043R - Mega Backdoor Roth

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3 - 38 Jonathan Mendonsa Hello and welcome to the ChooseFI radio podcast. For those of you that are checking this out for the first time this is a twice a week show on Mondays and Fridays on Mondays we introduce a new concept or guest. Typically that is related to financial independence or personal finance. And then on Fridays which is the episode that you're listening to today we take extra time to really dig into that content and give you our feedback bringing thoughts and ideas from our community which allows us to capture the ideas that we might have missed on the first pass and also bring in your feedback as well. So it's a crowdsourced show. So to help me with this today I had my co-host Bradd here with me in the studio. How are you doing buddy.
38 - 90 Brad Barrett I'm doing really well Jonathan. Yeah this is it's been a good week here in the household. Yeah I actually had a couple kind of neat things in my little Fi world happened. My youngest daughter just started kindergarten and they have this neat little thing called mystery reader. So it's basically like one of the parents every Tuesday comes into the class and reads to the class. But the kids have no idea whatsoever like which parent is coming and hence the mystery part of it. And you should have seen the look on my daughter Molly's face when she saw me walk into that classroom. It was one of those amazing moments. Your heart just like melts. It was really really cool. And I just love getting the opportunity to do that. And you know it's neat because I am here at home I told the teacher I'm like I would do this every single day if you let me. So whenever you need somebody like that somebody cancels. Just give me a call I'll be there in five minutes so it's just like a neat thing.
90 - 92 Jonathan Mendonsa You know that's so cool. What book did you read.
92 - 97 Brad Barrett I read a bunch of books I read. Giraffes can't dance which is a neat one.
97 - 105 Jonathan Mendonsa What I just read that book to my son yesterday is I don't know if he understood all the words at six months old but yeah that's what we read.
105 - 111 Brad Barrett Yeah the kindergartners love it. So yeah that's that's a book that you'll be reading for many many years now.
111 - 122 Jonathan Mendonsa That is awesome man. It's going to be funny like a couple of years from now the teacher's going to be saying. Does anybody else other than Brad Barrett want to come in and read the book. Anybody anybody anybody.
122 - 157 Brad Barrett Yes. Now I totally hear you. Yeah I don't know. I just love it it's it's fun. So yeah. So that was neat. And then we actually went on a hike this past Saturday. So I we're trying to kind of go outside of our comfort zone a little bit as a family and like instead of just like hanging around the house or doing something locally we just grabbed this book from the library called the best hikes to waterfalls in the state of Virginia and it's just like this random neat little book. So basically now like we have this two hour radius that we're willing to drive like on a Saturday or Sunday and you know we found one to this natural bridge State Park. Jonathan have you ever been to Natural Bridge.
families, library
157 - 161 Jonathan Mendonsa I have driven by it. I believe there is a fee to actually go there right.
161 - 231 Brad Barrett There is. Yes. So it is a state park now but man it was just one of these seven wonders of the world type things like we didn't know what to expect. Like you've seen it on you know and anybody who hasn't heard of the Natural Bridge just kind of Google at it it looks neat. You know it's like OK here's this bridge made out of rock. But like when you're there it is just mind blowing and really you can see why for a long time it was considered one of the wonders of the world. And the funny kind of FI aspect of this and why I'm telling this story is that there was a little sign like an informational sign saying that actually Thomas Jefferson purchased this back in the 7500 and he bought it for I think it was twenty shillings which they said parents that actually two dollars and forty cents. OK. So my daughter Anna what you should have seen like her eyes bugged out of her skull like she's like two dollars and forty cents. We paid $22 as a family to get in here. Like how is that possible and you know I'm telling her I would probably be worth. I mean that's state park he bought up 173 acres with this basically world renowned Natural Bridge it's probably a billion dollars today you know. And so trying to explain to her that concept it was kind of neat like learning lessons that we didn't anticipate when we set out to go on a random hike that day you know.
231 - 248 Jonathan Mendonsa It is definitely the second generation fire conversations that give me more excited than anything else. The more we talk about them in these little light bulb moments that you have with your daughters are just totally priceless and we got to capture them and then kind of build on them is really something that I latch on to both as a host but also as a listener.
248 - 287 Brad Barrett Nice. Yeah it's cool. And I hope it's adding some value to people out there. You know we're not like china stuff this down our girls throats by any means. It's just like these topics come up in conversation and it's fascinating to see how interested they are and I think we've laid the groundwork for that. Certainly over months and years just kind of talking about money. But like in a very positive and constructive way and saving money and you know the value of compounding and things we're trying to teach them and when it does come up organically like this it really is fun. And that was so cool and that was difficult to explain like how two dollars and forty cents turns into a billion dollars and that's just me guessing about the billion. But I would have to imagine it's somewhere in that vicinity.
287 - 320 Jonathan Mendonsa Wow. Well you know the other half of that is this idea of exploring your state. I think there's so many of us that think that oh one of these days once I'm on the other side then I'm going to get a chance to explore the world or I get a chance to explore the country and how many of us haven't even checked out our city much less our state and one of these kind of there are there are so many resources out there similar to the book that you purchase that will help you learn all the really cool things that are available to do in the particular geographic region that you're in. And what if you just took that on as a challenge and how much more interesting is that than binge watching the latest show of some TV show on Netflix.
320 - 355 Brad Barrett Yeah you're absolutely right. And it's just like we kind of talked about here fairly often just just thinking a little bit differently and stepping outside your comfort zone. It's easy for us to kind of lie around the house and play board games and do fun stuff. You know like that's not insignificant but we've kind of taken it up as a challenge to alright. We have resources we have time we can do fun things like this. Let's take a trip once a month even you know and just do some kind of family hike and explore some new area. It's really I mean that was the farthest we went and that was about two hours and it was really not a bad day. You know we left at 8:00 in the morning and got back before dinner time and it was just a lovely day.
355 - 398 Jonathan Mendonsa So this past Monday we had the episode with Fritz from retirement manifesto talking about the idea of a drawdown strategy. And that episode was a very valuable conversation and hopefully this round up will add something to that conversation as well because while in the FI community we spend most of our time talking about how to accumulate this nest egg or what we have called this perpetual money making machine at some point in time you get to the place where now you're not talking about wealth accumulation but wealth preservation or maybe even decumulation depending on your perspective and how you tackle drawing down on that nest egg is a crucial part of the equation that I think a lot of us have just had a blind spot to.
398 - 415 Brad Barrett Yeah I agree. This was one of my favorite episodes I listen to and I think four times since we recorded it and I took more notes on this episode with Fritz than any other episode to date. So yeah I think this should be a really interesting conversation Jonathan. And yeah let's kind of kick it up.
415 - 536 Jonathan Mendonsa And let's start by reading some feedback that we got from Frank and Frank listened to this episode and he said you don't have to take more risks than you have to take. Learn it know it love it. And I think what really came through in this episode was this idea of balance. Brad and I have harped on this idea that a controlled degree of risk is important. It's important not to just leave money on the table and it's important to realize that if you have a net worth of a million dollars it's not good enough to just put that in a coffee can or put that into a bank account where it's not earning any interest or it's earning an extraordinarily minute amount of interest like 0.1 percent or 0.25 percent. That's not good enough because the value of your money is slowly eroding over time to inflation. So your dollar becomes worth less. So that's kind the premise for how we try to set up our investment strategy we need to have investments that at least match inflation or hopefully exceed inflation and have some margin built in there for growth and for those of you that are tuning in for the first time this isn't the episode where we talk about how to go about investing. We have certainly had plenty of episodes to discuss that already. In particular I'm thinking about the two episodes I believe it's 19 & 34 with JL Collins and the two round ups that are associated with each of those episodes. But there is another side to that at which point you really have enough. You have made it and you don't have to take more risk than you need to. And I think that's what came through with Fritz. He had been making the right choices for a long enough period of time that he had far exceeded the 4 percent withdraw rule. In fact you could tell. I mean what I came away with is probably realistically he could use like a two point eight or 3.2 percent withdrawal rule and he's still going to have more than enough to take care of his family. And so he was willing to go ahead and use a much more conservative asset allocation. I believe he said 60 percent bonds 40 percent equities because even though he knows that's going to reduce his his returns and even though he knows he's going to have a pension coming in down the road it probably doesn't need to be that conservative. He doesn't need more than that. He's going to be ok either way.
families, networth
536 - 697 Brad Barrett Yeah I agree with you I think that is a very important kind of larger point. And it's interesting because that is something that I jotted down in my notes which was about this balance right. And also Fritz's exact plan. Mike to your point Jonathan I think I suspect his safe withdrawal rate is much less than 3 percent even especially with the pension with potentially Medicare coming up in only 10 years away. And the fact that he has been diligently saving for 32 years in a career I would have to imagine he has safety baked into this more times than than just about anybody in the early retiree world. But you know whereas some people might look at that and say oh wow he could have pulled the trigger years before on his early retirement. This was his plan. And I think that that came through to me in this episode and I don't mean this in a negative way at all. But like Fritz has what he has in mind and he's rolling with that Like he, He has his plan and that works for him and that lets him sleep at night. And that's what he's going with. So whereas I think Fritz clearly is very open minded very intelligent and obviously so many ways it's like I'm not sure that I could convince him that quote unquote My way is right here as opposed to him putting off his retirement date till 55 where it you know I think there is a legitimate difference of opinion potentially. And I try to ask that in early in the episode about if he had found FI earlier would he have in all likelihood to have retired earlier. And he said we wanted to balance that and enjoy today. And he thinks that they would have followed that balanced approach of taking these family vacations and doing these all these other things that he kind of alluded to there. And I'm not sure in my mind's eye that that's the choice that I would have made because I think it was almost like setting up the straw man and I like people pursuing FI are not living a balanced life. So like whereas And this again is always personal. Right there are some people who are living a life of deprivation pursuing fi and that's their plan which is perfectly fine like mine. I think mine is the balanced plan which is we're still living life. We're going out to restaurants we're going to breweries we're taking these trips to family trips. You know this weekend trip costs a decent amount of money when you throw in gas and the amount that we spend to get into the place and my kids even suckered me into they got souvenires. So they paid for it with their own money which is actually part of our whole plan of giving them an allowance and giving them like a savings bucket of spending and a charity by. So theoretically they're supposed to be able to spend their spending money how they want. But Jonathan I've got to tell you it killed me. They bought this nonsense that nearly killed me.
familytravel, savings
697 - 712 Jonathan Mendonsa I've been waiting for the period on the end of that sentence so I can make fun of you even though I know I'm headed there and I'm probably. The bar is much lower for me to buy into that stuff. I cannot believe that the Barrett family got souvenirs. You guys are human after all.
712 - 739 Brad Barrett No we are and my older daughter Anna she insists on buying like they sell these a bag of rocks or like they're basically like gems they call them or you can like grab a bag full of gems for $8 or some. I'm like I'm thinking to myself think this is absolutely worthless. But she just loves these gems so I don't know if she. Everywhere she goes when we go to the Science Museum she buys them. She bought them here at Natural Bridge it was like enough rocks already. But you know I guess she was it's her money and I have to make decisions you know.
739 - 745 Jonathan Mendonsa Well the good news is you have space for it up in your attic now that you and Molly have been throwing away all your other junk.
745 - 818 Brad Barrett That is very very true. Very true. But are getting back to the like the whole balance thing and I hope I'm being clear here is that I think a balanced approach is correct and I agreed with Fritz entirely and I think it just comes down to personal preference. Whereas for me pursuing FI from someone just starting out right like with a high savings rate at 22 years old if you can reach FI in 15 years at 37 and be able to have some flexibility like that like we've talked about with Joel from FI 180 where OK if you need to work a couple more days or a couple of days a year in the rest of your life. It's not this horrific thing. Whereas you know Fritz wanted absolute safety and he was willing to work till 55 to do that. That's not a decision that I'm willing to make. And like I'd rather those years for me in post FI but for Fritz that clearly was a decision that he thought through and that's the takeaway for the audience. There is no right answer. OK. This is not me saying Fritz did something wrong or Fritz telling me that he thinks I'm being irresponsible for retiring early when I don't have 100 percent safety. That's not the issue. We have each thought through what we value in our lives and that is the key. And we've made the decisions based on those values.
savings, valuist
818 - 833 Jonathan Mendonsa Yeah I'm glad we brought Fritz on because I think he actually reflects a larger percentage of our audience than either of us. Our own personal biases would allow us to see. And that is that many people are taking a traditional path but they want to take that traditional path in a smarter way. Right.
833 - 834 Brad Barrett Absolutely.
834 - 895 Jonathan Mendonsa And the other key to that is this idea of optimization and what the math says would be optimal. We've kind of hit on that word as almost something that we have rejected to some degree it's something that we fight against because although we know what the math says and many times we also realize that fi is inexorably tied to personal finance and the part of personal finance that you really need to latch onto is that word personal and what's right for you may not be right for me. Ultimately it comes down to that value choice. And honestly what I came away with from this episode with Fritz is that he is very happy with his choice which means that the decisions that he has made and is making right now are perfect for him. And what I love about it is now that he's taken probably hundreds of hours over the last two years to determine what his personal money philosophy is and what the practical execution of that philosophy should be he's written it down. He's put it out on his blog and now he can walk away from it. He doesn't have to second guess it because you know what. Even if it's not optimal it's going to work just fine and him and his family are going to be totally fine.
895 - 1036 Brad Barrett Yeah and that discussion of optimal versus not optimal that's something that we've actually had some people in our Facebook community kind of call this out on it in a very good natured way. But I think it speaks to a larger point and that's where I wanted to talk about here is that Jonathan you alternately say something like It's all about the math but then you say things like what you just said which is it doesn't always have to be optimal. Right. And sometimes it comes down to the personal side. Now those sound like two irreconcilable points of view like it can be all about the math but then not all about the math but I think on some levels it can be like we are cognizant of how important the math is and really how easy this is at its essence. Right. You live below your means you try to save as much as you can. You invest probably mostly in index funds. Maybe if you feel like diversifying in real estate and other things those things we can kind of argue at the margins but but it's really easy right it's not rocket science to live below your means save a lot of money and invest it. But then it comes down to the personal side which is the psychological that we're always talking about. And each of us have different levels of safety and security that we need. We have different different levels of risk things that let us sleep at night is a phrase that we use here a lot. Those things matter and those do impact the math sometimes because talking about just the simple one that we hear over and over and over again is paying down your mortgage rate like quote unquote. Everybody knows that the math suggests you should not pay down your mortgage if you have a low interest rate which for the last decade or so they've been 4 percent plus or minus a little bit which is at or near historic lows and you should invest that money in the stock market or or wherever you see fit. And the math will let you right off into the sunset with more money than you would have had you paid down the mortgage. But that said psychologically paying down the mortgage is fantastic. And a lot of people died that appeals to them and I don't tell those people they're wrong. It's not my place to and I frankly don't think they're wrong if that lets them sleep at night. And that gets them to a place where they are comfortable with their FI choice so this is very personal. And I really want to ram that home as often as possible like the math is the math. And it's important but you need to figure out what works for your life.
indexfunds, stocks
1036 - 1199 Jonathan Mendonsa And Brad I want to I want to come back that. I want to find tune that even more like my line is it's just math right. And I think what I have latched on to as I've seen these questions pop up over and over in our community when I try to take the high level view of what that decision actually looks like. The one thing that ties our entire community together regardless of how we end up landing on each and each particular decision is that we do start with the math right. Ultimately we do have this in common because we look at the math whereas so many people in the world just make a decision based purely on emotion in our community because we understand how the math works and we understand that it is just math. We can start there. And then once you realize what the two different outcomes would be based on the math then we add all these other things like value like personal choice like psychology and then those augment that decision. And that turns into an equation that is something that is slightly more objective and it allows us to make a decision and be more comfortable with it even if we know it's not the most optimal choice. Take my case for example if I were to take a step back and re-evaluate my own decision and made the choice to not pay off my student loans aggressively and I'd made the minimum payment on my student loans and I put every dollar that I had into the stock market I can look at that right now and say OK I would have been. By putting that into a pretax bucket I would have been avoiding that 25 percent marginal tax bracket that I'm in I would have been benefiting from the nearly 12 percent rate of returns year over year that we've seen over the last several years. I would have far exceeded my fixed rate of return of the 6 percent on my student loan. So when you start with the math and you say it's just math I can objectively say that this was a sub optimal choice. Right. But I was aware of that ahead of time I started with that and then I added in the personal factors and the personal factors said as long as I have a $2000 a month student loan payment I am tied to this job. I am tied to this career and I'm tied to the hamster wheel. It is much more difficult for me to make creative choices and have the freedom to fail if I have to make sure that I can make this fifteen hundred dollars a $2000 month payment and my family is tied to that decision as well. So once you go through this process of discovering what the math says is the most optimal choice then you get to take the opportunity to add back in those personal factors. And even though I am cognizant of the fact that I left money on the table and you could quantify that and that's probably somewhere between 40 to $60000 I have no regrets about the choice I made because it's given me the freedom to pursue this life choice and ultimately it's just math has to be weighed in the context of it's your life.
career, college-loans, families, stocks, tax
1199 - 1220 Brad Barrett Yeah and that is perfectly legitimate Jonathan that is the perfect end cap to what we're saying here which is you made a decision some other people may listen to you and say oh he made the wrong decision. Well OK that's fine. They can think what they want but for you that was the right decision. So it's important to start with the math and then think through what works for your life. I think that's a perfect way to look at it.
1220 - 1290 Jonathan Mendonsa So we got a lot of feedback on this episode. Stacy said loved the timely message on drawdown strategies by Fritz. I'm excited to dig into his blog in more detail since it really hits our season of life and that really doesn't have to tie to age that can just be tied to where you are on your FI journey. If you're at the point where you're within this five year window that you're going to be drawing down on your portfolio this is something you need to think about and then just taking the time to document it and plan it out. We talked about this idea decision fatigue. Well if you do it now you're doing it from a very unemotional objective place. If you do it when you're experiencing a market crash you're going to be in a very stressful and emotional place which probably will lend itself to making poor or irrational decisions. So getting a plan in place that you follow is exactly what we want this conversation to be about. So Danny in our Facebook group said thanks to this great episode I am living in drawdown. Here's what's on my mind. Maybe it's a bit unorganized and Danny highlighted several points which are going to take a few of and discuss today and hopefully get to draw on some of Brad's feedback mine and Fritz and Big Ern's as well who participated in this conversation. You ready for this Brad.
1290 - 1328 Brad Barrett Yeah let's do it. And just to be clear this was on our Facebook group. So choose FI dot com slash Facebook to gain access to it. And yeah we had both big ern and Fritz just responding to Danny's eight points here. It was 21 different replies which is just such a neat thing that we talk about community here all the time Jonathan and like. This is the exact example of that we have our guests just in the group and regardless of whether they are responding or not like we have thousands of people now it's well over 4000 people in here and the conversation is fantastic. So this is a perfect example of why that group is so powerful.
1328 - 1439 Jonathan Mendonsa So Danny says the first point that really struck him is inflation risk. When you're a drawdown and you don't get a paycheck tied to inflation anymore. So it's death by a thousand cuts. I latched onto that just because accounting for inflation is something that you don't see talked about very much in the F-I community. I'm not saying that there aren't people that have addressed it but it doesn't get a lot of exposure a lot of people just take the 4 percent rule at face value and just assume that they have a million dollars they're going to live on $40000 a year. I think it's a light bulb moment it was the light bulb moment for me when I realized wait a second $40000 a year right now. Is it going to be the same as $40000 20 years from now. I think it's important that you recognize how do you account for that in your drawdown strategy. And Fred says inflation scares the Jeepers out of me. And Brad I was skeptical but I actually went and looked it up and you can find the word Jeepers on urban dictionary. So definitely go check that out. If you're looking for some context but. He said we didn't get a chance to get into it on much on the podcast but it's one of our biggest concerns my pension which is a sizable amount of his retirement income is not indexed for inflation so it's definitely something he's thinking about. I do think that's one of the things that is interesting about the 4 percent rule and maybe even the 4 percent rule of thumb. We did an episode about a month ago with big Ern from early retirement now and in that episode and in the following round up he shared with us how he actually builds inflation into all of his calculations. And so that's one of the reasons that he thinks you need to be a little bit more conservative with what your number is especially if you're trying to have capital preserve at the end of your drawdown period. And Big Ern has stated that's actually one of the reasons he's a little bit more conservative and he doesn't feels comfortable using the 4 percent rule I think he lands somewhere between 3.3 and 3.5 depending on whether or not Social Security is part of the picture because he plans on adjusting that withdrawal rate to inflation each year.
1439 - 1500 Brad Barrett And that was a hopeful message for me from big Ern's episode which was inflation is already baked into the 4 percent rule or in his case you know at 3.5 percent I think he said is the ultimate safety. But even though conceptually most of us don't really think about inflation when we're doing just these back of the envelope. OK. I have a million dollars. My 4 percent is 40000 and that's just that. But the people who are actually thinking through this and really running the scenarios are baking inflation into this. So I just keep that in mind when you hear someone like ern who has done these calculations in depth talk about 3.5 percent plus or minus a little bit you know depending on the situation depending on what's going on like he has baked into it. So like this is not some calamitous thing that is going to destroy your entire retirement and nobody's thought about it like that. That's kind of my my summary is people much smarter than me are thinking about this and are baking it into the calculation so like it's not an existential threat as far as I'm concerned.
1500 - 1599 Jonathan Mendonsa And if you want to hear a little get more information on the idea of how to adjust the 4 percent rule for inflation we address that to some degree. Big Ern in Episode 35 and then he also weighed in in the friday in the Friday round up that was attached to that episode 35 R we talk about how to adjust your withdrawal year to year based on inflation. So hopefully you'll find that helpful as well. OK. Next today we want to spend a few minutes talking about this idea of delaying Social Security. So Danny also says mitigating inflation risk by deferring Social Security until age 70. It's a cheap longevity inflation insurance. But the break even period is long 22 years. If you're married you may only want to do this for one of you. It's better for the women to do this than the men and Fritzes feedback on that was that the Social Security DeLay is one of the strongest inflation hedges in his mind if he can get it to that higher base by delaying until the age of 70. Then from there the annual inflation adjustment is worth more in money. On the same percentage higher base it compounds. So to him it's a great longevity insurance. The best he's got. I think we actually got some feedback on this one. That was and this is really God was actually contesting this or was actually saying I don't know if that's the right approach. It does depend on what your long term strategy is. And I think the point that people were highlighting was the idea that it depends. Are you trying to preserve your assets like for instance Social Security is a guaranteed amount and even if you're making less it prevents you from having to draw down on your other investment vehicles like your 401k like your taxable account so you can use your Social Security which is guaranteed even if it's a smaller amount by not delaying that by taking that early. You can leave all of those other accounts in place to a larger degree to continue to grow.
401k, insurance, socialsecurity
1599 - 1671 Brad Barrett Yeah that's a very interesting point and that also again comes down to math and ignoring the math or accepting the math like Fritz is clearly saying in his opinion that is a guaranteed return of whatever he said eight percent or somewhere in that vicinity like that it makes sense to him. Math wise but as you're going through that feedback from the audience I'm thinking to myself OK if my expenses are low enough which they probably will be that social security between myself and Laura I can basically cover our entire yearly expenses even at the earliest age to take it. I think I might just take it right like that I would then preserve all my other assets. So like that's an instance where maybe the math isn't quite as clear as what the personal decision comes down to for me. So like again this is the first time that I'm thinking about it. So please bear with me here. But but that's kind of the cool aspect of this is like we can all think through like how these things work for us. So I see the allure certainly of just taking Social Security as quickly as you can and maybe forgoing that 8 percent guarantee in return. But you know what you're getting money to cover most if not all of your expenses if you are living this FI lifestyle and that's pretty cool.
1671 - 1809 Jonathan Mendonsa Now what's really cool about this is Seonwoo who is the moderator in our Facebook group now he is a pure ultra optimizer in every way shape or form and he writes over a FI by 40 dotcom and he says I completely disagree with the Social Security discussion on today's episode guaranteed 8 percent return by delaying Social Security. The problem with that argument is that the Social Security payout tables are actuarially fair and what he means by that is when you take into account the lifespan of the average person the average person will get the same lifetime lifetime pay out regardless of when they start claiming benefits. The difference is going to lie with the widow or benefit so when someone dies his or her spouse is entitled to the deceased benefits. So if the higher earner is older it's statistically better to delay taking Social Security benefits. So here's a back and forth of that. If you delay till 70. Yes Fritz is completely right. You're going to get that increase in pay out year over year so it's a guaranteed rate of return. But the but practically speaking every single year you delay is a year or less that you're probably going to get this because most of us Tim Ferriss aside don't have 120 130 years in the bank. Most of us are going to probably cap out right around 95 unless the robots take over our organs for us. So you can see how yes the math says you're going to get this guaranteed rate of return. But if now you're only able to use that for 10 years instead of for 16 or 17 years. Seonwoo is saying that may not be a great choice. With the exception of thinking about your surviving spouse that is what you're going to have to weigh. And I don't think I can give you the one size fits all answer in this episode but I can say that when you're building your drawdown strategy that is what I would be considering. Is your spouse significantly younger than you than you. Then there's a case that they would have a much longer timeline to be drawing down on that money for. And I think those are the the key points you have to think about when determining what to do with this. And then the last point that we wanted to talk about from Danny was this idea of keeping money in your taxable account to can to cover the Roth conversion tax cost especially in a market downturn. You should get aggressive on the conversion. You also need to fund living expenses as well. So I wanted to spend some time on this because Brad I think some people do have a tendency to confuse the Roth conversion with the mega backdoor Roth. And I'd love to get your take on that.
roth, rothbackdoor, socialsecurity, tax
1809 - 2013 Brad Barrett Yeah. No I think they absolutely do. And I think even for about 10 seconds and in the episode with Fritz I think you might have even confused it for just a second. But you know I know when we talk about this stuff it all kind of comes comes fast and furious so I know you understand it conceptually but like if that can even happen to you it can happen to anybody. So it's important to have the distinction between the Roth IRA conversion which we talked about in the sphere of the Roth IRA conversion ladder but mechanically it's just a Roth IRA conversion which means you're taking money from a traditional pretax retirement account like like a 401k or really it's going to happen from and from your IRA and you're making a conversion. OK. So that is actually a taxable event. You're taking money out of your pretax IRA and pulling it out and converting it to a Roth IRA. Now since a Roth IRA is after tax money you actually have to pay tax on that conversion. So let's say you pulled $30000 out of your IRA converted to Roth that $30000 goes on to your tax return as taxable income. So even though you're putting 30 grand from your traditional into your Roth and that money is just moving one to one you actually do owe tax liability on that. So to Danny's point like it's important to keep track of that. I give you all of a sudden at tax time. Have a if you're at a 25 percent tax rate and you have seventy five hundred dollars worth of tax on that. On that event now hopefully most of us are not making that conversion if we're in that tax bracket. But again you need to set aside that money for the tax liability on that conversion. So I think that is a crucial point and might help kind of make that distinction in your mind of what is mechanically happening with that Roth IRA conversion. So when Fritz was talking about in their first two years in retirement they were going to live off their investments which is in bucket one in his three buckets strategy. All right. They're going to live off of their just regular investments that they have sitting around and they're going to convert as much as possible for the Roth IRA conversion. Now that's the play there. OK so what he's going to do is his taxable income is going to be close to zero. Right. Because he's in retirement he has no income coming in. He hasn't started his pension as we've discussed previously. So his income is zero. Now this is like the millionaire educators free money concept. Right like Fritz and his wife on their tax return. They will have some amount of free money and you know I don't know Fritz's tax situation dependence things like that. So you know I don't want to get into the exact amount but let's say $25000 of a free money that he can convert from his traditional IRA to his Roth IRA each year and pay $0 of tax on it. All right so that's the crucial point is he's living off these investments. This is just a straight tax play. Because it's brilliant like he's created that taxable event put it into his Roth and now that money is tax free forever. But he's essentially paid $0 in taxes. So it is a brilliant brilliant play if that works into your plan raid's as it did for Fritz here. So I absolutely love that. And I really wanted to make a point of that that this is the Roth IRA conversion that he's doing. And it really is a smart strategy.
401k, ira, roth, rothladder, tax, traditional
2013 - 2064 Jonathan Mendonsa And then I wanted to say that there is a distinct thing called the mega backdoor Roth and I'm going to let Brad kind of introduce this concept as well. But before I do that I wanted to talk about one point which is in that episode Fritz says that in order for you to be able to do this your H.R. department has to allow in-service withdrawals and the only reason I say that is I think some people took that as a mandatory requirement for H.R. departments and I wanted to stress that unfortunately it is not mandatory. He was saying that in order for you to be able to do it your H.R. department will need to offer this now they don't they don't have to they're under no requirement to and in fact many businesses don't. But if you're lucky enough to work for an employer that is H.R. department does allow in-service withdrawals then you should be able to do this. And so it's worth going to your H.R. department to ask them whether or not they make that allowance.
2064 - 2125 Brad Barrett Yeah and that's built into the 401k plan so it's not just like on the whim of like the V.P. of H.R. it's what does your 401k plan allow. And yeah the two keys to be able to do the mega backdoor and I will explain that a little further in-depth in a second but the two keys are that they allow after tax contributions and in-service withdrawals. OK. So those are the two absolutely essential points so when you do talk to your H.R. department and ask them about the rules of your particular 401K. Those two things have to exist in order for this mega backdoor to work. All right. So just reading that mad Fientist article Jonathan that you quoted in the Fritz episode there are many people in the comments who are saying oh this sounds great in theory but my company doesn't allow for it. I don't I don't know what percent of companies do 10 20 percent or something like that it didn't seem like an significantly large percentage but that's just anecdotal obviously. So the only way to know is to ask your H.R. department it's simple as that.
401k, rothbackdoor, tax
2125 - 2137 Jonathan Mendonsa So I want to go and start off the segment on the mega backdoor Roth by playing a voicemail that we got from ViShal. He has access to the mega backdoor Roth and he is going to quickly take a few minutes and walk us through how it would work practically.
roth, rothbackdoor
2137 - 2371 Vishal - (voicemail contributor) Hello Jonathan and Brad. This is the Vishal calling from Silicon Valley California. I'm calling because I was happy to hear that in the latest episode you guys talked about the mega roth and I wanted to send a quick voicemail because I do it myself you know regarding the steps involved in doing a mega Roth. So the first thing to understand is that your 401k to your employer can have three kinds of contributions. One is the pretax. The other is your employer is matching. The third is after tax and I'm talking about the traditional 401K. We're not talking about Roth 401K which is a different beast. Now among the three kinds of contributions you might be already maximizing the $18000 of pretax that you're allowed to contribute and the employer might adding on that. I don't know 8k 9k to it. So you're sitting on like 26 27 27. But the 401k limit imposed by IRS is 54 per year. So there's room to contribute 27 more to this pie. And if you do that and if you leave in the 401K it does not give you a lot of benefits number one first after tax money. Second when you draw it and retirement you have to pay taxes on the earnings. So it's not a great idea to leave them there. But there is this mega roth thing that you can do and the way it works is take what is called in service distributions and similar to what say somebody is leaving the job. They can roll the one key to someplace like an IRA in service distribution is on some of their lines of what you can do is you could take an in service distribution for example my plan allows me to do that once every 12 months. So you take the inservice distribution and you put it in the Roth. And what I focus on is the after tax contributions let's say I contributed 27K in after tax 401K. Since they only come from your paycheck it's a good idea to do it around the time or withold money from a paycheck around the time when you get a bonus or something because what that helps you that is you're not growing that money in your 401K account because if you wait for a long time. Money grows and then after that if you move it to. Roth Ira you have to first pay the tax on the growth not first. But you know you have to do a tax return. So that's why it's better if you can in a short interval of time withhold that paycheck. A lot lot from out of the paycheck and then eventually move it to Roth IRA via in service distribution. But not every company allows that. So not everyone has the ability to do this magic trick. But if your company's 401K allows you to do that. It's one of the greatest techniques because you could put in 27K in your Roth. Ira Well you're only allowed to do five point five K in the roth IRA the earnings. As I said if the money grew it has to be taken with you again. if You put the earning in the roth it gets taxed. If you put it in deductible IRA then it won't be taxed because it's still earnings are still pretax. The problem with that is if you're familiar with back door Roth the traditional backdoor roth like contributing 55 hundred to traditional IRA and then converting it to you know roth if you leave your earnings in the deductable IRA then while doing backdoor roth you might incur a tax. And so I would advise just bite the bullet take it to Roth all of it to Roth and this is how it works in my company I contribute about 75 percent of my paycheck to after tax. But again it get caps out at 54K. Thank you guys if you have any questions let me know.
401k, ira, megaroth, tax, traditional
2371 - 2412 Jonathan Mendonsa That was a very thorough walkthrough and then just to our audience for those of you that are interested and getting a little bit more of a tutorial on this. Vishal shared with us a post that he wrote specifically because we brought this up he got a lot of value from that episode but he really wanted to highlight that. I think that Mad Fientist did a pretty decent job talking about it. But I think there's definitely room for another article on the mega backdoor Roth and so we're going to put a link to this in the show notes Vishal writes over at. Everything about education dot net. And this was a great walk through on how to tackle the mega backdoor Roth I highly encourage you to check it out. It'll be in the show notes. On today's episode and before we move on Brad did you have any final thoughts on that. Anything else that we should clarify before we keep going.
2412 - 2622 Brad Barrett Yeah the mega back door and this is kind of a bizarre thing and we and we laughed about it on the episode because it seems like such a gimmicky loophole that like it's hard to even imagine this exists. It's just allowing you to put in in some cases up to $35000 in money into a Roth IRA each year even if you're excluded normally based on income limitations from like a regular Roth IRA. So that's why it's called this backdoor Roth. So what's happening is you actually have a $53000 limit. I think it's increased in 2017 to 54000. But I know in 2016 it was definitely 53000 So we'll go with that. And you can put in $18000 of employee deferrals to your regular 401k. All right. And we always talk about you want to max that out right because that's that's what lowers your tax liability. That's a tax deferred item. All right. So we highly recommend maxing that out. But the cool thing is you have that total $53000 limit. So we're getting the 35 as you just take the 53 back out the 18000 that you put in. And that's $35000. OK. So that's the potential additional amount that you theoretically could contribute to your overall 401K. Now what does include in that is your employer earns contributions or matches or whatever so that all gets added together up to this maximum $53000 limit. But just for back of the envelope math will say there's no employer match you've put in 18000. You still have that $35000 limit. And now if you're fortunate enough to have a 401K your company that does allow for after tax contributions and in-service withdrawals then you can put in up to that 35000. You don't have to put in 35 Obviously whatever you have extra lying around that you want to get into a Roth if you put that money in as an after tax contribution and then you have to actually mechanically make an in-service withdrawal. And that money then goes as as I understand it it goes to a Roth IRA of your own. OK so that's hence the in-service withdrawal you're actually withdrawing that money from that after tax account in your company 401K into a an actual Roth IRA account. All right. And it is as simple as that. That's that's the crazy part about this is why this exists how this exists is beyond my comprehension honestly and I can't imagine this will last forever. But again if you have those two things you can do this and then it is a Roth IRA forever and it's tax free forever even when you pull it out 50 years from now. All right so that's the beauty of this. And of course since this is an after tax contribution that money is taxed currently. All right it's just as if it was going to go into your regular savings account. You just decided to put it into this after tax contribution in the 401K. And then do this in service withdraw to get it to turn it into a Roth IRA. So that's just a decision you're making obviously with the money you have left over. So that's why I say like it's not a slam dunk to put in thirty five thousand dollars because then it's it's in your Roth IRA. Right so that's a decision you have to make but mechanically that's how this works. So Jonathan does that does that make sense.
401k, ira, roth, rothbackdoor
2622 - 2741 Jonathan Mendonsa Yeah I mean I think between you and Vaishal I have a pretty good handle on it. I think next we need to start working on it like a crowdsourced list of employers that actually allow this after tax contributions and this in service distributions that would be an extremely valuable resource and we could put it in the new Choose F-I vault which is where we're putting all of our resources. And by the way guys if you did not know that is live you just got to choose F-I dot com slash vault and you can get access to the vault today and it's got great content in there. It's got a loan amortization spreadsheet PMI removal calculators. It's got resources from big Ern over at early retirement now retirement manifesto shared his net worth template sheet so very valuable resource. It'll continue to grow Laura is actually put in three of the top 50 recipes. So that is can't miss content and it is totally free. Definitely go check it out choose F-I dot com slash vault. Know I actually think this is a great place for us to slow down and actually talk a little bit about the Roth and I don't want to set this up by saying that Brad and I and most of the FI community are very pro pretax investment vehicles and we prefer to start with those almost as a rule anytime possible. I would say that the the traditional personal finance community and I would say that Fritz to a large degree I identify with that is much more pro Roth and I think one of the things I'd like to do today is kind of figure out where is that point because I think there is common ground there. I think that in the Dave Ramsey community they are they just have a huge blind spot to the power of investing in pretax vehicles. I think that the FI community has done a great job of highlighting the value of potentially getting your money in pretax growing tax free and then pulling out at very at a very low tax rate or maybe at zero percent tax which obviously would be the best of all worlds. But I think there's going to be value today in maybe trying to pin myself down and maybe Brad down. Where is that line at which the Roth is obviously too valuable to ignore and have a voicemail that I got from Zach that I'm going to go ahead and play now to set this up.
networth, ramsey, roth, tax, traditional
2741 - 2795 Zach - (voicemail contributor) And I guess this is Zach. I'm just calling in. I had a question for you. I've been working my way through the podcast but I'm only on episode 18 so far. So if someone has already asked this sorry great stuff by the way I've been self-educating on fire for a few years now but my situation is a little different than the norm although my adjusted gross income was about 75 K.. I have a tax rate that's actually zero percent or actually negative. Point three percent. This is in large part due to the fact that I'm married filing jointly. I've got four kids so I'm not your average fire community member is it really worth me maxing out my traditional 401k when I don't pay taxes anyway. My research seems to tell me that I'd be better off maxing out the Roth 401k option instead as this is all after tax. It seems like that would make it completely tax free for the whole life of the investment. What do you guys think anyway. Thanks. Keep up the good work.
401k, roth, tax, traditional
2795 - 2979 Brad Barrett My thoughts are he is exactly right. Yeah yeah I mean it's kind of hard to give blanket advice on a podcast Too many many tens of thousands of people when you don't know everybody's situation. Right. So Zach clearly took the intelligent approach here and said OK well that sounds like general advice that Brad and Jonathan are giving out on a regular basis and the fi community at large that doesn't make sense for my life. And clearly Yeah if you're already paying a zero percent tax liability then having tax deferred 401Ks or IRA is to lower that tax liability does nothing. Obviously there's no benefit whatsoever. So in his case I would definitely max out the Roth 401k option max out your Roth IRA if you can then that money is tax free for ever. It's locked in. You're locked in a zero percent tax rate now and it grows tax free and can be pulled out tax free for ever. So to me that is an absolute slam dunk and I think Jonathan you set this up to kind of get our opinions on like where that line is. I I'm not sure again that it's so great to give blanket advice but I think people need to look at what is there what is their marginal tax rate and if you're in a 10 or even 15 percent marginal bracket. Maybe you don't. That's a choice you make over whether I want to pay tax on that now. Locked in a 10 percent or 15 percent and then have it grow tax free forever. It also depends on your life circumstances if you have a side hustle that's making a lot of money or you have a pension where you're going to have guaranteed income and your taxable income. So this is the play right like the play theoretically that we always talk about which is the beautiful FI scenario is when you get to retirement you have $0 of income and then you can do all this fun stuff like pull out from your traditional IRAs and 401 ks which again are theoretically taxable events that go on your tax return. But because you do have some of that quote free money right with the standard deduction personal exemptions things like that that would bring your tax liability down to zero on that. Right so that's the beautiful play of why we suggest so strongly that you control what you can control and put money into these tax deferred items and then boom maybe on the other side of retirement you can pull this out with zero tax right. So That's the beautiful thing. But for some situations that just doesn't work right again if you had a pension if you had a side business that's making money like you don't want to throw away a business. Right. Because you want to do some funny fi hack. And know you have money coming in from a side hustle or a business or whatever it is. Obviously you want to keep that going but it then precludes some of these amazing fi hacks and that's fine but you need to look at your circumstances so Zach said all right my circumstances are I pay zero dollars in tax liability already. Let me funnel as much as I can into Roth options 401Ks IRAs. That's brilliant. That's how you should look at it.
401k, Guest_Catchphrases, hustle, ira, roth, tax, traditional
2979 - 3067 Jonathan Mendonsa Let's be realistic. Ultimately in our show we don't we can't shy away from giving blanket advice to some degree but we're here for so let's try the best we can give some blanket advice or at least give like a mental framework. Obviously if you're at a 0 percent tax rate. Yes. Yes. You want to go ahead and do all your post-tax contributions you want to max out that Roth 401k max out the Roth IRA like that's an obvious play but like you said it gets a little bit more nuanced when you get into the 10 and 15 percent tax bracket. Fritz counterpointed this is well he said you're in those lower marginal tax brackets tax the crap out of those Roth IRAs. And I began to think to myself we have kind of skipped over that because we're so focused on this idea of all these optimization strategies we potentially have to pay nothing in tax. And by using these tools like the Roth conversion ladder we can avoid paying even that 10 percent early withdrawal penalty. We have kind of bypassed some of these obvious tools that people have available to them. And so let's go ahead and take a few minutes and pigeonhole ourselves into committing to an answer on this. Let's make this into a hot seat for our first scenario let's tackle someone that has a $25000 income they're a single individual so they just have your standard deduction and they have four tools available to them they have the 401k the Roth 401k they have the traditional IRA and the Roth IRA. How would this individual tackle this problem.
401k, ira, roth, rothladder, tax, traditional
3067 - 3247 Brad Barrett Yes so this is an interesting one so they have $25000 worth of gross income. And let's just kind of take a step back and look at what their tax return would look like in its most simplistic form. So $25000 of W-2 wages goes on there and then they get to deduct because the government gives everyone a standard deduction and a personal exemption. All right so this is just a single person their standard deduction is sixty three hundred fifty dollars. The personal exemption is four thousand fifty dollars for a total of ten thousand four hundred dollars. All right. So that just gets deducted straight off the top and it leaves them with taxable income of fourteen thousand six hundred dollars. All right so that's what you then go to the tax brackets and see how much tax am I going to pay what marginal tax bracket am I in which means what is that last dollar or the next dollar of taxable income. Can it be taxed at. What tax rate. So I'm looking at the 2017 tax brackets. And for single individuals the 10 percent bracket goes up to nine thousand three hundred twenty five dollars. All right. So this person's fourteen thousand six hundred of taxable income 93 25 of it is being taxed at 10 percent. And now the remaining 5000 $275 is taxed at the 15 percent rate. So how I would approach this conceptually is OK 15 percent. I want to make contributions to my 401k to lower my taxable income to get me out of that 15 percent range. So now none of my dollars of income are being taxed at 15 percent. So what this person would have to do is if they made contributions five thousand $275 into their 401K it would lower their taxable income down to nine thousand three hundred twenty five dollars which is the exact upper limit for the 10 percent tax rate. All right so now they've lowered their gross income from twenty five thousand all the way down to 93 25 and now every single dollar of their taxable income is taxed at a 10 percent federal rate. All right. So we're talking about federal taxes here obviously. Now they have a decision to make going forward which is every subsequent dollar that they put into a 401k or a traditional IRA is now only worth 10 percent in ultimate tax benefits in the current year. Right. So now they have a decision. And I'm not so sure that I would continue putting in a tax deferred item. I might put into a Roth IRA or Roth 401K at that point. Now that's a decision of course they have to make. But but at least it sets up for you the audience the conceptual framework of what we're working with here. Right. So you have to look at those tax brackets. You need to see where you fit into them. And then like Fritz said you need to make that decision on on what makes sense for you based on your personal situation and your tax bracket.
401k, ira, roth, tax, traditional
3247 - 3314 Jonathan Mendonsa And I think the framework that Brad just laid out is what that decision tree actually looks like specifically you want to focus on the fact that your 401k is a vehicle to allow you to navigate some of these marginal tax brackets and make some of these other tools that you have available a little bit more appealing. And I think for both of us in our mind once you can get down to that 10 percent marginal tax bracket at that point the Roth IRA looks very appealing especially since now you don't have to jump through any hoops dealing with Roth conversion ladders all that stuff goes out the window you're already able to get that directly into the Roth. Yes you're paying the 10 percent upfront but that 10 percent tax rate seems like a very appealing fixed rate to know that you're paid and never have to pay tax on that again. I think that's just kind of a comprehensive way of looking at it once you can get that 10 percent marginal tax bracket. Sure. Yeah there may be a way down the road if you're willing to frame your life in a certain way that you can pay zero dollars in tax and obviously that's that's appealing but 10 percent is a pretty reasonable rate to never have to pay money on the growth and then never have to pay money or taxes on the 20 or 30 year outcome of whatever that ends up growing to.
401k, ira, roth, tax
3314 - 3377 Brad Barrett Yeah I agree completely and in fairness the 10 percent bracket is very small as we're saying it's ninety three hundred dollars for single individuals for married filing joint it's double that it's 18000 650 or so. So that's a somewhat difficult needle to thread there. But that said you might expand that choice for yourself to the 15 percent bracket that is your personal preference over what you can control. So ok then the question becomes if you could pay 15 percent and lock it in forever would you pay that. Some people might. Right. So it depends on your facts and circumstances of what your retirement is going to look like. How many of these FI hacks you'll be able to take advantage of it and things like that like there are different considerations. But I think the 10 percent to me is an absolute slam dunk 15 percent. You might consider doing the Roth IRA and 401 K as well. Or some some combination there of like at least there is a decision point for me. But unquestionably in my eyes I would personally lock in the 10 percent if I could.
ira, roth
3377 - 3388 Jonathan Mendonsa All right. Now let's go ahead and stretch this out for the sake of completeness and let's take a look at the single individual making $60000 a year with the opportunities for the same vehicles that we just discussed.
3388 - 3544 Brad Barrett All right. So again very simplistic. We'll take 60000. We will lop off the standard deduction and the personal exemption of ten thousand four hundred. And they are down to a taxable income of forty nine thousand six hundred dollars. OK. Now if you look at the tax bracket for single individuals the 25 percent bracket actually starts at thirty seven thousand nine fifty one. So this person is actually in the 25 percent bracket and the last eleven thousand six hundred fifty dollars of their income is being taxed at 25 percent. So if they put eleven thousand six hundred fifty dollars into their 401K or traditional IRA that is all being taxed at 25 percent. But if they did make those contributions that would come off their taxable income on their tax return and it would lower them down to actually jumping all the way down to the 15 percent bracket. So that is an amazingly valuable contribution. Right. You you're making eleven thousand 650 into your for on K and all of your remaining taxable income is being taxed at either the 10 percent bracket for the first 93 25 or 15 percent for the remaining roughly $28000. So that is an ultra valuable contribution to a 401K to get yourself out of that 25 percent bracket for any one of your dollars. So I mean that that's really pretty cool. And again this is why you kind of just take a quick look at this. I know a lot of people kind of shy away from understanding taxes and looking at these brackets. But like when we're in the FI community like you need to understand this at least at a conceptual level so I hope that this conversation is really hitting home to. These are the considerations. Now this person once they've made those contributions they're in the 15 percent bracket and then they've got a decision to make on what they want to do. They want to max out the remaining 401K amounts that they have. Up to 18000. Through an additional six thousand three hundred fifty dollars. That's possible. But you know they're getting 15 percent in value for that in the current year. Maybe they want to put some in a Roth IRA maybe they're just have an 80 percent savings rate maybe they live at home and they want to do both. Right like that's a consideration as well. So again you need to look into the situation and figure out what works for you but you need this information you need to just google something as simple as 20:17 tax brackets. That's literally what I did for this exercise and I'm looking at the tax brackets right now and it's really really simple. So this is just important background information and I hope you enjoyed this exercise.
401k, ira, roth, savings, tax, traditional
3544 - 3630 Jonathan Mendonsa And my takeaways on that are that the 25 percent is a no brainer for tax deferred. I think you will always be able to find creative ways to do this once you're in the F-I community where you are the 25 percent marginal tax bracket. See what you can do to get that income into a tax deferred tax advantage vehicle when possible. If you're down in the 15 Obviously you are hearing me and Brad hem and haw a little bit about it which means that there's probably not a wrong answer. Instead focus on your savings rate and figure out how you can get as much as possible into that don't lose tons of sleep trying to figure it out try to do both right Max out that 401k as early as possible. Just the fact that you're at the point where you are maxing out the 401k and you're thinking about what else you can do on $60000 a year. We're going to do. Great. And then either way that you go down the road you're going to have a play because you're in our community there are tools you can use to just totally crush this game so just feel good about that. I'm trying to pin myself down because I like to force myself into the uncomfortable situation of having to make the choice and I don't want to just say well these are what your options are. Do what you want to do and I want to put Brad on the spot and I'll commit to an answer as well. Brad you're in the second bracket you're making $60000 a year you make that decision to max out your 401k so you fill that bucket up $18000 goes and your tax deferred it gets you out of the 25 percent marginal tax bracket. Now you're sitting in the 15 you have a choice. Roth IRA or a traditional IRA. Where are you going to put that extra. Fifty five hundred dollars now realizing with the context of you're going to be fine either way. Which one do you do.
401k, ira, savings, tax, traditional
3630 - 3639 Brad Barrett Well I'm sitting here cringing I'm not sure I know the answer. I probably would do Roth in that case.
3639 - 3678 Jonathan Mendonsa Gosh I'm cringing too Brad. I might lean towards the traditional IRA because there are some other variables with taking the hit on the Roth early on and that is your state tax. Now this is where individual circumstances and facts on the ground come into play. But I know in Virginia it would be at least an additional five or six percent state tax and because you're not going to be itemizing at this point you're just taking the standard deduction you're going to take that hit as well. So I think I would be tempted into just doing the traditional IRA just to avoid that extra that extra state tax which practically speaking would put by that tax rate at right around 20 percent. So I think I would lean towards the traditional IRA.
ira, roth, tax, traditional
3678 - 3740 Brad Barrett Yeah that's a good point. And yeah it's funny because as I was sitting here kind of cringing through my answer because I'm not sure what what it would be. It really is that close is that I was thinking about how kind of we're setting up a simplistic example. Obviously just for federal because it's just easier and it makes more sense conceptually for people. But yeah that does factor into it as you're really adding your federal and your state tax liability and so in this case right for Virginia it would amount to somewhere between I think 20 or 21 percent. But if you lived in a higher tax day it could be up to twenty four twenty five percent. So that's a different decision. Right. Like if you lived in a no income tax state then it's only 15 percent. So again it just it really does come down to individual facts and circumstances so that does make it a tough thing to say Blanket early on on a podcast of what I would answer but yeah I think I probably would go with the Roth but I would be very tempted by that traditional or putting more into a 401K.
401k, roth, tax, traditional
3740 - 3890 Jonathan Mendonsa And the other thing you'd have to look at really to round that out when you're making your choice depending on where you live and the state that you're in. Some states have thresholds for where those tax brackets actually start. So going back to our first case study where the person was making $25000 a year they could by funding that 401k they could potentially drop themself below that threshold in which case they would only be subject to just that federal tax and so it's a very very obvious play. Well I hope you found that helpful. Especially having me and Brad squirm our way through that hot seat question there at the end in my mind this episode accomplished three or four different things. One for those of you that were trying to figure out how the mega backdoor Roth worked practically speaking they should lay the groundwork for that. And should be a great reference for you going forward two. So for the parents that are trying to help their children tease out whether or not that first investment vehicle should be a 401k and then whether or not they should be putting money into a Roth IRA or a traditional IRA. This episode should clarify that decision three for that single path to fi or for that first job. Those early years this should clarify how to approach those early investment strategies. Very comprehensive. Probably going to be an episode you're going to need to listen to a few times and. I think it's just an extremely valuable conversation that kind of gets glossed over. Because Brad and I find ourselves talking many times about the married couple with one child that's 10 years or 15 years into their journey. So hopefully for those of you that are in this season of life you'll find this a very useful episode. We like to close every show by doing a giveaway for a book that we have found useful and traditionally we do. JL Collins book the simple path to wealth and we do. Dominic Quartuccio's book design your future for this will be the last week we're doing it and then we actually are going to be featuring a new book. But for that for one more week we're also doing Tim Ferris's book tools of titans and that's one that both Brad and myself have read and found extremely useful and it's just the tactics routines of millionaires billionaires and high performers. And I think it's one that both of us have found extremely useful and insightful and we just wanted to share it with our audience so if you're interested in that and you want to participate in this give. All you have to do is go to choose FI dot com slash iTunes. Follow the instructions there. Leave us a short written review and then send us an e-mail to feedback at Choose FI dot com letting us know that you left the review and what screen name you left it under and will enter you in the drawing. We give away one book for every five written reviews that we get and we would love to include you in that. Brad how many winners do we have today.
401k, ira, roth, rothbackdoor, tax, testimonial, traditional
3890 - 3930 Brad Barrett All right. Today we have two. And the first winner is Stephen and he called this literally life changing discover this podcast a few months ago and I've been hooked ever since I am now disappointingly all caught up. So I have to wait for the new episodes. But it gives me more time to continue making the changes that will benefit my family's lives in the future. As recommended by Jonathan and Brad accounts have been moved to Vanguard savings have been made in car insurance groceries and gas. Best of all we're using travel rewards so now I see a chance for our family of five to visit the relatives in the UK thanks to credit card rewards and for that I will be forever grateful. Please don't stop. Thanks guys.
families, insurance, savings, testimonial, travelrewards
3930 - 3963 Jonathan Mendonsa Thank you so much. I have no plan to stop and I will make sure that Brad doesn't get the opportunity to consider the possibility. But for those you know that are thinking how do I travel to the UK with my family using just travel rewards. Definitely go check out Episode 9 which is kind of our pillar post on how to really discovered the world of travel rewards and how to travel the world at very low cost. It's something that we've been doing in the FI community for a while now and you won't hear about this talked on the Dave Ramsey Show. So definitely go check that out if you're interested. I'm pretty sure if you haven't heard of it before it will blow your mind.
familytravel, ramsey, travelrewards
3963 - 3967 Brad Barrett Yeah I totally agree. And our Jonathan our second winner is Pria.
3967 - 4019 Jonathan Mendonsa And Priya says changing the world brand Jonathan are just phenomenal the best part of the podcast series is a change in the way we think about collecting skills. I look forward to the podcast every week and the content is varied. They keep crushing it every week and then inspires me to crush it at work week after week. Having this online community to help with both the strategic and the tactical approaches to financial prowess is fantastic. Can't wait to read the simple path to wealth Well we will get that on out to you. Thank you so much Priya for being a part of the show today and thank you to our community for joining us. One quick favor if you enjoyed the podcast today if you got value from this episode please just take a second and press the subscribe button. It tells the algorithms and the platforms they are listening to this on. You get value from the show and as a result we're able to continue to get you guys these higher profile guests and we're just we're very grateful that you're here and we'll see you next time as we continue to go down the road less traveled.

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