(upbeat music) - Hello, and welcome to another episode of All The Hacks, a show about upgrading your life, money, and travel. I'm your host, Chris Hutchins, and I love sharing whatever knowledge I have to help people earn and save more, and leveraging your tax advantaged accounts is one of the ways you can do that.

And who better to have this conversation with than my good friend and host of the Money With Katie podcast, Katie Gaddy Tassin. She and I will cover everything, including IRAs, 401(k)s, Roth conversion ladders, which might help you completely avoid taxes when you take money out of your 401(k) in the future.

We'll cover backdoor contributions, HSAs, donor advised funds, and a lot more. So let's jump into it right after this. Did you know that someone new gets impacted by identity theft every two seconds? It makes sense when there's so much of our personal information getting shared online without our consent.

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And as an All The Hacks listener, you can get priority on their wait list. Just head to allthehacks.com/Gelt, G-E-L-T. Again, that's allthehacks.com/G-E-L-T. Katie, thank you for joining me. This is a long time coming. Chris, it's a pleasure to be here. Thanks for having me on. I've always wanted to break down retirement accounts, and I was looking on the internet.

I was like, who do I know that's great at this stuff? And not just retirement, but all tax-advantaged accounts. You've called yourself a freak for tax loopholes, so I thought you would be a great person to come on. You've done a ton of episodes on your show about this topic.

What do you say we just break it all down and go through all the different ways to use these different investment accounts to make the tax code work for you? I love it, let's do it. My caveat to all of this is, I don't think that we shouldn't pay taxes, right?

I think taxes are important. They make the country function, but there's just a big knowledge gap between people that really dial this in and understand it all and the rest of us. And I think the tax code, last I remember reading somewhere, grows by like 150,000 words a year.

And so I feel like most people don't know this. So I just wanna be, this is not a, how do we get out of paying all the taxes and let other people pick up the tab, but there are very specific rules out there set for helping people save money, mostly for retirement.

And if they're out there, people should all have access to them and information should not be the reason they aren't being used. A hundred percent. And I would add that the idea that someone who is gonna contribute to a pre-tax account and therefore save a little bit of their money on their taxes and is gonna be taking advantage of something that's out there that the IRS and the federal government fully intends for them to use, that person taking advantage of that and not paying, let's say four to five grand a year in those taxes, that's not gonna make or break the national budget, right?

I think it's a little bit like someone who is flying commercial being like, I should only bring one suitcase instead of two 'cause fuel efficiency while like a billionaire is flying across the country in a private jet, not worried about it. So I always too feel like it's kind of important to say that these rules exist for a reason.

The IRS and the federal government want you to know about them and use them. You're fully within your rights to do so. And everything that we're talking about, I remember when I first learned about this stuff, I was like, how is this legal? This is crazy. I'm about to save, I think like 20 grand in taxes because I just am putting money in the right quote unquote buckets.

Like that's unbelievable to me, but it exists and to your point, you don't want a lack of knowledge or information to be the reason that someone is overpaying. - So maybe we'll start with the fundamentals of tax advantaged investing accounts. We'll start with 401ks, go into IRAs. I know there are a lot of them.

You know way more about some of the obscure ones than I do. It probably doesn't make sense to go into every possible random account that you could get if you work for the government or work for a school teacher. A lot of them function similarly. Is there any high level overview you want to give to some of the more obscure ones?

- So I kind of think about them in categories. So the first big one that I'll talk about is the, what I would call 401k category. This includes the 403Bs, the 457Bs, the TSPs, the simple IRAs, things of that nature that you're going to get through an employer. And depending on what type of employer you work for, it might look a little bit different and your options might be a little bit different, the plan provider, the fees, et cetera.

But generally speaking, it's like the employer-sponsored account that you may or may not have access to that is likely going to have a contribution limit somewhere in the ballpark of around 22,500 per year, at least in 2023. It should be somewhere in the ballpark in 2024 of around 23,000, though, to your point, because of some obscurities, some of these accounts have different rules.

But the point is, it's the one that you're probably going to get from an employer. And if you don't get it from an employer and you're a W-2 employee with no other sources of income, you're kind of SOL on this one. You're going to have to go look elsewhere.

That's bucket one for me. Then I would think about things like the standard Roth IRA, traditional IRA bucket, which I believe is going up to 7,000 in 2024 as a contribution limit. And there are all sorts of smaller limits and penalties to be aware of as far as the income that you need to have in order to contribute to one.

And there are ways to get around that. But that is kind of the bucket that's the most freewheeling in the sense that anyone that has earned income can go open one. You don't have to get it from an employer. You don't have to have, say, a specific healthcare plan to get one, things of that nature.

The qualifications, we'll say, are fewer. And then we'll say small business pre-tax accounts. So generally speaking, in my mind, this is going to mean the solo 401(k) or the SEP IRA. This is where people will start to get thrown off because we're now using a lot of the same words, 401(k), IRA, but in the small business sphere, they do function a little bit differently than the other two categories that we just mentioned.

So the contribution limits are higher. The way that contribution limits are determined are higher, because if you're self-employed, solopreneur, you are the employee and the employer. So now this opens up some wiggle room for you to get a little bit more creative. And a lot of people that have W-2 jobs and side hustles or W-2 jobs and businesses that they're operating to, I did that for several years, you can contribute to two 401(k)s.

If you have a different source of income funding each of them, you're fully within your rights to use both. So I always think if you can use it, use it, right? Get all the benefit you can. So that's the tax advantaged world at a high level that I would point to.

And then I kind of think about the taxable brokerage account as that stepsister off to the side where you're not getting any tax advantages up front by contributing to one, but because of the way capital gains are taxed in the United States, at least right now in this current tax code and paradigm, there is a pretty generous allowance of 0% capital gains.

So even though it's not tax sheltered every year, and like you're buying and selling within this account, you're still gonna be paying capital gains as you're building it up. If your income goes to zero and you start withdrawing earnings from that account to live on, you can spend a lot of money before it starts taxing you anything on those gains.

So kind of think of it like a poor man's Roth IRA, but my love of tax advantaged accounts extends to non-tax advantaged accounts too, because investments are just taxed so favorably in the United States, or gains on investments, I should say. So that's kind of how I conceptualize the landscape.

- Maybe we'll put three others in this other bucket of tax advantaged accounts that we'll touch on at the end. - I'm dying to know what this other bucket is. - Well, we have HSAs, we've got 529s, and I'll throw donor advised funds in there as well. - I need to do some digging on the donor advised funds.

So I'm glad that you brought that up. - Let's put those to the side. We'll come back to them. And I've got one more. I've recently been doing some digging on cash balance plans, which is like another small business type of retirement plan that's super interesting. But let's start with the employer plans.

Anyone who's employed probably has had one at one point in time. And I guess there's a few questions. So one, I wanna make sure we cover, some companies now are starting to offer the choice between pre-tax and Roth, which is an interesting one, which will apply to IRAs as well.

And then also is the constraints on these accounts or really any retirement accounts worth the trade-off that you don't get to access the money? - I'm glad you asked. - First off, one of the craziest things is that so few people are actually enrolled in these. And when I joined Google, I remember talking to someone that said the best way to increase the number of people who contribute to their 401k is to just default, turn it on, because so many people aren't.

And I've heard people say that in their companies, even with matching, 50% of people aren't doing this. And so just being more aware of how it works, I think will just help everyone, but let's jump in. - What might be helpful is if I break down what to me is the best strategic way to approach this dilemma of, I have this investable income every year, I'm not sure where to put it.

I wanna optimize where I'm putting it so that I'm getting the best bang for my buck, the best ROI. A lot of people, when they think about investing, they think about ROI, they're thinking about the underlying assets that they're buying. What am I gonna buy in these accounts that's gonna return the most money back to me, that's gonna perform the best?

But beating the market, we know, is very hard. And active investing or taking a more active role in the choices and trying to watch things and sell and buy at the right times, I think of that a little bit as a fool's errand. If the people at the hedge funds are not consistently beating the market, the chances that you're gonna beat it in your spare time, probably unlikely.

But what we can do is try to outsmart the tax code. There we have the rules spelled out to us. We know exactly how we can increase our returns by, if you're in the 24% bracket, 24% per year. You're in the 32% bracket, increase your return on that money by 32% per year.

How? By putting it in a pre-tax account. Then you get 24% or 32%, whatever your marginal tax rate is, assuming the entire contribution falls into that top marginal bracket. That's money that now stays in your pocket. You are now keeping that money instead of paying it in taxes. Now we'll get to what happens later because people love to say, "Well, you're not not paying it, you're just deferring it." Maybe.

With some careful tax planning, you might never be paying it. So we'll get into that in a little bit. - In advance of the new year, Amy and I are really getting our life organized and a big part of that is our digital life. Think everything from family to home, to travel, and that doesn't even include work.

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So definitely check them out at allthehacks.com/viore. Again, that's allthehacks.com/v-u-o-r-i. And get yourself some of the most comfortable and versatile clothing on the planet. - To your question about, is it worth the penalty, right? Or is it worth locking it up? 'Cause I think that that's a great question and it can be addressed with some strategy.

But when you contribute, let's say I'm in the 32% tax bracket marginally and I'm not exactly sure of what that would put my income at at this point in time. We'll say maybe like in the 300,000 range, if I'm single, I honestly don't remember. But let's say I've got my 22,500 to invest, right?

So I'm gonna put it in my employer 401k. I'm gonna buy something boring inside there like VTSAX or a target date fund. I'm gonna get my money invested in the 401k. I'm gonna get that great employer match. Honestly, the employer match to me is like, yeah, cool. Okay, thanks for like the little extra on the side.

The main benefit is that tax break. So on my 22,500 or I guess next year, my 23,000 that I'm putting in, I'm gonna get $7,360 in tax savings based on that one move. My tax liability is now gonna go down. I still have to pay FICA taxes on it.

That's fine, that's true across the board. I'm gonna have to pay that payroll tax, whether it's traditional or Roth, but my federal and my state taxes that I would owe on that money now come back to me. This is partially why this stuff is so great for people who live in California, in New York, in these states where state taxes are so high, particularly if they plan to retire to Florida, where there is no state tax.

Don't pay your state income taxes on this money now, pay it later when you're in Florida and the rate is zero, right? So I get my 7,360. I know that that's the tax break I've just unlocked. And in order to do this right, I'm multiplying the contribution by my marginal tax rate.

There are more sophisticated ways to do this if you wanna be like super, super precise, but that's the ballpark. And what do you know? What's the Roth IRA limit next year? Oh, it's $7,000, cool. There's my Roth IRA contribution that I didn't have before that I can just now pop into that account.

I got 360 leftover, but in doing so, in contributing to that pre-tax account, I just created more investable income for myself to go get that Roth diversity elsewhere. So this is my favorite approach for people that have access to both. And you may have noticed that I was like, oh, 300K, 32%.

People that are familiar with income limits for the Roth IRA might be like, ooh, but Katie, there's an income limit. Very simple workaround. You've probably talked about this on the show before. Back to a Roth IRA, it's a very simple maneuver. It doesn't take long and we can get into that, but there is an easy way to get some money in a Roth IRA if you want to, even if you're over the income limit and that loophole is still open.

So remains to be seen if it stays open. But that's my favorite way to approach this is to use that bigger bucket to get a good tax break and then take those tax savings and invest them somewhere else. I recently had a CFP come on my show and I went through my strategy with him and we basically debated it.

And then he ended up coming to me with a spreadsheet that he made that brings in social security, RMDs, inheritance taxes, all the other complex, nuanced considerations for someone that also takes into consideration age and how long they're gonna work, who they're gonna pass the money down to. And we ended up coming to the conclusion on the show that in most cases, with the exception of I think the 12% bracket and people who end up working and earning income until they're like well into their 70s, this approach, this traditional 401k Roth IRA or taxable account for the tax savings is going to create net more income later in life, even if you have very little tax planning later because it just generates a bigger portfolio to draw down from.

So that's kind of my favorite bread and butter strategy that I like to follow. - So I wanna clarify a few things. So you said, oh, if you're in the 32% tax bracket, you'll save 32% this year. That is true, but all of the money you put into your pre-tax traditional 401k, you're gonna pay taxes on all the contributions and all the gains in the future.

Some of the optimization is, well, if I'm not living in California, I'll be at a lower tax rate. Some of the optimization is, well, if I'm not making as much money, I'll be in a lower tax rate. We don't know what will happen with the tax code. So who knows?

But what is certain is that if I had taken that, let's call it $23,000 and I had paid taxes on it now, it would have been reduced to let's call it 16,000. So that 16,000 will only, even if I doubled my money, it would only go to 32,000. Whereas if I do it in the 401k, it stays as 23,000.

And if I doubled my money, it would go to 46,000. So because you have a higher base, you're earning on a higher amount. Those earnings will be greater over the lifetime of the account. And yes, you will have to pay taxes on all of it when you take it out.

But even if the tax rates were the same, because you have a higher base to grow, it still works out. - Right, and I think that that's a really good qualification to make because we can get into how to optimize later and how to pay very little, if any taxes, depending on your situation.

But I always assume when people are making this decision, they're like, "Should I do traditional or Roth 401k?" But you're right. Most people are not even going that far. They're going, "I'm gonna take all my income home and then I'm gonna figure out how to invest it and what to do with it." And to your point, if you're doing that, well, now you're paying all the taxes on the money and it's not gonna grow tax-free.

Usually, if you're gonna pay all the taxes on the money, you at least want it to end up in a Roth account where it's gonna compound tax-free for the rest of your life. But if you're just taking it all home and you're not taking advantage of that account, whether you choose traditional or Roth, depending on your situation and what's right for you, yeah, you're gonna be in a position where you may have more flexibility, you can access it sooner.

And in some cases, that's desirable if you're gonna use it for something. But most Americans are under-saving for retirement. They're not putting enough money into these retirement accounts and they're figuring out what to do with their savings once it's in their checking account. By that point, you've already sacrificed a lot of the potential gains that you could have gotten by simply using one of these employer accounts.

- Let's add a few things. One, there are some trade-offs, right? The liquidity is real. If you need to buy a home, I know there is an exemption to take some money out, penalty-free for a home, but it's a very small amount relative to the cost to buy a home in America right now.

- And not an ideal, really, approach to be using, I would say. - So the penalty on taking the money out is high enough that I don't think it's worth putting the money in if there's any chance you're gonna have to take it out early. You should always be not putting money into these retirement accounts if you happen to know that you need money to pay a tax bill, make an investment, buy a home, any of these things.

So I think it's really important to make sure you max out your emergency fund before you invest in your retirement accounts and all those things. With the exception, if your employer offers a match, I know you kind of brushed over it briefly, but at Google, I can't remember the match, it was something like 50% up to the full amount.

Whatever the amount was, I think I got $8,000 free. And so getting $8,000 free and truly at no cost to you other than contributing to your 401(k) would actually even be worth it if you had to pay the penalty next year to withdraw the money out of the account.

- Interesting, I know I'm now thinking through the back of the napkin math of like, well, the penalty is 10% plus the tax on the contribution, but to your point, unless there is some rule in the account that the match goes away, I don't think the match would go away.

I think it's locked. I think it's locked once you get it. So like, yes, in a following year, if you were to have to withdraw the money and it wasn't protected by any of the 401(k) loan requirements or the hardship that there's some withdrawals where if you're in a really hard up position, they'll let you withdraw money.

I would agree that depending on the amount that the match is gonna generate for you, then yeah, it might be a worthwhile trade-off. - Yeah, I mean, if the match is 5%, then it's not gonna outweigh the fee. But if your employer is matching 25, 50, or even 100%, I would make the case, maybe it's not worth it for the hassle if you don't even have one month of emergency savings.

But if you've got two, three months of emergency savings, my personal belief is max out your 401(k) to the match no matter what. Then consider whether you have any liquidity issues that you will need to resolve, whether that's resolved because you owe money to someone or resolve you wanna buy a home, then I would say you don't necessarily wanna put that.

And then everything else is fair game for tax-advantaged accounts. - I think it also, I would add too, a lot of people will not even think about the 401(k) until they're out of debt, even credit card debt, because they're like, "Well, the interest rate's so high." But to your point, if they're matching 5% of your salary, if you put in 5%, they'll put in 5%, that is a 100% interest rate on your money 'cause they're matching it.

So that should also probably be a top priority even if you're in a position where you're like, "Ooh, but I'm still in debt, so investing is not a super high priority for me right now." I would still put that 401(k) match. I think I kind of write it off because I hear people say, "I don't get a 401(k) match, so I'm not gonna use the 401(k)." And I'm like, "Oh, no, no, no, that's not even the primary reason you should be using the 401(k).

That's great if you have one." Especially if you're earning a lot of money, a 4% to 5% match on your salary could be significant. It could be another 10 or 20 grand a year, depending on how the matching is structured. So it's not that it's insignificant, it's just that if you don't have one, I don't think that that's a reason not to use it because to me, the primary benefit is the tax break up front that's gonna create more investable income for you, and then the years and years and years of tax-sheltered compounding, which we'll have to pay taxes on later in some way, shape, or form.

But that is a huge benefit, especially as your network starts to get bigger. A couple percentage points or dividend taxes on your taxable account may not feel like that big of a deal when it's worth $100,000, but when it's $2 million, well now with 3% dividend yield, you're starting to pay taxes.

It catches up to you, and I think just kind of being smart about tax planning is important for that reason. - Totally agree. So the last two things. One is fees. I have worked at some companies where the 401(k)s are pretty terrible. The investment options are actively managed mutual funds with high fees.

And then I've worked at a company like Google where it was like the lowest cost Vanguard Admiral Fund, tiny expense ratio funds, no cost to manage the 401(k) to the employees. So I found this data point, which was that if you assume a portfolio return of 6%, I believe that the underperformance where a 401(k) stops mattering and the tax benefit stops mattering is about 2.1%.

- In fees? - No, no, no. I'm saying like, if you're going to get 2.1% less performance, the tax advantage kind of goes away. So if you have funds where the only options are actively managed funds with really high expense ratios, I could make a case that it doesn't work with maybe an exception.

If you can roll it out into a Roth IRA or something later, great. But if you're at an employer with really high fee. - If you're like, you know you're not going to be there for a long time, but you're making a lot of money right now and you just really need the tax break.

Because I think what happens is those fees compound, right? So it's like one year of having the fees or having shitty investment options. You might be able to just keep it in cash and not invest it in anything if the investment options are truly terrible, but get your tax break.

And then if you know you're going to leave in a year or two, you just roll it out and put it in an IRA and self-manage it. I generally agree that the fees, you should be very wary of them. And there are absolutely terrible 401k providers. There are even more terrible 403b providers.

There is like a very well-known, maybe not as well-known as it should be, scam that has kind of been quietly perpetrated on public school teachers over the last few years where these annuity salespeople will go and sell teachers these very expensive annuities within their 403b's that are vastly underperforming and have crazy fees, like three to 5% per year.

It's just like unbelievable. The SEC is actually suing this company like $50 million for misleading investors. So those things are out there and it is 100% possible for the fees or the plan structure or the investment options to ultimately negate any benefit you would be getting. So I'm glad you brought that up.

The general position or orientation that people should take is assume it's probably gonna be okay, look into it to double check, but don't let the fear that there might be fees keep you from even going down that path in the first place or looking into it. And you can always email someone at HR or a plan administrator if you're not sure.

Usually it's in the paperwork, but sometimes the paperwork is a little bit confusing. - There's actually websites. I wanna say, if you search 401k fees, I don't know one off the top of my head, but there are websites where you like type in your employer and they've already like read the plan docs and will tell you, hey, your 401k sucks.

It has really high fees. - Man, I love that. - And most of the reason they do this is around what you can do with your money after you leave your employer. You can take your money from a 401k and one, you can roll it into your new employer's 401k.

So I remember I had a 401k and my wife had a 401k at old companies that actually were pretty terrible, but then we joined companies that had great 401ks and by great, I mean just low fee and we could roll those 401ks into our new 401ks. You can also roll it over into a rollover IRA and we'll get into some of the rollover stuff in a little bit, but know that yes, you're not stuck in this terrible 401k forever.

And if you have old 401ks just lying around, but you like your current 401k, then you can also roll those all in and put them all together and stop managing them separately. But not every company has this option. I know I did when I was at Google and I know it's being more popular.

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Head on over to allthehacks.com/daffy where you can get a free $25 to give to the charity of your choice. Again, that's allthehacks.com/daffy for a better way to give. I just wanna thank you quick for listening to and supporting the show. Your support is what keeps this show going. To get all of the URLs, codes, deals, and discounts from our partners, you can go to allthehacks.com/deals.

So please consider supporting those who support us. How do you think about the option if your company says traditional versus Roth 401(k)? Traditional 401(k) is my preference for the reasons that I highlighted. The additional piece in what I thought you were gonna say with Google is that after-tax option.

Oh yeah, so I wanna get to that also. But is there ever a case, let's say right now you're living in Florida and you have no state tax and you're not making that much, is there a case to pick the Roth 401(k) option? Here's who I would say Roth 401(k) is best for.

12% tax bracket or below. Because the jump from 12 to 22, that's a pretty big increase. 22 to 24, okay, we're talking two incremental percentage points. But 12% marginal tax bracket, if after your standard deduction and other deductions, you are in the 12% bracket and your 401(k) contributions will be taxed at 12% rather, Roth 401(k), it's gonna be hard to do better than that.

The other people who would be a good candidate for Roth 401(k) are those who expect to work for a very long time. If for some reason you're like, oh, I know I'm gonna have earned income into my 70s. Or like I have rental properties that are gonna create taxable income later.

Or I have a business that I'm gonna retain partial ownership of and I expect to be taking money out of that business even after I'm retired and no longer working there. If there's a lot of other sources of income that you expect to have in retirement after you stop quote unquote earning income, then the Roth 401(k) probably makes more sense.

Now, the reason that I always prefer traditional for myself and people who are like me, in that I mean, you are earning a really healthy income now, you have a high marginal tax rate now, you intend to retire probably in your 50s and you don't have a bunch of other sources of income that are gonna be coming in and jacking up your tax rate in retirement unnecessarily or unwantingly, we'll say.

I tend to think that traditional makes more sense, but there are 100% use cases for Roth 401(k). I would just say that the expectation that a lot of people have that, oh, well, this question is often positioned to people as, do you think you're gonna earn more now or earn more later?

Most people hear that and they go, huh, well, I'm making $100,000 a year now. Am I gonna earn more when I'm 55 or 58, you know, whatever? Yeah, like I'm a trajectory that's going up. My career is gonna keep getting better. I'm gonna keep earning more money, but you're not taxed on your traditional 401(k) withdrawals in retirement based on your last working salary.

You're taxed on the amount that you're taking as earned income in retirement, which for most people, just by nature of how these things work, even with social security, once you turn, I guess you can delay it after you're 62, but you could start taking it when you're 62. Even with social security, most people are not able to create more earned income for themselves in retirement than they are as employees that are earning salaries and focused on increasing their compensation.

It's weirdly hard to do for most individuals. Now, if you have a $15 million nest egg and you're like, my safe withdrawal rate is 500,000 or a million dollars a year. Okay, well now you might be making more in retirement, but maybe not, because how did you get that $15 million nest egg in the first place?

Well, you're probably making a lot of money. You're probably making more than 500 or a million dollars a year. So I think it's kind of that like, in order to be in a higher tax rate in retirement, to have enough money in retirement that you can be living so large that you're pushing yourself into a higher marginal tax bracket, you have to be making a lot of money now and investing a lot of money now.

So probably gonna be hard to out-earn. And it's not that that's impossible, it's just that we choose Roth 401k for certainty without often looking at like, okay, but what is the lifetime tax bill that I'm paying by taking this approach? Am I inadvertently paying more money than I would need to be on these contributions when I could be a little bit savvier about this decision and create more net investable income by using pre-tax and then investing the tax savings?

The other person that should not do this is the person who's not gonna invest the tax savings. If you just invest in your traditional 401k and then spend the tax savings, well, congratulations, you should have used Roth because you kind of defeated the purpose of the strategy. That's a great thing, you know, like do what you're actually gonna do.

If you know yourself and you're like, "Yeah, there is no fricking chance that I'm gonna actually end up investing that money," it can be a forced savings device. Just pay the taxes now and use Roth and like forget about the optimization and the math. But I guess I would assume that the people who listen to this show are probably not the people who would be like, "Yeah, no, I'm not gonna invest that money." I think your audience is probably pretty interested in optimizing their financial situation.

So of course there are scenarios, there are just fewer and farther between than most people would probably think. - The overarching theme is no matter what tax advantage to count you're choosing, it probably shouldn't affect how much you've spent in a given year, right? For me, I know there are people who think, "Oh, I spend whatever's left over." I'm typically the person that's like, "I'm not gonna change my spending based on how much I contribute to an account.

I'm just gonna spend independently of that thing." - The way that it works for most people is they maybe make the switch, right? They go from Roth 401k to traditional 401k. They're contributing the same amount of money to that 401k, but now their paychecks are higher because of the tax break.

So they're like, "Ah, cool, extra money. I'm gonna spend it." I tend to agree with you that I try to make my spending decisions independent of like what number is actually in my checking account. That is, I try to plan that type of thing ahead of time so that my investments don't wobble, we'll say, based on tax breaks that I may or may not be generating.

- Last little thing is, it's interesting, the contribution limit for a 401k, we talked about it next year being 23,000, but that's not quite true. The total contribution limit will be 68,000. And by the way, if you're over 50, both those numbers go up by $7,500 in 2024. But that $23,000 is the cap for the pre-tax employee contribution.

And so this is where I wanna get kind of ninja style and go a little deeper and commonly called the mega backdoor 401k, a really Roth contribution. I was fortunate that Google's 401k allowed it. - Yes, a lot of tech companies do this. Microsoft, Google, Facebook, Apple, Meta, I should say.

They all, for whatever reason, I think Dell too. I've worked at a couple that have done this and it seems to be a commonality between tech companies if they all are in the know about this. - The trick here is you can make more than 23,000 next year, whatever the limit is, in contributions, but they are non-deductible post-tax contributions into your pre-tax 401k.

And on the whole, that is a horrible thing to do. It doesn't make any sense to contribute post-tax money into a retirement account that you can't take money out of for many years and have to pay penalties, except when you are allowed to take those after-tax contributions to your 401k and roll them over to a Roth 401k.

And so that lets you take money beyond the next year, $7,000 you could get into a Roth IRA and put a lot more money into a Roth investment vehicle, which then, like we've kind of mentioned, you aren't gonna pay taxes when you make contributions to a Roth account, whether it's an IRA or a Roth 401k, you don't pay taxes on any of the gains or any of the money you take out.

So I loved that strategy when I had it available to me, but when I worked at Wealthfront, it wasn't an option. - You know what's interesting is I took screenshots of the language in my old Fidelity account with, I believe it was with Dell, the 401k. I think I might have screenshots from Facebook too, where I wanted to see how they were referring to this.

Here it is, with the mega backdoor Roth IRA, how it came up on the screen when I was like reviewing elections. The way that you determine this is there will be your contributions per pay period. So it'll say, okay, pre-tax, Roth, after-tax, and usually there will be like bonus elections and things like that.

But what you're looking for is that after-tax option, which is again, different than Roth, right? It's not a Roth contribution to that elective deferral, that 23,000, that after-tax option is referring to how much of your salary you want deferred into that difference between the $68,000 limit and the 23,000 elective deferral.

So it's about $45,000 total that you could put in, in 2024. And so you would choose your percentage, right? You could do up to 45K. And then there's often gonna be, in both plans that I had, this was the case. So I'm not gonna blanket statement say it's gonna be in everyone, but typically it's these in-plan conversions that you're looking for.

In the case of Fidelity, it was the daily Roth in-plan conversion. Do you want to convert your after-tax contributions to Roth? And you basically just have to select, yes, that is what I want you to do with these after-tax conversions. I want you, plan administrator, to every day, anything that's going in, check and then convert it to Roth right away.

So that you're really not even having to do anything beyond checking the button when you're making those contributions. But I think every plan kind of does it differently. It's just that keyword. When you're filling this out, it's not gonna say, do you wanna do a mega backdoor Roth IRA?

It's gonna go, do you wanna make after-tax contributions to this account? And that's kind of the buzzword. And then do in-plan Roth conversions. - Yeah, and then do in-plan conversions, which at Google, you had to do manually one-off. You couldn't automate it. - Oh, that's annoying. Tell me more about that.

Did you have to physically roll over the funds every year to get them into a Roth IRA? - I mean, it's been almost a decade, so. - They probably fixed it. They probably got a better plan now. (laughs) - But the only other thing that is really very, very important is that you can put in $68,000 next year into after-tax contributions.

Your 401(k) will let you do that before you put in your pre-tax. So it is important to make sure that you don't set up, put 100% in both, because sometimes your plan will put money in the wrong thing. This is especially true, at Google, one person had this problem.

First, at the beginning of the year, they said, let's max out my pre-tax. And then they switched and said pre-tax down to 0% and after-tax to 100. And then next year, they left it at that. And in their early, the next year, they've maxed out the entire, it was probably wasn't 68,000 back then, amount into after-tax, and they were no longer eligible to put anything in pre-tax, which also included the match.

And so I would just say, make sure you're maxing out your pre-tax, maxing out your match before you do the after-tax contributions. - Love that note. I think that's amazing. In the screenshot that I was just looking at, I think I had put like 17% in pre-tax and then another.

They were both weird percentages, but I had sat there and calculated like, what is 23,000 worth of my salary? And then what is the 45? Or I think at the time it would have been 42, to make sure that the percentages were like, taking the correct numbers simultaneously versus going, I'm gonna do all of this first and all of this second.

'Cause you're right, I think you can get into hot water with that. That's a really good example. You know, and that person's not gonna be sad if they have 60 something thousand dollars of Roth money later, but it is kind of a bummer 'cause it's like, oh, well man, now I'm not really getting my juicy tax break that I wanted.

I also think it's worth noting that like, we keep talking about not being able to access the money. And I feel just this little like footnote trying to climb out of me that's like, except for your Roth IRA cost basis, that your contributions to Roth IRAs, you technically could access.

- So I think we exhausted the non-self-employed, non-company owner retirement plans. Let's talk quickly about the IRAs. Downside being much lower limits, upside being available to anyone. Where do we go? - Okay, so to me, the IRA kind of flashing headline is that if you don't have an employer-sponsored retirement plan, you are a W-2 employee who only has W-2 income and you have no employer-sponsored retirement plan for whatever reason, and you still want a tax break, you can contribute to a traditional IRA, pretty confident regardless of your income and get that deduction.

It's a much smaller deduction, but if you're really hungry for a deduction, you can get it. Everyone else is probably gonna be better off with the Roth IRA. Both because at this point, if you do have the employer-sponsored plan, you cannot then also get a deduction in this traditional IRA unless your income is below, I wanna say it's in the 70,000 range next year, but like most people earning 70K are not gonna be able to max out all these accounts and still be able to support themselves with the remaining income that's left over.

So for most people, it's gonna be Roth IRA. Again, with that $7,000 limit. And there are income limits with the Roth IRA where I believe in 2024. - Yeah, I pulled it up. It's somewhere around the 150, 160,000 if you're filing single and 220, 240,000 filing jointly. - Great, and there's that phase out in there.

So that's where the ranges come in. - But if you're anywhere close to those, just backdoor, don't worry about it. - Exactly. And so the backdoor Roth IRA is a pretty simple maneuver just in case this is not something that a listener has heard of before or is not super clear on.

It's pretty simple. You basically just make a contribution to a traditional IRA, but you make it non-deductible. So it's been a while since I've done this. So I can't exactly remember if you clarify when you're making the contribution that it's non-deductible. I think it's on your taxes, right? Where it's like, oh, great.

Yeah, you're like filling out your taxes and it'll ask you, did you make deductible IRA contributions? You don't claim the deduction for that. You just put the funds in a traditional IRA, allow them to settle, convert them to Roth. There's gonna be a button that probably says convert to Roth in most major brokerage firms.

And then once it's in a Roth IRA, which you'll have to have a Roth IRA opened in order to be the receptacle of that conversion, then you'll invest it once it's in the Roth IRA. And yeah, for whatever reason, they have not closed this tax loophole. So it sounds like you just did this.

Any updates? - There's a form 8606 you have to file in your tax return that's for non-deductible IRAs. I would say they've gone even further than not closed it. I believe there was a letter somewhere like five, 10 years ago that the IRS put out that more or less endorsed that this is a legitimate thing.

They didn't go as far as say, which is silly, that if they're like, we think it's okay that anyone of any limit can do this thing, but we're not gonna just change the tax code to make it easy. - I know, it's so strange. Okay, good to know. I was gonna say, I think I just saw that 8606 is ringing a bell because I use Tax Act to file.

I just like their software. And I was helping a friend file on Tax Act who had to do this. And I remember Tax Act prompting her with form 8606 at some point because she had answered some question a certain way. So it was like, oh, you need this form.

So it's not like you even have to go hunting this down if you're using a CPA or a sophisticated tax software like Tax Act, it's probably going to serve you that form if you're answering questions accurately too. - By the way, we didn't mention this. Your 401k contributions are things you have to elect during the year.

They have to come out of your employer income. You can't do it on your own. The IRA, you can do on your own, not only during the year of the tax year, but up until your filing deadline. So I don't know what day this will come out. It's possible this has come out before November 15th or whatever the new tax deadline is for all but two counties in California for 2022.

So we're recording this in October. I made my 2022 IRA contributions for non-deductible, converted it to Roth for 2022 just a few weeks ago because California extended the filing deadline all the way until October and then again to November. So if you're listening to this, you could do it for this year.

You probably, by the time this comes out, won't be able to do it for last year. But even if you wait until March or April when you're filing your taxes, you can still do it for the year prior. I believe if you're filing taxes on your own, I seem to remember from a while ago that it's like 20% more complicated if you do it in the next year than it is if you just do it in the calendar year in terms of what form you have to file.

I don't know if that's true. I'm not a CPA, but I would say if you want to do it and you can do it in the calendar year, it's probably better. So back to a Roth IRA, amazing. Obvious benefits of Roth IRA, you don't get that tax deduction up front.

You don't lower your taxable income, but that money can grow tax-free forever and you can take it out as soon as you're 59 and a half, but you can take it out before, right? - Well, you can access your cost basis before. So that is kind of the big footnote on these tax-advantaged accounts is I believe, well, HSA and 529 put a pin in those, but I believe as far as the major players, the Roth IRA is the only one where you can access your cost basis.

So that means the contributions that you put in at any time for any reason. So if I invested 6K this year in a Roth IRA and the next year I was like, "Oop, I need to get some of that contribution back." I could go in and take it out.

I can't access the growth, right? Like I can't touch that, but I can go in and remove cost basis if I needed it. Now that's not recommended obviously, but it is a footnote worth knowing, particularly for people who may be starting this journey and a little bit on the fence or like mentally a little bit feeling funky about quote unquote locking up their money.

Sometimes the Roth IRA is like a good baby step 'cause it's like, well, it's not really locked up. Like you could technically get it back, but you're just not gonna be able to touch the growth. And obviously you're not gonna be wanting to be removing it from the account 'cause there's no like putting that back in.

You can't be like, "Oh, I took out 5,000 "of my $6,000 contribution. "I wanna go replace it." The ship has sailed. You cannot go and replace that contribution. So it's definitely not advisable, but it is possible. And that little weird oddity about the Roth IRA that you can access cost basis is partially what makes more complicated withdrawal strategies later in life possible.

So if you've heard of like the Roth IRA conversion ladder, that cost basis little hack is what really makes that possible. - It's funny 'cause I was Googling around trying to find someone explaining the Roth withdrawal cost basis contributions, et cetera. And it's funny, it's so obvious that no one's actually written an article about this, at least that I could find.

But it's as simple as if you have contributed $5,000 for four years and your account is now at $23,000, but you've put in 20, you can take the 20 out. You can leave the three in, let the three continue to grow and take that out tax-free in retirement, but you can take the 20 out.

And to me, I was like, "Well, how do you determine how much? "What if the account went down? "Which piece of the money do you take out?" And it's not that complicated. It's just, you do have to keep track of it. I've found that if you've moved your Roth IRA from multiple institutions over time, they don't necessarily always, at least I couldn't find the historical contributions.

So I would say, I don't know, create a Google sheet that logs all of your contributions so that you don't forget it and kind of go back in time, especially if you've done a lot of rollovers, it can be a little confusing. But all of that, I think is a great strategy.

We did forget to clarify one thing. When you do a backdoor Roth, when you go to convert your non-deductible traditional IRA contributions into your Roth IRA, there is this pro rata rule in the IRS that requires you to convert an equal or a proportionate share of your pre-tax traditional IRA and after-tax IRA contributions.

So the general strategy is never have pre-tax traditional IRA. And the way to avoid that is never contribute in the first place, which if you don't make enough money or you have an employer plan is probably already the case. Or even if you have traditional IRA contributions already, you can usually roll them into your pre-tax 401k, clear out all of your traditional IRA basis, everything, and then do the backdoor strategy.

So I would say, if you have traditional IRA contributions today, and I believe that includes rollover IRAs. - It does, unfortunately. And this is why I haven't done a backdoor Roth IRA in a while, 'cause I've been lazy and I have a big rollover IRA that I'm sitting on, but yes, so you're right.

This is an amazing call-out because it trips people up, but yes, you basically don't want any money in traditional IRAs if you're going to do this. So that could be a regular shmegular traditional IRA. It could be a SEP IRA, which we haven't even talked about yet. It could be a rollover IRA from an old 401k plan, but any IRA that has pre-tax dollars in it will foul up a backdoor Roth IRA.

And the workaround is, as you highlighted, very simple. It's either roll it into a 401k plan through your job, or if you're self-employed too, get a solo 401k and roll it into that. It's kind of funny and annoying that the type of account really makes that big of a difference, but this is definitely a dependency to be aware of, 'cause that pro rata rule is, it's a little complicated, but yeah, the TLDR is that you don't wanna be doing this if you have pre-tax funds, or maybe if you have like 50 bucks, the Roth conversion ladder and all the tactics there.

That's one thing that I've always known is a thing that people talk about, and I've never really been able to dial it in in my head. - Yeah, okay, so this is one of my favorite, and I'm gonna try to explain this as simply and as clearly as I can, because it is a little complicated.

So this is something really blew my mind and was like when I fell in love with tax strategies, because I was like, holy smokes, like by literally using the right bucket later in life and being a little creative with your account conversions and withdrawals and where you're physically taking money from, you can avoid taxes altogether.

I think with the exception maybe of like state income tax, but we'll, you know, we can come back to that. So, and like state capital gains tax. It relies on a few key priors that we'll establish first. The first prior that's important to know is that for the year 2024, you will pay 0% capital gains on capital gains tax rather, on long-term capital gains with a taxable income of filing single up to $47,025.

And if you're married, $94,050, which means if I have no other income, my husband has no other earned income, we're just, you know, fly in an early retirement, not making any money that if we had a taxable account that we wanted to withdraw $94,000 of gains from, the tax bill on that money would be zero, despite it coming out of a taxable account.

So that's prior number one. Prior number two is that the standard deduction is in 2024, it's gonna be like 14,600 for singles, call it 29,200-ish for married filing jointly. The standard deduction is basically if you're not itemizing your deductions, I believe like 90% of Americans take the standard. So this should be most people.

That is money, but the IRS basically says that's a freebie. We'll give you that one. So you can look at these two pieces of the tax code that tell you, okay, I'm gonna get between 14 and $29,000, quote unquote, as a freebie from the IRS on my earned income.

And I also have this amazing like 47 to $94,000, zero, you know, to single or married filing jointly, 0% capital gains tax bracket. So using those priors and then using what we know about how Roth IRAs work, which is that conversions that you make from pre-tax dollars to Roth dollars become the cost basis in that Roth IRA.

We can combine these three things and create a tax-free retirement income strategy. The caveats that I will mention quickly before I kind of break this down and walk through it is that if you are a married couple that intends to spend more than, let's say 9405 plus, fast math, 29 to, if you're a married couple that intends to spend more than around $123,000 per year in today's dollars, so that's like what, over 10,000 a month.

If your retirement spending goals in today's purchasing power is more than 10,000 a month, you're gonna end up with a tax bill. But if it's under that, you could be totally tax-free. The other thing that I would note is it does take some fancy footwork. You're gonna have to be a little strategic here, but in any case, basically what we would do if we wanted to do this Roth IRA conversion ladder and pay no taxes on it is we would take our 401(k) or 401(k)s, if there are two of us, two earners, and they're all in, you know, traditional, right?

If we've followed this broader strategy, this optimization, we'll take our traditional 401(k)s, we'll roll them over when we leave the workforce into traditional IRAs. They just basically become rollover IRAs that we now control. Now that they're in that rollover IRA status, we can do Roth conversions with them. So we're gonna look at our standard deduction, we're gonna say, all right, what is the amount that the IRS is gonna give us as a freebie this year as a married couple?

Well, it's 14,600 each or 29,200 together, so maybe we wanna use just one 401(k) or maybe we're combining all the funds into, I guess that wouldn't work, you'd have to have two separate rollover IRAs, but in any case, you're gonna convert a standard deduction size chunk to Roth in much the same way that we just talked about converting your non-deductible chunk to Roth for a back-to-a-Roth IRA.

Same principle, you're converting a chunk to Roth. Now, once it's been converted to Roth, it's gonna be sitting there in that Roth IRA. The hack or the trick here is that because of, I would call it like the five-year rule, I don't know the true IRS terminology for this, but there is a five-year rule that once you take pre-tax funds and you convert them to Roth, that whole amount, even if it was all gains in your 401(k), even if it represented capital gains or earnings in the 401(k), not contributions, it becomes the cost basis of that new Roth IRA, which means, what do we know about the cost basis?

You can access it. You don't have to be 59 1/2, you can touch it at any time. A 35-year-old could do this, but you have to wait five years. So you begin your Roth IRA conversion ladder in year one of retirement, early retirement, 'cause if you're already retired, if you're 59 1/2 or older, you don't need this because you can just access the money straight away.

You're above the age limit. But let's say you're 40. You start in year one, you convert your first standard deduction size chunk. You let it sit. You can use a Google Sheet to track this stuff too if you're like, I don't wanna lose track of my conversion. Year two, you do the same thing.

Year three, you do the same thing. This is why they call it a ladder because you're doing that standard deduction size chunk every single year, and you're basically getting a 0% tax rate on your Roth conversion of that money that you have never paid taxes on to begin with, and it's probably all gains from sitting there and compounding.

- This assumes that you don't have any other income, right? - Yes. So we'll talk about where your income is coming from at this point, 'cause obviously you have to live on something, right? So basically then, the moral of the story is by year six, the funds from year one are now "touchable." By year seven, your funds from year two are now touchable, so on and so forth.

You can access them. They are now Roth dollars that you can use. So in those first five years, though, too, like you need money to live on, right? So that's where your, I'll call it, original Roth IRA and/or primarily and preferably your taxable brokerage account that has that super high capital gains tax rate of zero comes in.

So I could theoretically, if I'm doing this this year, if I'm in early retirement, I have no other earned income, I don't have a job anymore, I'm not earning money from anything else, I could take my husband and I's standard deduction in 2024 of 29K, do that Roth conversion, let it sit, and then we could take 94K from our capital gains, you know, that 0% tax bracket, we could take that out of a taxable account and live on it tax-free.

And then starting in year six, you can combine them and get your full 0% cap gains bracket, your standard deduction-sized Roth chunk from the pre-tax conversion that you did five years prior, and then if you have Roth IRA, money that you wanna use, too. Obviously, Roth is like the playground where you can use as little or as much of it as you want, it doesn't impact your tax rate.

So lots of fancy footwork, obviously that's not gonna be the right move for everybody, and there are plenty of people listening to this that will probably continue to have royalty income or business income or income from real estate or other deals they're doing even when they're not earning money, but if you can structure your financial life such that you don't have earned income when you start doing this, you can basically not pay any taxes, at least federally, on the investment income.

One other important thing is that if you have that taxable account, yes, the capital gains have that treatment, but the dividends might not. So if they're qualified dividends, then again, they're treated kind of similarly to the way of capital gains, but if they are non-qualified dividends, they will count as earned income.

I just quickly looked at my brokerage account, my 1099 for last year. It looks like about 80% of the dividends I have in my Wealthfront account are qualified, and the dividend rate is somewhere, I don't know, let's say on average 2.8, 3%, let's call it 3%. So 3% times 0.8, 2.4, so about 0.6% of my account balance ends up being earned income.

So you will have some earned income from your brokerage account, but less than 1% likely. Obviously, I don't know if you're a dividend stock portfolio, it'll be very different. Right, yes, if you're trying to invest in dividend, but yeah, I agree. I think mine was something similar, just anecdotally.

So let me try to recap. You're in retirement, you have no income, and you've got a taxable brokerage account, which is fine. The only income it's spitting off are these non-qualified dividends, which is gonna be probably less than 1% of your balance. You take the amount of your standard deduction and minus whatever income you have, so maybe minus your non-qualified dividends, and then you take all of your traditional IRA assets, which are likely things you've rolled from your 401(k) over to your rollover IRA, and then you roll that amount over into a Roth every year, and then five years later, you can take that money out.

And then separately, you can use your stocks in that taxable brokerage account, you can sell up to the capital gains limit, and you can use that money to live on. That is correct. I will make a few little finer points to close this out, is that some people think about that taxable account like a bridge account.

So it's possible that if you are intending to start depleting it and eating into the principal, you could actually be withdrawing more than 94(k) and just be taking cost basis out, and then you're not paying capital gains taxes on it 'cause it's your principal, it's your contribution, so you wouldn't owe any additional tax money on that.

So that's one consideration. The other finer points on the accounts themselves is that by the time you're doing this, you may have a lot of different pre-tax accounts in your life that you have contributed to. You might have multiple 401(k)s, you might have multiple rollover IRAs, or traditional IRAs, or SEP IRAs, or SOLO, whatever.

Sometimes, because of how complex this process is, if you can simplify things on the front end, it can help. So if you wanted to get all of your pre-tax accounts and all your pre-tax funds that are in your name into one rollover IRA or one traditional IRA, just to have that one bucket.

Now, granted, you and your spouse, if you have one, will both have to do this 'cause you can't have a joint IRA, but sometimes that can be helpful, and then you'd end up having two Roth IRAs, I guess, per person, 'cause you'd probably have the Roth IRA that you were contributing to the entire time that you were working, and then you're gonna have this new Roth IRA, a separate account, that is gonna be the receptacle for these conversions.

And I only say you might wanna keep them separate just for bookkeeping purposes of knowing, okay, this Roth IRA I've been contributing to, it's all cost basis and growth. This one over here is basically all gonna be cost basis after the five years are up. And so keeping them separate can just make it a little bit easier on you to mentally know where that money is and what is "usable" and what's not.

So that's kind of like a extra little level of detail, but sometimes for me personally, it's helpful to imagine how these accounts, what the interplay is actually gonna look like. - Okay, and does the five-year rule apply to all conversions, including backdoor Roth conversions? - No, because the backdoor Roth conversions are post-tax conversions to Roth.

The five-year only applies if it's a pre-tax conversion to Roth. - We've covered a lot. I wanna briefly spend a few minutes on work small business plans. I know not everyone listening is a business owner, but there are a few things to hit on here. So why don't you quickly run through a few, and then I'll talk a little bit about this cash balance plan thing I've been exploring.

- Amazing, 'cause I'm really interested to hear more about this. So this is actually pretty simple. There are really two major players if you're, I will say, a solopreneur, or like a entrepreneur where your only employee is like your spouse. Things get more complicated once you have employees, so definitely consult your CPA if that's the case.

But if you're just like a side hustler with 1099 income, you are a solopreneur, right? So you can use these. So if you've got 1099 income, this is for you. The two major things to be aware of is your solo 401k, which is basically you need an EIN number to open one, like the business needs to be incorporated, but EIN numbers are pretty easy to apply for online.

Same rules in a lot of respect that an employer account would have that we've already talked about. So 2024, overall contribution limit, 68K. You have that $23,000 elective employee deferral that you could use. But as I would maybe say, the only kind of like complicated, nuanced thing to be aware of is that for whatever reason, the IRS looks at these different 401ks, your 401k from your job and maybe a solo 401k from a side hustler or a business that you're running.

And they're like, "Cool, as long as different sources "of income are funding those, you're good, have at it." Except for that elective employee, $23,000. That is by person, by social security number, not by source of income. So if you are already putting in 23K at your job into that 401k, you could still put 68,000 into that solo 401k on the side funded by your business, but your business has to have enough income in order to justify it.

And so for most sole proprietors, solopreneurs, it's the easy way to find that is that you can put in up to 20% of your net business income into that solo 401k up to 68K, but it all has to be employer contribution, you as the employer, right? You are your own employer in this case.

Employer contribution based on the net income of the business. SEP IRA, very similar, no elective deferral option, only employer contribution option. Again, if you're a sole proprietor, usually works out to around 20% of your net business income that you can defer up to $68,000 per year in 2024. And it's for all intents and purposes, like you can kind of think about it functioning on the tax side of things, pretty similarly to the way that like you would benefit from the 401k at work or like a deduction from a traditional IRA.

- I can't remember all the reasons why, but when I looked into it, I opened up the solo 401k. I didn't pay myself a high enough salary that I could do a lot last year, but this year I'm really gonna focus on optimizing it. But one cool thing is the same principles apply in terms of being able to make after-tax contributions, being able to do Roth and everything.

So I have, technically I have a solo 401k with three accounts. It's a pre-tax, a Roth and an after-tax. You can mega backdoor it, you can do all kinds of stuff. So that's super interesting. I set mine up with a company that was formerly called Ocho and is now called Carey, but there are other providers out there that let you do this.

But I don't think Vanguard has all the mega backdoor, fanciness. - I use Vanguard, I think for mine. I think they call it like an individual 401k. I don't think so either. I think it's more kind of standard or like traditional. - And then the only reason I know about this cash balance plan is actually 'cause Carey sent an email out saying they are working on this product and I went down a rabbit hole.

And so a cash balance plan, it's a type of defined benefit plan, meaning there are kind of two kinds. There's defined contribution and defined benefit. In a defined benefit plan, it's a form of pension. The company says this is the benefit you're going to get. So the company is actually on the hook for any of the investment risk down the road.

But the plan effectively is like a simpler pension for small business owners. And the goal of the plan is to get to this maximum balance at retirement, which right now is around $3.5 million. And based on your age and some actuarial assumptions, there is an amount you can try to get to, an amount you can contribute.

And if you are a business owner making mid to six figures, it is possible to get a pre-tax deduction all the way up to 100, 200, maybe even $300,000, depending on how old you are. So obviously this is the next step. It sits on top of it, right? You can do your solo 401(k), you can max everything out there, and then you can do your cash balance plan.

The cost, it does have an administration cost in the kind of low single digit, thousands of dollars a year to set up. It is even more lucrative the closer you are to retirement because the goal is to hit this huge number at retirement. But if you are making a lot of money and you want to put that in a pre-tax vehicle, you wanna reduce your taxable income, it is definitely something to look at.

There are a lot of companies that seem complicated that offer it, Cary or Ocho, which I'm gonna see if I can set up actually a referral code for people that might offer some discount. So look at the show notes. I'll set it up at allthehacks.com/cary, C-A-R-R-Y, and I will get something set up before this episode comes out because I happen to have met the founder.

I am optimistic he will be willing to set something up for us. So that's one. Yeah, Anker is amazing. Some of the content they produce is incredible. They do a lot of content for business owners. The other really cool thing is it's an incredibly low fee with access to all the basic Vanguard ETFs in it, 401(k), and you can roll your past 401(k)s into your solo 401(k).

So right now, my wife and I are both in the process of taking our old Census Fidelity Vanguard 401(k)s and rolling them all into our solo 401(k) so we can manage them all in one convenient place that happens to be low fee and easy to take care of. So when we're done, we will have one account for all of our retirement vehicles, except Roth IRAs.

One account each. Beautiful. I should have known that you would have this on lock. Well, I went pretty deep 'cause I was like, now that I have a business, I need to figure this out. If you had asked me two years ago, I would have been like, "Is that by IRA?" I don't even know if I knew what a solo 401(k) did or was.

But one thing we didn't talk about, which I'll touch on because it's part of this whole strategy, now that you have all this money in your tax-advantaged accounts, how do you think about your investment strategy? So I think it's important to consider, let's say, hypothetically, you had $100,000 in a taxable account and $100,000 in a tax-advantaged account, be it a 401(k), a Roth IRA, whatever it is, there's this concept of what's called tax-aware allocation, which is how you think about what to put in each.

So for example, if you wanted an investment strategy, and I'm not gonna pretend here, nor think are you, to tell people how they should invest their money, but if you wanted to have part of your strategy be allocated toward real estate in the form of REITs, ETFs that invest in real estate, the income that gets distributed from a REIT is taxable as ordinary income.

And so that tax feature, you could maybe call it negative. A bug. A bug is definitely something that makes it almost not worth including in a taxable account. In fact, at Wealthfront, when we built portfolios and we ran them through and wrote all the white papers, we found that adding real estate to a taxable account wasn't worth it.

Adding real estate to a tax-advantaged account was. And so I think it's worth thinking about how you want to use the funds in different Roth pre-tax or taxable accounts in tandem. It's a bit more of a... It's like asset location. It's like, how do I optimize that I'm not basically holding all of my bonds that are throwing off a bunch of interest and all my dividend-yielding stocks in my account that is the least tax-sheltered?

Like if it's all the same to me, I'm not as well-versed in asset location, but I think typically people will recommend high growth and large cap, high growth stocks and ETFs, just like standard S&P 500 or like Russell 1000 in the taxable accounts because those stocks are very rarely going to be paying high dividends.

And I think usually people will say, hold bonds and hold things that are yielding interest and dividend stocks and things like that in the tax-advantaged accounts so you're not getting dinged every year. - A link to a Bogleheads Wiki page that's called "Tax-Efficient Fund Placement" that goes into all of this.

It has a little chart about halfway down where it's like the most inefficient are real estate, REIT funds, high turnover active funds, which by the way, I don't recommend anyone invest in, and high-yield corporate bonds. So that's something to think about. It does make your entire process much more complicated.

So for me at Wealthfront, if I want my portfolios to kind of all work in tandem, it kind of breaks if you say, well, my investment account is all real estate and my personal account doesn't include it because they're, to my knowledge, is not a automated solution to rebalance across all accounts.

So it might not be worth it to do this, but it is just something to consider. The other one is when it comes to Roth IRAs, people may have seen articles about how people like Peter Thiel have these massive Roth IRA accounts. And part of the reason is there is an ability with Roth IRAs and even some 401Ks.

In fact, Cary actually has this feature to self-direct your investment accounts. And so you can elect to use a custodian or create an LLC, and I'll get to that piece later, and invest in whatever you want. You could invest in startups, in venture capital, in various things and put the assets that you think have the highest return potential in your Roth IRA, where you are going to pay no taxes on all of those gains.

There are a few requirements. You can't invest in companies that you have control of. So you couldn't start a company and invest in your own company, invest in a company you're on the board of. I would say, when you get to this level of detail, do more homework than we're gonna cover today.

But there is a very important caveat, which is this is a strategy for people who already have retirement covered. Because the last thing you wanna do is say, well, all my retirement is in my Roth IRA, and I'm gonna go put that in something with the highest return potential.

I'm gonna invest in 10 startups and have your retirement go to zero. So if you already have things covered, and you are investing for the future, and you're disciplined enough that your non-retirement assets are going to be where they need to be, and they're not gonna be touched, you can elect to have a self-directed IRA or 401(k) and invest in some of the more high return, high risk assets to kind of reduce the future tax liability on those assets.

Yes, and if you wanna go one step further, I was reading about how this feature works. It's not just having self-directed, but having what's called a checkbook IRA. So your self-directed IRA gives you all these options, but you usually have to have a custodian manage it. So if you wanted to invest in a fund, you say, hey, custodian, can you write this check?

And a lot of times you're making these investments, things are moving quickly. So you can actually create a self-directed IRA LLC, also kind of a checkbook control IRA, which is a special type of self-directed IRA that uses an LLC to give you full checkbook control on your own. So you control the checkbook, you're able to make those contributions or investments on your own.

Buying real estate funds, buying real estate, even you can buy lots of things on your own. I noticed Kerry has that feature. There's another company that I think is mysolo401k.net or something. It's basically like, looks like a site from 20 years ago, but is able to do this as well.

But after looking at a lot of things, I went with Kerry personally. I have no vested interest. In fact, I tried to invest in the company, but it didn't work out because they'd already closed the round, but I was very excited about the company. And so that's what I use, but they have this feature.

So if I were to make an angel investment, if I were to make a higher risk investment, I could do all that through my Kerry account. So that's something to know. Okay, so that was employer plans. We covered rollovers, we covered pretty much all the kind of standard retirement investment plans.

Let's quickly run through a couple of things we said we would. I actually think let's punt on HSAs because I did a whole episode on open enrollment, covered HSAs, we don't need to go there. Although just to be clear, they are my favorite tax advantage to count. Pre-tax in, no taxes on gains, no taxes on withdrawals, max that out, don't spend it, great.

529s, now that we have children, it's something I've been thinking about. I will say there are a few quick things. One, the hesitation I have is I don't know the future of education. So for me, I don't know what education looks like. On one hand, you know, now and 20 years ago, it looked the same.

And on the other hand, it'll probably look the same, but I'm nervous. You can use it for room and board, apprenticeships, professional education, secondary education, lots of things, even private school for primary education. You can change the beneficiaries, but the tax benefit is not quite as good for most states.

There are some states where you get a state tax deduction, but in California, for example, the only benefit is that you don't pay taxes on the gains as long as they're used for those educational expenses. - And there's no federal tax break for contributing to a 529. So if you're interested in federal tax breaks, the 529 will not give you that.

- I think putting in enough money to cover what you're pretty confident will be expenses, great if you are starting to do private school for your kids and you know you're gonna have that cost for 10 years, there's probably a way you can optimize it. But at the end of the day, it's not nearly as lucrative as other accounts in terms of the tax breaks you get.

But if you're confident you're gonna spend this for education, you could put the money in now and not have to pay taxes on the gains, assuming you're using it for those purposes. And I have to believe, maybe not, but if something drastically changes with the educational system, I think it's possible that they would make some changes to the rules, but who knows.

- That's a good point. I agree with and co-sign everything you just said. They're not my favorite for the reasons you just stated, but if you are pretty confident about your expenses, I think that they make sense if you're in a state where you're gonna see some sort of benefit for that.

I hope the educational bubble bursts before my unborn children are in college. And that's how I will finish that section. - And then the last other one I'm gonna cover is donor advised funds. I don't know how much you've gone into them. For me, they are not a way to grow your wealth, but they are a way to tax advantagely contribute to charity.

We've talked about them in the past. I'll link to a few episodes where we cover them. At the highest level, you are able to make contributions to charity by contributing to a fund that is itself a charity. And then you get access to those funds. You can invest those funds in whatever investments the provider offers.

You don't pay tax on any of that 'cause you've already given it away, but you don't have to make all the contributions now. So really great if you're in a high tax year because you can make 10 years of contributions to charity in that year. And then later in lower tax years where you're not getting as much value, you're not making any taxable contributions.

And so that's something that is a tax advantage to count, but it is a little bit different in that you're giving the money away, right? Nothing's coming back, but it does give you a lot of efficiency in terms of reducing your taxable income and growing that money tax-free for the purpose of giving.

So if you're charitably inclined, it's a great option. And the absolute best way to fund it is with appreciated securities because when you donate those appreciated securities, you're not paying the capital gains tax. So if you had some stock at a company you worked at or something you've held for many years where let's say you bought it for $1,000 and now it's worth $2,000, if you were to sell that, you'd pay taxes on that $1,000 of gain.

If you donate it, you don't, but you get the full write-off for the $2,000 amount. And fun hack, there is no wash sale rule that applies here. So you could donate $2,000 of Apple stock and immediately rebuy $2,000 of Apple stock. You increase your cost basis, you don't pay capital gains tax, and you get $2,000 contributed to charity that you can kind of give over your life.

And the other really efficient thing is that if you're the kind of person that might make five, 10, 15 charitable contributions a year, you are not going to have to keep track of all those receipts because you make one contribution to your donor-advised fund, it's so much easier to keep track of at the end of the year.

So people who've listened for a long time know that Daffy is a donor-advised fund that is a partner of the show. They're a sponsor of the show. They're where I keep all of our charitable giving. It's where we've made all of our donor-advised fund contributions. It's an amazing product.

They are paying me as a sponsor, but they are not paying me to say this. They don't know that we're even doing this episode. And so I had the Daffy account opened up before they even became a partner. I'm a big fan of Daffy. And if you are charitably inclined, definitely check it out.

You can even get $25 towards a charity of your choice at allthehacks.com/daffy. I think that's a lot. I mean, we went 90 minutes into tax-advantaged accounts. - I mean, that was a lot. That was definitely a crash course. And I think that if there were things specific to what I talked about, that you're like, "Oh, wait, I wanna go deeper there." I'm almost positive we would have a podcast episode about it.

And if we don't, Chris almost certainly does. So I'm glad that we did the crash course, though, 'cause it's a nice little, let's address all the big points for someone so that they know where to go next and what to focus their effort on now. - Thank you for hanging in with me.

Thank you for joining me. For people that wanna go deeper, because you've talked about all this stuff, where should we send them? - If you like podcasts, "The Money With Katie Show," wherever you listen to your podcasts. And if you prefer to read, you like blog posts or you like written content, moneywithkatie.com will have you covered there.

- And I assume it's a podcast audience, since you had to have been listening to the podcast to get here. Katie, this has been awesome. Thank you for going over an hour on a nerdy topic. There are only a few people in the world that I think would enjoy a conversation like this as much as you.

I am so glad we are friends and can have conversations like this. - Likewise. Well, it was truly my pleasure. I could feel myself getting excited. I'm all energized now after talking about this. So I'm excited to have you on my show as well, so we can talk about all the hacks for high earners and people that are looking for that next level of optimization.

- I really hope you enjoyed this episode. Thank you so much for listening. If you haven't already left a rating and a review for the show in Apple Podcasts or Spotify, I would really appreciate it. And if you have any feedback on the show, questions for me, or just want to say hi, I'm chris@allthehacks.com or @hutchins on Twitter.

That's it for this week. I'll see you next week. (upbeat music) (bubbles popping) (bubbles popping) (bubbles popping)