Loading summary
Transcript65 lines
- [00:00]
A
What if i told you that retiring early could lower your tax bill instead of raising it most people think that leaving their job means losing tax advantages but today we're revealing why early retirement might be the best tax strategy you've never considered hello hello hello and welcome to the biggerpockets money podcast my name is mindy jensen and with me as always is my never taxing co host.
- [00:29]
B
Scott trench and thanks mindy great to be here we won't defer the tax puns we'll get started immediately on today's show we are so excited to be joined today by sean mullaney and cody garrett here at biggerpockets money we've had them separately on the podcast before but we are so excited to be joined by them together to talk about their new tax book tax planning to and through early retirement sean and cody welcome back to biggerpockets money thanks so much.
- [00:52]
C
For having us yeah we're glad to.
- [00:54]
D
Be here thanks so much do you.
- [00:55]
B
Guys both agree that people believe that taxes in early retirement are going to be worse than they ultimately end being.
- [01:02]
C
I generally think that's true there's this i call it an inchoate fear right because people talk about widow's tax trap irmaa required minimum distributions these things have scary names and so they become these sort of boogeymen but a lot of times you know i think the next time you think about a commentator or some sort of commentary talking about taxes are going up in retirement or taxes are going to be daunting in retirement ask where the math is and it tends to be look we cannot give one hundred percent blanket statements on the bigger pockets money podcast but it tends to be that most people are going to pay less tax in retirement during their working years mostly for the simple reason that they don't get up every morning trying to go to work to earn an income it turns out when you don't try to earn income you tend to pay less tax so scott i do think there is this sort of inchoate fear out there that that oh no you know taxes are going up and i'm paying a lot of tax in retirement and you know in our book we go through several reasons why we don't think that's true but the one i'll touch on right here is it's going to be very helpful to not go to work every day because when you don't go to work every day you're not generating you know ordinary active income every day you tend not to have as much taxable income.
- [02:23]
D
One thing that sean mentions in the book is this idea of like spending being a break on your income so when you're working right regardless of what you spend right your income is based on how much you're getting paid at work you know that w two income is coming in at ordinary income tax rates so the worst quote unquote the worst tax rates if you wanted to add a little spin of fear there but when you're in retirement you know you don't just take income you know based on you know some some magic number it's really your spending is a break on your income so however much you spend you're typically going to take you know equal to your spending or less in retirement versus when you're working you know you just get paid and then you typically spend less than you make so another thing about that is there's this fear right now that tax rates are going up you know whether they look at the deficit or there's a lot of political divide on this that tax rates are going up but in retirement it's so much more important to focus on your sources of taxable income rather than the tax rates themselves so even if tax rates might go up even sean has done some awesome calculations that even if tax rates you know go up by fifty percent we still have many cases that retirees will still pay less in retirement than they.
- [03:27]
B
Did while working that's really interesting sean could you give us another layer of depth on that analysis i think that's a major thing in the back of my mind here is tax rates got to go up over the next couple of years and i'll throw this in there i and more than half of the biggerpockets money community which i think is different than the choose fi community for example but more than half of the biggerpockets money community wants to continue building wealth after early retirement and i think implied in that is an eventual realization of a chubby or fat fire lifestyle which may end up producing more or higher taxable income even in that situation i'm hearing really you got to believe something really arrogant if you think your taxes are going to be higher for you in retirement is that what i'm hearing sean scott i think it's.
- [04:11]
C
Helpful to divide retirement particularly for a prospective early retiree into early retirement and later retirement generally speaking early retirement even if you're still building up financial assets is going to be mostly characterized by long term capital gain income and some qualified dividend income for most early retirees we're talking very early retirees most early retirees are going to live off capital gain sales in their taxable accounts most in the audience are probably familiar with the zero percent long term capital gains rate and then the fifteen percent long term capital gains rate so a lot of that income is going to go off at zero percent federal yeah there'll be some state tax but that's no big deal the other thing about capital gains is basis recovery so scott say you get to early retirement fifty years old and you say hey we're going to live off one hundred fifty thousand dollars of mutual fund sales this year well what's your taxable income going to be it's going to be a lot less than one hundred fifty thousand dollars now it depends on what the stock or mutual fund you're selling is but maybe there's one hundred thousand a basis in that holding so you're spending one hundred fifty thousand a year but your taxable income is fifty thousand if it was one hundred thousand a basis and oh by the way that's long term capital gain for the most part zero percent up to for a married couple year twenty twenty five ninety six thousand seven hundred dollars of income goes off at zero percent long term capital gains so that's the early part of retirement well what about the later part of retirement and yes here there is more risk but again we have to run up through the progressive tax brackets and the very large standard deduction this is one of the favorable changes in the twenty twenty five tax bill the higher standard deduction was continued permanently and slightly increased one thousand five hundred dollars for a married couple this year there's also a new senior deduction that's temporary we could talk about that but essentially what's going to happen in retirement is you're going to spend say just out of those traditional retirement accounts so the first dollars will come out against the standard deduction that's zero percent now eventually social security will soak up that standard deduction but at least for some of that we're just going to take against the standard deduction and then we go against the ten percent bracket and the twelve percent bracket and so even if we increase the ten percent bracket to the fifteen percent or you know fifty percent increase or twelve to eighteen percent fifty percent increase you're going to find a lot of that income is still going to enjoy a lower tax rate than the rate it enjoyed on the way in to say a four hundred one k a lot of the viewers are probably going to be deducting to say a traditional four hundred one k at work at twenty two percent twenty four percent thirty two percent so that's a current benefit and to get back to a level where in retirement that benefit's going to be erased they're going to have to increase taxes a whole whole lot that tends to be politically unpalatable and so look is there a risk of future tax increases in the united states absolutely but part of our thesis is well if you're deducting into four hundred one ks at twenty four percent or thirty two percent and then you tax it back into income at ten percent twelve percent twenty two percent well they're going to have to do some significant tax hikes to make that trade off not worthwhile not exactly a risk free proposition but boy the tax hikes that would be needed to get us to a place where that's not a favorable trade off for most viewers most listeners the political environment isn't there today and i don't think it's likely to be there in the next decade yeah.
- [07:44]
D
And sean you know really visualizing that when you're working and contributing to those traditional four hundred one ks traditional qualified plans you are deducting or excluding that from your income really top down so if you think about the brackets like ten twelve twenty two twenty four thirty two etcetera when you're contributing while you're working you're deducting income from the top down right so you're cutting off your deducting income at your highest tax rates while working but in retirement you have to think differently you kind of have to flip the switch in retirement when you're filling up your income you're actually going bottom up rather than top down so you're deducting top down but you're you know drawing and distributing bottom up so that's really filling up like you mentioned those significant standard deduction which is effectively a zero percent tax rate ten percent twelve percent so when you average out your tax rate in retirement we call this the effective tax rate the average tax rate that's typically i mean most of the analysis that we've done your effective tax rate for most early retirees is going to be like half or less than the tax rate that you deferred those traditional retirement account contributions.
- [08:46]
A
We are going to take a quick ad break but more from sean and cody right after this finances can be.
- [08:52]
B
Messy and confusing and it's a lot of work for many of us just to get to the starting point in personal finance which is understanding what you've got and where your money's going that's why virginia my wife and i use monarch money as our personal financial command center for our bank accounts credit cards investment portfolio and as our budgeting and spending tracker monarch automates everything it's all linked and every transaction is automatically categorized into each category of spending in just a few minutes a month i have a complete picture of where every dollar is being spent and i have a real time net worth statement i've recommended and personally used monarch money for years i am thrilled and proud to be sponsored by and partnered with monarch money here at biggerpockets money biggerpockets money listeners get fifty percent off their first year which is usually ninety nine bucks with the code pockets at monarchmoney dot com that's monarchmoney dot com with the code pockets when i evaluate debt funds i look for things like first position loans personal guarantees deep experience by the fund operator low fund leverage fast liquidity and consistent returns these are some of the reasons why i'm excited to partner with pine financial group their fund six offers investors exposure to real estate credit largely for construction and rehab largely here in colorado with loans originated by an experienced originator with over one billion dollars in origination volume seventy five percent of their borrowers have been repeat customers over seventeen years they offer investors an eight percent preferred return paid monthly and a seventy thirty lpgp split of everything over ten percent paid annually the lockup period is nine months with liquidity available within ninety days after that nine month commitment the fund is open to accredited investors only the fund's minimum investment is typically one hundred thousand dollars but pine financial is able to reduce that minimum for some investors and have agreed to do so for biggerpockets money listeners to a minimum of twenty five thousand dollars full disclosure i am personally invested in this fund through my self directed ira and of course pine financial is sponsoring this message and our podcast if you'd like to invest or check out their prospectus go to biggerpocketsmoney dot com pine today that's biggerpocketsmoney dot com pine please note that returns are not guaranteed and may vary based on fund performance this episode is.
- [11:13]
A
Brought to you by state farm checking off the boxes on your to do list is a great feeling and when it comes to checking off coverage a state farm agent can help you choose an option that's right for you whether you prefer talking in person on the phone or using the award winning app it's nice knowing you have help finding coverage that best fits your needs like a good neighbor state farm is there.
- [11:34]
B
Foreign well thanks for sticking with us.
- [11:44]
A
We'Re coming back cody a moment ago you said in retirement it's more important to focus on your sources of taxable income and then sean you said that long term capital gains are taxed first at zero percent up to ninety seven thousand five hundred i believe is what you said so are there other sources of taxable income that are taxed at different rates yeah so the two that.
- [12:10]
D
We focus on especially for the like early retiree is going to be ordinary income right so i talk about fire as financially independent recreational employment so some people you know even when they reach five they continue working so you know if they have self employment income or maybe a w two job that's ordinary meaning that's taxed to those marginal tax rates that we mentioned the ten twelve twenty two twenty four etcetera also in early retirement if you're distributing income from an ira again you have to be careful about using tactics that will avoid the ten percent early withdrawal penalty but if you're taking money distributing money from an ira or doing roth conversions that's also considered ordinary income at those marginal tax rates but then the other side of the coin are these long term capital gains tax rates so those are for your qualified dividends and your realized long term capital gains so as sean mentioned a lot of people in early retirement they're going to have some taxable brokerage money so we think about our checking accounts our savings accounts and taxable brokerage that when you sell those investments a lot of them have been held longer than a year so when you sell them only the gain is going to be included in taxable income but taxed at that favorable long term capital gains tax rate versus the ordinary rates.
- [13:15]
C
Mindy we also happen to live in a period of history that's very favorable for this sort of planning so what i mean by that is low yields now look is it possible that we go back to the nineteen eighties and the s and p is yielding five percent and you know t bills are yielding you know fifteen percent or whatever they were yielding but in today's environment what you can do is generally speaking through a concept through of called asset location you can put your taxable bonds in traditional four hundred one ks traditional iras so even if yields spike that income is going to be deferred still and protected from this year's tax return and then think about the early retiree who's under age seventy five they're not taking rmd's they have these capital gains in equity mutual funds well what's the dividend yield on the equity mutual fund in today's environment if that's a domestic well diversified equity index fund it's almost certainly under two percent assuming it covers most sectors of the us economy so yields are tiny and we are living on capital gains so yes our our income on our tax return in early retirement is capital gains that's the preferred rates these small dividends right very small yields those also mostly qualify for these preferred rates and yeah maybe we have a small bank account four percent five percent interest on a small savings account no big deal so yes history right now is being very favorable to us could these things change yes but we have the protection of traditional retirement accounts for our interest bearing our bonds and then we also have roth accounts so we could put some of those equities and roth accounts and escape taxation that way too in our book it's not all just deducting the four hundred one ks and that's your path right we talk about all sorts of different tactics we happen to like roth iras at home and so if you have taxable accounts roth iras traditional four hundred one ks the odds are you're going to have asset location where even if yields spike your income in the early part of retirement is going to be relatively.
- [15:23]
A
Low is there a calculator that you're aware of that you can use to help you really understand your effective tax.
- [15:31]
D
Rate yeah i would say you can use something like a dinky town calculator some online federally these are just you type in your sources of income right from w two you know self employment your dividends your interest income things like that maybe even some roth conversions if you that's your choice but once you do that what you can do is again even if it doesn't tell you your effective tax rate you can effectively get to the bottom and look at your taxes owed your total tax liability and then divide that into your total income sources so in retirement that might mean i have some income from interest from my bank accounts or my money market funds and my taxable brokerage accounts i've got qualified dividends non qualified dividends including you know reits we're going to talk a little bit about real estate today and then i also might have some you know some ordinary income from doing roth conversions some other sources but you can add up all those make that your big gross number then you go through the income tax formula again thankfully the book has this fundamental calculation showing step by step how to calculate that but once you get to the bottom number which is your taxes owed or your total tax you can divide that you know some people divide it into their taxable income or their agi we actually prefer at least at the first level to divide your tax liability into your total gross income sources to truly understand you know your lived experience of how much you pay in taxes and as a percentage for most early retirees it's very rare for that number from my perspective to be over ten.
- [16:50]
A
Percent oh okay there are people who say that taxation is theft and i think that i like having streets and roads and interstates and police and fire and schools and all the things that you know taxes go towards so ten percent i'm okay with the ten percent.
- [17:07]
B
Rate one more question on this point because i think it's so easy to sweep away some of the analysis around taxes with this kind of this kind of question here which is out there but i'll ask anyways like that doesn't make any sense from a civilizational perspective right like why would the workers pay all of the taxes with their wage income and the capital like it seems like it doesn't seem like a smart system to have it where there's so such a much lower effective tax bracket on capital gains and wealth than there is on wage income you can feel how you want about that right right or wrong around there but it's it feels like that's a risk that's going to change at some point in the future fundamentally right in some election cycle ten fifteen twenty years down the road is that not something i should be worried about as an investor here great.
- [17:54]
C
Question and there's no definitive answer but i can share some thoughts first thought is this if we look at the electorate in the twenty twenty four election one source we found claimed that fifty eight percent of the electorate was age fifty or older so your typical voter is a relatively old person at or near retirement and that matters okay it's hard to envision an environment where politicians of either or both parties are going to be eager to increase taxes on those at or near retirement the other thing we talk about in the book is well you can disguise a tax hike you could sort of make a tax hike more on workers than on retirees by upping the the twenty two twenty four thirty two percent thirty five thirty seven percent brackets but leaving those ten and twelve percent brackets alone what you're going to wind up doing is taxing workers a lot more than you are retirees now i do agree with you scott that work is a good thing and productivity is a good thing and we might want to start rethinking some of these policies now i will say though late taxation of capital gains is not unique to the united states your friends bill and jackie on their catching up to fi podcast recently had a woman named ruth from new zealand and she was talking about capital gains they're just exempt in new zealand well that's not uncommon capital gains are this sort of funny thing because there's an argument it's double tax i go to work i pay taxes on that money i take that money i invest it then i have a gain on that and you know now i pay a tax on that we can quibble and we could fight about that all day we're not going to resolve that issue today there's a lot of tension in the system scott i very much agree with that but i don't see a radical change and you got to remember too the government could print money and i'm not for printing money but the government can run deficits in a way that you and i cannot and so that's another thing out there that sort of says well maybe they're not just going to rush to increase taxes to close the deficits and by the way they haven't thus far it seems like.
- [20:00]
B
You shouldn't be taxed for preserving wealth right like if you have a million bucks keeping it a million bucks in inflation adjusted dollars over thirty years that doesn't make sense to tax right and of course our system does tax that but on the other hand it seems like they and gains about real gains and inflation it seems like there's some there's some world where that's going to change at some point in the future which is which has always been bugging me but either way if you keep your expenses low and your tax planning here you really won't have to worry about it because there almost certainly be these these buckets of income right these these tax brackets that will work through and your point remains the same this is not something that derail people's retirement plans so with that let's talk about the nuts and bolts of some of the key takeaways that you guys have for retirement planning like what should people do given these assumptions that hey you're going to be in your high tax years while you're working and you're going to be in a relatively low tax environment when you retire rather early or a traditional age how does that impact what you should do one of the.
- [20:54]
D
Biggest concepts in this book is called pay tax when you pay less tax sean came up with that line and i think the biggest thing here is as i mentioned before a lot of people are focused on what are my tax rates now we're typically saying what are my marginal tax rates now my highest tax rate now and then they think well tax rates are going up so i'm just going to have higher tax rates than i do in the future but we talk about this idea of paying tax when you pay less tax we did mention that you're usually going to pay less tax in retirement and there's kind of this fear though right is when people go into retirement they're already scared sometimes often to even take money out of their accounts right and then when they say like why should i pay my tax in retirement where that's actually where i feel like they need the most money it's one of those psychological you know quantitative versus qualitative issues to go through and i think a lot of this comes down to i think of really this this tolerance this behavior and emotion around investing and paying taxes again some of it's political some of it's just based on how you grew up and even what you what you learn from your parents about money whether a frugal mindset or a money avoidance mindset that that it's often really easy to go into this confirmation bias of looking for fear driven data there's a lot of books out there that even the title of the book will make you think oh my gosh i must read this book otherwise i'm going to be crushed by taxes if i don't we specifically wanted to lean into no fear in the book so that concept quantitatively of paying tax when you pay less tax and then qualitatively really understanding this analysis fundamentally and if you want to go into the more advanced tactics but from a place of absolutely no fear and sean i'd love for you to kind of mention that i love this idea even in the introduction you say before we talk about the numbers we first have to understand our emotions coming into this and i know we've talked about the middle class trap in here and other podcasts we have to understand both the quantitative and the qualitative concepts at the same time to really have a successful retirement with clarity and confidence yeah scott i'll.
- [22:49]
C
Just mention a couple of the tactics right so if we think we pay less tax in retirement than we do when we're working we probably should prioritize tax deductions for most listeners that starts with a traditional four hundred one k you know you say well the roth four hundred one is not objectively a bad thing it's not but it sacrifices what might be your most valuable tax deduction so for most out there we tend to favor traditional four hundred one s at work what about at home you have an ira well there we tend to like the roth ira well wait a minute i thought you said traditional at work well yeah i did but the roth ira at home has several benefits one is many listeners cannot deduct a contribution to a traditional ira so there's really little value there outside of something like a backdoor roth ira we could talk about that if you're interested but there's been lots of ink spilled on that but you know so in many the combination in terms of retirement accounts is traditional four hundred one at work roth ira at home and then a lot of viewers are going to say well that's not enough to get to early retirement and often that's true so then what else taxable accounts and we have got a couple of examples later on where i think we're going to find those taxable accounts aren't all that taxable in early retirement so we call those in the book the compelling three traditional four hundred one k or other you know it could be a four hundred three b four hundred fifty seven tsp so traditional at work roth ira at home taxable accounts you're setting yourself up for success in an early retirement and then even in a.
- [24:15]
B
Later retirement let's check our order of operations here what we spent the first fifteen minutes talking about are a philosophical overview of the fundamental assumptions that we're working with here the assumption is we're taking somebody who is looking for that kind of classic one to two point five million dollars fire number they are a middle to upper middle class income earner typical of the fire community probably maybe starting out somewhere in that seventy five thousand dollars range and ending their career in that one hundred fifty thousand dollars range over a fifteen twenty year career they're in a relatively higher tax income bracket during their working years than they will be in retirement this person will have a very low effective marginal tax bracket at retirement age so with those assumptions that we worked out here's the order of operations that we suggest here can you guys beat us up here and tell us where you might modify based on your extensive research and being true professionals in this space with the tax certifications to back them up so we have one thousand dollars emergency reserve paying off any high interest rate debt the tax tail does not wag the investment dog here we gotta you gotta have a buffer against the world and pay off your high interest rate debt take your employer match if you have an employee stock purchase plan take advantage of it and sell immediately have more taxes to pay but take your gain your fifteen percent discount and get the free money there fully fund the emergency reserve and then we get into our tax world right we suggest the hsa first the four hundred one k second the roth ira third at home as you've put it love that then any five hundred and twenty nine s of college planning is part of that part of the deal there then after tax brokerage then low interest rate debt and of course we could swap out the four hundred one k for teachers military all that kind of stuff what do you guys think is this is this the right kind of classic order of operations for financial independence the typical.
- [26:01]
D
Pathway yeah i think that's a great general order i would say this order there's this idea of flexibility versus tax optimization there are a few things on that list that are really focused on risk management right and flexibility and like access to funds quickly so that emergency fund the time horizon for emergency could be as little as a moment's notice so typically yeah like building an emergency fund that's certainly a risk management tactic that's focused on flexibility really like i want you know liquidity and stability i don't want this money you know volatile but i also want access to it quickly if my car breaks down et cetera i definitely believe in that you know the high interest debt being not necessarily like your hair is on fire but making a a very thoughtful approach to having flexibility around paying that off from the tax optimization standpoint we can kind of see the compelling three in here right we see the fully fund the four hundred one k the roth ira the after tax brokerage even though it's lower on the list you'll notice that some of the things on this list they're like do these if you have access to them so you'll notice the employee stock purchase plan the espp and that qualified espp like you know that's not going to be offered you know at most companies again certainly in the tech world you see this a lot but then when you see hsa in twenty twenty five you have to be covered by a high deductible health plan whether through work or even in retirement by the way you can still contribute to an hsa even without earned income assuming you have that coverage and then the five hundred twenty nine right that's one of those kind of optionality kind of in the same realm as optionality for those future savings and investing.
- [27:24]
C
Oh i got a couple of thoughts to share first one scott is you are a very brave man you put fully fund four hundred one k ahead of a roth ira and in other personal finance forums you're going to get torn apart for that assertion so i commend you for that because i agree with it well done scott i don't know if mindy this is your list as well well done to the both of you so just be aware of that there's a lot of roth ira rabid fans out there so you might get some feedback on that from them.
- [27:55]
B
Not from me can we dive into that point i know you have more more on this but like let's let's cover that because there's going to be seven or eight versions of this order of operations and when we talked about this we said if you're a real estate investor you're looking to house hack you stop here and you start building cash for that house hacker real estate investment right in there and you're foregoing these and this is the challenge here is the order of operations is great but a lot of it just assumes oh you make so much money you can just neatly go down the entire list here no problem right but nobody.
- [28:27]
D
Can do that very few people can.
- [28:29]
B
Do that you have to stop somewhere there's a prioritization component here and that's where this gets really heated because it's usually somewhere in the process of seven and eight here of fully funding the four hundred one k or the roth versus the roth ira my belief is that the goal of personal finance and tax play the holy grail is to get the money into the roth ira it's just that the best way to get the most money into the roth ira for many people especially those looking for early retirement is going to be to fully fund the four hundred one k and then to at some point in their life they're likely going to have an opportunity in a low income tax year maybe when they have a loss or whatever be able to roll that money into the roth ira at a future point so i have a more nuanced take of like i agree with people in the quorums going with the roth ira component it's just that this is the more tax efficient way likely for many people unless you're truly going to work for you know through to traditional retirement age earning a high income the entire way through and never have that opportunity to do that conversion but what's your response to that so.
- [29:28]
C
Scott i like the roth ira and i do advocate for some roth conversions i don't think the holy grail is to get everything into the roth ira and i'll give you just two quick reasons for that one we live in an era of high standard deductions so for a lot of retirees having somebody in that traditional just to take that out against the standard deduction i refer to that phenomenon as a so called hidden roth ira like why do we need to convert into a roth ira if we can withdraw from a traditional ira tax free against the standard deduction particularly for those in their mid to late sixties that can be very valuable distribution planning and then the second thing is qualified charitable distributions the tax laws do love retirees one of the ways is this at age seventy and a half and older you know if you're giving to your church or any other charity five hundred one c three do it directly from the traditional iraq it goes around everything else it's just excluded from income you don't get a tax deduction but you don't need a tax deduction because you're going to take the standard deduction anyway your charitable distribution is excluded from income it's a way of tax free bailing out the traditional ira so for those two reasons alone i'm not a big fan of having every last dollar in the roth not that that's a horrible horrible outcome but you're wasting standard deductions and you're wasting charitable or qualified charitable distribution rule so why pay a conversion tax even if it's a small tax to get every last bit into the roth ira and i.
- [30:58]
D
Think that thinking about roth there's this binary decision of do i contribute to roth now or do i never get roth at all right i think you know maybe leading up to the holiday season with halloween we can kind of talk about now and later right as a candy but it's really you know do i want roth now or do i want roth later and i think for most you know on the path to early retirement you know they might you know might contribute to the roth ira at home like sean mentioned but in terms of the traditional four hundred one k versus the roth four hundred one k i think a lot of people on the path to early retirement are saying well i've heard roth is amazing and i love roth i've even learned a lot about it i'm going to contribute to my roth four hundred one k and we're like wait hold on hold on just at least pause for a moment and think it's not roth now or never it's roth now or later and for most early retirees it's actually like better to contribute to the traditional four hundred one k at work to get those tax deferrals and then in early retirement possibly later convert that money to roth at a much.
- [31:52]
B
Lower tax rate that's my rationale pretty much in a nutshell here it seems like we certainly agree on the order if not fully agreeing on the motivations behind it at certain of those levels but it seems like this is like the classic kind of approach for that sweet spot like that very traditional path the middle to upper middle class earner looking for fire in a fifteen twenty year period maybe in their forties for example what would it take to get this to flip for you guys under what conditions would you have someone max out the roth before the four hundred.
- [32:22]
C
One k all right scott so you're asking a really good question and there are times where roth beats traditional so i'll give you a couple of examples one is in the book we use the term income disruption so this could be mini retirement this could be sabbatical this could be layoff this could be grad school right so we could have these times where hey you know i've been accumulating and now i'm only doing a little bit of accumulating or not any accumulating so at these times what i might do is prioritize a roth ira contribution or do a taxable roth conversion in my accumulation years because my income has been either fully disrupted or largely disrupted and the you know another thing to think about is early career so think about that person who's twenty two twenty three they just graduated college and they start their first full time job in october and their three months of salary just aren't that high maybe then do the roth four hundred one k capture the match and then maybe when we get to a twelve month income year we flip to a traditional that sort of thing there are absolutely times the other time is end of career so there are going to be plenty of people who don't just retire they phase out so they go from forty hours to thirty hours to ten hours and at that ten hour point maybe all right those last few contributions.
- [33:42]
B
Maybe we do the roth i think there's a lot of people who again in the bigger pockets money community who again a third of the members of the bigger pockets money community certainly plan to build a business following their early retirement another third are unsure and another third are definitely not going to do that they're going to traditionally retire and not do much and there's a big third and a small third and a medium sized third in that analysis by the way but that's roughly breaking it out let's say that you're one of those people who intends to pursue chubby or even fat fire and know you're going to build a business after you leave your wage income and so you're going to have a very prolonged period of high income years and your choice is four hundred one k or roth four hundred one k what would you advise that person one of the fascinating.
- [34:30]
D
Parts about this is going into early retirement let's say you do build a really awesome successful business with lots of income what's really nice is you know one part is you're switching from a w two earner to a schedule c you know self employment you have a lot more opportunities for deducting your expenses so ironically they're moving into early retirement and starting a business those first few years of starting your business you might actually have fantastic opportunities to deduct as you know startup cost starting a business is often more expensive than you know you're running it ongoing so one example here you know i left a w two job to launch my financial planning firm back in twenty twenty one and my first year income i left there kind of half year i actually had income from self employment when i was you know building my business but i had a lot of deductions right i had to register my business i had to file all the things i had to pay for all the you know the home office kind of stuff with the startup cost of launching a business in early retirement you might have one to two years of fantastic opportunities to actually be doing those roth conversions and things to get ahead of your ultra successful years of growing that business in.
- [35:31]
B
Retirement all right this is our final ad break and then we'll be right back to this not very taxing conversation in a minute finances can be messy and confusing and it's a lot of work for many of us just to get to the starting point in personal finance which is understanding what you've got and where your money's going that's why virginia my wife and i use monarch money as our personal financial command center for our bank accounts credit cards investment portfolio and as our budgeting and spending tracker monarch automates everything it's all linked and every transaction is automatically categorized into each category of spending in just a few minutes a month i have a complete picture of where every dollar is being spent and i have a real time net worth statement i've recommended and personally used monarch money for years i am thrilled and proud to be sponsored by and partnered with monarch money here at biggerpockets money biggerpockets money listeners get fifty percent off their first year which is usually ninety nine bucks with the code pockets at monarchmoney dot com that's monarchmoney dot com with the code pockets when i evaluate debt funds i look for things like first position loans personal guarantees deep experience by the fund operator low fund leverage fast liquidity and consistent returns these are some of the reasons why i'm excited to partner with pine financial group their fund six offers investors exposure to real estate credit largely for construction and rehab largely here in colorado with loans originated by an experienced originator with over one billion dollars in origination volume seventy five percent of their borrowers have been repeat customers over seventeen years they offer investors an eight percent preferred return paid monthly and a seventy thirty lpgp split of everything over ten percent paid annually the lockup period is nine months with liquidity available within ninety days after that nine month commitment the fund is open to accredited investors only the fund's minimum investment is typically one hundred thousand dollars but pine financial is able to reduce that minimum for some investors and have agreed to do so for biggerpockets money listeners to a minimum of twenty five thousand dollars full disclosure i am personally invested in this fund through my self directed ira and of course pine financial is sponsoring this message and our podcast if you'd like to invest or check out their prospectus go to biggerpocketsmoney dot com pine today that's biggerpocketsmoney dot com pine please note that returns are not guaranteed and may vary based on fund performance you just realized your.
- [38:01]
A
Business needed to hire someone yesterday how can you find amazing candidates fast easy just use indeed when it comes to hiring indeed is all you need that means you can stop struggling to get your job notice on other job sites indeed's sponsored jobs helps you stand out and hire the right people quickly your job post jumps straight to the top of the page where your ideal candidates are looking and it works sponsored jobs on indeed get forty five percent more applications than non sponsored posts the best part no monthly subscriptions or long term contracts you only pay for results and speaking of results in the minute i've been talking to you twenty three people just got hired through indeed worldwide there's no need to wait any longer speed up your hiring right now with indeed and listeners of this show will get a seventy five dollars sponsored job credit to get jobs more visibility at indeed dot com biggerpockets just go to indeed dot com biggerpockets right now and support our show by saying you heard about indeed on this podcast indeed dot com biggerpockets terms and conditions apply hiring indeed is all you need you know last.
- [39:01]
E
Year we went on a trip to rhode island and we stayed at a hotel and even though we had a great time we felt like we couldn't stretch out and be comfortable so we decided that for our next trip we'd like to stay someplace different someplace where we can enjoy local sites experience unique eats but can still cook a few of our own meals and have our own space since we definitely need more than what a hotel can offer we're planning a warm beach vacation and staying in an airbnb and i had a thought while we're away maybe we can host our own home on airbnb it could be a really cool side hustle to earn some extra income and then i found out about airbnb's co host network and it's easier than ever it's amazing you can hire a high quality local co host to handle the details for you hire a co host who can help take care of your guests they can also create your listings manage reservations provide on site support and they can even do design and styling find a co host at airbnb dot com host mint is still dollar fifteen a month for premium wireless and if you haven't made the switch yet here are fifteen reasons why you should one it's fifteen dollars a month two seriously it's fifteen dollars a month three no big contracts four i use it five my mom uses it are you are you playing me off that's what's happening right okay give it a try at mintmobile dot com switch upfront payment of dollar.
- [40:23]
B
Forty five per three month plan dollar.
- [40:24]
D
Fifteen per month equivalent required new customer offer first three months only then full price plan options available taxes and fees.
- [40:28]
B
Extra see mintmobile dot com.
- [40:35]
A
Let'S jump.
- [40:35]
B
Back in there's this concept that we are getting credit for inventing which we did not invent but we've talked about here on biggerpockets money called the middle class trap i think that as we've explored this topic it's clear that there are many ways mechanically to access funds in retirement accounts well in advance of traditional retirement age live your life if you leave work and access those funds right it's just not a mechanical issue and there are many workarounds however i do want to call out that i think that there's a challenge to accessing those funds while one is still working and that creates i think a bridge problem to that future state right folks who have been accumulating for many years are not well versed in the decumulation portfolio strategies and then the mechanics of actually setting these things up and it's very difficult to stop work on monday and set up these things on tuesday are there tax advantaged ways to to begin practicing or accessing these things in advance of leaving one job maybe a year or two in advance so i can bridge and get comfortable with the dynamic of my early retirement withdrawal strategy before i actually stop earning that high.
- [41:40]
D
Income i think this idea of the bridge is somewhat like a misconception or misnomer i think it actually came from the idea of what we call the roth ira conversion ladder where they say you need to have at least five years of income like as you're doing these you're laddering out these roth conversions so you have you know you have penalty free access to that money in five years i think that concept has also kind of told people i need at least five years of income in my checking savings tax or brokerage before i can retire and i think that bridge is actually a misnomer i do believe that somebody retiring without money in a checking again most people are going to have at least you know a small you know we talked about emergency fund was up in your up in your list of order of operations typically when somebody retires they're at least going to have some money in checking and savings even if they have a lot in their four hundred one k they'll probably have enough time again that bridge doesn't need to be five years right i guess that's a way of saying it if the bridge is really just you know enough time to set up those distribution strategies which thankfully don't take too much time to set up i would say though you know your four hundred one k you know doing that trustee to trustee transfer from a four hundred one k to your ira you might be doing the rule of fifty five from your four hundred one k right some of those things administratively might take a few weeks maybe a month or two to set up but i don't think you need like years of bridge to become an early retiree i.
- [42:54]
B
Guess at the higher level i don't know if that's the problem i think the problem is people feel like the money is inaccessible in those accounts and to begin accessing it you would then have to distribute it using perhaps like a sapp or seventy two t type distribution and you will pay taxes at your marginal bracket in that situation during any period that overlaps with your work like i think that's more more of the issue is you know you take these people that have you know a million to two million dollars in net worth and it's all in their house their four hundred one k and a little bit in their roth and it feels inaccessible especially in those years that are grinding out the death march to fi right it's hard to coast in that particular situation or begin withdrawing it seems like given how the tax code is set up is that the right assessment in your guys view i think.
- [43:44]
C
A few things are true one i do think it is helpful to have taxable accounts and cash going into early retirement one hundred percent it's very helpful but just because something is very helpful does not mean it's required so i think you can think about well okay i'm two years out from retirement all right what's it going to look like and what am i going to live off of and it may just be that the lion's share is in the old four hundred one k that exists in the world where people have four hundred one ks that just crushed it and they just don't have a lot else well okay in the last few years of work set up a bit of a bridge in terms of maybe it's a three month cash fund or six month cash fund i'm not big on mitigating suicidal return risk with three years worth of cash right but that's me you do you i think the exceptions that exist today are voluminous enough and reliable enough including a seventy two t which is not that difficult to set up relatively quickly now you're absolutely right that if you retire on june thirtieth and you have the four hundred one k at the employer you're not going to get that seventy two t set up for a couple of months probably right that just is what it is but it's probably a two three month transition issue it's not a year's transition issue so as cody alluded to what you probably want to do is work with one of the financial institutions to do a direct trustee to trustee transfer of that old four hundred one k to the ira now there are going to be some people in this audience who are maybe they're fifty seven years old well maybe they got the rule of fifty five right where they don't even have to do the seventy two t and this rollover to an ira at least not initially they can just take from their old plan as long as the plan has partial distributions so that's going to be a potential option government four hundred fifty seven there are going to be some folks who have a governmental four hundred fifty seven b where it's same thing it doesn't even matter their age no penalty on that just take as you take so scott i think there are transition issues but they tend to be months long if that they certainly don't tend to.
- [45:54]
D
Be years long and i'll add that there that one of the concepts is like how can you speed up that transfer again you have to be careful with transfers but how can we possibly speed up a transfer so let's say that i have all my investment accounts are at vanguard and my four hundred one k is at fidelity net benefits what i might want to do is rather than trying to send a four hundred one k from fidelity to an ira at vanguard maybe i set up an ira at fidelity so that you know sometimes depending on the employer and how it's set up sometimes that four hundred one k to ira transfer at the same custodian could be you know within the week right so if we want to get to our ira quickly and another thing to keep in mind is that you know moving an ira to ira somewhere else is a lot easier than moving a four hundred one k or another qualified plan to an ira at a different custodian so we might want to just consider a tact of kind of speeding up again doing it smartly but you know speeding up that transfer so that we're not waiting you know for for a traditional check in the mail for two months kind of figuring out okay i can't retire until this your check comes in the mail it might be just a week or two that you can get that four hundred one k to the ira maybe even work with a professional to set up the seventy two t if certainly that's not something to guess really you want to really truly want to understand that tactic but thankfully again if you have two years out to retirement now you have the time to understand how it works the fundamentals and the.
- [47:11]
B
Advanced tactics let's take a different example here someone who's just starting out on their journey there's two people that come to mind we have average joe's a median income earner starting out at you know in their very early years no wealth whatsoever and their equivalent who we're calling barb lately there's been a lot of interest in barb this is a fifty year old divorced woman who has been a stay at home mom for twenty five years and is terrified about traditional retirement and in these situations my belief is that they should not invest in their retirement accounts for a year or two because they need to jumpstart the income and wealth building journey and that first twenty five thirty thousand dollars of accumulation in cash can be used to either house hack or begin a business opportunity and so i not anti retirement accounts people think that that i just in this situation i like to defer those because retirement accounts almost always come with these restrictions on buying real estate that you're personally using or business assets that you're actively managing what's your reaction as tax professional and cfp to that statement there how heretical is that in your view just for the first.
- [48:21]
D
Two years i do want to mention so one thing you mentioned is divorced mom right you know like maybe they've been married a long time i would say that one of the possibilities for taking money out of a traditional retirement account early is with that qualified domestic relations order that quadro so in divorce that can actually be a way to avoid the ten percent penalty again it has to be set up correctly don't just assume it's that way if you're divorced you can don't just start taking money out of your retirement accounts but you know there might be a possibility to avoid the ten percent penalty if you do need access access to you know liquidity quickly or even like scott like you mentioned after a divorce if you if you are splitting up some retirement accounts like don't feel like they're off limits you know now that you're you know you're kind of you know kind of starting from the bottom up and you know catching up to fi as an individual now i will say.
- [49:07]
C
You know most americans are not as entrepreneurial as scott trench is right so you know look if you're setting up a business i agree with you that absolutely the flexibility of having cash checking account savings account and all americans should have at least some emergency savings to a degree at least particularly accumulators but i also look at where people who are essentially just you know thirty year old just starting out or the fifty year old starting over i really like managing today's tax liability that person whether they're the thirty year old starting out or the fifty year old starting over they don't have a tax problem in retirement so that sort of tells us that roth is probably not the path for them at least initially it could become part of the path they might crush it over the next five or ten years but when you're just starting over or starting out at that point in your life you don't have a tax problem at all in retirement and that strongly points to hey i got to get my finances in gear today i could really use that tax deduction if i am saving for my future so just sort of my take on it i do think it's commendable to build up some emergency savings and if you are going to be more entrepreneurial yes you're going to need more in those taxable accounts but most americans tend not to be that entrepreneurial i mean yes we are an entrepreneurial country but a lot of americans have jobs and so okay let's manage first for today's taxes and then maybe in the future we're going to have a tax issue in retirement we can then start thinking about more roth type stuff and i'll.
- [50:34]
D
Add scott and mindy we talked earlier about kind of my path you know going from an employee to employer self employed and one thing for me as i mentioned i haven't contributed to a four hundred one k in the last five years and everybody like oh my gosh like what how can somebody who's such a big fan of these these concepts not contribute to a four hundred one k but like sean said like that flexibility and that liquidity especially when you're starting a business is really important not just for your runway for your personal and professional expenses but also just the you know the future opportunities you're like i'm willing to say no i think that this is where it comes down to intention it's intentionally saying no to tax optimization versus not understanding it exists so you know me not contributing to a four hundred one k was really focused on increasing my flexibility but i made that decision intentionally not just you know without knowledge going in i.
- [51:21]
A
Love the intentional ness of your decision and that's probably the best decision for you in this specific situation but i don't want somebody to hear oh well cody's not contributing to his four hundred one k so i don't have to either well well no that's the exact wrong time to make that decision why would you be making this decision just because cody did it i mean cody's done a lot of things that are great for cody and are terrible for you just like sean has done a lot of things that are great for sean because he thought about it so i love that you caveat that with i did think about it it was.
- [51:55]
D
Intentional and guess what i'm doing this year i'm contributing to a four hundred one k so now people are like what he's flipping back and forth what's.
- [52:01]
A
Going on oh that's another good point.
- [52:03]
B
I think sean's right most people are not not that entrepreneurial but if you are then those investments like a house hack or maybe a business could completely overwhelm the opportunities that come into your life relative to the tax advantages of these accounts and when the income stream is on max out the accounts basically for the rest of your career on that and that's what you're going to.
- [52:23]
A
Do cody well cody and sean this was a super fun conversation i learned a lot i learned that i need to start planning my income and review that way earlier than i actually do so i have already learned so much from you but we didn't even get to the retirement withdrawal order of operations so we're going to have you back next episode which comes out on friday to talk about the order in which we should be withdrawing from our account so i am super excited to talk to you guys again in just a couple of days tell us more about this book what is the name of it where can people get it cody i'm putting that on you yeah so.
- [53:05]
D
The book is tax planning to and through early retirement it's actually available today when this is coming out as a paperback or kindle ebook you can go to amazon for that but if you want to just easily go to measure twice money dot com book and that'll have all the links ready for you.
- [53:22]
A
Awesome and sean where can people find.
- [53:25]
C
You online thanks so much for having me today mindy and scott you can find me at my blog fitaxguy dot.
- [53:30]
A
Com all right cody and sean thank you so much again for your time today and we will talk to you in just a few days all right scott that was cody and sean and that was so awesome i love talking to those guys they're always such a wealth of information what did you think.
- [53:45]
B
Of the show my gosh these guys are a great source of knowledge and we only covered the accumulation phase on the tax side we didn't even get to how we're going to distribute funds in retirement and how there's even more advantages that come into play not with relative to just the lower income tax brackets that most retirees find themselves in versus their working years so i think it was a great concept and i think that it's illuminating to see just how much tax brackets would have to rise for a typical person pursuing financial independence for them to be paying in a higher marginal tax bracket in retirement in almost any circumstance than what they're paying during their working years sometimes it's.
- [54:24]
A
Just really helpful to see actual math oh that really opens my eyes so i'm so glad you asked that question and i'm so glad they had such a great answer for it all right scott should we get out of here let's do it that wraps up this episode of the bigger pockets money podcast my name is mindy jensen he is scott trench we'll be back next episode with more cody and sean and i am saying for now take a bow.
- [54:48]
B
Highland cow attention law enforcement you took an oath to protect and serve to keep your family your neighborhood safe but in too many cities dangerous illegals walk free as police are forced to stand down join ice and help us catch the worst of the worst drug traffickers gang members predators join the mission to protect america with bonuses up to fifty thousand dollars and generous benefits apply now join dot ice dot gov and fulfill your mission.