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- [00:00]
Brian Preston
How to make your first million and then turn that into five.
- [00:10]
Bo Hansen
Brian, I am so excited to talk about this because we love talking about building towards financial independence, but oftentimes people will say a million dollars just isn't enough. Isn't enough. Isn't enough. Well, you can't get to 2 or 3 or 4 or 5 unless you get that first million first. So we want to tell you how to get to that first million and then just like you said, how to get to 5 million.
- [00:33]
Brian Preston
Bo I like that. We're, we're people's millionaire gateway. We are their tour guide. We've come from humble beginnings. We know that the world is out there telling you you can't do this. But we've got so much experience, we've got so many people that we've helped bring across the gates of seven figures. We want you to just, just breathe in our optimism and you can do this too.
- [00:57]
Bo Hansen
So let's talk about this through the decades. How make that first million. Let's start at the very beginning, Brian. Let's talk about the 20s. This is the stage where you're just starting out so you don't have to get a lot of things exactly right. But there are a few things that we want you to know. Because if you can get these few things right, there's a really good chance you can set yourself up. And the first one, Brian, is just simply this stage, knowing what tools you ought to use.
- [01:23]
Brian Preston
I like that you just said just simply. I think an important thing is, is that don't overcomplicate your life at this level. This is where I want you. Following the financial order of operations. If you're trying to figure out what to do with your next dollar, you don't have to create a better mousetrap. We've actually created what to do with every dollar that comes into your army of dollar bills. And I like the fact that this is, when we're talking about this, we're talking about Roth IRAs.
- [01:49]
Bo Hansen
That's right.
- [01:50]
Brian Preston
I mean, why not start in step five with Roth IRAs, health savings accounts, where these things are growing completely tax free and letting you take advantage, maxing out the growth opportunity of compounding interest.
- [02:04]
Bo Hansen
And then even how about your employer sponsored retirement accounts, Whether that be a 401k or a 403b or a 457. These are all great tools that you have at your disposal. So just being in your 20s and understanding what tools you have available can be wildly beneficial. But then not only do I need to know where to invest in terms of what kinds of accounts can I use. I also need to think about what do I invest in, what are the tools that I use. And we actually have a great mini show out there that you can go watch called Investing 101. And it walks through the different types of investment accounts that are available to you, the types of investment options you can use inside of those investment accounts, and then how you know which one to choose. Am I someone who should be using index funds or active funds or managed funds? What's the best solution for me?
- [02:53]
Brian Preston
Well, what I like is, is that I remember when I just graduated from Georgia with that accounting degree, Everybody thinks just because I grew graduated with this accounting degree, I knew what to do with money. I was so far from it, I didn't even know where to make that first investment. I love that we kind of open it up. We talk about index target retirement funds, we talk about the power of buying index funds for the low cost, their tax efficiency. We actually try to load you up so you can make the best decision possible for your personal finances.
- [03:21]
Bo Hansen
So in your 20s, you don't only need to know what tools to use, you also need to make sure that even at the very beginning of your journey, just starting out, you keep a long term perspective. Building towards financial independence is a marathon, not a sprint. But it is so easy as life happens for us to lose sight of the big picture.
- [03:39]
Brian Preston
I've told many stories where I've had friends who are just now introduced to the wonderful world of finance. They start investing, but I always know it's that first five to ten years is risky for them because they just don't know any different. And then we hit our first downturn because we know every decade there's going to be two downturns. And you just worried, how does that brand new investor handle that? So we've come up with something, and you've heard a lot of other financial content talk about this as well is when in doubt, zoom out. Do not get distracted by that first downturn. Just keep driving through it. Always be buying and you'll come out on the other side better.
- [04:17]
Bo Hansen
And as an investor, when you zoom out, you'll recognize that perhaps the long term is not nearly as frightening as the short term. We have an illustration that we like to show that just shows the S&P 500 over the last 20 years. And if you think about the Great Recession, you think about the year 2008. If you just look at where the S&P 500 started 2008 and where it ended 2008, it lost 37% in that single year. But if you can zoom out and you can look six years into the future, the S&P 500 was positive. You can look 10 years into the future, the S and P over that decade annualized 7%. And if you can even zoom out 15 years past the Great Recession, past that one singular point of volatility, the S&P 500 annualized over that period, 15% per year. So even though today the ups and downs might seem uncertain, might seem volatile, might seem scary, if you can pause and zoom out, you recognize that over the long term, it's a pretty attractive picture.
- [05:20]
Brian Preston
Well, for all my visual learners, I've been using this analogy for decades now, and I think it clicks with a lot of people, is that I want you to envision somebody who's walking up a hill, a hill with a yo yo. So, yes, they're throwing that yo yo up and down. And in the short term, yes, each, you know, it's down and then it's up. It's all over the place. It's volatile, just like the financial markets. But here's the thing about when you're walking up a hill, you're going to higher and higher elevation even with that yo yo going up and down. That's exactly how investing is. I think everybody. What I love to show clients is when we, on our, on our quarterly report, we have since inception what their graph of investments looks like. And I was like, do you remember how stressed out you were about 2008? Can you go back and look on the graph now what that looks like in your portfolio? And it's just a slight little hiccup. It really is. But at the time it felt massive. And that's just the power of zooming out and also keeping your perspective and understanding that over the long term, that volatility cannot, it can feel not great, but it can actually be a value add or something that helps you build your great big beautiful tomorrow.
- [06:32]
Bo Hansen
And one of the single best things that you can do to keep that long term perspective is make good habits as easy as possible to replicate in your 20s. This might be a great season of life to start budgeting, understand, okay, where are my dollars going every month, every week, every pay period? And am I allocating and deploying them into the right places? Am I just wasting a bun of money every time my paycheck hits? Or am I commanding my dollars so that I build this habit of continually and consistently saving over time?
- [07:04]
Brian Preston
Well, a great way to make the good habits easy, make them automatic.
- [07:07]
Bo Hansen
Yep.
- [07:07]
Brian Preston
So I love dollar cost averaging every month. I always talk about always be buying where I've automated a lot of my wealth building journey so that I don't have to worry, is the market up? Is the market down? Is there a presidential election going on? Are we, you know, what's going on in the real estate economy? It doesn't matter. I'm always be buying. And if you can just have that mindset and then couple that with how do you make other good habits as easy as possible? Couple that with. We have an illustration on what 1% more can do for you. It doesn't have to be, I think everybody thinks about to build a million dollars. Oh my gosh, that is, I'm so far from that. I've got credit card debt, I've got student loan debt. How am I ever going to get to a million dollars? Don't think about it in terms of where the whole big kick and caboodle that you're trying to reach. You've got to think about this in small, incremental, small steps you can do. And that's why I love our illustration. If you go to moneyguide.com resources, it breaks it down to say if you can just give me 1% more, what does that do in the long term? And I think you'll be shocked at how just a little goes so far.
- [08:10]
Bo Hansen
Okay, so if we're in our 20s, how does this play out? How do we actually build towards that first million? Well, let's investigate a case study. Let's consider Manny the Mutant starting out in his 20s. And let's say that Manny begins his working career at age 25, making $50,000 a year. We're going to assume over his career he gets on on average about 3% annual wage salary increases. Let's assume that he starts investing at 25. So if he graduated early, that's going to be the first year he starts investing. And let's say that when he starts investing, he can only do 15%. He can't save the 25% that we prescribe right out of the gate. He can just start at 15%. And because he's a more aggressive investor, we think he can average an 8% annualized rate of return over the long term. But every single year, Manny recognizes the power of just 1% more. So he is going to begin increasing his savings rate by 1% every year. So at 25 it's 15%. At 26, it's 16%, 27, 17% so on and so forth. Well, if he can do this for the remaining half decade of his 20s, by the time he gets to age 29 at the end of this decade, Manny will have accumulated $54,680.
- [09:25]
Brian Preston
Yeah, that's pretty amazing if you think about. Because one of the things we try to tell you to do by the time you get close to age 30, it'd be nice if you had one time salary. We've already shared that. Manny started out with $50,000. He got 3% pay raise increase. He's right there just from starting. He didn't start at 20, by the way. He started at 25. And he made those small incremental decisions. But Bo, that's only half the story. Because I think a lot are going to say, well, $55,000, that'd be nice to have that in the bank. Maybe that helps you buy a car. Maybe that's a good house down payment. But how is that my journey towards a million dollars? Well, hang in there and we'll show it.
- [10:01]
Bo Hansen
Yeah. Remember, the goal is to get to a million. Well, at the end of your 30s, you're about 5% of the way there. If you've accumulated $50,000. Well, if you don't save. If Manny does not save another dollar and just lets those dollars continue to grow at 8% all the way out until he hits a million, he will cross his first million. He will become a millionaire at age 66. Mind you, he did not save anything else. At age 29, he stopped saving and just let that $54,000 continue to grow. And age 66, he crosses into millionaire status.
- [10:35]
Brian Preston
So 10 years worth of savings, not even.
- [10:37]
Bo Hansen
He started at 25.
- [10:38]
Brian Preston
Five years of savings, that equaled almost 55,000. If you give it enough time, it can reach a million dollars by 66. Now, a lot of people, I thought you guys said this headline was going to be how to turn your first one into 2, 3, 4 and 5. What's the rest of the story? Because that seems like a long time. 30 to 66 to reach the first million. What does it make to make the next million?
- [11:02]
Bo Hansen
Well, once you've done that, the bigger the numbers get, the bigger the numbers get again. If Manny just let his dollars continue working without saving anything else, he crosses 1 million at 66, 2 million at 75, 3 million at 80, 4 million at 83, and 5 million at 86. Assuming he lets those dollars continue to grow. But remember, Manny is a mutant. So I don't think Manny's going to stop in his 20s.
- [11:27]
Brian Preston
No, I mean let's this, I love that we gave it the extreme. Now let's bring it back to reality because I think a good, a person who starts at 25 is not just going to shut it off after that first five years of saving, investing. They're going to keep the good, good habits going forward. Let's see what happens as they add to this in their 30s.
- [11:44]
Bo Hansen
So now as we get into our 30s, there's a really good chance we have sort of the basics down. So now we want to start optimizing. We want to think about what are the decisions that we make that can be small marginal decisions today that can have large impacts later on. So there are a few key takeaways we want you thinking about in your 30s, the first of which maybe this is the time of life, the season where you should reassess your tax situation.
- [12:09]
Brian Preston
Well, yeah, you're starting to make more money. We love for our 20s and even early 30s while you're in those lower income tax brackets, when you're under 25%, we want you max out those Roth IRAs. But I do think it makes sense, especially when you get in your 30s, you start making more money. Let's reassess that tax situation because you might need to balance out. Are we doing Roth, which grows tax free currently and forever, or are we doing traditional where we get a tax deduction now but we're going to have to pay the full ordinary income taxes on when we pull it out? There's a balancing act. If only there was somebody out there telling you how to navigate this.
- [12:47]
Bo Hansen
Yeah. So how do we think about this? Well, it's not incredibly complicated. What you want to do is you want to look at your combined marginal tax rate. That's the marginal tax bracket on the federal side plus the marginal tax bracket on the state side. Well, if you add those two marginal rates up and they're under 25%, there's a really good chance that Roth is going to be the best solution for you moving forward because you're in a very low tax bracket. If you're between 25 and 30%, it becomes a little more nuanced based on your individual factors like age, your current estimated tax rate, your future estimated tax rate, your account structure. But once you add up your combined marginal federal and state tax rate and it's over 30%, the tax savings you accrue today are so valuable that it's really, really difficult to walk away from that pre tax savings. So if you do find Yourself in this income situation, pre tax 401k contributions might be the best solution for you.
- [13:42]
Brian Preston
Don't miss out on that tax arbitrage situation because those that are over 30. A lot of you think about the federal tax. Top marginal rate is 37%. There are states out there that will tax you at levels as high as 13% on your income. You add those two numbers together, that's 50% is going towards taxes. It makes sense when you're paying 50% towards taxes. Why don't we take a tax deduction now with the thought that down the road when I no longer have high earned income W2 wages or ever how it's flowing in, maybe there'll be an arbitrage situation is that once that earned income goes away, my tax rates crater because now instead of being at the 37%, maybe I'm at a 12% tax rate for local and maybe my state because it gives retirees some tax favored, you know, planning opportunities. They don't even charge on certain type of distributions. What if you could go from 50 down to 12? That's an amazing opportunity. And as much as I love Roth, sometimes I think that tax arbitrage is powerful and you don't need to sleep on that.
- [14:46]
Bo Hansen
And these decisions can be impactful even in this present time. You think about someone who is in 24% marginal bracket and another 6% of the state side. So they are at that 30% threshold. Do you realize just switching your contributions from being all Roth to all Pre tax in 2025. So $23,500 of salary deferrals, just making that one decision to get that tax savings this year will save you over $7,000 in taxes. That in and of itself is enough to fund an IRA to put money into your HSA to continue adding to your army of dollar bills. So then the next thing we want you to take away, the next idea we want you to have in your 30s is make sure you don't miss out on low hanging fruit. Savings opportunities. One of our favorite Brian our health savings accounts.
- [15:36]
Brian Preston
Yeah, we love the triple tax advantage. You get the deduction on your contribution, it grows tax deferred. If you use it for qualified medical expenses, you get to pull it out completely tax free. And here's the cool thing. It turns into a retirement account that you can use even for outside medical expense. If you don't need it for medical and you just want to use it for lifestyle or retirement expenses, you can still get access to your health savings account. Post 65 you just have to pay income taxes on the gains. Pretty cool thing.
- [16:03]
Bo Hansen
We love HSAs. It's why they're step five, Brian. We hold the thing up. It's why it's step five of the financial order of operations. But it's not just HSAs that offer tax free growth. We also love Roth IRAs. But maybe you are in this stage in your 30s and you are beginning to reassess. Okay, am I where I'm supposed to be from a saving standpoint and from a tax optimization standpoint? Because once I'm single and I make over about $150,000, I'm not able to do full Roth contributions. Or once I'm married and I make over 236,000, my ability to do Roth contributions is now limited. So perhaps I need to be thinking about doing backdoor Roth IRA contributions.
- [16:46]
Brian Preston
Backdoor Roth contributions, what's known. But it's really, it's a Roth conversion strategy. If you realize, if you know anything, if you follow financial history. In 2010, they changed the tax policy to where there was no income limits on doing Roth conversions from traditional IRAs. So here's how it works. You got to make sure you contribute to a traditional ira. You then convert those dollars to a Roth ira. You don't pay taxes except for any gains that occurred as long as, and this is a big asterisk. You don't have any other IRA assets out there. So you need to be careful if you have a rollover ira, a former traditional IRA that you took tax deductions on. If you have a simple IRA through an employer or a sep, be careful because those things can create some weirdness in how you have to allocate that conversion. But if you don't have any of those accounts I just named and all your money's in your 401k because they don't count against you or an inherited IRA, you're a okay to consider this type of strategy.
- [17:46]
Bo Hansen
And then as you're thinking through this, as you're not missing out on that low hanging fruit, the other thing we want you to keep your eye on and stay mindful of is should I be rebalancing, should I be rethinking about how I have the risk assets inside of my portfolio structure? For a lot of people just starting out, if you're using a Target retirement index fund, all you have to focus on is how much can I save and when do I think I need the dollars? And the portfolio will automatically rebalance for you. But as you hit your critical Mass as you hit your boiling point and you move from a generalized investment solution to a specialized investment solution, you want to make sure you're factoring in your unique risk tolerance, your unique risk capacity, and rebalancing your portfolio accordingly so that it can be maximized and optimized for your unique situation.
- [18:33]
Brian Preston
You just kind of covered. I love when people start. You know, you start out in the index target retirement fund because your savings rate is more important than the investment. But once you reach multiple six figures, this can get scary. You do need to start thinking about tax location and spreading out the money in different ways. But I also want to point out we have a lot of you. We know you're out there from our mutant survey where you have restricted stock units, you have employee stock purchase plans. You have a lot of concentration, not only of where your human capital is, meaning your wages and your time, but also your investment capital through your employer. Don't sleep on the fact that you might need to be rebalancing those great incentives so you just don't have everything all in your employer. We want to make sure we diversify that over time.
- [19:18]
Bo Hansen
So, okay, how does this play out in our case study? How does this look for Manny? Well, let's remind you of the assumptions. Manny started working making $50,000 a year at age 25, and he gets about a 3% pay raise every year. He began investing at 25, and he began investing at 15% per year, increasing it by 1% each year until he maxed out at 25% savings rate. We're also going to assume that Manny can make about 8% annualized on his investments over the long term. He hits his 25% savings rate in his 30s. So once he hits that, he gets to stop. Because at that point, once you hit that, you get to decide what you want to do with your dollars above and beyond that. And so he decides, I'm going to keep investing that 25% all the way until I get to age 39 or when I get to age 40. So if Manny did this beginning at 25, going all the way out until the end of his 39th year, Manny would have $352,000 saved up in his portfolio.
- [20:19]
Brian Preston
Yeah, that's pretty amazing. You think about, because we covered the 20s, where he ended up a little over $53,000. Now he's ending right at the end of his 30s, and he's at $352,000. That's starting to feel like a large sum of money. But it's Still BO in a lot of ways it's a long ways from a million dollars. But we know that we're missing some key components here. This is from ending at age 39. I'm curious to know what that $352,000 if you give it the most powerful of the three ingredients of wealth building time. What does this look like in the future? When does he actually cross over seven figure status?
- [20:56]
Bo Hansen
That's right. At 40 he is 35% of the way, but not all the way there. If he lets that money keep working for him, earning 8%, he will actually cross into millionaire status at age 53.
- [21:08]
Brian Preston
Wow.
- [21:08]
Bo Hansen
Remember, that's no more additional savings in his 40s and 50s, just letting that $350,000 grow. So now he has shaved just by saving in his 30s. What is that, 13 years off of his 20 year old self just by staying consistent for the next month.
- [21:24]
Brian Preston
And I think that when I, when we were, you know, when we're setting up this show content and I saw just the rewards you get for Investing in your 20s, just that 10 year decade of your 20s was going to reward you crossing into seven figures at 66. In a lot of ways that sounds old, sure, I mean it really does. But when I see 53, I'm like wait a minute, 53 feels much more of what people is an ideal of when you want to cross into seven figure. Because now you, you get the flexibility of what do I want to do with my time.
- [21:54]
Bo Hansen
That's right.
- [21:55]
Brian Preston
Maybe I keep working, but I'm also maybe getting to the level of assets where I'm at financial independence, where, where I can let my army of dollars work harder than I do with my back, my brain and my hands. This is a powerful age to really reach millionaire status.
- [22:08]
Bo Hansen
And it doesn't just stop there. If Manny were to let his dollars continue growing past age 53, he'll actually hit $2 million by age 61, 3 million by age 66, 4 million by age 70 and 5 million by age 73. Remember, this is him not saving another dime after age 39. And when you compare this trajectory versus what his trajectory was at his 20s, it is a very different picture. Instead of not hitting 5 million until age 86, he now hits 5 million at age 73. And that has him only saving for 15 years. But again, Manny is a mutant. I don't think he's stopping at 39 either.
- [22:50]
Brian Preston
Well, you're definitely not stopping there because think about this. The highest earning years are typically in your mid to late 40s. The other thing is, I know most millionaires, despite what you see on social media, cross into seven figure status in their 40s. So why would we stop on applying the gas and making this thing go until we actually reach the seven figure status? And that's a perfect transition to talk about the 40s.
- [23:17]
Bo Hansen
So in our 40s, obviously we got the basics down in our 20s, and then we began to be optimized in our 30s. Well, in our 40s, it's likely our financial situation looks very different than it did 20 years ago. So we want to think about, okay, am I not just optimizing that the accounts, I'm not just optimizing the accounts, I'm using, optimizing how I'm using those accounts. Am I building my assets in the best way that's going to allow me to live my great big beautiful tomorrow? So as we move through this decade of the 40s, some of the takeaways we want you to have center around specifically setting yourself up for a positive tax situation. One of the most impactful ways that we do that in the accumulation phase is thinking through our three bucket strategy.
- [24:02]
Brian Preston
Yeah, I mean, I loved how you kind of set that up is the fact that I love that you're thinking about tax strategy. In the beginning, a lot of the financial order of operations is motivated by maximizing taxes. But when we get into, in focusing on the financial order of operations, step seven, in your 40s, it's very likely you could be crossing into step seven all the other strategies. We're talking about how we maximize the taxes. But what actually says, hey, how are you going to use this money? How do you think about from a tax strategy plus a goal based strategy, where's the intersection that is the perfect segue into thinking about your different account structure and what the three different buckets, because they all do things more efficiently than others. And we ought to lean into that a little bit.
- [24:46]
Bo Hansen
Yeah, we know that each one of them, the three buckets is treated a little bit different. Tax free bucket obviously grows tax free. That's Roth 401ks, Roth 403bs, Roth 457s, Roth IRAs, Health Savings Accounts. We know the tax deferred bucket grows with taxes being deferred until you put it out. That's traditional 401ks, 403bs, 457s and traditional IRAs. And then you have your regular after tax bucket. Well, given the fact that each one of those buckets is taxed differently, the types of assets that you hold in Each one of those buckets ought to be thought about differently. So obviously in your tax free bucket, you want to hold your highest growth potential assets. You want the things that are going to really give you the biggest bang for your buck. From a tax free perspective, in the tax deferred bucket, you want to hold anything that's going to generate ordinary income, like fixed income investments or different types of bonds, because you want to be able to defer that income. And then in your after tax bucket, you want to hold anything that's subject to capital appreciation or maybe has favorable distributions at lower capital gains rates. If you can make those small adjustments not just in your asset allocation, but in your asset location, they can have significant impacts through time.
- [25:54]
Brian Preston
Well, after tax is especially powerful if you're retiring early because it can serve as a very powerful bridge account because not only has it got some tax favored status with qualified dividends with long term capital gains rates, but it's also usually an account that you can get easy access to for retirement purposes. So we want to make sure we're making good management decisions to really maximize this great bridge account.
- [26:18]
Bo Hansen
That's right. There's a couple things you can do that because obviously the beauty in tax free accounts and tax deferred accounts is that all the taxation gets deferred. But now after tax accounts, you pay taxes as you go. However, there are some ways you can plan around that and one of the very best ways, because we know that about 2 out of every 10 years markets are going to be down. And we know that intra year on average, we see 14% drawdowns in the market throughout the course of a year, even good years, if you can take an active role in your portfolio, and when the market shows you volatility, when it shows you uncertainty, when it shows you downturns, you can execute a strategy known as tax loss harvesting. This is something we love seeing and something we love doing for our clients every year.
- [27:02]
Brian Preston
Yeah, I like it because it turns lemons into lemonade in a lot of ways. I mean, I get very busy not only from my clients accounts, but also from my own personal accounts. When we go through these downturns, I'm locking in some of these paper losses as much as possible because I know in the future, when we get back to the growth phase of things, it's nice if I can take those losses that I've built up in the past, use those to offset any future distributions and other gains out there, it really can be a powerful tool. Don't sleep on tax loss harvesting the other thing I like is when we do tax planning and other things, it's not uncommon because here you are accepting losses and turning those negatives into positives. There might come a time in your tax planning that you're also accelerating your capital gains as well.
- [27:45]
Bo Hansen
So what's the logistical way that you do this? How do you actually execute it? Well, when you have those bouts of volatility, you sell a security at a loss, the value of your holding goes down. You can then buy a similar fund, or you can wait at least 31 days to go rebuy the same fund. You get to report those losses on your tax return. And if you don't have capital gains to offset this year, you can offset up to $3,000 of ordinary income or you can carry those losses forward. And one of the great benefits, Brian, if you do carry those losses forward, is that then in years where you do have big gains, you can accelerate those gains and you can harvest gains to use those losses against. Or maybe you're just in a really unique income situation this year where you're going to be very low income. You might want to trigger capital gains, but you're able to trigger them at the 0% capital gains.
- [28:36]
Brian Preston
0%. That's an awesome capital gain.
- [28:39]
Bo Hansen
So there are certainly ways that you can consider optimizing that after tax account so that it's not just an account that sits there that you can't touch because of the tax implications. It's an account that you can tax manage through time and can be one of the most valuable tools in your financial tool belt.
- [28:55]
Brian Preston
Another good after tax strategy that we've seen people use is once you've been investing for a period of time, you start having appreciated long term holdings. If you're charitably minded, you're crazy if you don't take advantage of donor advised funds. One of my favorite things to do is because you get to give to your favorite charities and organizations you care about. They get the full fair market value of the assets you donate. You get a charitable deduction at the full fair market value of the contribution, and you never pay income taxes on the gains that are built into those portfolios. That's a pretty powerful thing. Bo, do you have some guidance or thoughts on how people can implement this in their own plan?
- [29:35]
Bo Hansen
Yeah, I think that if you are someone who is charitably minded, you want to think through. Well, obviously being able to use appreciated securities is a great way to do that. But also you can look at charitable bunching or it might just be A logistical way for you to keep track of all your charitable contributions in a very nice neat way. But that's not the only advanced strategy you may have access to in your 40s. A lot of people don't realize that when you put money into your 401k there are normally two ways to do that. You can do pre tax contributions or you can do Roth contributions. Few people realize there's actually a third way that you can put money in your 401k and it's called an after tax 401k contribution, also known as potentially.
- [30:16]
Brian Preston
A mega backdoor Roth.
- [30:18]
Bo Hansen
That's exactly right. And these after tax contributions are not subject to the normal 23,500 salary deferral limit. They can actually go all the way up to $70,000, the full section 415 limit. So if you're someone who is high income, not only can you put in your 23, 5 and not only can your employer put in a matching contribution, but you can do after tax contributions all the way up till $70,000. And those dollars will end up growing tax deferred. When you go to pull the money out, you get to pull your contributions out tax free. But you'd have to pay earning. You have to pay taxes on the earnings. Unless your plan allows for in service Roth conversions or in service rollovers where you can then roll those after tax contributions directly into a Roth. This is a non taxable event because you already pay taxes on those dollars. So a lot of folks by using this mega backdoor strategy, they're able to execute large 20, 30, maybe even $40,000 backdoor Roth 401K contributions, which are huge.
- [31:24]
Brian Preston
Well, you just threw a lot at our audience. I want to make sure people understand is that there's usually a progression on how this stops. 23,500 is the amount that is considered like your salary deferral that you get to put in. And that can be pre tax, that can be Roth. You're talking about going beyond that. That is the part. Now there is a cautionary tale. You have to be careful you don't crowd out your employer's money too. You know the matching as well as the profit sharing. But it is pretty powerful when you compare and contrast these different contribution types.
- [31:57]
Bo Hansen
But I think a lot of people get confused on it. So I think it's worth pausing for a moment. After tax contributions and Roth contributions are different. Even though we're talking about mega backdoor Roth using the after tax, they are not the same Roth 401k contributions go in with after tax dollars. Same as after tax contributions. Roth are limited to the 23,500 after tax are not. Both of these grow tax deferred. Roth 401k contributions can be tax free, but after tax must be converted in the plan or must be rolled out of the plan in order for them to be tax free. So often we see people get excited about this. I'm going to do it, I'm going to do it, I'm going to do it. And they get halfway there, they skip.
- [32:41]
Brian Preston
The step of this conversion.
- [32:43]
Bo Hansen
That's it. They skip that. And it's the most valuable step because until you do the conversion or until you do the rollout, the dollars don't actually become tax free. They stay tax deferred. So again, if you're going to execute this strategy, you max out your salary deferral, then you do an after tax contribution and then you must convert that after tax to Roth or do an in service roll out to Roth. If you don't do step three, the dollars do not grow tax deferred. Ron, I have a good friend who got so excited watching our content and he built six figures up in his after tax bucket and never converted it. And now we've caught it and we're going to correct it. But man, there's so much tax free growth that was missed out on because he did not carry out that third step. That's why if you are someone who is considering this type of strategy, this is a great example of when it might make sense to potentially take the relationship to the next level.
- [33:38]
Brian Preston
Well, yeah, you measure twice, cut once. You don't want to screw up something where you got all the key components, but then you just skipped a step. You know, it's the same thing when you find out from Vanguard that so many rollover IRAs just go uninvested.
- [33:51]
Bo Hansen
Tragic.
- [33:52]
Brian Preston
I hate when I see good behaviors, but they just didn't finish the drill and complete all steps or measure twice, cut once and then you see them unfortunately not getting the maximized financial mutant benefit out of this opportunity.
- [34:04]
Bo Hansen
Okay, so if Manny begins to again execute on these strategies consistently through his 40s, let's remember he started investing at 25 years old. He was making $50,000 a year and his wages have increased by 3% every year. He started saving 15% when he was 25 and he increased it by 1% every year until he had 25% savings rate and then he stopped his savings rate at 25%. We also assume that Manny can earn 8% on average, on his investments over the long term. So he's going to save 25% from age 25 all the way through retirement. He's just simply following the money guy rules. Well, if Manny does this, and Manny carries his behavior through his 20s, through his 30s, and into his 40s, he actually crosses the $1 million mark at age 48.
- [34:54]
Brian Preston
Isn't that amazing? I mean, that is statistically we hear all the time that most millionaires reach that level at age 49 after 28 years of saving and investing. And here we are doing a case study on Manny the Mutant, and it almost mimics those numbers. And here's another thing. A lot of people are probably gonna be like, yeah, but he probably makes.
- [35:12]
Bo Hansen
A fortune, probably a huge income.
- [35:13]
Brian Preston
We started off on purpose with a case study for somebody who makes $50,000 a year and gave them 3% pay raises every year. You realize when he crossed into millionaire status at age 48, his annual income was $98,679.
- [35:27]
Bo Hansen
Never crossed six figures, never reached six.
- [35:30]
Brian Preston
Figures, but yet crossed into seven figures with his assets. But that's only part of the story, because we know, and this is what I get really excited. You have $1.1 million at age 48. That's just the beginning of you controlling your financial life and maximizing this. Because remember, what we started this show with is how to make your first million, turn that into 2, 3, 4, and even $5 million. Look at this. It took you those 28 years for this case study. We started at 25, so we'll just keep it at that. So that's 23 years to get first million, but then you reach 2 million at 55, 3 million at 60, 4 million at 63, 5 million at age 65. Pretty slick.
- [36:15]
Bo Hansen
It's wild. 23 years for the first million, then 7 years for the next million, then only 5 years for the next million, then Only 3 years for the next million, and then at the very end, going from 4 to 5 million. It only took two years to do double what took you 23 years. This is why the bigger the numbers get, the bigger the numbers get. Let's remind you, this is just Manny staying consistent from age 25 all the way through age 65. When you compare that to someone who stops in their 30s because the messy middle got too middle, and it stops in their 20s because they believe that they'll always be able to save at some point in the future. If you can start early and save consistently, your great big beautiful tomorrow gets pretty exciting because 48 year old Manny and 55 year old Manny and 6 year old Manny has options. He gets to live life on his terms, the way he wants to, when he wants to, because he made those decisions early on.
- [37:11]
Brian Preston
Well, and it's small decisions. You know, when you look at this and you think about the fact that we're doing 15 to start off with, but then as we get each of those pay raises, we go up 1% till we finally, somewhere in our early 30s, reach 25% savings rate and that's it. We never increased it beyond that point. I love that we cut off close to 20 years on the savings investment journey through those small decisions. I love that you see how the sooner you reach seven figure status, you know, the sooner it's going to have that doubling effect and tripling effect and then, you know, head on its way into $5 million. So whenever you hear anybody out there who is talking about how hard it is to reach millionaire status and they even pick on, they say millions of dollars is not enough. You know what gets you to $5 million? That first million and then rolling into the next 2, 3, 4 and 5. This is so powerful. And like I said, that's why I like us to be your gateway. We are your tour guides. We come from humble beginnings. If we can do it, you can do this too. You just have to make those small incremental decisions to help you build your great big beautiful tomorrow. By the way, if you're looking to fast track that, let me go ahead and give you some head starts on some things. I want you to go to moneyguy.com resources. We have so much free stuff out there just to go ahead and speed you up. And maybe after you've taken advantage of all of our free stuff, you say, I need something more specialized to me, but I don't quite need a financial advisor yet. I want you to go to learn.moneyguy.com and we actually have a net worth tool. We have a know your number course so you can figure out if you're ahead of the curve, behind the curve, right where you're supposed to be. And then we also have our financial order of operations. I mean that this is the course that will actually go deep dive and tell you exactly what we're doing. And we have made this a much more affordable pricing for everyone because we think it's that important. Because this is the abundance cycle. We give it away. We want you to learn, apply, grow, become the best version of yourself. And you're going to reach a point that life has gotten so complex from this success. That's where we're going to leave the porch lights on for you, and we're going to take that relationship to the next level. And that's the completion of the abundance cycle. And hopefully you'll become clients of Abound Wealth. If you want more information, go to aboundwealth.com or Money Guy and we have a work with us. We just love creating this content. Money is nothing but a tool, but it can help you live your best, most abundant life because we give you the tools, the techniques, and all the things you ought to be thinking about. I'm your host, Brian Preston. Mr. Bo Hansen Money Got Team out.
- [39:37]
Unknown
The MoneyGuy show is hosted by Brian Preston. Abound Wealth Management is a registered investment advisory firm regulated by the securities and Exchange Commission. In accordance and compliance with the securities laws and regulations, Abound Wealth Management does not render or offer to render personalized investment or tax advice through the Money Guy Show. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.