. That cuts your

00:16:51.320 | 4% pre-tax return to about 3%.

00:16:53.240 | Then, let's move on to the most tax-efficient vehicle, which is municipal bond interest.

00:16:57.760 | Ultimately, if you're owning a municipal bond in the same state, your pre-tax return is

00:17:03.360 | exactly equal to your post-tax return because you're not remitting anything to taxes. Ultimately,

00:17:07.900 | take a look at the yields. I think that's really important to focus on, is that the

00:17:12.000 | most tax-efficient vehicle, depending on your tax rate, may not give you the best return.

00:17:16.520 | Ultimately, again, you need to do this math. The second thing, Ben, I want to bring up

00:17:20.160 | is liquidity. If you lock your money up in a 30-day U.S. Treasury bond, you don't get

00:17:24.840 | that money back for 30 days unless it's a marketable security, whereas in an FDIC-insured

00:17:29.040 | account, that's pretty liquid. You can trade at any time.

00:17:31.480 | I was thinking about this. The different variables you consider for cash management are liquidity,

00:17:35.000 | ease of access, yield, safety, all that stuff. I think taxes probably do rank pretty low

00:17:39.800 | in the hierarchy from my perspective. If you want that money to be there, I think you want

00:17:46.120 | to make sure you have access to it if you know you're going to be spending it at a certain

00:17:49.760 | point.

00:17:50.760 | I would agree 6,000%. One of the things, Ben, that we've observed in our practice is rich

00:17:55.160 | people hate paying taxes more than they like making money. That's a real thing, but you

00:17:59.400 | do not want to become blinded. Don't let the tax dog wag the tail or whichever direction

00:18:04.160 | we're going in here. I agree with you 100%.

00:18:07.000 | Close enough. All right, Duncan, let's do another one.

00:18:10.000 | Good advice. Up next, we have a question from Ethan. "I recently heard about Secure Act

00:18:15.640 | 2.0 that allows 529 plans to be converted to Roth IRAs. Not to brag, but I expect our

00:18:20.840 | daughter's 529 account will be worth about $70,000 when she graduates high school. Not

00:18:25.960 | Michael Batnick-level 529 money, but respectable. We didn't open an account when my son was

00:18:31.400 | born in 2020, assuming that we would transfer whatever remained into our son's name from

00:18:36.960 | our daughter's account. This new law has me thinking about ways to take advantage of opening

00:18:41.280 | Roth accounts without the headache of finding ways for them to have taxable income. If we

00:18:46.020 | have enough to cover two conversions, one for each child, can we do it out of the same

00:18:50.280 | 529 account, or do we need to open up a separate 529 for our son?"

00:18:55.840 | My favorite comment of the day so far from the people in the chat here, someone said

00:18:58.280 | that Bill's on the next season of Last of Us.

00:19:00.440 | I'm out here surviving, guys.

00:19:04.120 | All right, Bill, we've gotten a handful of questions on this from people who pay attention

00:19:09.400 | to this kind of thing. So obviously, this is on people's top of mind. I didn't really

00:19:13.920 | know about this until you brought it up. So my first question is, why don't we just allow

00:19:19.160 | parents to open a Roth in their child's name? Maybe they don't want that tax handoff to

00:19:23.880 | richer people, I guess. But what's going on here? Does this make sense to you in terms

00:19:29.040 | of the strategy they're taking?

00:19:30.400 | Yeah, the first suspicious thing, the last questioner's name was Bill. My oldest brother's

00:19:33.840 | name is Ethan, so this is getting real familiar here. But no, Ben, you're right. I mean, the

00:19:39.440 | answer to why you can't just contribute directly to a Roth IRA is you have to have earned income.

00:19:43.800 | And that's exactly what Ethan is getting at here, is that he's thinking long-term. So

00:19:47.240 | I give him a lot of credit there. He has one 529 account open, and he's saying, "Hey, I

00:19:52.480 | really want to take advantage of this provision. Let's talk about it really quick." The idea

00:19:55.680 | is if you have money left over in a 529, Ben, I don't have a lot of clients that spend too

00:20:01.280 | little on college. Ultimately, college is a very expensive enterprise.

00:20:04.560 | Yeah, it is funny when people worry about that, that it's pretty rare for that to happen.

00:20:08.940 | That is a very good problem to have. But I think if you think long-term about this, ultimately,

00:20:13.440 | it could happen. And I think what Ethan's going is, "Do I want to purposely do this,

00:20:18.080 | overfund a 529?" That ability to transfer, basically, rollover from a 529 to a child's

00:20:23.000 | Roth is super cool. And Ethan gets to the key point, Ben, you brought it up a second

00:20:26.400 | ago. It avoids the earned income limit, right? And so then he could potentially transfer

00:20:31.040 | money from a 529 to a Roth for a teenager, right, that may not be working. Somebody in

00:20:35.080 | college probably should be focusing on college and not working. And it's a great avenue to

00:20:39.440 | basically do an effective backdoor Roth. The problem is, that Ethan's getting at, is there

00:20:44.120 | a couple of contingencies here. Number one, the 529 account needs to be open for 15 years

00:20:49.200 | for this to happen, right? So if you're opening a 529 account now, yeah, you're looking at

00:20:53.040 | 2037, 2038 being the earliest time that you can conduct this rollover. The second provision,

00:20:58.400 | Ethan mentioned this is original question, contributions that you roll over need to be

00:21:02.520 | more than five years old. So ultimately, again, you can't do this instantaneously. You can't

00:21:06.560 | just open up a 529 and then roll it directly to a Roth. That's not the way it works. And

00:21:10.440 | so Ethan's thinking long-term. I think this is great to answer your question directly,

00:21:13.920 | Ethan, get that 529 open for your son, because that will start that 15 year clock. But I

00:21:18.720 | give you a lot of credit because thinking on 15 to 20 year timelines, that results in

00:21:23.440 | success in investing. And so ultimately, I think this is a great option for an investor.

00:21:27.460 | We never really know the motivations of politicians, but why do you think they put this in the

00:21:30.920 | Secure 2.0 Act in the first place? Who is this helping?

00:21:33.560 | It's a great question. I think bluntly, it's helping people like you, me and our clients,

00:21:38.200 | right, that are thinking on these timelines. But it is a very common question to say, hey,

00:21:42.640 | I've been successful, or let's say my child gets a Rhodes Scholarship, or let's say they

00:21:46.000 | go to a service academy at USMA or the Naval Academy. These are great things. And if I've

00:21:49.920 | done everything responsibly, why am I paying a 10% penalty, right? I'm a saver. I'm an

00:21:54.440 | investor. Why am I paying this penalty? How can I effectively move this forward? I think

00:21:58.200 | it's a neat provision to have. And the guidelines, furthermore, that they put on this, I think

00:22:01.840 | will prevent folks from using this, let's say, to their advantage. Because again, 15

00:22:06.200 | years is a long time to plan for. So I think generally it's a good thing then.

00:22:09.560 | All right. I think we have another question on Roth IRAs, because we have to hit our quota

00:22:13.400 | here. That's what I'm here for.

00:22:15.560 | We can never have too many. OK, next we have a question from Jordan. Is there any downside

00:22:21.080 | to doing a backdoor Roth IRA conversion if you end up under the Roth IRA limit? This

00:22:25.880 | is the first year I think my wife and I might wind up above the MAGI limit. I'm pronouncing

00:22:31.440 | it MAGI. I don't know how you say it, but-- Is that like a king, Duncan? What--

00:22:35.400 | It sounds like a gift to the MAGI, right? Yeah, the gift, yeah.

00:22:39.360 | But with variable comp and deductions, I'm not positive. I'd like to contribute now,

00:22:44.120 | so that the money is invested in the market. Is there any reason I shouldn't do my 2023

00:22:48.520 | Roth IRA contributions via backdoor Roth IRA conversion now, so I'm OK if we end up over

00:22:54.680 | the Roth limit? I don't have any traditional IRA balances, but my wife does. Does her traditional

00:23:00.720 | IRA impact the pro rata rule for me to do a backdoor Roth conversion? I said this off

00:23:06.480 | show. These kinds of questions sometimes become word soup to me, and I know that a lot of

00:23:11.880 | our younger-- That's a lot.

00:23:12.880 | --and people that are new to investing, I know that they don't get this. Can you also

00:23:16.200 | just sum up at the end of this what the main idea is here? What the point of all this is,

00:23:19.760 | what they're trying to do? Yeah, before we get into this, Bill, here's

00:23:22.320 | my-- if I became tax czar one day, or if you did and you're asking me for some advice,

00:23:26.120 | we get these questions all the time about people who are close to the limit. Why don't

00:23:28.680 | we give people a one-year mulligan? One year, you get close, maybe your income goes over

00:23:33.440 | because you have variable income. Oh, whoops, you were over the limit, but you contributed

00:23:38.040 | to Roth, one-year mulligan. Yeah, I like this idea. Unfortunately, Ben,

00:23:43.120 | you and me are not writing the tax code. They haven't let us do this from Grand Rapids or

00:23:46.880 | Pine Island or where Duncan is right now. Duncan, let's talk about what you're talking

00:23:52.080 | about. In order to directly contribute to a Roth IRA, your income cannot exceed $214,000

00:23:57.280 | joint, right? So these are relatively wealthy people problems. Let's go back to question

00:24:02.200 | one, or let's start making $200,000 at age 23. That's what this is for. And the idea

00:24:07.040 | is, hey, you're making too much money, right? We want to take some of the tax benefits away,

00:24:11.400 | and ultimately, let's reallocate those tax benefits to folks at lower incomes. However,

00:24:15.640 | due to a quirk in the tax code, you're allowed to circumvent this by a backdoor Roth contribution.

00:24:20.720 | And the idea is there's no income limit to contribute to a traditional IRA, and there's

00:24:24.520 | no income limit to convert from traditional to Roth IRA. There is a massive catch, but

00:24:29.240 | to answer the listener's question directly, if you think you're going to be in that income

00:24:32.880 | limit, and Duncan, I think the problem here that the questioner is going through is they

00:24:35.960 | don't know exactly where last year's income is, right? Maybe they have some expenses that

00:24:39.440 | they need to deduct. Maybe they haven't sat down to give their shoebox to their accountant

00:24:42.640 | yet. We don't know what the situation is, but ultimately, they're not sure. And if you're

00:24:46.240 | not sure, the idea is just do the traditional contribution, and you can backdate that up

00:24:50.800 | to April 15th into last year. That's the concept. It kind of sounded like an anvil was falling

00:24:55.160 | from the sky on you. I don't know if you heard that. That was kind of a porky pig, bug's

00:24:59.400 | bunny. That was the fungus coming to get me. Hey, Bill, we better put an end to this show

00:25:03.960 | because I'm pretty sure I see your car up on cement blocks back there. They stole all

00:25:07.040 | your wheels. That's not me. That's a much nicer ride than I can afford. But ultimately,

00:25:11.440 | the idea is backdoor Roth contributions are great, but the big catch that the listener

00:25:15.080 | gets at is if you do an IRA conversion, you have assets that are in a tax-deferred IRA,

00:25:20.940 | you have to convert as if that's the entire balance. And so ultimately, the problem is

00:25:24.660 | you could be paying income tax on the conversion unless you're careful. But to answer the other

00:25:29.320 | question, your wife's IRA is not your IRA. So that does not count for the purposes of

00:25:33.620 | a Roth conversion. You're good to go there. How about one more thing, as Ben being the

00:25:37.120 | tax czar, why do we make people go through the process of the backdoor Roth IRA? Is it

00:25:40.620 | because they don't want people to do it because they make it hard? Can't we just make it easier

00:25:43.740 | for people? Do we have to go through this whole ordeal? Isn't that kind of ridiculous?

00:25:47.820 | You're preaching to the choir, Ben. Ultimately, I agree with you. Either have it or take it

00:25:52.100 | away or don't. Why have all these complicated rules? But nothing in the tax code is direct.

00:25:58.220 | And ultimately, this is one of many, many very quirks. And I give anybody credit for

00:26:02.260 | looking at ways, how can I save on taxes? This is one of them.

00:26:05.900 | Right. Well, job security for you.

00:26:08.180 | Indeed.

00:26:09.180 | Someone has to pay for your car repairs.

00:26:11.220 | Yeah, this ain't cheap. The only thing more expensive than getting your car repaired these

00:26:15.100 | days is going out to buy a new car. I can't believe it. We haven't got more, you know,

00:26:18.700 | used auto car prices yet.

00:26:20.220 | When they fix this policy, will they call it a front door Roth?

00:26:23.660 | I'll take it. Turbocharged Roth. That's what I'm after here today.

00:26:28.140 | All right. Thank you to Bill for calling in from his nearest federal location today on

00:26:33.100 | the Last of Us set.

00:26:34.500 | Yes, he's a yes. Very dedicated. If you have a comment for us, give us one on YouTube.

00:26:43.260 | Come watch live. We thank everyone for showing up in the live comments as usual. Never email

00:26:47.380 | us. Askthecompoundshow@gmail.com. Leave us a review, hit the like button, subscribe,

00:26:51.540 | all that good stuff. And we will see you next week.

00:26:53.940 | Free week deadline for your IRA conversion. Get them in. IRA contributions.

00:26:57.660 | Good to know. See you, everyone.

00:27:00.180 | [Music]

Are We Done With High Inflation? | Portfolio Rescue 68

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