Q&A: When a Million Dollars Feels Like a Burden

Summary

Afford Anything Podcast: "Q&A: When a Million Dollars Feels Like a Burden"

Release Date: November 8, 2024
Host: Paula Pant
Guest Co-Host: Joe Salsihai

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Introduction

In this episode of Afford Anything, Paula Pant and co-host Joe Salsihai delve into pressing financial dilemmas faced by listeners. The primary focus revolves around navigating sudden wealth, refinancing an adjustable-rate mortgage (ARM), and choosing between Roth and Traditional retirement accounts. The hosts provide expert insights, practical advice, and psychological perspectives to help listeners make informed financial decisions.

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1. Navigating Sudden Wealth: Stephen’s Dilemma

Listener Question Overview:
Stephen, a 32-year-old accounting professional, recently gained control of a $1 million trust established by his late grandfather. Raised with a "save, save, save" mentality, Stephen now faces the emotional and psychological challenges of managing substantial inherited wealth. He grapples with feelings of unearned luck, guilt, and uncertainty about how to utilize the funds without disrupting his disciplined financial habits.

Key Discussions:

• Sudden Wealth Syndrome:
  Paula introduces the concept of Sudden Wealth Syndrome, highlighting its symptoms such as isolation, guilt, fear of losing money, stress, and confusion. Notable examples include celebrities like J.K. Rowling and lottery winners like Willie and Donna Seeley, who experienced depression and paranoia after sudden financial gains.

  "[00:34] Joe Salsihai: Yeah, absolutely. I think you feel this weight of responsibility to do the right thing with the money."
  "[09:51] Joe Salsihai: Stephen. And I like that too, because by identifying what the issue is, it's easier to solve the problem."

• Emotional Attachment to Money:
  Paula emphasizes that money received as a legacy holds more emotional weight than earned income. This distinction affects how individuals perceive and value each dollar, often leading to compartmentalized financial planning.

  "[14:52] Paula Pant: ... the emotional component of receiving an inheritance ... people attach emotion and value differently to each dollar."

• Strategic Allocation – The “Buckets” Approach:
  The hosts advocate for assigning inherited funds to specific "buckets" based on time horizons and purposes. For Stephen, they recommend dedicating a portion of the trust to secure his retirement (age 65+) while using the remaining funds for immediate and mid-term goals like buying a home or starting a family.

  "[13:04] Paula Pant: If you expand my lifestyle today, I am not going to have the flexibility tomorrow... What do I want to do?"

  "[22:43] Joe Salsihai: ... use a longer term lens ... it buys you more time."

• Psychological Benefits of Securing the Future:
  By allocating funds for retirement, Stephen can alleviate the anxiety of future financial vulnerability, allowing him to make present-life decisions with greater confidence and less fear of jeopardizing his financial stability.

  "[16:19] Joe Salsihai: ... knowing that you have a bucket for the far future ... makes your decision making process in the present much more value of life focused."

Conclusion:
Paula and Joe commend Stephen for his responsible handling of the inheritance. They advise maintaining financial discipline by securing long-term goals first, thereby granting Stephen the flexibility to pursue personal aspirations without jeopardizing his financial future.

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2. Refinancing an Adjustable-Rate Mortgage: Jack’s Inquiry

Listener Question Overview:
Jack and his wife secured a $435,000 physician-assisted adjustable-rate mortgage (ARM) with a 4.875% rate, fixed for seven years. As the adjustment period approaches in June 2030, Jack is uncertain about refinancing options. He seeks advice on timing, lender selection, and associated costs.

Key Discussions:

• Understanding ARM Variables:
  Paula outlines the four critical variables of an ARM:

  1. Fixed-Rate Period: The initial period during which the interest rate remains unchanged (e.g., seven years).
  2. Adjustment Frequency: How often the rate can change post the fixed period (typically annually).
  3. Rate Increment: The maximum rate increase per adjustment period.
  4. Lifetime Cap: The highest possible interest rate over the loan’s lifespan.

  "[33:57] Paula Pant: ... four variables that you need to know... fixed duration, adjustment period, adjustment increment, and total max."

• Strategic Refinance Timing:
  Joe advises acting as the "CFO of your family," evaluating whether to refinance based on current and projected interest rates. He emphasizes monitoring Federal Reserve indicators to gauge future rate trends.

  "[38:03] Joe Salsihai: ... If the Fed signals that we are either going to leave things the same or we're going to lower it, well, then I wouldn't do anything."

• Flexibility and Options:
  The hosts discuss various refinancing strategies, including:

  • Mixed Allocation: Allocating portions of the inheritance towards refinancing while retaining some funds for flexibility.
  • Recasting the Mortgage: Adjusting the mortgage terms without fully refinancing, potentially lowering payments with minimal fees.

  "[45:37] Joe Salsihai: ... recasting your mortgage means you're going to change the interest rate on the product without changing the length of the mortgage."

• Decision-Making Framework:
  Paula and Joe emphasize the importance of understanding personal financial goals, assessment of future economic conditions, and the current lender's terms. They recommend caution and thorough analysis before making refinance decisions.

  "[50:54] Paula Pant: ... Remember how earlier I said that the mortgage is described as the fixed rate period of time... check your loan documents."

Conclusion:
For Jack, Paula advises maintaining the current favorable interest rate for the remaining seven years, given its competitiveness. Joe concurs, highlighting the unpredictability of future rates and suggesting a watchful approach, reassessing closer to the adjustment period by then.

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3. Roth vs. Traditional Retirement Accounts: Jack’s Second Inquiry

Listener Question Overview:
Jack seeks guidance on optimizing his 401(k) contributions. He wonders whether to maximize contributions to a Roth 401(k), Traditional 401(k), or a combination of both. Additionally, he mentions that contributing to a Traditional 401(k) could reduce his and his wife’s tax brackets from 32% to 24%.

Key Discussions:

• Assessing Future Income and Tax Projections:
  Paula outlines critical factors to consider when choosing between Roth and Traditional accounts:

  1. Future Income Expectations: Anticipating higher, lower, or similar income levels in retirement.
  2. Life Events: Potential sabbaticals, caregiving, or chronic health issues affecting future earnings.
  3. Geographical Changes: Relocating to regions with different tax structures.
  4. Business Ventures: Plans to engage in income-generating activities like LLCs or S Corps.

  "[53:16] Joe Salsihai: ... your question in generalities should I put my money into a Roth account versus a Trad account?"

• Bias Towards Roth Accounts:
  Both hosts express a general preference for Roth accounts, emphasizing their benefits:

  • Tax-Exempt Growth: All earnings within Roth accounts grow tax-free, maximizing compounding over time.
  • Greater Contribution Effectiveness: Roth contributions allow more money to remain invested as taxes are paid upfront.

  "[62:23] Joe Salsihai: ... when you put money in The Roth, a dollar in the Roth, any money that dollar makes is 100% mine."
  "[61:42] Paula Pant: Exactly. So think of it as a tiered system..."

• Tax Efficiency and Planning:
  Paula explains the intricacies of tax brackets, clarifying that moving into a higher tax bracket doesn’t tax all income at the higher rate—only the incremental portion. This demystifies concerns about significantly higher taxes when one's income increases.

  "[60:31] Paula Pant: Exactly. ... it's tax bracket is a reference to the sliver of their money that has the highest rate."
  "[60:07] Joe Salsihai: You get to go to work. Because tax brackets are incremental."

• Long-Term Financial Security:
  Roth accounts provide certainty regarding tax obligations in retirement, simplifying tax planning and ensuring complete ownership of retirement funds without future tax liabilities.

  "[62:23] Joe Salsihai: ... It's functionally a Roth account where any money that dollar makes is 100% mine."

Conclusion:
Paula and Joe recommend favoring Roth 401(k) contributions, particularly for individuals expecting to be in higher tax brackets in the future. They highlight the advantage of tax-free growth and increased investment efficiency. However, they acknowledge that individual circumstances—such as anticipated lower future income or specific financial goals—might warrant a blend of Roth and Traditional contributions.

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Final Thoughts

Throughout the episode, Paula and Joe stress the importance of understanding personal financial situations, acknowledging the psychological aspects of money management, and making informed, strategic decisions. By addressing real-life financial questions with depth and empathy, they empower listeners to navigate complex financial landscapes with confidence.

Notable Quotes:

• "[00:34] Joe Salsihai: You feel this weight of responsibility to do the right thing with the money."
• "[14:52] Paula Pant: People attach emotion and value differently to each dollar."
• "[36:05] Joe Salsihai: You have a lot more flexibility than you may realize."
• "[62:25] Paula Pant: ... locking in a lifetime of tax exempt growth."
• "[64:54] Joe Salsihai: Traditional 401k splits your money with Uncle Sam."

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Stay Connected:
For more insights and personalized advice, visit Afford Anything to download the free book Escape and subscribe to the newsletter. Follow Paula Pant and Joe Salsihai on Apple Podcasts, Spotify, or your preferred podcast platform for future episodes.

Transcript

[Paula Pant]

Joe, when you were a financial advisor, did you ever have clients who came into Sudden Wealth?

[Joe Salsihai]

I did. And it is the toughest time, Paula, because as you can imagine, you are emotional about the money. You may be emotional about the circumstances by which you received the money or the people you received it from if it was an inheritance. But heck, I mean, even if you won the lottery, Paula, it's an emotional time.

[Paula Pant]

And so many people listening might think emotional, like, great. Who wouldn't want Sudden Wealth? But it is actually quite challenging.

[Joe Salsihai]

Yeah, absolutely. I think you feel this weight of responsibility to do the right thing with the money.

[Paula Pant]

Well, we are going to talk today to someone who came into Sudden wealth and is now grappling with what to do next. Particularly because his entire life he has been save, save, save, save, save. And now suddenly he's playing with different decimal points. He's playing in a pool of orders of magnitude different than anything he's ever really been accustomed to. So we're going to talk to him. We're also going to talk to a listener who has an adjustable rate mortgage that he's going to have to refinance and is wondering how to game that out. And also we're going to have a discussion about Roth versus Trad retirement accounts. Welcome to the Afford Anything podcast, the show that understands you can afford anything, but not everything. Every choice carries a trade off and.

[Monarch]

That applies not just to your money.

[Paula Pant]

But to your time, your focus, your energy, your attention to any limited resource you need to manage. And that opens up two questions. First, what matters most? And second, how do you make choices accordingly? Answering those two questions is what this show is all about. My name is Paula Pant. I trained in economic reporting at Columbia and I help you prioritize every other episode. We answer your questions and I do so alongside my buddy, the former financial planner, Joe Salsehai. What's up, Joe?

[Joe Salsihai]

Hey. I am sitting here with a cup of Luwak coffee ready to go. Have you had Luwak coffee?

[Paula Pant]

I have not. What is this coffee?

[Joe Salsihai]

Luwak coffee has a better name. I think Luwak coffee is the marketing name.

[Paula Pant]

Wait, is this the Asian civet poop coffee?

[Joe Salsihai]

This is more commonly known as weasel poop coffee.

[Paula Pant]

Yes, Weasel poop coffee. When I was a freelance writer, I used to be a full time freelance writer. I wrote an article for specialty coffee retailer magazine about weasel poop coffee. It actually doesn't come from weasels. It comes from the Asian civet.

[Joe Salsihai]

Yeah.

[Paula Pant]

And they eat the coffee beans and then poop it out and there's something about that digestive process that makes the coffee beans taste better. I suppose there's two things.

[Joe Salsihai]

There's the digestive process, but there also is the animals only pick out. They're very discerning and they only pick out the best coffee beans. It is the least acidic coffee I've ever had. As you know, because you've written about it. There are places in New York where people are paying $100 for a cup of this coffee and I got it when I was in Southeast Asia recently and it's amazing. It's so good.

[Paula Pant]

Well, I hope that you use the energy from that coffee to bring it for this first question, which comes from an anonymous caller.

[Anonymous Caller]

Hey Paula and Joe, Anonymous caller here. I'm 32, work in accounting and make about $80,000 a year in salary. I'm single and rent an apartment where I can pretty easily afford my fixed cost of living with my salary paid off, old car, no credit card debt, no student loans. My question is more money psychology based. My grandfather who passed away in 2012 had set up a trust for me that I gained control of two years ago when I turned 30. The account is worth about $1 million with about 50,000 in a money market fund and the rest is invested in mutual funds and single stocks. I really haven't done anything with the account except reinvest the dividends and mostly operate as if it's not there. I've been raised to live below my means and work and save, save, save. It feels strange to all of a sudden have a lot more wealth than my close friends and none of them are aware of this change and it's weird to inherit this much money because it feels unearned. I became a money nerd before I got control of the trust. I have about $100,000 invested outside of the inherited account from my 401k, HSA, Roth IRA and a taxable brokerage account. I max out my Roth and HSA and with my employer match I get up to 15% into my 401k. I'm putting aside money for a house down payment as well. That all leaves me really tight as far as money left over for non essential spending. Knowing the power of compounding makes me want to not disrupt it and keep feeding money into the machine. Since I have no idea what my life will look like in the future and I want to have a family and home and leave behind money like it was done for me, it's really hard to predict how much I need since that's so different from where I'm at now. And I always find myself on the overly cautious side with money. I didn't want to use the term Coast Fi for Joe's sake, but it kind of feels like maybe that's been reached. What kind of things do you tell people once they reach that sort of critical mass with investing and maybe they can afford to back off some, or should I keep going since I don't know what the future is going to hold? You've had discussions with people about windfalls, you know, from inheritances and waiting to mourn and not make rash decisions. And now that I know that I won't, you know, go crazy with it after that period, what do you kind of tell people whose financial life has completely changed in a positive way to help them feel safe about using that money finally, Right? Thank you.

[Paula Pant]

Anonymous thank you for the question. It is such a beautiful question. And the first thing I want to say is that your grandfather is very lucky to have a grandson like you because there are many people who devote their lives to building a legacy for their future generations, for their children and grandchildren. But there's wide variation in how those children, grandchildren actually treat that legacy, with some squandering it, with others neglecting it, which is kind of a derivative of squandering, but not in a spendy way, just in a avoidant way with some falling victim or prey to scams, which is perhaps one of the saddest outcomes of a legacy. There are many, many ways that legacies can go wrong. You have had control of this for two years, and over those last two years you have handled it beautifully. You also, generally in other arenas of your life, practice financial responsibility. So you are a well qualified recipient of the work that your grandfather has done for you. So that's the first thing that I want to commend you on. The second thing is we have to give you a name more important, right? And Joe, I've got one.

[Joe Salsihai]

Oh good.

[Paula Pant]

So there is this syndrome. It's called Sudden Wealth Syndrome. And Sudden Wealth Syndrome symptoms include feeling isolated from your former friends, feeling guilty about your good fortune, having an extreme fear of losing your money. It can cause stress, it can cause confusion, it can cause adjustment issues. There are many, many cases of people who have had to grapple with Sudden Wealth Syndrome. People who come into that sudden wealth and have a hard time adjusting. J.K. rowling, who famously was a single parent struggling to pay rent and then became a billionaire in rather quick time through the success of Harry Potter. J.K. rowling is a one of many examples of someone who has suffered from sudden wealth syndrome. Celine Dion, another example. She was one of 14 kids, they had no money and of course now she has a ton. So there are a lot of examples of athletes, of actors, of musicians. One of the most prominent examples are is a couple by the name of Willie and Donna Seeley. They won the Powerball in 2013. They won $3.8 million through the Powerball lottery and they went through extreme depression and paranoia. The reality is that sudden wealth can lead to a bit of an identity crisis and a reckoning. And it's unfortunate, an experience for which the wider world does not have a lot of empathy. If you try to talk about this publicly, if you ever try to talk about it on social media, everyone's going to be like, ah, play me the world's smallest violin. Boo hoo. But it's unfortunate that people are so quick to invalidate the emotions of those with money, because people with money have emotions that are just as real. People with money have stresses that are just as real. So, Anonymous I would like to name you Stephen, after Stephen Goldbart, who is the psychologist who coined the term sudden wealth syndrome.

[Joe Salsihai]

Stephen. And I like that too, because by identifying what the issue is, it's easier to solve the problem. Right. The first step is identification. And I love that Stephen has identified that. He's really not sure where to go from here. And like you, Paula, I love the fact that he has done nothing right.

[Paula Pant]

Yet, that that's the best. When in doubt, do nothing.

[Joe Salsihai]

Yeah. Which also, Paula, brings up the critical piece of information that we truly need to help out, which is this. Maybe you could slow down like you suggested because you said it's a little tight. You could change your lifestyle today. You said you want to buy a house, you could maybe buy the house early. The biggest issue that I have, Paula, is I don't know what Stephen wants. And I think when you start with what do I want? Which becomes, by the way, talking about problems when your wants are controlled by a limited supply of assets and income, it's actually an easier question because the field is very narrow. And now Stephen suddenly has a million dollars which could, every seven, eight, nine years could double. He's, he's potentially looking at a lot, lot, lot more money than that if he saves it for later in life. So this potentially is a $10 million problem, not a $1 million problem. So the field of what can I do becomes much more open. So I know there's a lot of people listening that'll go, oh, this is an easy problem. If I had a million dollars, I would. And you don't. You freeze and you think that I'm going to do the wrong thing and I'm going to blow it. You see people blow through Powerball money all the time. We read it over and over and over. We see pro athletes who blow through their income, huge income stream, only to realize later on that they made a bunch of unforced errors and you don't want to be that person. I think it's a critically important question. Here's what I wouldn't do. I wouldn't change my lifestyle just because I can. And I kind of heard a little bit of that in the question. Should I back off my savings? Should I back off what I do now? If you're comfortable doing what you do now and you like doing what you do now, pretending like that money doesn't exist and continuing your lifestyle, if you like it, all that does is buys you flexibility in the future, which you mentioned. I might want a house, I might want a family in the future. If you just keep going the way that you're going and have this as money that buys you flexibility. That's a great thing to do. You don't have to do anything now. But if you've always thought, I would like to live a little bit more extravagant lifestyle today, I will take that million dollars and I will leave it invested and I'll slow down the investment into my 401k. That frees up cash flow. And I can now do some of the things that I felt like I wasn't able to do before. Fine. The issue is, Paula, a lot of the time people make these decisions in a vacuum. And I think what Stephen is feeling, and rightfully so, is that the Stephen Covey conundrum of the stick, right? If I do this with a stick today, the other end of the stick comes with it.

[Paula Pant]

If you pick up one end of the stick.

[Joe Salsihai]

If I pick up one end of the stick, there's going to be the other end that comes with it. And people forget that there's going to be a consequence. So if I expand my lifestyle today, I am not going to have the flexibility tomorrow. Let's go to the other side. I don't expand my lifestyle today. There is a possibility I may pass away. And I never enjoy myself the way that I thought that I could have. So each side has a consequence that comes along with it. And I think this is a very serious game of which consequence am I most comfortable with When I decide to do this, which is why I think you start with what do I want to do?

[Paula Pant]

Given that Stephen is 32, and from what I heard in his question, his future is totally open. He might meet somebody that he wants to marry, he might not. He sounds like he's maybe hoping for that, but that's not a guaranteed thing. So he might want to buy a home, he might want to start a family. If he does, who knows? He may or may not need ivf. He may have one kid, he may have three kids, he may have eight kids. I don't know. There are so many unanswered questions about his life. And so I think that, as he pointed out, you hate the term coast fi. But I do think the concept is really appropriate here because I think that he can take this million dollars bucket, this, as money that he will use when he is age 65 plus, and then use the remainder of his money to save for these shorter term and more ambiguous goals.

[Joe Salsihai]

So use it to lock in the far future.

[Paula Pant]

Yeah, exactly. Then he also has the peace of mind because there's such an emotional component of receiving an inheritance. In theory, money is fungible. In theory, any $1 can be substituted for any other $1. But what we know from behavioral economics is that if $1 was given to you from your deceased grandfather, who spent his 30s and 40s slowly building it, whereas a different dollar was given to you by your boss in your paycheck, for which, let's be honest, you were kind of scrolling Twitter for an hour at work the other day anyway, you're going to value that dollar from your grandfather far more than you're going to value a dollar from your last paycheck.

[Joe Salsihai]

We attach emotion and value differently to each dollar. You're saying, even though.

[Paula Pant]

Exactly.

[Joe Salsihai]

The money has no emotion, even though.

[Paula Pant]

Money is fungible, there's a different emotional weight to different buckets of money. And so I think one of the benefits when you get an inheritance that saying, I'm going to put this into a bucket for when I am age 65 plus, is that you know that it will be there for you when you are in your most vulnerable phase of life. Because it is when we are seniors that we are most vulnerable as adults. What are the two times in a human life that you have enormous vulnerability? It's when you're under the age of 10 and when you're over the age.

[Joe Salsihai]

Of 70, in the absence of a goal that Stephen told us. I like that strategy. I would prefer Stephen to assign, what do I really want to do. I'd still want to hear that, but in the absence of that. Paul, I love that, but here's why I love it. I love it because if you secure the future, it makes your decision making process in the present much more value of life focused than what do I need to do to get through to tomorrow? There was a piece. I've told my story here before, but there was a time when was just worried about the next paycheck. I couldn't think about what strategically I wanted to do with my money because I had to be so tactical. Every dollar mattered. To get out of the hole that I dug myself into, I had to assign my future income to the next day and the day after that and the day after that. But knowing that Stephen doesn't need to do that. He can make career decisions with a much more clear head, can decide on life path much more based on what do I want to do than what do I feel like I need to do. It clearly buys so much flexibility in the present by securing the future. The other thing I like about this discussion is that because there is no time frame that this money's been assigned to, it's impossible to know if Steven's grandfather's investments are appropriate or not. This was a question. I got a lot. Hey, I got this narrative. Do you like these stocks? Do you like these mutual funds? I don't know. But once I know, Paula, what the timeframe is, then it's much easier to apply that lens to is this appropriate or should this be sold for something that's more appropriate?

[Paula Pant]

Right. And so by virtue of assigning a time frame to this bucket of money, and in this case that timeframe will be when Steven is age 65 plus, it solves the asset allocation question as well.

[Joe Salsihai]

We know. Yeah, I mean, we don't know exactly what he want to do. There's some more questions there. But it certainly takes this huge field of investments and narrows it by a ton.

[Paula Pant]

Exactly. We know we're investing on a 30 plus year time horizon.

[Joe Salsihai]

Yeah.

[Paula Pant]

And again, given that this is an inheritance, the emotional heft to inherited money is the lingering question, would my grandparent be proud of the way that I handled this? And I think anyone who takes that a bucket of money that was passed down to them and says, I'm going to preserve this for my own retirement, I think any grandparent would be proud of that. Right?

[Joe Salsihai]

Absolutely.

[Paula Pant]

And honestly, a lot of it goes back to when you're in your 30s or 40s or 50s, assuming that you're healthy, you have the ability to go stand on your own two feet, assuming that you're healthy. When you're in your 30s, 40s, 50s, 60s even, you're in the prime of your life and you can go out there and make it and be a grown up. So emotionally it can be a little bit more difficult to think, oh yeah, my grandparents sacrificed for their entire lives so that I could have extra padding during a phase in my life in which I'm perfectly capable of taking care of myself anyway. By contrast, if that money is saved for those more vulnerable senior years of your life, those elderly years of your life, and then you redirect the paycheck that you're making today into those shorter term goals, buying a home, possibly getting married, possibly starting a family, maybe traveling, whatever that is that you want to do in five, 10, 15 years, you get the solace of knowing that your grandparents would be proud of how you preserved their money. And you also get the pride of knowing that you built your own adult life through your own effort and volition. I think there's a big part of adult self actualization in which we need to know that we built our own path, that we paved our own way. You look at even very wealthy children who technically don't have to work. Paris Hilton, right, could have easily not worked. She built an empire valued at over $100 million. Why? Because she didn't want to just have a handout from her parents. She wanted to put in the 7am mornings, the conference calls, the meetings, the slack threads. Like she wanted to put in the effort to build something of her own. And that is so common among even the richest amongst us. There, there is, I think, a very innate human need to know that this life I have is one that I built.

[Joe Salsihai]

I think on the tactical side. Don't forget though, if your company's giving you free money in terms of a match, I would still. Paula, build that in. Make sure, make sure that you take advantage of any spot where there's, there's free money. I wouldn't give that away. But direction, I really like where you're going. And the other thing that I will also say is even directionally, if you told me what you want, I still directionally like the bias toward what Paula is telling you, Stephen. I like the bias toward later with that money and securing later. That said, it doesn't have to be an all or nothing. You could assign part of it to now to maybe help with the house down payment or whatever it might be. You already have the 50,000 sitting in cash from the inheritance, maybe part of that, but it doesn't have to be just all one way or all the other way. But I do like the bias of what Paul is saying toward use this to secure the far future and then work back toward today and build it for yourself.

[Paula Pant]

And the last thing I'll say, Joe, what you just said reminds me of a call that we answered on a recent episode from a caller who said that she was working towards work optionality. And the way that she approached it was that first she completely filled the bucket of age 60 plus. And once that bucket was filled, now she's trying to infill the bucket of age 30 through 60.

[Joe Salsihai]

Yeah, I remember that. That was great.

[Paula Pant]

Yeah. And that framework, that approach is I think, a very smart one because it's life planning taken from you start at age 100 and then you just work backwards to today and you do that incrementally in buckets of a decade at a time.

[Joe Salsihai]

It gives you a great feeling doing that too because you know that once you reach X spot that I am very comfortable pivoting. I can be incredibly comfortable doing something completely different because I know that I get to X date that things are going to be okay. And it's funny because it isn't so much about reaching that line as it is knowing that that line exists and exactly where that line is. Or you're never going to know exactly where it is. But you get my meaning that I know it's probably going to be in 2031 or 2035 or 2050 or whatever that line is. I know ish that I'm going to be good after that date. I think a lot of people have difficulty with uncertainty. I certainly do. Just when there's something out in the air. Let's say that Paul and I were having a chat and Paula says something very weird and I don't know what that means. Whatever she said, I will spend the next six hours going, what do you think Paula meant? What she mean by that? And it will drive me crazy.

[Paula Pant]

Joe, I said, how's the poop in your coffee?

[Joe Salsihai]

What do you mean? So I have to pick up the phone just because I don't like uncertainty. I'd be like, Paula, what did it mean when you said that? So I'm not alone there, though I know that when I was a financial planner, just the certainty of, yeah, I'm gonna have to work harder. Or the certainty of I don't have to work as hard just knowing and getting rid of that was is so important, I think, to the human psyche and definitely influences our behavior.

[Paula Pant]

So, Stephen, I hope that was helpful. I want to commend you once again for being such a worthy recipient of your grandfather's efforts, so thoughtful with this money. Thank you, Stephen for asking that question and best of luck. We're going to take a break to hear from the sponsors who make this show possible and when we return, we will tackle two questions, both from a caller named Jack.

[Joe Salsihai]

I don't know Jack.

[Paula Pant]

We know you don't know Jack.

[Joe Salsihai]

How high is the interest rate for the new Laurel Road High Yield Savings Account?

[Paula Pant]

This high.

[Joe Salsihai]

The air is really, really thin up here. The Laurel Road Very High Yield Savings Account Variable Annual percentage yield APY is.

[Paula Pant]

Subject to change at any time. No minimum balance required.

[Anonymous Caller]

Fees may reduce earnings on the account. For full terms and conditions, see laurelroad.com savings.

[Joe Salsihai]

Laurel Road is a brand of key bank member FDIC.

[Monarch]

Monarch is the modern way to manage your money. Whether you need to stick to a budget, track your investments, or collaborate with your partner, you'll get clarity, confidence and peace of mind for your finances With Monarch. Here are a few things that I like about it.

[Paula Pant]

First of all, there's a widget that's.

[Monarch]

Directly on my phone.

[Paula Pant]

I could just I see it at.

[Monarch]

A glance in the same way that.

[Paula Pant]

I look at the weather.

[Monarch]

So I can really quickly glance at my most recent transactions. And I also can see these dashboards where I see my income, I see my expenses, I see how much I'm spending in different categories. It's just a really good at a glance on your phone way for me to get a quick snapshot of my finances. Now Monarch is the top rated all in one personal finance app because Monarch helps you make smart money moves. And right now, listeners of this show can get 30% off your first year by going to monarchmoney.com Paula Monarch is super customizable. You can customize dashboards. You can create budgets and notifications. And the Wall Street Journal awarded Monarch the best budgeting app of 2024. After trying out Monarch for myself, I get why it's the top rated personal finance app. And right now listeners of this show will get 30% off your first year. When you go to monarchmoney.com that's M O N A R C H M o n e y.com Paula to get 30% off your first year. When you think about businesses that grow their sales beyond forecasts like feastables by MrBeast or a legacy business like Mattel, you know you've got a product with a lot of demand. You've got a focused brand. But there's also an overlooked secret, and that is the business behind the business that makes selling and buying simple. And for millions of businesses, that is Shopify. Nobody does selling better than Shopify, home of the number one checkout on the planet. And it includes Shop Pay, which boosts conversions up to 50%, meaning fewer carts going abandoned and more sales going. If you're growing your business, your commerce platform needs to be ready to sell wherever your customers are scrolling or strolling, whether that's online or in your store. Because businesses that sell more sell on Shopify. Upgrade your business and get the same checkout that Feastables by MrBeast and Mattel uses. Sign up for your $1 per month trial period at shopify.com Paula all lowercase go to shopify.com Paula to upgrade your selling today. Shopify.com Paula.

[Paula Pant]

Welcome back. Up next, we're going to talk about refinancing a mortgage. And after that, we're going to tackle a question about traditional versus Roth retirement accounts. So our next two questions both come from Jack.

[Jack]

Hi Paula. Jack here. I'm calling in to get some advice on a soft spot I have in my personal finance knowledge and that's concerning the area of refinancing a mortgage. So my wife and I are proud homeowners and our first mortgage payment was June 2023 and we got an adjustable rate mortgage seven year. That kicks into gear, I guess June 2030. So we got this on a physician assisted mortgage plan which for your listeners out there, if they don't know about it, great option for doctors who are going through medical education. We did $0 down, got a 4.875% mortgage rate on a $435,000 house. To give you a few more facts that maybe will help the situation, our credit's good, it's over 800 and we could outright buy the house, but we've decided to have the money stay in the market rather than pay down the interest that we'd have to pay. We're in a good place. But basically I don't know the first thing about refinancing. And I have been led to believe that come June 2030, I could get whacked with something way higher than 4.875% interest rate. We don't plan on ever selling the house. We want to basically be landlords if we ever move to a bigger place or we might actually expand the house. If we welcome some children into the family. But this is all to say that at some point we're going to need to refinance either by the force of the end of the seven year period or voluntarily. And I don't really know what goes into that. So do I have to use the same lender? Should I do it now, should I do it later? Is this something that I will have to pay closing costs for if I do it now? And I would have to do it, wouldn't have to pay closing costs later. You can tell I don't really know much about this, so hence why I'm leaving you this voicemail. Thank you so much for the podcast and all the advice and I look forward to hearing what you have to say.

[Joe Salsihai]

This is a fabulous question, Jack. Thank you so much. And it's really great, Paul. This type of decision making I love because we often will go to work and we'll make very pragmatic decisions on behalf of the organization we work for. And then we come home and our emotions get involved and we really, for this question, Jack, we want to put on our CFO hat. If I'm the chief financial officer of my company, that's the way I want to think. And so the cool thing is the CFO of your family, AKA you, you have a lot, a lot, lot, lot more flexibility than you may realize. Because let's say that your time runs out on the adjustable rate mortgage. Seven years comes up. The critical thing that the CFO needs to know is if you do nothing, what will it adjust to? And that'll be in your contract. And often, Paul, as you already know, but a lot of our audience may not know is maybe it goes up 1% per year until you do something or until it finds equilibrium, whatever equilibrium means prime plus, whatever the thing might be that it will adjust to, there will be a cap on how high it'll go. I want to know what that is. I want to know every year that I do nothing, what it goes to. Because if you're sitting at 4.875%, you may have another year where the interest rate is higher than it is now, but it's still lower than anything else that you can get. I seriously doubt it because even if he made that move today, there may be products which will allow him to get fairly close to 4.875, but they're going to adjust very quickly. Like if he does an adjustable rate mortgage, Paula, that's going to adjust day after tomorrow, right? Somebody might give him some money. That is at a very Short timer for a lower interest rate. Basically, Jack, what happens is the longer the period is that the company is going to loan you money for the higher the interest rate is going to be, the quicker that you're going to repay them or the more certainty they have, they're going to repay them because it's quicker, the lower that interest rate will be. So I don't know what the interest rate is today on a one year arm. I can see the look in Paula's face. She's probably looking it up right now. But there are some adjustable rate products that are going to give you a lot of flexibility in terms of interest rate that allows you to use a football metaphor, punt the ball down the field, meaning delay my long term decision making until later because interest rates aren't where I want them to be. So in the next seven years, I don't know what's happening. I do know generally that right now interest rates are expected to lower over the short run. So I'd be paying attention to over the short run. Is there an opportunity for me to lock this in to a fixed rate product instead of the adjustable rate product that I have now? Is there an opportunity so the show.

[Paula Pant]

To answer what you just mentioned earlier, the current rate on a one year ARM as of this is actually as of a couple of weeks ago was 7.125%.

[Joe Salsihai]

Okay. And you and I know that's going to come down.

[Paula Pant]

Yeah, exactly. I want to take a pause here and zoom out and give a little bit of a broad lesson on how ARMs adjustable rate mortgages work.

[Joe Salsihai]

Let's do it.

[Paula Pant]

There are four variables that you need to know. The first variable is the obvious one because it's right in the name. It is what is the period of time for which the interest rate is fixed. So Jack, you've got a seven year arm. That means for seven years your adjustable rate mortgage is going to stay at 4.875%. So on a seven year ARM, that interest rate, it stays fixed for seven years. On a five year ARM, the rate stays fixed for five years. On a ten year ARM, the rate stays fixed for ten years. Three year ARM, it stays fixed for three years. You get the picture. So that is one of four variables that you need to know and that's the most obvious one because it's right there in the name. There are other three variables that every person who's considering an ARM should know and that is the periodic increment of time that the mortgage adjusts, the amount that it can adjust per adjustment Period. And that maximum cap which Joe talked about earlier. So, for example, and this is just a hypothetical, there might be a given mortgage that adjusts once per year and each time it adjusts, it can go up by a maximum of 2%. This is a bit purely a hypothetical. It adjusts once a year, it adjusts 2% per adjustment period, and it can go up to a grand total of no greater than a maximum cap of 10%. That would be a hypothetical set of variables. There's the adjustment period, there's the maximum rise per adjustment period, then there's the overall absolute max. Those are the three variables that they're going to be written into your mortgage loan documents so you can read it right there in your loan paperwork. But anyone who's considering an adjustable rate mortgage should know all four of those variables because those four variables together piece together the full story.

[Joe Salsihai]

At any time during the next seven years and even after, once you know how much money this is going to go up by per year and what that means for your cash flow, you can make the decision based on cash flow, based on interest rate, based on whatever's going on in your family. So as an example, if you just want to delay the decision a year and get the lowest rate possible, you may do a one year adjustable rate mortgage. There are even products that are one year adjustable rate interest only products, meaning you're not going to pay down any of the principal. Because with the difference between seven point x, what's the one year, Paula, as.

[Paula Pant]

Of a few weeks ago, current rate on a one year ARM was 7.125%.

[Joe Salsihai]

So if you're just solving for payment and you don't like how much the payment is going up, you could do an interest only loan. Obviously you're not making any headway on your debt. Not my favorite product by the way. But if you're solving for payment, you can do that. If you're solving for payoff, you can do that. If you're solving for interest rate, you can do that. So there's going to be jack a lot of levers between now and then. And when you ask about lender, I think my CFO analogy, Paula, answers that question immediately. If you're the CFO of a company, I'm going to look at all different lenders. Yeah, I'm always going to compare.

[Paula Pant]

It's a jack, it's a free market. You are welcome to go with any lender you want to. You have no obligation to stay with your current lender.

[Joe Salsihai]

So I think knowing that the clock is ticking for the next seven years. What I would do is this. I would pay attention to interest rates. I don't know that you're going to find 4.875 again in normal circumstances. In a normal market. Paula.

[Paula Pant]

But we have no idea what the economy is going to look like in 2030.

[Joe Salsihai]

We don't. We don't.

[Paula Pant]

Maybe in 2029 we'll have a huge market crash or another pandemic or zombie apocalypse. We have no idea.

[Joe Salsihai]

But if I'm going to start making long term decisions, where do I want to be And I want to get away from adjustable rate mortgage. I want to use a longer term lens of where have markets been historically.

[Paula Pant]

Right.

[Joe Salsihai]

And you know, a 30 year.

[Paula Pant]

I'm being slightly facetious with the zombie apocalypse. Yeah.

[Joe Salsihai]

I had no idea.

[Paula Pant]

Trying to underscore the uncertainty. We cannot predict black swan events that could throw the best laid plans out of whack.

[Joe Salsihai]

But I think over long periods of time, if we look from the 1950s, let's say to today. So that gives us 75 years. Ish. If you find something in the sixes that you can lock in long term, 30 year fixed, that's a good place to start making permanent decisions. Because anytime interest rates have gone below 6, we're in a pretty extraordinary market at that point. So if your goal is to lock in a long term interest rate and you get probably 6.5 or less if we get to that point then I'm making long term decisions. Obviously if you can afford to make a long term decision before that, that's at a higher interest rate and buys you more time. I don't know if I do that or not. I really don't know if I would do that or not. Or wait until we get closer to that seven year mark and maybe refinance into another adjustable rate mortgage to just keep the interest rate as low as I possibly can until I'm ready to pull the trigger on a six point. What. Whatever it might be.

[Paula Pant]

Yeah. He's got such a good interest rate. 4.875.

[Joe Salsihai]

That's the problem.

[Paula Pant]

He's got such a good interest rate. I would leave good enough alone for.

[Joe Salsihai]

He could leave it alone for all seven years.

[Paula Pant]

Yeah.

[Joe Salsihai]

And probably for another. Let's say it goes up by 2 percentage points. He could leave it alone for eight years because he's. Now he's only at 6.875. And once again this depends on what it does to his payment and what that means for his budget which we don't know to Your point? He has more flexibility than he thinks he has.

[Paula Pant]

Yeah. I would not refi out of it for the next seven years because I don't think you're going to find anything better.

[Joe Salsihai]

I don't know, Paula, because interest rates just generally over long periods of time below 6.5% are so hard to find. Let's say that three years from now it goes to 6.25, 30 year fixed. I may make that move because I don't know how long it's going to last. I don't know if it's going to come around again anytime soon. I don't know. And so if he can get below six and a half percent and buy more certainty, I might do that. Even if he's at 4.875 and he's two or three years away.

[Paula Pant]

Wow. That's the difference between you and me. I would not do that. I see where that's coming from based on historic trends. But if we get into an environment where interest rates start dropping, it's because the Fed is creating stimulatory activity. And that might mean a number of things. It might simply be that they have a whole lot of confidence that inflation is under control, or it might be that the economy is contracting and we're trying to pull ourselves out of a nosedive. So I would, I think we definitely.

[Joe Salsihai]

Paula, to your point, you and I are both saying right now the Fed, the current Fed, likes to telegraph which way they're going. And I think if we get to the point that I've got a 30 year, six and a quarter ability right now, I've got that ability today, I want to look at what the Fed's kind of saying at that point as well, because to your point, if they're saying we're either going to leave things the same or we're going to lower it, well, then I wouldn't do anything. But if we get to six and a quarter and the Fed signals that we are done lowering for the time being, then I think historically I'm sitting in a spot where interest rates are lower than they are than the mean is historically. And they're then just looking at reversion to the mean. The next up move would be then more likely to be up than down. I'm going to go ahead and I'm going to lock at that point. So I guess I need to know where I'm at.

[Paula Pant]

Yeah, I'd be reading the Fed pretty carefully. I'd be spending a lot of time looking at economic indicators because the question is Is the Fed trying to stimulate the economy because we are heading towards a recession, in which case there's a likelihood of interest rates continuing to drop, or are we simply mean reverting?

[Joe Salsihai]

I generally, and this is you too, Paula, we generally on this show tell people, don't pretend you have a crystal ball. Don't pretend that you do. I will say this, though. The Fed makes it really easy. Like out of all the indicators, we get this current Federal Reserve anyway likes to give you a roadmap of what they're thinking and where they're heading. And it isn't looking into a crystal ball. They are telling you, hey, when we meet again, we're probably going to lower. It is not like deciding where Microsoft stock's going to go next week. If you ask me where Microsoft stock's going, I have no idea. If you ask me what the Fed's going to do, I'm like, they're probably going to lower interest rates.

[Paula Pant]

Yeah, there are a lot of indicators that can sort of feed into that. You look at the jobs report, you look at unemployment claims, you look at.

[Joe Salsihai]

Yeah, cpi.

[Paula Pant]

Yeah, exactly. You look at cpi, you look at R star. There are a lot of indicators that you can sort of pull together in order to get a much more clear picture of where interest rates are going to be headed. But I don't think he needs to worry about that until 2030. He just has such a good interest rate right now that again, I would leave good enough alone until I think I would not.

[Joe Salsihai]

I would look at what the Fed's doing. I would. Anytime I have any adjustable rate product, I want to know where safety is today and what the trend is. Is it towards safety or is it away from safety? And that means in this case, interest rates going down is safer, interest rates staying the same with the probability of trending up that I'm losing safety. And if I find that I'm losing safety, then if I'm the CFO of my company, I want to think about how dangerous it is to leave things the same. And certainly, Paula, to your point, 2030 is so far away right now. If the trend reverses in the next few months and interest rates are headed up, I'm staying right where I'm at. Right. Because it's so far away. But if it's 2020, late 2028 or 2029, I'm thinking much more about what my options are to extend that clock.

[Paula Pant]

Part of the question, one unknowable piece of this puzzle is after those seven years expire, what is the periodic term in which his rates go up, what is the duration of that periodic term? Is it a year, is it six months or what is it? The other question that we don't know is how much will that mortgage rate go up in that first periodic term? And then of course the third question we don't know is what is the absolute maximum? What's the worst case scenario? What's that cap? Those are the three questions that would also play a role in any year 2029 decision that he makes.

[Joe Salsihai]

One question that I may also ask of your current lender is is there a possibility to recast this mortgage? And I don't see this a lot, Paula, on adjustable rate products. I see it much more often on fixed rate products. But I wouldn't not ask this question. I would definitely ask it. Recasting your mortgage means you're going to change the interest rate on the product without changing the length of the mortgage. So if he gets a favorable interest rate that he wants to lock in, he may be able to have a 23 year mortgage at a fixed rate. You know, because he's already seven years in a 23 year mortgage. So he's still on the same payment, still the same payoff timeframe, not have to do the full refinance. And sometimes the fees to get that done are much, much lower. So sometimes 250, $350 to do that versus all of the pain of a refinance. Recasting a mortgage is also a question I would ask when you're looking at all of your options. I don't think in this case he'll be able to because it's an adjustable rate product.

[Paula Pant]

But I'm not familiar with recasting on an adjustable. Only on a fixed.

[Joe Salsihai]

Yeah, I would still ask though.

[Paula Pant]

I'm guessing that the duration of his adjustment is probably one year. He didn't say that he has a 7:1 arm, but that seems to be the most for a seven year. That seems to be the most common.

[Joe Salsihai]

I would totally Bet it's a 7 one.

[Paula Pant]

Yeah, but he didn't say it, so I don't want to make that assumption. But just to broaden this out for everybody, when you are looking at a mortgage, remember how earlier I said that the mortgage is described as the fixed rate period of time? So five year adjustable rate mortgage keeps that interest rate for five years. A seven year mortgage, which Jack, is what you have, a seven year adjustable rate mortgage keeps it for seven years. Well, there's another number typically after that that indicates the duration of time after which it adjusts. So if it was a 7.1arm, for example, then it's fixed rate for the first seven years and then that duration is every one year. So for example, if a person has a 5 1arm, then they know they've got that fixed rate for five years and then that duration of time is every one year. Subsequently, if a person has a 5arm, it's a duration of time, fixed rate for five years and then it adjusts every five years. Typically with a seven year mortgage, those usually commonly come with 71 arms. But Jack, I don't want to make that assumption because you didn't say that it was a seven. One arm, you said it was a seven year. And I want to be very cautious about making any assumptions that are not stated within your question. So I would absolutely check your loan documents. But I'm guessing you likely have a 7.1arm. That is the most probabilistic answer. What we don't know again is how much it will adjust in any given one year increment of time. Nor do we know what that maximum cap is going to be.

[Joe Salsihai]

However, those are knowable numbers.

[Paula Pant]

They're in your contract, they're in your loan documents. You can just look those up.

[Joe Salsihai]

Yeah.

[Paula Pant]

The answers to those two questions will, I think, resolve the disagreement that Joe and I are having right now over whether in my view to leave good enough alone or in Joe's view to lock in that bird in the hand.

[Joe Salsihai]

Well, and here's what would change my mind, Paula, as an example, if it only goes up by 1%.

[Paula Pant]

Yeah.

[Joe Salsihai]

If it only goes up by 1% per year in year eight, then it's at 5.875, still much better than historical averages. The next year, 6.875, still not bad. So I almost look like he's got nine years instead of seven years where that interest rate still is pretty kick ass.

[Paula Pant]

Right.

[Joe Salsihai]

When it gets to 7.875. Not horrible, but not wonderful. And then certainly the next year when he's at 8.875 in most normal economic circumstances that's above average, but not like the 80s. Yeah, it's an above average interest rate. We could probably find better. Given a 1 percentage point maximum adjustment per year, he may have safety through year nine, maybe even 10.

[Paula Pant]

Yeah.

[Joe Salsihai]

So he may have a long, long time until he truly is going to be looking at doing something. And you can see then mathematically if it's 2%.

[Paula Pant]

Yeah. If it's 2%, that shortens your window for in terms of making a decision.

[Joe Salsihai]

At that point, I'm much more worried about certainty quicker.

[Paula Pant]

So Jack, and to everyone listening, I hope that was a good overview of how to think about adjustable rate mortgages. And remember the four variables that you want to look for when you are assessing any given adjustable rate mortgage fixed duration, adjustable duration, adjustable increment and total max. All right. Well Jack, thank you for asking that question. And our next question also comes from you. We're going to take one more break to hear a word from the sponsors who make this show possible. And when we come back, we will have a discussion about Roth versus Trad retirement accounts. Stay tuned.

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[Paula Pant]

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[Paula Pant]

Paula this guide is free to you.

[Monarch]

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[Paula Pant]

Welcome back. Our final question today comes from Jack.

[Joe Salsihai]

Hi Paula.

[Jack]

Jack here. I hope I have a straightforward question and that's basically what should I do next year, 401k wise? Should I max out the Roth 401k? Should I max out the pre tax 401k or should I do a mix of both? If it helps, I think if I did pre tax, it would bring us down, my wife and I, from the 32% tax bracket to the 24%. So that's kind of the ordinary income we'd be saving, at least in the short term. Curious for your thoughts. Thanks.

[Joe Salsihai]

Okay. He doesn't know how effective tax rates work versus tax brackets.

[Paula Pant]

Yeah, exactly.

[Joe Salsihai]

Which is common.

[Paula Pant]

Jack, thank you for the question. You remember how for the adjustable rate mortgage question, there are four variables that I need to know from you in order to be able to better answer this question. Now for this question that you've just asked, Roth versus Trad, there are a few variables that I'm going to need to know from you. And I want to expand this answer out. So for anyone who's listening who has a similar question, should I put my money into a Roth account versus a Trad account? Here are the questions that I have. Number one, do you expect that in the future your income will be substantially higher than it is today? Number two, do you expect that in the future your income will be substantially lower than it is today? For example, do you at any point in the future want to take a sabbatical in which you will have either no income or substantially lower income? Do you plan to take any time off for caregiving duties? Do you have any chronic health issues that might render you unable to work for some limited period of time? And by limited period, I mean maybe a few years at some point in the future? Do you have a simple desire to take a year off to write a book or to drive a motorcycle across Central Europe? Do you plan on moving to a different state at either in the near future or in your retirement in which your state tax bracket will be significantly different? Do you plan on amassing investments in anything that would have pass through income? So anything that has either an LLC or S Corp structure? Do you plan on becoming a business partner in any of those in the future because that will substantially change your tax brackets? The reason that I'm asking all of this is because the fundamental question of Roth versus Tradition unpacking that to answer it at an individual level hinges on your assumptions about how much you are making now relative to how much you will make in the future. Because what you're doing is you're gaming out paying taxes at your current tax bracket versus paying taxes at your future tax bracket. Now, in the absence of those answers at an individualized level, if I were to make a broad sweeping generality, in general, I think it's better to pay the taxes now and therefore to bias towards Roth accounts. And the reason that I think that is because in general, and again, I'm just speaking in generalities, most people tend to have income that goes up over time. Now again, there's asterisk. If you know you have a chronic health condition that's probably going to render you unable to work for a five year increment of time starting in the year 2030, that's a different story. But in general, most people tend to have income that goes up over time, meaning your tax bracket will be higher over time. Most people tend to amass greater investments as they age, which means that you likely are going to have higher income through LLCs and S Corps, higher pass through income from private ownership and businesses in the future than you do today. And then the part that we haven't addressed yet, but that is absolutely unknowable, what are your assumptions about where the government is going to set tax rates? If you assume that the government will raise taxes in the future, that's yet another reason to bias towards Roth accounts today. And the reason that I'm emphasizing how much of this hinges on assumptions is if you know that you are going to move to Puerto Rico or to Dubai, that's going to change the answer. If you know that you're going to be geo arbitraging into a place where your tax brackets are going to dramatically change, it changes the story. But in the absence of planning to move to Puerto Rico and also planning around a chronic health condition and a few sabbaticals, in the absence of that, I would bias towards a Roth.

[Joe Salsihai]

That's always generally my bias as well. With regard to the government. If we think that at some point the government is going to begin addressing the debt, it's just mathematics that tax rates will go up to address the debt, they have to go up to address the debt. If we think that there's going to be another avenue that magically appears, then that may be poor. But I do like the fact that at the end of the day, Paula, this is an assumptions answer and you have to know what the assumptions are. Because when you assume, something is always going to go differently than what you assumed. And then you'll be able to know the extent of the course correction you'll have to make to make up for what the change is versus what you assumed, which I like knowing what that delta would be if I assume incorrectly. But generally speaking, I'm with you. My bias is toward the Roth. And then you will talk me toward the traditional 401k given what your circumstances are. And Jack, also when you said that your tax bracket will go up, one thing that a lot of people don't understand, I don't know if you understand it or not, but your tax going into the next tax bracket is not the huge tax burden that a lot of people think that it is. I have had married couples, Paula, back when I was an advisor, that would come to my office and they would explain to me that one family member works and the other one stays home because all of the money that the person makes who's staying home would be at a higher tax bracket. And they did the math and all that money would go toward taxes. So it doesn't make sense. And I would answer, I have great news for you.

[Paula Pant]

Right.

[Joe Salsihai]

You get to go to work.

[Paula Pant]

Right.

[Joe Salsihai]

Because tax brackets are incremental. So if we start with the lowest bracket that fills up at the lowest rate, and then starting with the next dollar, that next dollar gets taxed at the higher rate. So if he said the words 24 and 26, that means the very next dollar is at the 2% higher rate, right?

[Paula Pant]

Exactly. So if you imagine your money as a tiered pyramid, the base of that pyramid, or I guess depending on how much you make, it could be an inverted pyramid, but the base of that pyramid has money that is taxed at the lowest possible rate, dollar number one, that you make, no matter who you are, no matter what tax bracket you're in, dollar number one is taxed at the lowest possible rate. And so it isn't as though you cross some threshold and all of your money is magically taxed at this higher amount. It's that those incremental dollars are taxed at a higher rate. So think of it as a tiered system in which this tier of money or this bucket of money has a given tax rate, and this other bucket of your money has another tax rate, and this other bucket of your money has a different tax rate. And so when people say, I'm in the X tax bracket, that number, that X that they're referring to is a reference to the sliver of their money that has the highest rate.

[Joe Salsihai]

What we're really concerned about is what your effective tax rate is, and that's very easy. You go to last year's tax return to find out what it was last year. You take the amount of money that you paid in tax, which will be at the bottom of the back page for most people on their 1040, and look at the top line income that you had come in, which is at the top of the first page.

[Paula Pant]

Joe, I want to lay out a little bit about why I bias towards the Roth and why when answering this question in generalities, my typical answer is use a Roth account. Unless there is a very specific reason not to.

[Joe Salsihai]

I can tell you mine then, too.

[Paula Pant]

Ooh, okay. All right. All right. Well, I've got two. We'll see if either of these steal your thunder. One of them is because you then are locking in a lifetime of tax exempt growth. So all dividends, all capital gains, all the growth for the remainder of your life is completely tax exempt. And given the power of compounding, given how much that money is going to grow. And of course, the younger you are, slash, the longer you expect your life expectancy to be, the more that money is going to compound, right? The greater the timeline on that investment, the more compounding you have. There's an enormous power to having a tax exemption on all of that compounded cumulative growth. So the math of that is one very powerful reason. So that's one of my two reasons. The other of my two reasons is because a Roth account functionally allows you to make greater contributions. So think about it like this. Let's say that you have $7,000, and you are either going to put $7,000 into a Roth IRA or you're going to put $7,000 Into a traditional IRA. It sounds as though you're contributing the same amount of money, and you're just trying to decide, do I put the 7,000 into a Roth versus traditional account? But what is actually happening is that a greater percentage of your money is getting invested, because by virtue of putting that $7,000 into a Roth account and paying income tax on that $7,000, a greater amount of your money is going towards the funding of that contribution. There's the 7,000 contribution itself, plus there's the amount of money that you use to pay the tax bill. And so by virtue of taking that same $7,000 and choosing to put it in a Roth account instead of a traditional account, you are functionally making a greater contribution. And as we all Know, it is the size of your contributions that is the single biggest determinant of your lifetime returns.

[Joe Salsihai]

Yeah, I love both of those. My favorite way to look at the Roth advantage takes your first example, but restates it differently.

[Paula Pant]

Ooh, let's hear it.

[Joe Salsihai]

Which is when you make a traditional 401k contribution, every dollar that makes, you are splitting with your uncle in Washington. And it's not even your real uncle is Uncle Sam. Ed Slott says, yeah, not even my real uncle. So, but I got to split it with him. So as I make money, I'm taking the government along for the ride. And the better I do, the more, the better Washington does. And don't get me wrong, I want to pay my fair share, but with a Roth, Paula, and this is again just a restatement of what you said, but I like the imagery of this. When I put money in The Roth, a dollar in the Roth, any money that dollar makes is 100% mine. It is 100% mine. Assuming that I follow the rules of the Roth, right? When I can take it out, how I can take it out. And they're very simple rules, but assuming that I just follow the simple Roth rules, it's all mine forever. And then what I like about that is we talked about all of the assumptions, all the assumptions that we make around the tax brackets and tax rates, those are all fine. But when I know that it's mine 100%, the only thing that I truly am betting on is that the rules are going to stay the same with respect to the fact that the government is not going to tax this in the future. So that's my feeling about the Roth and why I bias toward the Roth.

[Paula Pant]

And it certainly makes tax planning in retirement a heck of a lot more fun because you get to look at the bucket of money and be like, this is all mine.

[Joe Salsihai]

So much easier. Yeah, so much easier. Which is another reason the government also has all these provisions that allow you to use the Roth IRA for college. And I will often meet people that will say, you know, I don't like the 529 because what if my kids don't go to college? So I'm going to use the Roth as my college plan. I do not like that because I like, don't get me wrong, I like the rules around college with the Roth, but I like the retirement planning so much better with the Roth. I would rather find a different means to pay for college and to do any of your college planning, short term planning, whatever the planning is, leave that Roth money for later in life, because you're really going to high five yourself that you simplified everything, Right?

[Paula Pant]

So, Jack, there's your answer. We both are big fans of the Roth. I would default Roth unless you have a good argument for something else.

[Joe Salsihai]

Yeah.

[Paula Pant]

And if you do, have fun, enjoy your move to Puerto Rico.

[Joe Salsihai]

Woohoo. And apparently, Paula, we do know Jack. Maybe a little.

[Paula Pant]

Ooh, we do know Jack. Look at that. All right, well, Joe, when you're not drinking civet poop coffee, delicious. Where can people find you?

[Joe Salsihai]

You will find me, Paula, at the Stacky Benjamin's podcast. Do you know what's going on this week?

[Paula Pant]

What's going on?

[Joe Salsihai]

We are playing some of our top mentors, top guests from past episodes. So for people that have never heard the Stacky Benjamin show, we're going Monday through Friday with some of our favorite episodes. So come join us because it's a fun week.

[Paula Pant]

You're having a greatest hits week.

[Joe Salsihai]

It is a greatest hits week. This week.

[Paula Pant]

Greatest hits week. Those are fun.

[Joe Salsihai]

Super fun. Because we get to pick some of the ones that. Don't get me wrong, I think we always have some great guests that bowl us over, but the ones that really made me go, wow, we're playing this week. So come find them at the Stacking Benjamin show.

[Paula Pant]

Oh, beautiful. Well, and thank you for tuning in to the Afford Anything podcast. If you enjoyed this episode, please do three things. Number one, share it with a friend or a family member. That's the most important thing you can do to spread the message of having strong financial health. Number two, subscribe to our newsletter affordanything.com newsletter and number three, make sure that you are following us on Apple podcasts and Spotify and any other favorite podcast player you may have. Thank you again for tuning in. I'm Paula Pant.

[Joe Salsihai]

I'm Joe Salsi. Hi.

[Paula Pant]

And we will meet you in the next episode.