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Bogleheads® University 101 2023 - Intro to Roth IRA, 401(k), & Other Retirement Accounts Mike Piper


Whisper Transcript | Transcript Only Page

00:00:00.000 | [ Applause ]
00:00:06.780 | Mike is ever so helpful, always.
00:00:09.280 | And Mike has a wonderful blog called The Oblivious Investor.
00:00:13.280 | He's also the author of numerous helpful short books
00:00:17.480 | on single topics like social security and tax planning.
00:00:21.560 | His latest book is called More Than Enough,
00:00:23.820 | which I think is highly relevant to a lot of people
00:00:27.020 | at this conference, which is considerations
00:00:29.640 | if when you look at your finances you actually see
00:00:32.880 | that you have more than enough to do the things that you want
00:00:36.520 | to do within your own lifetime, thinking about things
00:00:40.200 | that you might want your money to do
00:00:41.720 | for you, for others in your life.
00:00:45.240 | He is going to be doing a session on Sunday morning
00:00:49.240 | that I wanted to call attention to that's kind
00:00:51.920 | of a reluctant spouses conversation.
00:00:55.960 | And the idea is that we've spoken to attendees
00:00:59.560 | in the past who have said, "You know, I am the enthusiast
00:01:03.080 | in my family, my spouse is not into this stuff at all.
00:01:06.680 | What's the bare minimum that he or she needs to know?
00:01:10.120 | How can I get him or her a little more enthused
00:01:13.840 | about this stuff?"
00:01:15.120 | So that will be the topic
00:01:16.880 | for Mike's discussion on Sunday morning.
00:01:19.920 | The thing we're doing that's a little bit different
00:01:21.800 | about that session is that your partner needn't be enrolled
00:01:25.800 | in the conference, so they needn't be registered,
00:01:28.680 | they can come and join us for breakfast and hear Mike's tips
00:01:32.840 | for getting the reluctant spouse along for the ride.
00:01:37.560 | So I am so thrilled to introduce Mike, he's going to be talking
00:01:41.560 | to us about tax-advantaged accounts.
00:01:44.400 | Thanks, Mike.
00:01:46.200 | [ Applause ]
00:02:02.480 | >> All right, so Alan and Rick both spoke with you about how
00:02:06.520 | to select different investments.
00:02:08.360 | And so now what we're talking about are the different types
00:02:10.160 | of accounts in which you might own those investments.
00:02:13.320 | And we're going to be spending most
00:02:14.480 | of the time discussing tax-advantaged accounts.
00:02:18.000 | But before we can actually talk about tax-advantaged accounts,
00:02:20.840 | we have to spend just a couple of minutes talking
00:02:23.240 | about regular taxable brokerage accounts so that then,
00:02:26.520 | once you understand how those work, we can talk
00:02:28.520 | about how tax-advantaged accounts work differently.
00:02:31.480 | Ah, okay, gotcha, thank you.
00:02:39.280 | All right, so a taxable brokerage account,
00:02:42.000 | this is anything that's not an IRA, not a 401(k),
00:02:44.800 | it's not a 403(b), it's basically just if you went
00:02:48.800 | on the Vanguard or Fidelity or Schwab website, you opened
00:02:51.760 | up a new brokerage account,
00:02:53.240 | it would be a taxable brokerage account.
00:02:54.720 | That's what we're talking about here.
00:02:56.920 | And in these types of accounts, the interest that you earn every
00:03:00.000 | year is taxable at your ordinary income tax rate.
00:03:03.280 | And the dividends that you earn are taxable as well.
00:03:05.960 | The tax rate's a little bit lower, basically it only goes
00:03:08.680 | up to 20%, but they're still taxable.
00:03:11.680 | And then whenever you sell something in a taxable account
00:03:14.680 | for more than what you paid for it, we call that a capital gain.
00:03:18.400 | And capital gains are also taxable, and the tax rate depends
00:03:22.040 | on how long you owned that investment for selling it.
00:03:24.960 | So if you owned it for one year or less,
00:03:27.960 | we call it a short-term capital gain.
00:03:30.120 | And those are taxable at your ordinary income tax rate,
00:03:33.400 | whereas long-term capital gains,
00:03:34.840 | which is when you've owned the investment for longer
00:03:36.440 | than one year, those are taxable
00:03:38.200 | at the same rates as qualified dividends.
00:03:40.040 | So the summary of this whole slide is really just
00:03:43.760 | that we call these taxable accounts, because the returns
00:03:47.240 | that you earn in a taxable account are taxable.
00:03:51.620 | That's the idea.
00:03:52.920 | That's the thing you need to know about a taxable account.
00:03:55.120 | And then in contrast, we have all of our tax-advantaged accounts.
00:03:58.540 | And tax-advantaged accounts includes IRAs, 401Ks, 403Bs,
00:04:02.800 | 457s, HSAs, and 529s, and probably some other stuff too.
00:04:07.040 | And in these types of accounts, you don't have to pay tax
00:04:11.760 | on the interest that you earn every year.
00:04:13.800 | And you don't have to pay tax on the dividends
00:04:15.480 | that you earn every year.
00:04:17.080 | And you don't have to pay tax
00:04:18.440 | on the capital gains whenever you sell stuff in one
00:04:20.520 | of these types of accounts.
00:04:22.360 | And so the most important thing to know
00:04:26.040 | about tax-advantaged accounts is
00:04:28.320 | that they literally grow more quickly than a taxable account.
00:04:32.640 | If you have the exact same investment in a taxable account
00:04:35.440 | and in an IRA, you're going to earn a greater return
00:04:38.840 | with that investment in the IRA
00:04:40.640 | because you don't have taxes taking a bite
00:04:42.880 | out of your return.
00:04:44.680 | And there are also tax consequences,
00:04:49.000 | either for putting money
00:04:50.300 | into tax-advantaged accounts or taking money out.
00:04:53.080 | And what those consequences are depends
00:04:54.640 | on what type of account it is.
00:04:56.120 | And we're going to dig into all of that.
00:04:58.080 | But again, the single most important thing
00:05:00.160 | about tax-advantaged accounts is simply
00:05:01.840 | that you get the whole rate of return every year.
00:05:04.200 | They grow faster than taxable accounts.
00:05:06.080 | And that's a big deal.
00:05:08.720 | So the first type of tax-advantaged account
00:05:10.800 | to discuss is the traditional IRA.
00:05:12.840 | An IRA stands for Individual Retirement Account.
00:05:16.360 | And with IRAs, there's a limit
00:05:18.920 | to how much you can put in every year.
00:05:20.800 | So the limit is the lesser of your earned income for the year
00:05:24.040 | or a fixed dollar amount for this year at 6,500 or 7,500
00:05:28.080 | for anybody age 50 and up.
00:05:31.120 | And with a traditional IRA, the money that you put
00:05:34.080 | into the account, the contribution you make,
00:05:36.120 | you get a deduction for that contribution
00:05:38.840 | if you don't have a workplace retirement plan.
00:05:41.920 | So that's if you don't have a 401(k) or a 403(b), which again,
00:05:45.080 | we'll talk about those in a minute.
00:05:46.360 | But if you don't have anything like that,
00:05:48.120 | then you get a deduction for contributing
00:05:49.520 | to a traditional IRA.
00:05:51.800 | If you do have a plan like that, then there are income limits.
00:05:55.840 | And what that means is that if you have a 401(k)
00:05:58.840 | or something similar, and your income is above this limit,
00:06:02.400 | then you're still allowed to contribute to a traditional IRA,
00:06:05.800 | but you won't get a deduction for doing that.
00:06:09.280 | And with a traditional IRA, just like every type
00:06:11.840 | of tax-advantaged account we're going to talk about --
00:06:13.920 | all right, with a traditional IRA, there is no tax
00:06:17.160 | on the growth while the money stays in the account.
00:06:19.240 | So again, they grow faster than a taxable account
00:06:21.320 | because they're not paying tax on the interest
00:06:22.720 | and dividends every year.
00:06:24.600 | And then when you take money out of a traditional IRA --
00:06:27.960 | so when you take money out of a tax-advantaged account,
00:06:29.880 | we call that a distribution, and distributions
00:06:32.320 | from traditional IRAs are taxable as income, generally.
00:06:35.960 | And so we call these tax-deferred accounts
00:06:38.600 | because the idea is that you get some tax savings
00:06:40.480 | at the beginning because you get a deduction,
00:06:42.680 | and then you get some tax savings along the way
00:06:44.560 | because the growth is tax-free.
00:06:46.360 | But then there's additional taxes at the end
00:06:48.280 | because it's all taxable when it comes out.
00:06:50.040 | So you've deferred taxes.
00:06:51.280 | You get savings at the beginning,
00:06:52.760 | but additional taxes at the end.
00:06:53.920 | So it's a tax-deferred account.
00:06:56.960 | And one last thing to know about traditional IRAs is
00:06:59.680 | that there's a 10% penalty for any money you take
00:07:02.080 | out before age 59 and a half.
00:07:03.600 | And the idea here is that Congress made these
00:07:05.480 | to be individual retirement accounts.
00:07:07.880 | So they put that rule in place to discourage people
00:07:09.600 | from spending the money early, basically.
00:07:12.160 | And then we have the Roth IRA.
00:07:14.360 | In Roth accounts, Roth IRAs share a contribution limit
00:07:17.160 | with traditional IRAs.
00:07:18.320 | So 6,500 for this year, or 7,500 for anybody age 50 and up.
00:07:22.360 | And it is a shared limit.
00:07:23.640 | So for instance, if you put 2,000 into a traditional IRA,
00:07:26.920 | the most you could put into a Roth would be 4,500
00:07:29.080 | if you're under age 50.
00:07:30.680 | And the ability to contribute to a Roth IRA phases
00:07:34.480 | out based on your modified adjusted gross income.
00:07:37.680 | Really all that means is that if your income is too high,
00:07:40.200 | you can't contribute to a Roth IRA directly.
00:07:42.760 | There is something called the backdoor Roth IRA strategy.
00:07:46.320 | Admittedly, we don't actually have enough time to go
00:07:48.240 | into the details of that today.
00:07:49.800 | But if your income is above those limits, that's something
00:07:52.200 | that you'll want to look up.
00:07:53.520 | It's not quite as good as a regular Roth IRA contribution,
00:07:55.760 | but it's still, it's pretty close.
00:07:58.840 | And with Roth accounts,
00:08:00.280 | you do not get a deduction for contributing.
00:08:02.760 | So there's no tax savings immediately.
00:08:05.280 | But the account does grow tax-free.
00:08:07.960 | And the contributions to a Roth IRA, so the money
00:08:10.360 | that you put in, you're allowed to take it back out tax-free
00:08:13.440 | and penalty-free at any time.
00:08:15.000 | You don't have to be age 59 and a half.
00:08:17.040 | Christine mentioned this earlier.
00:08:18.200 | This is a big deal.
00:08:19.440 | It means that Roth IRAs can kind of serve
00:08:21.200 | as a backup emergency fund.
00:08:23.000 | And this is a big advantage of Roth IRAs relative to all
00:08:26.480 | of the other types of retirement accounts.
00:08:28.840 | And then the distributions of earnings,
00:08:32.120 | so that's all the growth in the account, that's also tax-free
00:08:35.360 | if you've had a Roth IRA for five years and you're
00:08:37.920 | at least age 59 and a half.
00:08:39.960 | If you don't meet those requirements, then the growth
00:08:42.400 | when you take it out could be subject to a 10% penalty
00:08:45.000 | and it could be taxable, although there are some exceptions.
00:08:47.800 | The traditional 401(k) and 403(b), and these types
00:08:51.200 | of accounts, are tax-deferred.
00:08:53.320 | So they're a lot like a traditional IRA,
00:08:55.600 | just through your employer, in the sense
00:08:57.360 | that you get a deduction when you contribute,
00:08:59.160 | so you get some tax savings immediately.
00:09:01.040 | And then it grows tax-free, so you don't have to pay tax
00:09:03.120 | on the interest and dividends every year.
00:09:05.160 | And then it's taxable when you take it out.
00:09:07.120 | So again, tax-deferred because you get some tax savings
00:09:09.280 | at the beginning, but additional taxes at the end.
00:09:12.800 | And the contribution limit for 401(k)
00:09:14.320 | and 403(b) plans is a lot higher than for IRAs.
00:09:16.520 | It's $22,500 this year, or $30,000 for anybody age 50 and up.
00:09:21.240 | And some employers offer a matching contribution.
00:09:23.680 | And what that means is simply that if you put
00:09:25.120 | in at least a certain percentage of your pay into the account,
00:09:28.880 | then your employer is also going to put in a certain percentage.
00:09:31.680 | So for example, if your employer had a 4% dollar
00:09:34.000 | for dollar match, that would mean that if you put in 4%
00:09:36.960 | of your pay, or rather, at least 4% of your pay,
00:09:40.680 | you put in at least 4%, your employer will also put
00:09:42.920 | in another 4%, which means
00:09:44.520 | that you've basically doubled your money.
00:09:46.040 | So it's 100% return without any risk,
00:09:48.520 | which is obviously a better deal than you get anywhere else.
00:09:51.440 | And really, the big difference between 401(k)
00:09:53.320 | and 403(b) plans is not the tax treatment
00:09:55.840 | or any of the complicated rules.
00:09:57.000 | It's really just who offers them.
00:09:58.360 | 401(k)s are offered by businesses to their employees,
00:10:01.480 | while 403(b)s are offered by educational institutions,
00:10:04.080 | so universities and things like that,
00:10:05.520 | as well as nonprofit organizations.
00:10:07.840 | And then we have the Roth 401(k) and Roth 403(b),
00:10:10.640 | which is exactly what it sounds like.
00:10:11.840 | It's a hybrid between a Roth IRA and a traditional 401(k).
00:10:15.520 | So because these are 401(k) and 403(b) accounts,
00:10:18.400 | they share the same contribution limit.
00:10:19.920 | So it's $22,500 for this year, or $30,000 for people 50 and up.
00:10:24.760 | And with any Roth account, you don't get a deduction
00:10:27.640 | for contributing to the account.
00:10:28.760 | So there's no savings immediately.
00:10:30.880 | But just like every tax-advantaged account,
00:10:33.200 | these grow tax-free, so you don't have to pay tax
00:10:35.080 | on the interest and dividends every year.
00:10:37.960 | And then the distributions from a Roth 401(k)
00:10:40.320 | or Roth 403(b) are tax-free if you're at least age 59
00:10:44.760 | and a half, and your first Roth contribution
00:10:46.720 | to this particular plan was at least five years ago.
00:10:51.000 | And lastly, for retirement accounts,
00:10:52.760 | we have the 457 plan, which is less likely that you're going
00:10:57.040 | to run into this during your career, because they're offered
00:10:59.160 | by a lot fewer employers, but they work differently
00:11:02.480 | than 401(k) and 403(b)s.
00:11:04.000 | So if you do run into this, it's important
00:11:05.640 | to understand the distinctions.
00:11:07.520 | So first thing that's the same with 401(k) and 403(b)s is
00:11:11.240 | that the dollar amount contribution limit is --
00:11:13.840 | it's the same for any given year, so $22,500 for this year.
00:11:17.360 | However, it's not a shared limit.
00:11:20.560 | So what that means is that if your employer offers a 401(k)
00:11:24.240 | and a 457, if you had enough income and enough cash flow,
00:11:28.720 | you could put $22,500 into the 401(k)
00:11:31.800 | and another $22,500 into the 457.
00:11:35.440 | So if your employer offers both, and you've got enough cash flow
00:11:38.400 | to do this, you can contribute quite a lot of money.
00:11:42.800 | And 457 plans might allow
00:11:46.120 | for something called special catch-up contributions.
00:11:48.640 | This is a weird one, because the tax code doesn't say they have
00:11:52.160 | to offer it, and it has to work like this.
00:11:54.080 | So there's a little bit of leeway, basically,
00:11:56.040 | to the company offering the plan.
00:11:57.680 | So if you have a 457 plan at work, you basically just want
00:12:01.360 | to talk to your HR department and ask
00:12:02.920 | about special catch-up contributions.
00:12:04.840 | And then 457 plans can be tax-deferred,
00:12:08.360 | or they can be Roth.
00:12:09.560 | And if they're tax-deferred,
00:12:10.840 | they work pretty much how you would expect
00:12:12.680 | for a tax-deferred account, and that you get a deduction
00:12:15.280 | for contributing, the account grows tax-free,
00:12:17.840 | just like every tax-advantaged account,
00:12:20.200 | and distributions are taxable.
00:12:22.160 | And if it's Roth, again, more or less what you would expect,
00:12:24.960 | because you don't get a deduction for contributing,
00:12:27.280 | but it does grow tax-free,
00:12:29.120 | and the distributions are tax-free also,
00:12:31.520 | including all of the growth, if you're at least age 59 and a half
00:12:34.200 | and you've met the five-year rule.
00:12:35.960 | Now, one thing that surprises people about 457 plans is
00:12:40.080 | that there's no 10% penalty, whether we're talking
00:12:42.120 | about the tax-deferred or the Roth.
00:12:44.280 | There just isn't one.
00:12:45.120 | So that's a nice feature of 457 plans.
00:12:47.960 | And then the last thing to know about 457 plans is
00:12:52.080 | that we break them down further into two subcategories.
00:12:56.200 | The first is the governmental 457 plan,
00:12:58.720 | and then we have the non-governmental 457 plan,
00:13:01.000 | and that's basically based on who your employer is.
00:13:03.560 | If it's a government entity that employs you,
00:13:05.160 | it's probably a governmental 457 plan,
00:13:07.040 | and otherwise it's non-governmental.
00:13:09.360 | And the thing to know here, there's a couple of distinctions,
00:13:11.840 | but really the most important one is
00:13:13.840 | that with a governmental 457 plan, the assets are, quote,
00:13:17.760 | "held in trust" for the employees.
00:13:20.240 | What that means is that the money in the plan in an account
00:13:24.800 | with your name on it is literally
00:13:26.480 | in an account with your name on it.
00:13:28.120 | So you don't have to worry that if your employer goes
00:13:31.120 | out of business or gets sued or there's, you know,
00:13:33.520 | files bankruptcy or whatever, you don't have to worry
00:13:35.920 | that the money's going to disappear
00:13:37.520 | because it's your money.
00:13:39.120 | And by the way, that's also how 401(k) and 403(b) plans work.
00:13:42.040 | You don't have to worry that if the employer goes
00:13:44.400 | out of business, you'll lose the money because that can't happen.
00:13:47.760 | Non-governmental 457 plans don't work like that.
00:13:52.080 | With a non-governmental 457 plan,
00:13:54.680 | the money that you've contributed to the plan,
00:13:57.080 | which you're probably thinking of as your money
00:13:59.440 | because you get a statement, has your name on it,
00:14:01.400 | shows balance, it's technically the employer's money still.
00:14:05.240 | And so what that means is that if the employer goes
00:14:07.320 | out of business, you can lose that money.
00:14:11.040 | And so that doesn't mean that you shouldn't contribute
00:14:15.080 | to a non-governmental 457, but it does mean that you need
00:14:20.000 | to understand that risk
00:14:21.320 | and really carefully weigh the pros and cons basically.
00:14:24.520 | So that's it for retirement accounts.
00:14:27.520 | Now if we move on to 529 plans, these are a tax-advantaged way
00:14:30.480 | to save for college.
00:14:32.240 | And with 529 plans, there's no deduction for contributing
00:14:36.320 | to the account, but it grows tax-free just
00:14:38.880 | like everything we're talking about.
00:14:41.040 | And the distributions are tax-free if you use the money
00:14:44.560 | to pay for qualified education costs.
00:14:47.760 | And that includes college tuition and a handful
00:14:49.960 | of related expenses basically.
00:14:53.440 | So these are kind of like a Roth IRA, but for college
00:14:56.440 | in the sense that there's no tax savings at the beginning,
00:14:59.880 | but you get tax-free growth, and it all comes out tax-free
00:15:03.680 | if you jump through the appropriate hoops.
00:15:06.920 | But if you take the money out and don't use it
00:15:09.440 | for qualified education costs, then the growth, the earnings,
00:15:13.000 | that's going to be taxable,
00:15:14.360 | and it's subject to a 10% penalty.
00:15:16.800 | And lastly, we have the health savings account.
00:15:19.360 | And this is probably the most powerful account on the list,
00:15:23.240 | but the first thing to know about it is
00:15:24.960 | that you're not necessarily allowed to contribute to one.
00:15:27.760 | Because in order to contribute to an HSA,
00:15:30.080 | you have to have what's called a high-deductible health
00:15:32.640 | insurance plan, and that basically means
00:15:34.640 | that the deductible for the year has to be
00:15:36.360 | at least a certain amount, which varies by year.
00:15:39.280 | And so really the easiest way to know is every year
00:15:42.320 | when your employer sends you the PDF or the link
00:15:44.400 | with all the health insurance plans that you can choose from,
00:15:46.360 | or if you're buying insurance on the exchange
00:15:47.760 | and you're comparing the plans there, it will tell you.
00:15:51.120 | If a plan is HSA-compatible,
00:15:52.800 | it will usually just have HSA in the name,
00:15:54.680 | or it will say HSA-compatible somewhere in the bullet points.
00:15:57.760 | So that's the easiest way to know.
00:16:00.200 | And with an HSA, you get a deduction
00:16:02.560 | for the contribution to the account.
00:16:03.800 | So you get immediate tax savings,
00:16:05.920 | and then there's tax-free growth,
00:16:07.920 | and the distributions are tax-free
00:16:10.800 | if you use the money to pay for qualified medical expenses.
00:16:14.480 | So these are called triple tax-free.
00:16:16.480 | They're the only account like this
00:16:17.880 | where you get a deduction at the start, it grows tax-free,
00:16:22.040 | and the distributions are tax-free.
00:16:23.600 | Nothing else works that way.
00:16:25.280 | So if you have access to an HSA and you would plan
00:16:29.200 | to use the money eventually for qualified medical costs,
00:16:31.720 | or as Christine mentioned earlier, to reimburse yourself
00:16:34.720 | for previous qualified medical costs that you had,
00:16:37.640 | then an HSA is the best deal around.
00:16:39.440 | If you take the money out and don't use it
00:16:43.160 | for qualified medical costs,
00:16:45.080 | then the full distribution is going to be taxable,
00:16:48.080 | and if you're younger than age 65, there's a 20% penalty.
00:16:51.760 | And that's it for the different types
00:16:54.440 | of tax-advantaged accounts.
00:16:55.640 | A little bit later, we're going to be discussing
00:16:57.400 | the most tax-efficient way to use all of your accounts.
00:17:00.360 | (audience applauding)
00:17:05.360 | (audience clapping)