ChooseFI Podcast Episode Summary

Episode: Mailbag | Backdoor Roth IRA, 4% Rule & 401k Strategies for Retirement Planning | With Rachael Camp | 521
Release Date: November 18, 2024
Hosts: Brad and Rachael Camp, CFP
Duration: Approximately 68 minutes

1. PSA: Beneficial Ownership Information (BOI) Form

[00:40 - 03:17]

Brad kicks off the episode with an important Public Service Announcement (PSA) regarding the Beneficial Ownership Information (BOI) form, which is mandated by FinCEN. Business owners with legal entities, such as LLCs for businesses or real estate rentals, need to submit this form by December 31, 2024.

• Key Points:

  • Who Needs to File: Owners of legal entities like LLCs.
  • Deadline: December 31, 2024.
  • Penalties for Non-Compliance: Up to $500 per day.
  • Action Steps: Visit fincen.gov/boi and submit the form, which takes about two minutes.

• Notable Quote:

  • Brad: “If you own a legal entity in any way, Shape or form… just take a look. It’s really quite easy.” [02:15]

Rachael adds that while there are exemptions, such as for financial advisors, the guidelines remain ambiguous. She recommends reaching out to CPAs for assistance.

2. Retirement Account Options Without a 401(k)

a. Mohit’s Question: Pre-Tax Retirement Investments Without a 401(k)

[04:20 - 07:46]

Mohit inquires about investment options for his wife, who is employed by a company that doesn't offer a 401(k) or any retirement account.

• Rachael’s Response:

  • Traditional IRA: Eligible for contributions if income falls below specified limits. For 2024, the full deduction for a traditional IRA phases out for married couples filing jointly starting at $230,000 and fully phased out at $240,000.
  • Health Savings Account (HSA): Offers a triple tax advantage with a family limit of $8,300 in 2024.
  • Self-Employed Options: Solo 401(k)s or SEP IRAs for those with side hustles or self-employment income, contingent on having legitimate business revenue.

• Notable Quote:

  • Rachael: “The phase-out for a traditional IRA deduction… starts at 230,000 and is fully phased out at 240,000.” [03:39]

b. Follow-Up: Handling a Poorly Managed 401(k)

[07:46 - 12:49]

Brad brings up a listener’s concern about being offered a job with a poor 401(k) plan featuring high fees and low returns. The listener wonders whether to take the employer match despite the plan’s shortcomings.

• Rachael’s Insights:

  • Employer Match: Always take the match, regardless of fees. It’s often equivalent to a 100% return on investment.
  • Post-Match Strategies: After securing the match, consider other investment avenues like Traditional IRAs, HSAs, or brokerage accounts.
  • Future Adjustments: Upon leaving the job, consider rolling over the 401(k) into a lower-fee IRA.

• Notable Quote:

  • Rachael: “No matter what the fees are, it’s worth it.” [08:48]

Brad emphasizes the importance of advocating for better 401(k) options by approaching HR departments with research on the impact of high fees.

• Notable Quote:
  • Brad: “Be the change you want to see in the world.” [11:30]

3. Backdoor Roth IRA Concerns

Scott’s Question: Timing of Roth IRA Conversions

[12:49 - 21:08]

Scott raises a concern about the timing between contributing to a non-deductible Traditional IRA and converting it to a Roth IRA. His accountant suggested waiting to avoid potential scrutiny.

• Rachael’s Explanation:

  • Backdoor Roth IRA: A strategy for high-income earners to contribute to a Roth IRA by first making a non-deductible Traditional IRA contribution and then converting it.
  • Legal Loophole: While legal, rapid conversions could theoretically be challenged as circumventing contribution limits.
  • Recommended Waiting Period: Opinions vary, but many suggest waiting a month and a day to separate the contribution and conversion steps.

• Notable Quote:

  • Rachael: “It’s a rapid succession of events where hypothetically a court could look at this and say your intent was to make an impermissible Roth IRA contribution.” [17:00]

Brad shares his discomfort with the strategy despite its legality, citing ethical concerns and the complexity introduced by other IRA accounts affecting the pro-rata rule.

• Notable Quote:
  • Brad: “The juice never seemed to be worth the squeeze for me.” [17:46]

Rachael differentiates between the Backdoor Roth IRA and the Roth IRA Conversion Ladder, clarifying that the latter is a legitimate strategy involving taxable conversions without the intent to circumvent contribution limits.

4. Asset Allocation Strategies

Shane’s Question: Equity/Bond Allocation in Taxable Accounts

[23:52 - 35:57]

Shane asks about the appropriate allocation between equities and bonds in a taxable account to sustain the principal while applying the 4% rule, specifically inquiring whether to remain invested in VTSAX indefinitely or adjust the mix as retirement approaches.

• Rachael’s Response:

  • Dynamic Allocation: As retirement nears, shifting from equities to bonds and cash can mitigate sequence of returns risk.
  • Buckets Strategy: Creating buckets of safe assets (cash and bonds) to cover the initial years of retirement, allowing equities to grow for later stages.
  • Sequence of Returns Risk: Emphasizes that withdrawing during down markets can significantly harm portfolio longevity.

• Notable Quote:

  • Rachael: “We use bonds and cash as a sort of insurance for your equities.” [27:52]

Brad advocates for simplicity in index fund investing but acknowledges the necessity of adjusting asset allocations as one approaches retirement to protect against market downturns.

5. Funding Early Retirement with Brokerage and Rental Income

Bob’s Question: Sustainable Withdrawals with Rental Income

[37:01 - 55:29]

Bob outlines a retirement plan where he and his wife, both at 46, plan to retire at 48 with:

• Assets:

  • $1 million each in retirement accounts.
  • Five rental properties generating $5,000/month net income.

• Expenses: $15,000/month in a high-cost area.

• Strategy: Save $1 million in a brokerage account to withdraw $10,000/month until retirement accounts mature at 59½.

• Rachael’s Insights:

  • Asset Allocation: Ensure retirement accounts are aggressively invested to grow sufficiently by age 59½.
  • Sequence Risk: A decade-long retirement plan like Bob’s exposes them to significant sequence risk if market returns are poor.
  • Additional Income Sources: Suggest considering pensions and Social Security as part of the income stream to reduce reliance on portfolio withdrawals.

• Notable Quote:

  • Rachael: “The first five to ten years with sequence of returns risk… that’s where we want to make sure.” [43:41]

Brad adds that incorporating other income sources like pensions and Social Security can provide flexibility and reduce the pressure on portfolio withdrawals, enhancing the plan's viability.

6. Real Estate Portfolio’s Impact on Financial Independence (6% Net Yield)

Uthman’s Question: Accelerating FI with Real Estate

[55:29 - 65:16]

Uthman questions the feasibility of accelerating FI by building a real estate portfolio that yields a 6% net return, thereby reducing the required savings multiplier from 25x to approximately 16x. He wonders why this strategy isn't more widely adopted.

• Rachael’s Analysis:

  • Real vs. Stock Investments: Differentiates between real estate returns and stock market withdrawals, emphasizing that sequence risk affects each differently.
  • Net Yield Reality: Achieving a consistent 6% net yield in real estate is challenging due to market variability, management fees, vacancies, and other expenses.
  • Appreciation vs. Cash Flow: Stresses that net yields include both income and potential appreciation, making the overall return variable and not guaranteed.

• Brad’s Contributions:

  • Real Estate Complexity: Highlights the need for diligent property management and the inherent risks in real estate investment.
  • Appriciation Concerns: Points out that relying solely on rental income without accounting for property value fluctuations can be risky.
  • Practical Constraints: Notes that finding properties that meet the 1% rule (e.g., $1,000/month on a $100,000 property) is increasingly difficult in many markets.

• Notable Quote:

  • Brad: “We have to look at them separately… we can’t conflate a 6% net yield with a 6% dividend yield.” [64:03]

7. Roth IRA Rollovers

Robert’s Question: Withdrawal Rules Post-Rollover

[65:16 - 66:26]

Robert asks whether rolling over funds from a Roth 401(k) or Roth 457(k) into his existing Roth IRA allows immediate access to contributions and earnings, given his Roth IRA has been open for over five years.

• Rachael’s Brief Answer:

  • No as Contributions: The rollover doesn’t count as a new contribution; it retains the original account’s age.
  • Immediate Access: Since the Roth IRA has been open for 12 years, rolled-over funds meet the five-year rule and can be accessed without penalties.

• Notable Quote:

  • Rachael: “Those funds are going to be seen as having been in there for 12 years. So you’re good to go.” [66:03]

Conclusion

This episode delves deeply into complex aspects of retirement planning, asset allocation, and the nuances of various investment strategies. Rachael Camp provides expert guidance on navigating retirement without a traditional 401(k), the intricacies of Backdoor Roth IRAs, optimizing asset allocations to mitigate sequence of returns risk, and leveraging real estate for financial independence.

Key Takeaways:

• Enhancing Retirement Accounts: Always take advantage of employer matches, even in suboptimal 401(k) plans, and advocate for better options when possible.
• Asset Allocation is Crucial: Tailor your equity and bond mix based on your retirement timeline and risk tolerance to safeguard against market downturns during critical withdrawal periods.
• Diversify Income Streams: Incorporating rental income, pensions, and Social Security can provide financial stability and reduce reliance on portfolio withdrawals.
• Cautious Approach to Real Estate: While real estate can accelerate FI, it demands diligent management and comes with inherent risks that must be carefully considered.
• Understand Roth IRA Rules: Properly managing rollovers into Roth IRAs ensures tax-advantaged, penalty-free access to funds post-retirement.

Notable Quotes:

• Brad: “Be the change you want to see in the world.” [11:30]
• Rachael: “If you have access to the HSA, that’s another thing I would look at.” [07:46]
• Brad: “The juice never seemed to be worth the squeeze for me.” [17:46]
• Rachael: “We use bonds and cash as a sort of insurance for your equities.” [27:52]

For listeners seeking personalized financial advice, it's recommended to consult with a certified financial planner to align strategies with individual circumstances.

This summary captures the essence of the ChooseFI episode with detailed insights, preserving speaker attributions and notable quotes to provide a comprehensive overview for those who haven't listened.