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Afford Anything | Get Smarter With Money
Q&A: Can You Open an IRA for Someone Else's Kid? (And Should You?)
00:55:15
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- [00:00]
A
Hey, Joe, how many nieces and nephews do you have?
- [00:04]
B
So, wow, did I put you on the spot there? You did.
- [00:10]
A
Oh, man. I haven't counted.
- [00:12]
B
You did.
- [00:12]
A
How many brothers and sisters? Whoa.
- [00:15]
B
Yes.
- [00:16]
A
Wow. That's a lot. Direct first. Nieces and nephews. Wow, that is a lot. So do you give them?
- [00:24]
B
You know what we do. One side of the family, yes. The other side, my brother's kids I don't get to see very much. So we decided that Cheryl and I would take them on a big trip. So we get to know them when they turn 10 years old, we take them on this wherever we're going, some cool place we're going, and we get to know them. Just that one kid. And as these children get older, the older ones we know really well. The younger ones I still don't know that well. So there's eight on that side. And the other one, my sister's daughter, we give her gifts all the time. I see her all the time.
- [00:59]
A
Wow, that's amazing. That's great. Very cool to be part of such a big family. So the reason that I'm asking, Joe, and the reason I'm asking about gifts in particular is because we are going to answer a question from a caller who has a question related to giving gifts to nieces and nephews. And I think this is something pretty much everyone who's listening, or most people who are listening, think about. Everyone who's listening has family of some form or other. And. And we often talk about how to financially prepare for your children. And we talk about financially preparing for taking care of your parents, elderly parents, or grandparents. We're usually speaking at the vertical side of the family tree. We rarely talk about the horizontal side of the family tree. So I'm excited to go there today.
- [01:48]
B
Sounds like fun.
- [01:50]
A
Then let's get started. Welcome to the Afford Anything podcast, the show that knows you can afford anything, not everything. This show covers five pillars. Financial psychology, increasing your income, investing, real estate, and entrepreneurship. It's double I fire. I'm your host, Paula Pant. I trained in economic reporting at Columbia. Every other episode I answer questions from you and I do so with my buddy, the former financial planner, Joe Salsihai. What's up, Joe?
- [02:14]
B
Paula, I have the Ferrari mug today, which means, like a well oiled machine, we're gonna really ride.
- [02:23]
A
Wow. I've got sitting here my VGSAX coffee mug. This was given to me. It was a gift from a listener. So thank you to the person who gave this to me.
- [02:33]
B
But you're not drinking Those pens?
- [02:34]
A
No. Yeah, I use the coffee. It's too beautiful. I don't want to risk staining it. So I don't use it to drink liquids out of. So I use it as a holder for pens and markers. And then to actually drink liquids, I use just this stainless steel cup right here, which if I, I don't. Well, I guess I'm not going to stain it because it's stainless.
- [02:57]
B
Wait a min.
- [03:00]
A
I was about to say if I stain it, I wouldn't be upset, but you know, I, I suppose stainless is in the name, isn't it?
- [03:06]
B
I love just hearing the science going on in Paula's head as it occurs. Wait. Oh, oh.
- [03:13]
A
That's why they call it stainless steel.
- [03:16]
B
Incredible. Wait a minute. I wonder what this non stick paint.
- [03:20]
A
Oh, well, let's roll into our first question which comes from Nick.
- [03:27]
C
Hi Paul and Joe. This is Nick from Dallas. I was calling with a question about giving gifts to family members as investments. Recently became an uncle and was wanting to gift my nephew a investment account as he grows up. And I would give contributions to it year over year for him to have a nest egg when he gets to college. And I wasn't sure what the best way to do that would be. His parents were already opening a 529 for him, so I was considering just doing a standard brokerage account. But I wasn't sure if an IRA would be better or what my options, since I'm not his parent. Appreciate any insight you guys can give and look forward to your answer.
- [04:05]
A
Thank you, Nick. Thank you for the question. I love that you want to take care of the horizontal branches of your family tree. My recommendation, Nick, is that you open a 529 plan and name your nephew as the beneficiary of that plan. As long as they have a US Social Security number, you can name them as the beneficiary of that plan. Then they will have that 529 that's available for them when they're ready to either go to college or go to trade school or vocational school or whatever it is that they decide to do when they become an adult. Actually, you can spend 529 proceeds on K through 12 education as well, but that money is available for qualified educational expenses. You can go ahead and open it yourself and name them as the beneficiary. I would not, by the way, open an ira because money that's contributed to an IRA has to be earned income. And so for children that earn an income, there are plenty of kids, child actors, kids of that nature who do earn an income. Child YouTube stars who earn an income. For kids with earned income, that's a great vehicle, but that's not the situation here.
- [05:15]
B
The cool thing about the 529 plan, too, now if you don't use it for education expenses, it can be rolled into a Roth later on, possibly. So.
- [05:24]
A
That's right. Yes. That's a recent legal change.
- [05:27]
B
Yeah. So that could be attractive. You know, I'm going to give a little. A little more nuanced answer because I think, Paula, directionally, I like where you're headed. But here's what I worry about with gifting money. I like the 529 plan. Even though you have that Roth option later on. The beneficiary is the Roth option later on. What I also know is that if Junior decides to not go to college or parents are putting enough money in that could be overfunded. This could be for other things. So the first thing I'd want to talk about is, Nick, what are your goals with this money? Is it education or is it all the other stuff in life? Is it a head start on retirement? You know, you, you kind of mentioned about having a nice next step. What if Junior could spend time living and not have to save so much for retirement because you've already done it for them to some degree? I don't know. I would start there. The first thing that you could do. And I don't know if you know this, so I'm going to throw this out. You might already know it, but that is anybody can give money to a 529 plan. So even though your brother or sister opened the plan, the parent opened the plan. You can just put money in that plan, too. Multiple people can add money to Junior's 529 plan.
- [06:45]
A
Wait, Joe, can we clarify something? Does Junior have a 529 plan so far or is Nick opening Junior's first 529 plan?
- [06:53]
B
No, no. Nick said that Junior's parents are opening a 529 plan already. So he thought that was off the table. My point is it might be on the table. Putting money into their plan versus starting a second one.
- [07:06]
A
Got it. I'm sorry, I missed that portion of Nick's question. So, I mean, yes, Nick can contribute to the existing 529 or can open his own.
- [07:14]
B
Now, if Nick wants to keep it separate for some reason to brag about how much money the uncle gave versus mom and dad, you can do that. Your nephew can have money in different 529 plans. There's a few little rules around that, but nothing huge. So not a big deal opening a new one. Plus, if you don't like the administration, there's a great website called savingforcollege.com that you can go to that will grade a 529 plan on the investment choices on the investment fees. So it's much like, you know, Paula, you and I talk about Morningstar for mutual funds or exchange traded funds. This is kind of like the morning star of 529 plans. So start a new one. If you don't like that one, put money in that one, that's fine. Another option would be to create, and this is something you alluded to, Nick, which is just opening a regular brokerage account for your nephew. Here's why I don't like that. There's this thing when your nephew goes to apply for financial aid called the expected family contribution. And this thing's a little bit of a bear because it seems so convoluted to parents. Like how do you make sure that you fill this out right and there's people that understand it and people who don't. We can actually do this fairly quickly. Walk through expected family contribution in kind of a broad sense, the thought process behind this is any money in your nephew's name. The government who created the fafsa, which is the form that you fill out to calculate expected family contribution, the government wants education to be the number one priority of the person who's getting the education. So pretty much every dollar between the time that your nephew goes to college and the time that they leave college, they're going to make sure that every dollar that could be spent that's in your nephew's name is either spent or goes against any financial aid that you would get that is need based aid. Any aid that's merit based aid, that's going to be something different. But need based aid, if you have a brokerage account in your nephew's name and you're contributing to that, you're going against any dollar that your nephew may have gotten for need based financial aid because we don't know what the situation is going to be in what, 18, 17 years from now. So I don't like ensuring the fact that any need based aid that your nephew would have gotten that now he won't get because pretty much that's what you're going to do. If you're okay with that, then certainly it cleans up what I'm about to say by a lot what I had some clients do, Paula, back In the day. And I have some friends that have done this. They will just open up a brokerage account in their name. It's a separate brokerage account. So, Nick, it stays in your name. It's your brokerage account. You have one beneficiary on the account, and it's your nephew. So segregate it from any other account you have. Maybe put it. If all your money's at Fidelity, put this one at Schwab. Just so it's a separate account. It's a separate deal, and it only has your nephew's a beneficiary. So if something happens to you, your nephew gets all the money. Your nephew turns 18 and you're ready to distribute the money. There's some laws around gift taxation that you have to follow. You can still give your nephew a ton of money every year and empty out that account over the years that he needs it or wants it, or you want to gift it to him and. And maybe gifted to them over a few years versus one year also, by the way, if you've highly appreciated stock or a highly appreciated index fund, which would be a place you'd probably invest in a good index fund, you can just gift those in kind to him. So let's say, Paul, I'm giving you money. I don't have to cash in this highly appreciated index fund, and I pay the tax. I can gift you the fund in kind. We do something called an academic account transfer from me to you. It's actually fairly easy to do when you just involve the people at the institution. Create an accountant. His name at the time gifted over to him if he's in a lower tax bracket than you, or he may pay less tax, or heck, you. You built this money for him anyway. Let him pay the tax, regardless of the situation. He then cashes it in. He pays the tax because it was meant for him anyway. So you can get around the taxpayer that way. And you're in.
- [11:53]
A
And if he's younger, he's likely going to be in a lower tax bracket.
- [11:56]
B
Sure. Yeah, absolutely. I saw people do that. They will just accumulate money in their name in a separate account that's dedicated for that nephew. And if something happens to you, a hundred percent of it goes to him because of the beneficiary designation. But I think that's a long way, Nick, of saying that the one thing I would be wary of would be opening a brokerage account in your nephew's name wherever you live. By the way, that's called either an UTMA or an ugma. Account, uniform gift to minors Act. That is because back in the day, a long time ago. You want to hear a good story, Paula?
- [12:33]
A
Yeah.
- [12:34]
B
Before UPMA and UGMA designations happen, this is what wealthy people would do. They would go, I've got a lot of money in appreciated stocks or I have all of, all of these assets and I don't want to pay tax on them all. Wait a minute. I had a baby and the baby is in a way lower tax bracket than me. So here's what I'm going to do. I'm going to give all my money to Junior, wink, wink, nod, nod, you know what I mean? And then when I need the money, I just take it back out of Junior's account and I spend it. And the government went, no. How cute. This is implying. So back in the, for the most part back in the 1980s, the uniform gift to miners and uniform trust to minors, UTMA or ugma, depending on the state that you're in, those laws kind of came about because of all the tax sheltering going on. And what these laws say is that any money in, and this is what you want this for, Nick. So this doesn't apply to you. Any money spent out of your nephew's account has to be spent on your nephew stuff. And it can't be for, listen, I'm going to start charging my nephew rent or something ridiculous. It's something specific to him. So you know, nephew goes on high school trip to the nation's capital to visit all the museums and they need X amount of money for that trip. Fantastic. Family has dinner together. You don't, you can't take his portion.
- [14:08]
A
His portion we're gonna pull up split wise, we're gonna split the bill, right? The eight year old is in charge of know is responsible for this portion right now.
- [14:19]
B
Will you get audited if you do that stuff? Probably not. But those rules exist for a reason and I like them. You know, you really want this to be for your nephew. You don't want this to be commingled fund. That is why if you did go to opener, if anybody who's tried to open an account for either a child or a nephew, they're like, what is this? UTMA or ugma? That's how those came about.
- [14:40]
A
You know, there's also, and this is a non conventional answer, but there's also my other favorite way of setting money aside for the next generation. Joe, you're never going to guess what I'm about to say. It's buy a rental property who knew? It's my answer to everything.
- [14:58]
B
Well, this is going to require some care and feeding, but I don't hate this answer. This is a. This could be really good.
- [15:05]
A
Nice. Okay, well here is the ideal way that this would play out under ideal circumstances. You find a rental property that you can put on a 15 year mortgage and it at a minimum is cash flow neutral to you on a 15 year mortgage. 15 year mortgages of course have much higher monthly payments, although they do have slightly lower interest rates. But if you can find a rental property and it can be cash flow neutral on a 15 year mortgage, then essentially the money that you're contributing is simply the down payment money, plus maybe some initial like emergency fund reserves in order to get into this. So you frontload that investment, you never have to put any money out of pocket into it again. And because you've got it on a 15 year mortgage, then let's say that Junior right now is 3 years old by the time Junior turns 18. This property is now paid in full. Or you know, heck, even if Junior is 7 years old, it's paid in full when they're 22, 10 years old, paid in full when they're 25. You get the picture, you know, like no matter what, it's going to be paid in full when they are relatively young and can make good use of it at that young age. Once that property is completely paid off, you then have two very good options at your disposal. You can either sell the property, which will incur capital gains tax, but you can sell it and have a big lump sum, or you can use the enormous cash flow.
- [16:38]
B
Hold it.
- [16:38]
A
Yeah, hold it. And use the enormous cash flow that comes from having a fully paid off rental property to create sort of a, you know, a monthly income stream for Junior.
- [16:50]
B
A money tree. Like a. You just created a pension for them.
- [16:54]
A
Exactly. And then if Junior has a hand in helping manage it, if Junior can get involved in some of the management, the repairs, the maintenance, I mean, and maybe the rental property is out of state so they can't necessarily do physical hands on work. But if they can at least have some kind of an insight into the behind the scenes of coordinating with the out of state property manager, you know, they learn a bit of responsibility too. They have a little bit of, of buy in. So it's not just money that's being handed to them. They are learning how to manage an asset that creates an income stream.
- [17:31]
B
I like that. No matter what you do, Nick, I love the idea of them helping you with the rental property. I also like if you buy some investments when they get old enough to start introducing them to the investments that you chose and how you chose them and why you chose them. And you know, if you look in inside of these exchange traded funds and they see Nike in there, they, they see maybe some of their other favorite companies and they actually own a piece of those companies, like no matter what you do, investment wise, I think involving them in the tracking of it is very educational. I've spoken with a lot of people, by the way, about teaching kids about money. The lesson, Paula, people always want to teach kids is how not to get into debt. And by the way, whenever I used to speak at high schools, I haven't spoken in high school in a few years, but it seems like every time I speak at a high school, the question I get asked most is how do I get into serious debt up to my eyeballs, like over and over and over. How do I get a loan on a truck? How do I get a loan on a house? How do I get a loan on whatever the thing is that I want and adults really want to talk about that for whatever reason. I don't know why, to some degree, maybe I haven't picked the lock on it, but to some degree it feels like kids need to learn their own lesson there, maybe, maybe not. Or they need the cautionary tale, but then they touch the stove. Where you'll get kids in high school really excited is the rule of 72. If I can just cobble together a hundred dollars today and I don't touch it till I'm 65 and I can apply the rule of 72 to that and you just walk them through on your hands. That math. People get excited. You mean I could save a little bit of money today and I could be wealthy in my 60s? Yes, that excites the heck out of them. Guess what? You might be just a few lawn mowing jobs away from being a millionaire.
- [19:30]
A
Thank you for the question, Nick. Among this array of options, please call back and let us know which one you chose. We're going to take a moment to hear from the sponsors who make the show possible. And when we return, we're going to talk about how to protect yourself from inflation, which is something that we've all had to battle. Hey, folks, let me tell you that drinking and driving is the decision that will change your whole world. Things will never be the same once you get a dui because legal fees and time in court are just the beginning. Getting into a crash is another way your world could be irreversibly changed after drinking and driving. Your vehicle may not be the only thing that gets damaged in that crash. You could face a life altering injury or even death, but you're not the only one who could face those consequences. Your decision to drink and drive could permanently change someone else's world, whether you injure them or leave their loved ones grieving. The next time you're out drinking, call a rideshare, a taxi, a sober friend, or a designated sober driver. Always plan for a safe ride home. The only decision that will change your world for the better is the decision to call for a sober ride. It's never worth it to drive drunk. Don't risk it. Drive sober or get pulled over. Paid for by NHTSA so if you've been looking at my Instagram stories lately, you have noticed that I've been reconnecting with the kinds of books that I used to read when I was like 88 to 10 years old. Specifically, I'm thinking about the goosebumps series by R.L. stine and the reason I reconnected with this is because I watched R.L. stine teach a class about writing on Masterclass and it made me want to go back and reread the books. With a new appreciation for the craft, Masterclass really opens your eyes and with plans starting at $10 a month billed annually, you get unlimited access to over 200 classes taught by the world's best business leaders, writers, chefs and more. You can learn from current and former CEOs like Bob Iger and Howard Schultz. You'll access thousands of bite sized lessons across 13 categories that can fit into even the busiest of schedules. And 83% of surveyed members have applied something they've learned from Masterclass to their lives. Plus, every new membership has a 30 day money back guarantee. Right now, our listeners get an additional 15% off any annual membership@masterclass.com afford. That's 15% off@masterclass.com afford masterclass.com afford this.
- [22:15]
D
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- [22:58]
A
Welcome back. Our next question comes from Diana.
- [23:03]
E
Hi Paul and Jo, this is Diana in the Chicago suburbs. I'm calling because I have a question about TIPS or inflation protected securities. Do I need a TIPS ETF in my portfolio to protect myself and my retirement savings from inflation or can I compensate for inflation simply by adjusting the rest of my portfolio to return investments at a rate that exceeds inflation? I'm sort of confused by this. And if TIPS or an inflation protected bond is the way to go, what should people in their peak earning years do to deal with the tax implications of a TIPS etf? Thank you so much for all that. You guys do look forward to hearing the answer.
- [23:57]
A
Diana, thank you for the question. My answer is simple. No, you do not need TIPS in your portfolio and you do not need a TIPS etf. Except, except if you have money that you intend to use in the next three to five years, there it is. Yeah. If there is some particular savings goal that you have, maybe you want to make a down payment on a home and you really want to buy this home three years from now, that's the money that you would put in tips. Other than that, no. If you're planning on spending the money in five or more years, then no, you do not need to put it in tips. You can put that money into equity index funds and other types of assets where the growth is going to outpace inflation or is likely to based on historic norms.
- [24:49]
B
I love the goal of beating inflation. I think people forget about that all the time.
- [24:52]
A
Yeah.
- [24:53]
B
They don't think about the fact that it's nearly impossible to save dollar for dollar, especially when it comes to big goal like financial independence. So for these big goals we have to beat inflation. So Diana, you're right on there. I think the place, Paula, to phrase why you're correct by saying some of these long term assets is because if you think about inflation, invest in the things that are causing the inflation.
- [25:21]
A
Yeah, yeah, exactly.
- [25:23]
B
If you do those, you will beat inflation. And where do you see inflation? At the grocery store. So invest in grocery stores. You see it at the mall. So invest in those. And I'm not saying to invest in individual companies. I'm saying that by investing in stocks in the economy, these are the companies that are going to, over longer periods, ride out inflation and beat inflation if they're going to succeed. You and I, Paula, both like index funds because you don't have to clean it. It will find the companies, the index will find the companies that are more successful beating inflation by keeping them in the index and they will weed out the ones naturally. So Every year you've got companies leaving the S&P 500, you've got companies entering the S&P 500. If you own the S&P 500, guess what you got to do, right? Nothing.
- [26:12]
A
Exactly. Index funds are self cleaning, they are self managing. All you have to do is decide what your asset allocation is. Decide what mix of large cap, small cap, domestic, international. Decide that mix. We've had a lot of previous episodes where we've gone into that, so we won't repeat that here, but pick that asset allocation. Invest for the long term. You're good. Now the exception, of course, let's talk about this three to five year thing. If there is something that you want to buy within the next three years, some major purchase, maybe you want to buy a car in cash, maybe you want to make a down payment on a home, maybe you are planning on paying for a wedding in the next two years, right? Those types of very big ticket purchases that are going to happen in a relatively short three year or less time span, that money you do not want invested in any type of equities, that's the money that you would want to put into some cash or cash equivalent that is inflation protected, but that doesn't have the risk of principal loss. That's how you'd want to treat that money that you're going to spend in the next three years. Now, I think money between three years to five years, money that you're going to spend in between three years to five years is a little bit more of a gray zone because we've got a little bit more time there. Let's say that you've got a goal of buying a home five years from now rather than three years from now because that goal is quite a bit further out. I mean, five years is you've got 66% more years, right? Because it's a little bit further out, you're in a bit more of a gray zone. And so my follow up question then is how flexible are you on the timeline? If your answer is I definitely want to buy a house in precisely five years, then I would invest it more conservatively. If your answer is, nah, I'd like to buy a house in ballpark five years, but I'm willing to wait for six or seven if that's necessary. Cool. Then I think you can be a little bit more aggressive when it comes to that three to five year window. The flexibility is going to influence the degree of how conservative to how aggressive you treat that bucket.
- [28:31]
B
In my book, Paula, being a farm boy, what resonates with me on this is growing seasons, which is having worked in fields and having a huge garden growing up, every investment has a growing season that it's appropriate for. If you plant a stock and you plan to pull it up a year from now, who knows if it has grown by then? You have no idea. But for those short growing seasons, tips, you're not going to really beat inflation, but you're at least not going to have to worry about inflation because that's what they're designed to keep up with.
- [29:07]
A
Right? Exactly. But here's the thing, Diana. You asked about a TIPS etf. Honestly, I wouldn't buy a TIPS etf.
- [29:15]
B
I don't think you need that either. Good point.
- [29:17]
A
Yeah. I would go to treasurydirect treasurydirect.gov and just buy TIPS directly.
- [29:23]
B
Preach, girl.
- [29:24]
A
Yeah. Why get the ETF when Treasurydirect.gov is, as the name implies, a way to directly buy from the Treasury?
- [29:33]
B
And you know me, generally when people call in and they ask about fees, the fee doesn't matter. In this case though, this is my big point about fees. It depends on what you're getting.
- [29:43]
A
Right.
- [29:44]
B
And I think, I think by buying a TIPS etf, you're getting nothing.
- [29:47]
A
Yeah, yeah. You're paying the fees for no reason.
- [29:50]
B
It's safe enough just by buying the tip itself.
- [29:54]
A
Yeah, exactly. So treasurydirect.gov it is an official website of the U.S. government. You can buy TIPS directly there. That's what I would recommend if you want some tips for the short term money that you're holding on to. Now you also asked about tax implications. I've got two answers to this. The direct answer and then the questioning. The premise of the questioned answer. The direct answer is if you want to protect yourself from the tax implications of a tax TIPS fund or of any bond fund, keep it in a pre tax account. In fact, we actually have a free handout. It's called the asset location cheat sheet. You can download it for free@affordanything.com asset location. And one of the points that we make within that is to hold your bond funds in pre tax accounts with the exception of tax free municipal bonds. Otherwise you don't want to be holding bond funds in a taxable account. You want them in pre tax accounts. Now that is the direct answer to your question, if the question is how do I handle the tax implications? Now that I've given that answer, we're going to take a step back and I'm going to question the premise of the question because if this is a bucket of money that you're going to spend in the next three years, then you don't want it in a pre tax account unless you're.
- [31:19]
B
That's the hard part.
- [31:20]
A
Right. Unless you're on the verge of turning 59 and a half.
- [31:24]
B
Or over.
- [31:25]
A
Yeah, or over. Right. Unless you're at the age in which you can easily tap a pre tax account, then you're not going to want to put it there. So assuming that you're Nowhere near age 59 and a half or, or better, then put it in a taxable account and just take the tax hit.
- [31:43]
B
And this is where, you know, the goal supersedes everything. Too often we optimize for taxes and we need to optimize for money being available when we need it.
- [31:54]
A
Yeah, exactly.
- [31:55]
B
But Diana, and, and this was already implicit, Paula, in your first answer when it came to timeline. But during your peak earning years, you're not going to worry about the tax implications of having tips in your portfolio because your money for financial independence anyway is probably not within that five year period. And so you want us to worry about the tax implication. That'll be a non issue.
- [32:23]
A
Joe, can I also talk about one other. And Diana, you did not ask about this, but it relates to the answer that we are giving. And so I want to broaden this out for everyone who's listening when we talk about protecting a bucket of money that you are setting aside for some expenditure in the short term, something within the next three years. There are legitimately big ticket expenses. A wedding, a down payment on a home, buying a car in cash. But then there are these smaller things like you know that 18 months from now you're going to your cousin's wedding and that's going to cost $2,000 for the flight and the hotel. Don't bother playing these games when it comes to that kind of money because it's such a small amount that the juice isn't worth the squeeze. And I say that because I know that there are some people, you know this, of course, this is a community of personal finance enthusiasts and we want to optimize our money. But there is definitely such a thing as excessive optimization where you're spending so much time and so much energy trying to optimize the $2,000 that you've set aside to spend 18 months from now.
- [33:41]
B
When truly what we should be optimizing is how much money our time is worth.
- [33:46]
A
Right, Exactly.
- [33:48]
B
If we optimize for that.
- [33:50]
A
Right.
- [33:50]
B
First had that at the top of the filter. We do great things.
- [33:56]
A
Exactly. There's got to be a monetary threshold. And what that threshold is is going to be different for everyone. Depending on how much you make, depending on, depending on where you are on the wealth ladder. As Nick Magiulli talked about in our recent interview, that threshold, that monetary threshold is going to be different for everyone. But think, and this is an invitation to everyone listening, think about what your threshold is for whether or not it's worth your time to inflation protect a certain bucket of savings. So thank you, Diana, for the question. We're going to take one final break to hear from the sponsors who make this show possible. And when we return, we are going to answer a question that relates to changing your state of residence in order to optimize for taxes. That's coming up right after this. You know, as kids we have all of these big dreams and ambitions, right? To be an astronaut or to be an actor. As we mature a little, we ask the question, what skills and talents do I have that I can share with the world? Right? It's less about what do I want to do? I mean, that's important too. But it's also what can I contribute? What can I give? How can I make a positive impact? One major way to do that is by owning your own business or running some type of an organization. It could be a nonprofit or it could be a social enterprise. Whatever it looks like for you, you're going to need a website and a payment system and a logo and branding and a way to advertise to customers. You're going to need all of the infrastructure that comes with taking on this project. That's going to be the way that you contribute to the world. That's where today's sponsor Shopify comes in. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e commerce in the US from household names like Mattel and Gymshark to brands that are just getting started. So if you need to design a website, they've got beautiful ready to go templates. If you need help enhancing product images or writing product descriptions or generating discount codes, Shopify's AI tools can help you do that. They can help you find customers with easy to run email and social media campaigns. And they have award winning 24. 7 customer support. So turn those dreams into and give them the best shot at success with Shopify. Sign up for your 1 month $1 per month trial period and start selling today at shopify.com Paula go to shopify.com Paula shopify.com Paula get in the zone.
- [36:25]
F
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- [36:51]
B
Get in the zone.
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F
AutoZone restrictions apply.
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G
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- [37:12]
H
Hebglis Lebricizumab LBKZ a 250mg per 2ml injection is a prescription medicine used to treat adults and children 12 years of age and older who weigh at least 88 pounds or 40 kilograms with moderate to severe eczema, also called atopic dermatitis that is not well controlled with prescription therapies used on the skin or topicals or who cannot use topical therapies. Ebglis can be used with without topical corticosteroids. Don't use if you're allergic to Epglis. Allergic reactions can occur that can be severe. Eye problems can occur. Tell your doctor if you have new or worsening eye problems. You should not receive a live vaccine when treated with Epglis. Before starting Epglis, tell your doctor if you have a parasitic infection searching for real relief?
- [37:47]
G
Ask your doctor about eglis and visit epgliss.lilly.com or call 1-800-lilyrx or 1-800-545-597.
- [37:57]
C
Foreign.
- [38:02]
A
Welcome back. Our final question today comes from Pritvi.
- [38:08]
I
Hey Paula and Joe, I love the podcast. I've been listening to the show for about a year now and it's one of my go to sources to learn about personal finance. I have a two part question about where you retire affects taxes in retirement. The first part of my question is whether a traditional or a Roth 401k is better in terms of state taxes and I guess this applies to IRAs too. I know there are states that don't tax income and also those that specifically don't tax retirement income. In this light, should people just do pre tax contributions until it's time to retire and then move to one of these states. Part two of my question is how state taxes work with a pre tax 401k if one moves abroad. What if somebody who lives in one of these aforementioned states decides to retire abroad? Would they just not pay state taxes? Personally, I've just done Roth 401 and Roth IRA contributions. Since my wife and I are in the 12% tax bracket. However, I wonder if I should just make pre tax contributions and come retirement time move to a state that doesn't tax retirement income or maybe even abroad. Would that percentage really add up over time? Is this question worth pondering over or should I just continue making Roth contributions and forget about taxes? I love all the great advice you share and I hope to keep learning from you for many more years to come. Thanks Ritvi.
- [39:42]
A
Thank you so much for the question. And let's unpack this Joe, because there's a lot to discuss here. So the first thing that I want to lay out out just to give a background and a basis for the upcoming discussion, there are seven states that do not have a state income tax. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming. And there are also two other states, New Hampshire and Washington, that almost don't have a state income tax. Specifically New Hampshire doesn't have an income tax, but it does tax interest income and dividend income. But it is phasing that tax out and that tax is going to be fully repealed by 2027. And on top of that, Washington state, they don't have state income tax, but they do have long term capital gains tax on high earners. So there are seven states and or nine states depending on how you want to bucket those.
- [40:43]
B
It is interesting, you know, when you think about that Washington tax though, if you're talking about moving during your retirement years, then you wouldn't be a high earner. So it might not affect you.
- [40:52]
A
Well, I suppose it would depend on how big his retirement portfolio is because it's.
- [40:56]
B
Yes.
- [40:56]
A
Yeah, it's a long term capital gains tax. Currently it's set at 7% of profits that exceed 270,000.
- [41:03]
B
But I can already see the, you know, the spreadsheet, the calculator, you know, if I really want to move to Washington, what my numbers would look like.
- [41:12]
A
And Washington would be a beautiful state to retire in or to live in generally. I mean it's an absolutely gorgeous location.
- [41:19]
B
Next to Texarkana, Texas. I think it's pretty good.
- [41:23]
A
Well, and Joe, you live in one of those places one of the seven states with truly no state income tax.
- [41:29]
B
Yeah, but property taxes are higher, though.
- [41:32]
A
Exactly.
- [41:32]
B
There's no such thing as a free lunch. Right.
- [41:34]
A
Right.
- [41:35]
B
So where do they get you if you're going to own a home? So if you're going to rent, that's fine. Which, by the way, Paula, let's start off with on my end, I'm thinking the easiest answer is if we talk about going abroad. Because if you're going abroad, I think a key thing to do is to pick a state that's going to be your residence in the United States. If you're going to be a US Citizen, you're going to to just be living abroad as a US Citizen. You have a state of domicile. The cool thing is, and a lot of people don't think about this, you get to pick I mean, you can decide where you want to be before you move to Portugal or wherever the heck you're going to go. So choose one of those states where you have your, quote, permanent residence that you're a resident of that state and then move abroad. I think that's a fine strategy that a lot of people that not a lot of people, but some expats have told me they didn't even consider before they moved. They were more concerned and they should be and we'll get to this later with what am I going to do when I get abroad? Where am I going to live? What am I going to do there? Much more concerned about that than thinking about the tax they're going to pay on any money with the US Income tax form.
- [42:48]
A
Right. And if you go abroad, in some ways, you get the best of both worlds. Because, you know, Joe, to your point, the states that don't have state income tax, they still have to generate revenue and they generate that revenue in other ways. So in Texas, for example, property taxes are astronomical relative to most other states in the nation. But all of that said, there are other elements that I want you to consider before you're choosing a state in which to establish residency beyond just the state income tax. So, for example, what are the estate planning implications of residency in a given location? Because the estate planning implications having a will, having a trust, having property in a given location, it varies a lot, state by state by state by state. And an estate planning attorney can sit down with you and explain some of the implications between one state versus another. I actually my parents and I sat down with an estate planning attorney and she talked to us about the implications of property located in Georgia versus property located in Florida. Having property located in Florida is a lot more complicated than having property located in Georgia. So yes, Florida may not have state income tax, but there are additional complications that come from owning property there for estate planning purposes that don't apply in other states. Right. So those are things that you want to consider, particularly as you reach your retirement years. You're thinking about your heirs. You want to balance the income tax implications with the estate planning implications. Another thing that you want to think about, and I'm directing this to everyone who's listening. If you are married and you do not have a prenup, do you live in a community property state or do you live in an equitable distribution state? You should know that because that's going to make a big difference. Particularly if one of you is a business owner and started that business during your marriage. That's going to have huge, huge implications if that marriage were ever to be dissolved. Those are some of the things that don't get talked about when people talk about establishing residency in a given state. Income tax is only one element of a much, much bigger set of implications.
- [45:08]
B
I'd also like to address some of the pieces which fly under the radar that I think shouldn't when it comes to this decision, Paula, because especially in the financial communities like ours, we're people that are very careful about making sure we make decisions which reflect the bottom line well, which this question on the face of it really could help the bottom line. I love your question at the end, by the way, about how, you know, is this something that could pay big returns over time? And the answer is yes, potentially it could. However, I think sometimes in our community we think of this as a great hidden strategy. And yet when I look at the quote, high income tax states and the high taxation states of New York, Connecticut, California, there's a ton of people who are living phenomenal lives in these states even though they are paying a higher tax on the money that comes in. And part of that is the people they're surrounded by, the community that they have, the life that they built. And I feel like sometimes we make a decision that is a great financial decision and we don't think about these seemingly non financial factors that add incredibly to our happiness. And when you look at studies on longevity and happiness, community, whether you're an introvert or an extrovert, is a huge piece of that. And to discard a community of people where you walk into a grocery store and the, the clerk at the grocery store knows maybe not your name but knows your face and you Go over to a friend's house on a Friday night to play cards or to have a. Have just a cookout with them. Discarding your community and being more isolated because we didn't think enough about community in that place that we're going to, whether it's abroad or just changing states during retirement. I find that to be a big mistake, especially that money nerds fall into. I think it's a money nerd trap. I think the larger community doesn't think at all about that. They do think about things like following my kids, which can also be a mistake. Right. I have a child that has a kid and I want to be a great grandparent. Recent story in the Atlantic talking about how grandma and grandpa are tapped out because they become free babysitter. And your daughter or your son loves you and loves the fact that you're down the street, but they also have their own lives and they have friends as well. And if you don't create community outside of that child and those grandchildren, your grandchild turns 14, 15 years old. And they don't really want to spend time with grandma or grandpa that much. I mean, they love seeing you, but you see people's world kind of disintegrate and we isolate and that's not good for anybody.
- [48:13]
A
Yeah, you never want to let the tax tail wag the life dog.
- [48:17]
B
Yeah.
- [48:18]
A
And beyond, just anecdotally, I mean, if you look at the data, the highest income earners and the households with the highest net worth are concentrated in California, New York, Illinois, Florida.
- [48:33]
B
High tax, sometimes high tax areas.
- [48:35]
A
Yeah, exactly, exactly. Florida, of course, is a low tax area. No state income tax. But most of the areas where you see that concentration of wealth is high tax areas. And certainly there, there are population changes that are happening. There is net migration happening out of California as more people move to Texas. It's kind of gotten a, to be a bit of a joke, like people in Texas saying, like, all right, we, we don't want any more of you. No more Californians here.
- [49:04]
B
You know, we heard that last year when you and I were in Idaho.
- [49:08]
A
Yeah, yeah.
- [49:09]
B
As well. My, my Uber driver was talking about, there's a ton of people from California now.
- [49:13]
A
Yeah, I was just about to say Idaho, actually. A lot of people are from California are moving to Idaho. And so, so yes, we do see population changes and we see net migration flowing out of some of these high tax areas. That's true. And it is also simultaneously true that at least for now, the highest concentration of wealthy people are also in these high tax areas because this is where business happens, this is where commerce takes place, this is where things move. But I think that points to two kind of different trains of thought because there's the argument that I think is a very reasonable argument that there is benefit to spending your highest earning years, your peak earning years in some of these high tax centers that also have the greatest opportunity. Of course, this is obviously going to depend on what your career is, what your industry is, what your ambitions are, what your goals are. But there's certainly a reasonable argument to spend your peak earning years in high cost of living and often high tax locations and then retire to a lower cost of living and lower tax location. And that's what Preetvi is asking about.
- [50:36]
B
Yeah, I would think first about community and lifestyle and then taxation. I wouldn't lead with taxation and then community and lifestyle.
- [50:49]
A
Okay, but let's just say then, Joe, hypothetically, let's say that Prithvi has a bunch of family and friends who happen to live in Florida, right? And he could have great community and great lifestyle by moving to Florida and joining up with all the family and friends that he has there. Under that set of circumstances, would you recommend that he forego a Roth and contribute largely to pre tax accounts during his peak earning years?
- [51:19]
B
Not exclusively. Not exclusively. Because I'm so in love with the flexibility, the tax flexibility that the Roth gives me later on. If I'm comfortable biting the tax bullet today, why wouldn't I do that? If it's comfortable and it makes the rest of my life easier, Every dollar I put in that Roth makes things easy from here on out, pre tax makes my life easier today. And then in this scenario especially makes my life maybe even better later. But how many times have you seen the future change?
- [51:53]
A
Right?
- [51:53]
B
I mean, this is a big risk in the CFP board that I think a lot of people don't think about, which is time horizon risk. And that's the risk that your horizon or your goals change. And when that changes and I'm in a pre tax position that helped me now, it might change stuff later. So I feel like for me, optimizing for that flexibility still holds. Now if I'm getting, if I'm getting. I don't know. Yeah, I don't know. I still think the Roth is a better option. Even if mathematically it might be a little worse. I think I might still choose the Roth.
- [52:38]
A
I would also choose the Roth, but for a different reason, Joe. So you're choosing the Roth so that Prithvi can preserve the flexibility to live in any state, whether it's low tax or high tax. Right. That flexibility is there and that tax triangle is there. I'm also choosing the Roth, but. And I like that reason, but I'm choosing the Roth for a different reason. And it is that we don't know what federal tax rates are going to be at the time that he retires, and they might be significantly higher than they are now. And so by putting money in a Roth account today, we protect ourselves, we inoculate ourselves from whatever that tax rate is going to be in the future because we don't know what the government is going to do, we don't know what tax rate they're going to set. And we don't know if we're going to look back on 2025 and say, wow, remember the good old days of 2025 when taxes were that low?
- [53:31]
B
I'm laughing, Paul, because our mutual friend OG over on Stacking Benjamin's last week said he heard two people a couple weeks ago with the new obbb, the new tax legislation, and the person said, well, now that the OBBB makes this permanent. Oh, and OG started laughing.
- [53:52]
A
Right.
- [53:52]
B
And the person goes, what's so funny? He goes, look at all the past presidents that have made things permanent. Like whenever you get in a case where you think that tax law, no matter what you hear out of Washington, that it's, quote, permanent. Good luck with that.
- [54:08]
A
Right. The structure of the US System is that every four years things can dramatically change.
- [54:16]
B
Yeah. So to your point, the Roth locks it in. I love that the Roth locks it in. And if any of these states decides to change their system, who cares?
- [54:25]
A
Exactly. If any of the states change their system or if the federal government changes the federal tax code or, I mean, anything can happen. Like, we do not know what's going to happen even five years from now, much less 10, 15, 20, you know, x number of years in the future. We just, we simply don't know what type of tax laws are going to get put in place. So why not have the certainty of knowing that this money, no matter what happens to the tax law in the future, this money is protected from getting taxed. I see the Roth very much as a gift to your future self in that regard.
- [55:09]
B
And my freedom to not have to worry about it.
- [55:11]
A
Yeah, exactly. Speaking of taxes, Preetvi, I do have some bad news, which is that you asked about moving abroad. So I feel like it's important to mention that if you move abroad, there is the potential for you to get double taxed because the US Taxes its citizens who live abroad, and the country that you move to might also tax your income. Unfortunately, American expats living abroad often get hit by double taxation. Whether or not that happens, of course, is going to depend on the specifics of where you live, how long you're there, and all types of other complicating factors. So I would certainly recommend getting a tax professional involved before you make that move.
- [56:00]
B
I love this question because how often have we gotten into this, Paula, where in some cases this is a great strategy, but there's a lot to think about.
- [56:09]
A
Absolutely. So thank you, Prithvi, for the question. Joe, we did it again.
- [56:13]
B
Unbelievable. Again.
- [56:15]
A
Joe, where can people find you if they'd like to hear more of your wisdom?
- [56:19]
B
Well, you can find me and sometimes the Paula Pant on the Stacking Benjamin show every Monday, Wednesday, Friday, I, Paula, am doing an introductory webinar for people that just don't understand the basics. They have friends that don't understand the basics of an HSA. This is not going to be HSA 401. This is HSA 101. Like I, I've heard of it. I think I know what it is. Like, what are the basics? How does it work? This will be Wednesday, September 3rd at 8:30 Eastern, 5:30 Pacific. And for details on that, just go to stackybenjamins.com HSA and sign up. And I'm going to walk you through how the HSA works because if you have it available but you feel like people are talking over your head, which happens a lot in the financial world, we've got you covered that night.
- [57:13]
A
Wonderful.
- [57:14]
B
How can people sign up, Joe stackybenjamins.com HSA Perfect.
- [57:20]
A
Well, thank you for being an afforder, for being part of this community. If you enjoyed today's episode, please do three things. First, share this with your friends, family, neighbors, colleagues. Share it with the people, the great people of Alaska, Nevada, Tennessee, Texas, Washington. Oh, I'm trying to do this by memory. New Hampshire five. Well, New Hampshire. Oh, I guess. Yeah. New Hampshire ish. And Washington ish. South Dakota, Florida, Texas, Texas. We got all nine. We did that by memory.
- [57:54]
B
Wait, what?
- [57:57]
A
Share it with the great people of those nine states as well as 41 other states.
- [58:03]
B
Share it with the people at Treasury Direct.
- [58:06]
A
Yeah. Ooh. Share it with your nieces and nephews for whom you are giving gifts, as well as the person who helps you set up that 529, your brother or.
- [58:16]
B
Sister who had the nieces and nephews.
- [58:18]
A
Yeah.
- [58:18]
B
They created the opportunity in the first place.
- [58:20]
A
Exactly. Share this with them. Share this with all of the people in your life because that is how you spread the message of F double I R E. Also, open up your favorite podcast playing app, hit the follow button, and while you're there, please leave us up to a five star review. And don't forget, if you want to learn about why you should not put tips into a taxable account if you're planning on holding them for the long term, you can find that information in our free giveaway, which is called the Asset Location Cheat Sheet, all about where to locate your assets between taxable pre tax and tax exempt accounts. You can Download that@affordanything.com Asset location Again, that's affordanything.com Asset location. Thank you so much for being an afforder. I'm Paula Pant.
- [59:14]
B
I'm Joe Salcehei and we'll meet you.
- [59:16]
A
In the next episode.