Afford Anything - Ask Paula: Early Retirement and The Four Percent Rule

Episode Date: July 8, 2019

#203: Many people in their 50’s or 60’s warn us about catastrophic or ‘black swan’ events. But what’s the likelihood that this will actually happen? How can you use the 4 percent withdrawal rule for early retirement planning, given that your portfolio will be split among accounts with different tax treatments? How do you adjust your retirement plan for future taxes? Should a couple in their 30’s switch from term life to whole life insurance? Should a couple in their 50’s with adult children bother buying life insurance in the first place? Is it okay to keep all your assets at one investment brokerage, like Vanguard or Fidelity? And can you deduct rental losses if your income is over $150,000? Former financial planner Joe Saul-Sehy and I answer these questions in today’s episode. For more information, visit the show notes at https://affordanything.com/episode203 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to your time, to your focus, to your energy, your attention, any resource in your life that is scarce or limited. And that leads to two questions. Number one, what's most important to you? Not what does society say ought to be,

but what actually matters most in your life? And number two, how do you manage your day-to-day actions? accordingly, how do you manage your resources in the context of those daily decisions? Answering these two questions is a lifetime practice, and that's what this podcast is here to explore. My name is Paula Pant. I'm the host of the Afford Anything podcast. Every other week, I answer questions that come from you, the community. And this week, former financial planner Joe Saul Seahy is here to help me answer those questions.

What's up, Joe? Paula, I'm so excited. We've got some good questions this week. We have excellent questions, as we always do. You just came back from vacation. Where were you? I was just in Seattle. My twins turned, I'm going to tell you an old guy's story.

So my twins just turned 24. It's really fun. I'll tell you two cool things we did this time. We went and we hiked around Mount Rainier, which was incredible. Mount Rainier is just a beautiful place. And I'd highly recommend it. And also Olympic National Park. So we had to take a ferry over to Bainbridge Island and then take a, there's a bridge

off the island onto that peninsula. And that whole area was just also gorgeous. So a lot of hiking, Paula. Oh, that's excellent. Do you feel very in shape now? No. But we didn't see some really cool stuff. And yes, and it did remind me that I sit too much.

I do sit too much. And it also reminded me that it doesn't have to cost a lot of money to be really, really fun. That was an incredibly inexpensive vacation. And just with the four of us hiking together, we got a lot of time to talk and enjoy nature together and what a blast. Well, speaking of a lot of money, our first question, how do you like that transition? Best transition ever. Our first question comes from David. Hey, Paula, this is David from California. I have a question about the 4% withdrawal rate. The example that's often used is, hey, if you want to withdraw $40,000 a year, you need to have a million dollars. My question is,

why don't people talk about what that million dollars needs to be made up of? For example, if it's a million dollars of just Roth assets and it's $1 million and when you withdraw it, there are no taxes taken out. However, if that $1 million is primarily pre-tax money, then it's not really a million dollars. When you withdraw it, it's at your nominal tax rate. So that million dollars might actually be $700, $800, or $900K. So that's a problem. How do people know what their true number is when they have a combination of Roth, which is zero tax rate, capital gains, might be a 15% tax rate and then pre-tax money. So I guess how do you really come up with your number when that actual amount to the 25 times is a combination of different buckets of money?

Thanks so much. David, that is an excellent question. And the reason that more people don't talk about this, the reason that you don't see this in articles or as soundbites in podcast episodes, is because of the complexity of that question. When we're talking about a 4% withdrawal rate, meaning that if you have a portfolio of $1 million, then you can withdraw 4% in year one and 4% adjusted for inflation every subsequent year for anybody out there who's wondering what the 4% rule is. When we talk about that, it's very easy to use that broad, generalized rule because it applies to anybody living in the United States. And under that set of guidelines, as you know, if you do have a portfolio of a million dollars and you withdraw

40,000, that 40,000 is not necessarily the money that you can live on because it will be taxed differently depending on the tax treatment of the buckets from which you draw it. And because there's no short soundbite to answering that question, there's no 15 second elevator summary. It's a hard thing to address in an article when you have a couple of sentences to try to quickly summarize it as you're making a broader point or in a podcast episode when you have a few seconds to talk about it as you go on to a different or a bigger point. That's the reason that it's not talked about more. But your question is an important one, which is, as you've said, when you go to withdraw your money in retirement, you will be withdrawing that money from

various buckets. And each of those buckets have different tax treatment. Withdrawals from a Roth account will be tax differently than withdrawals from a tax deferred account, such as a 401 a traditional 401k or a 403B, which will be taxed differently from income that you derive from a rental property, which will be taxed differently from dividends that you collect from a taxable brokerage account without selling off the initial principal investment. All of this money that you cobble together will be tax differently. So how do you plan for that, particularly given that you don't know what your tax bracket is going to be or what the tax laws in the United States are going to. to be at the time that you retire? Well, and that brings up a bigger question, Paula, which is that this is why I don't start with something like the 4% rule. I start with when am I going to spend the dollar and then work backwards to today? So when I would help people build a financial plan, our goal was to minimize taxes by having

money in different buckets. So we've talked here before about the tax triangle, which is you've got money that goes in pre-tax. And then when you come out, it's all tax. Of course, that would be like a traditional 401k, a retirement plan at work. Some retirement plans at work, though, are Roth options, or you can do Roth 401K. You can also do municipal bonds. Those dollars go in completely taxable, but when you pull the money out, it's tax free.

And then the third corner of your triangle is the flexible one. You don't get great tax treatment. You're going to pay some taxes along the way on dividends, capital gains as you sell, those types of things. But you can pull them out without having to worry about restraint. You can do a couple things as you're building. Number one is make an assumption of what the tax is going to be on the pre-tax portion to come up with a net after-tax number and then work with that as your number for that. Obviously, the money that's in Roth or tax-free, you're not going to have to worry about that.

And then you'll have to apply a little bit of tax, a smaller amount than you will in a 401k or a pre-tax to your brokerage money as that money gets pulled out. So just for each of those accounts, apply a reasonable number that's close and work with a net after tax number based on where your money is today and as it grows. There's a second piece, though, because we don't know how taxes are going to be in the future,

also because we don't know how we're going to spend money from each bucket each year. Because of that, that's another reason why I don't like the 4% rule. And I like to build flexibility into my plan. So when I think about planning, I think like an engineer. I want to eliminate all the things that could go wrong first. And then I start building the road or the building or whatever it can be.

I think about all those contingencies. So I don't want to have just enough. I want to have more because things are going to come up that we didn't expect along the way. You want a safety margin or a margin of error? Yes. So let's just say hypothetically that David is, we'll say, 38 years old and he wants to retire. when he is 45. All right. So he wants to retire in the next seven years. So let's say that based on that, we have a decent idea of what his current tax brackets are. We have a decent idea of, you know, to the extent that we might guess that tax rates won't change highly dramatically in the next seven years. Of course, we have no idea what the government will do in the future. But to the extent that we might predict that tax rates in the next seven years, will not be drastically different than they are today. And we feel comfortable using today's rates

as we project forward seven years into the future. How would a person like David apply these scenarios to his buckets? Let's just say, I'm just making up numbers here. Let's just say he's got a portfolio of a million dollars, split one-third into Roth accounts, one-third into pre-taxed traditional, and one-third into taxable brokerage. What do you do? So we know the 33 that's in the Roth account that that number is going to be what he gets, right? He's going to get all that, the money in the tax free bucket. We know the 33 that is in pre-tax plans that there's going to be an uncle who wants to get paid on that money. So we do a future value calculation.

We take an interest rate assumption, let's say 7 or 8 percent between now and then. And once again, and here's where it starts to get fuzzy, and this is why you want to have a little more. we're going to make an interest rate assumption. We'll then figure out how much that 333 is seven years in the future. And then we figure out and then we decide what tax bracket he's going to be pulling that money out at. So if it's a combination of 15 and 25, let's say, we can say, well, on average it's going to be tax 20 or whatever the number is. It's going to be different for everyone. But figure out what that number is, lop that off the top.

And now you have the net after tax number of what that is. It'll be similar for the flexible account, but that's going to depend on what positions do you have. So if it's all highly appreciated stocks with a huge capital gains hit, you're going to have to factor that in versus if it's a bunch of cash sitting over there and you're just paying a little bit of interest on 0, 1, 2%, whatever it might be. it might be a lot, lot less tax. But that's going to depend specifically on what the asset mix looks like and then make a calculation based on what the level of taxation on those assets would be. And so the primary difference between the tax treatment of money in a traditional pre-tax account versus money that's in a taxable brokerage account is that money in a traditional pre-tax account will be taxed as income in the year in which you pull it out, whereas money in the taxable

brokerage account will be taxed based on capital gains and dividends rather than as income. Correct. Yeah. And if you get dividends or capital gains inside of that account, inside of the 401k or 403B or a traditional IRA, you're not going to pay tax on those until you pull it out. And it will always be as if you were earning the money and that's it. Which is why, by the way, you make a good ancillary point, not for David. But when you're organizing your portfolio, if you have positions that you really like, but they're these high dividend positions and you're not using them to eat every day,

so you're not living off of that income, I see people that pay a lot of tax by having those in just a regular brokerage account, rearrange your portfolio so that the less taxed stuff, like a tech stock, as an example, is sitting out in the open because that's not throwing off much in the way of dividends. your stuff that pays big dividends that you're not using, you're just reinvesting those, put that

inside your IRA because then you're not going to have all this friction from taxes every year if you're not spending the money. And you're referencing really either of the two IRAs because if it's in a traditional IRA, the dividends will be tax deferred. And if it's in a Roth IRA, the dividends will be tax exempt. So either way, you win. Yeah, absolutely. So look at your assets.

And if you go, boy, I really like this. I don't know, utility. thing, you know, or a reet that has a lot of dividends coming off and I don't need that money right now. Use that as an investment inside your eye. Well, David, I hope that that helps answer your question. Truly, the answer is, in a sense, to throw out the 4% rule because that is a great rule for introducing people at a high conceptual level to the framework of how to think, but for actual detailed planning. If you are looking for a specific plan as to how to withdraw your money,

the 4% rule, which is meant for a mass market audience, is not going to exactly apply to the specifics of your situation. And so the best way, if you do want a more detailed plan, is to look at the money that you have divided up between accounts of various forms and create a spreadsheet and project what you will net on each one using certain a about what your tax rate would be. Tadda. So thank you, David, for asking that question. Our next question comes from Nate.

Hey, Paul. This is Nate. I live in Atlanta. Thanks for taking the call. I've enjoyed listening to the podcast. Just wanted a follow up. I listened to a lot of the podcast that you've had, and I've really enjoyed listening to them. It struck me that a couple of the, let's call them the older people that have called into your show, like Susie Orman, Roger Whitney some time ago, had called. in, and both of those kind of older people had emphasized the likelihood of catastrophic events, which are called Black Swan events, those sorts of things.

But it seems to me that there's a lot of perhaps talking past each other, one group saying the sky is falling, and the other one perhaps saying the sky is not going to fall. I think it would be very interesting to know, you know, if you have somebody that's 30 or 40 years old, whatever, pick your date, who's going to live to be 90 years old, what is the actual likelihood of an event or a series of related events resulting in a financial hit of, say, $250,000 and more. So, interested in your thoughts there. Really appreciate the podcast. And thanks for taking the call. Nate, great question. And as another old guy here, I think Roger Whitney, Paul is one year older than I am. It's okay, Joe. You act younger. Thank you. That makes me feel so

much better. You're way less mature than Roger is. Your hair is better. It is, yes. Yes, I have significantly more, which doesn't mean that I have significant hair. You have insignificant hair. Right. I think that the reason older people think about contingencies and risk, and I certainly do more at 51 than I did when I was 30, is because they've seen more stuff.

I mean, it's just an example. When we were up in the mountains at Mount Rainier, we were talking about Mount St. Helens, which isn't too far away. I remember when Mount St. Helens blew up. And that was a complete surprise, not that it blew up, but the fact that it blew up so violently that it blew up from the side, which meant that not enough people were evacuated. And that ended up being a real catastrophe. You look at 9-11.

You look at all of these events that happen. We don't know when the next one's going to happen. And the longer you live and the more you see these Black Swan events, the more you realize they're not predictable. However, we do know that they happen, well, not regularly. They happen enough that they can factor into statistics that are used when you measure the ups and downs of your investments. As an example, I took a look at prepping for your question, Nate. I took a look at my favorite way to buy the S&P 500, which is ticker symbol IVV. It's the I shares black rock version.

And I like it because Paula, it's less expensive. Bam, I said it. How about that? What? You're the person who tells people not to hyper-focus on their expense ratios and you like something because of its expense ratio? I know. Oh. Are you? Yes. But if somebody's buying a new one, let's buy the less expensive one. But please, if you own the Vanguard version, don't go switch over to the I-shares because it's 0.001 better. Anyway, when you look at Morningstar.com, I love Morningstar because of the fact that it's a third-party rating rating.

site, they're not beholden to anybody when they rate these products. And you put in IVV, which is a ticker symbol for the I shares core S&P 500 exchange traded fund. You click on rating and risk, and you go down to volatility measures. And really, Nate, your question is all about volatility. How can we predict that things are going to be kind of volatile? And there's a cool measure when you look at IVV called standard deviation. And standard deviation will tell you how much in a usual market, and I'm not going to get all complicated about how standard deviation completely works. That's a longer show. But it will tell you that in the course of a normal market, most of the time, this is going to perform in a range. And what is that range? And you can see historically what that

range has been. And so when I would work with clients, Paula, I would show them standard deviation to explain, almost like a pilot when they say, fasten your seatbelts because we're coming up on things that are bumpy. And then it gets bumpy and you don't feel as bad, right? Because you're like, oh, the pilot said it was going to be bumpy. And so for IVV, the standard deviation is 11.69. And a three-year average return, by the way, is 11.68. Meaning, in the course of a normal market, this could be just to round the numbers, anywhere from

0 to 23.3%. So there's going to be a 23% swing between our highs and our lows. Now, if we take that out to a 15-year track record, the average return is just over 8%, and the standard deviation is 13.7, meaning most of the time in an average market, we might be between negative 5 over a 15-year period and 22% or 23%. So we can see that there's a swing there and we might have, we might have lost some money. So I like looking at those measures when I think about what you're talking about, about the chance that something bad might happen. And if something bad does happen, what would we expect this to do? Now, you and I know, the S&P 500 is done way worse, way, way worse than zero.

or negative five, we look back at 2008, 2009. It's done worse than that. So the next thing I like to do is just go back to a chart. And if I click on chart, now I can see, if we put this on a maximum chart that goes from 1999 to today, you'll see that in 2007, the price of IVV, and I'm just eyeballing this, was somewhere around 150. but in 2008, it went all the way down to 70. So it sliced more than half. More than half. And so preparing for something like that, having that as a worst case scenario, I think it's just a good idea and asking yourself, can I survive?

Can I survive that type of a peak to trough? In terms of how a person actually applies this to their life, particularly if they are interested in early retirement, I mean, it can be easy to go down the wormhole of, say, there are so many risks. There's the risk that the economy might collapse. We might have another recession that's as bad as or worse than 2008. My portfolio value could get sliced in half. And then in addition to that, I might end up with a disability at the same time. And I might also have to care for an aging family member at the same time.

And with those three things all compounded together with one another, combined with me being out of the workforce and nobody hiring, that's all going to result in an incredible catastrophe, and it can be easy to go from that type of a worst-case scenario to, therefore, I can never retire. So how do you balance what you've said, which is to prepare for that within your plan, with the reality that if you try to prepare for everything, then you end up with a mindset that you need $30 million to retire? Yeah. If you're working with a financial advisor, they use something often called a Monte Carlo simulation. Monte Carlo simulations show the percent chance of success based on tons and tons and tons of variables.

And if all these different outcomes happen. And we're looking for something in the 80 to 85 percent range. If you can make it 80, 85 percent of the time, that's fantastic. That's number one if you can find one of those. But the second thing is, this is why Paula, I think the FI part of financial independence is far more important than the RE part. I think there's a lot of people in the fire movement who have horrible, jobs and so they want out of that horrible job i don't blame you you should get out of that horrible job

but being financially independent means that you can do what our mutual friend brand in the mad fiantist did which is he has no interest in really retiring he just now gets to make money in the way that he wants and if you talk to him or if you go study him you'll see that what he did was while he had the job that wasn't optimal he began building out his optimal things that he was going to do, the things that he was going to do to make money, stuff that interested him. So that's what I would do. I get worried about people retiring early and losing their way in terms of their life's mission

and losing their purpose. And purpose isn't always about your job. I mean, this is going to get a little zen here. It's not always about your job, but it is about what am I doing next. It's not about what you're retiring from. it's about what you're retiring to. And I would begin to look at that also. If these calamities happen, are there ways that I can still make money?

We know that Brandon, the mad scientist, is financially independent, and he also has ways to make money. So if the market does what it did in 2007, 2008 again, Brandon will be okay. To that extent, fire is a stand in for a well-funded career change. in a sense, a well-funded career change that is done in a way in which you do not have the urgency of immediately making income. So if you need time to start at the bottom again, be an intern, be an apprentice, start your own business. If you need time to get your feet on the ground as you make that change, you have that transition time. But to that end, fire in the way in which it has been done by, I would say, most of the people in the fire community, Fire is not the end of income production, but rather a well-funded transition in the type of income that you produce. Into your dream, whatever your dream is. It's pretty exciting. Somebody said this on stacking Benjamin's with us one time. And I don't know if you were on this roundtable or not. But a financial planner said there's nothing wrong with a life well worked. And if you have a life well work doing something that you feel like is your mission. in life, that's awesome. You still want to work for FI because, you know, your feelings won't be

the same forever. They might not be the same forever. So still work aggressively for financial independence. But the quicker the RE becomes irrelevant in that case, the better. Now, there's one other element of Nate's question that I want to address. Nate, you asked about the probability of a Black Swan event that results in a major financial loss, like a loss of $250,000 or more. And there are two. elements of that risk. One element is a market crash. And Joe, you talked about that when you talked about the standard deviation of the broad market. But the other element of that risk happens at the individual level. The other element happens when we ask ourselves, what's the risk that we

might have a health crisis or a family crisis that results in needing to outlay $250,000 or more in money in order to solve this health problem? And so to the question of what is the risk of that happening? You know how in the previous answer, we told David that the 4% withdrawal rule is meant for the mass market, but it is not applicable at the individual level. It's not applicable as a one-size-fits-all formula because of the specifics of the tax treatment of accounts that a person would have? Well, similarly, the risk that any given individual, the risk that you, Nate, face when it comes to your risk of having to have a person, a health crisis or a family crisis, that's going to depend on your specific individual risk

characteristics. Because, for example, what do you do for a living? Certain occupations have higher risks than others. If you work a highway construction job where you stand on the side of the road laying asphalt or doing road striping, well, that's a riskier occupation than podcasting from the safety of your closet while you're working in your pajamas. So what you do for a living is going to play a role in the risk that you carry, your family health history is going to play a huge role in this. Do you have a family health history of cancer, of addiction, of dementia, of depression or other mental illness? There are a huge number of genetic diseases out there. What's your family health history? Whether or not you smoke is going to play a role in this.

Obesity is going to play a role in this, right? So there are lots of factors that affect the chances that you or a member of your family might have a health crisis or a medical issue that costs a lot of money. And so if you ask an incredibly broad paintbrush question of what are the chances that a person in the United States might get cancer or have heart disease or have some other major medical catastrophe, I mean, what is a typical person? who is a typical person? I think that that answer would be so broad as to be useless because the question that you really want to ask is, what's your risk? And your risk is going to depend on your own risk factors,

including your family health history, your environment, your habits, your occupation. Those are the factors that play into your own risk profile. And when we look at averages, I mean, in the same way, Joe, that you talked about standard deviation of the broad market, the standard deviation of people and their risk factors is enormous. So I don't go to my doctor and say, hey, doctor, what are the chances that the average American might be at risk of some major medical problem? I'll go to my doctor and say, hey, what are my risks based on my own health

history. And when you're making your financial plan, that's really the question that you need to ask and the risk level that you need to assess and the problem that you need to solve for. So thank you, Nate, for asking that question. And before we close out, Joe, I would like you to know that I looked up IVV, the I shares core S&P 500 ETF, and it has an expense ratio of 0.04. but the Vanguard S&P 500 ETF has an expense ratio of, Steve, can I get a drum roll please? 0.03%. I get really. Da, da, da, da, da, da, da, da, da, da, da, yep.

I haven't looked at it in a while because as long-time listeners know, to me, it's irrelevant. But IVV used to be cheaper and it's not anymore. Vanguard does have this habit of. when they realize that something is cheaper, they will undercut it. So for a long time, Vanguard and Charles Schwab kept doing that. They kept each mutually undercutting one another by one, one hundredth of a percent. And they kept doing that over and over and over and over to this race to the bottom, which was great for us.

It's great for average Joe and Jill investors because, heck, now we benefit from those low expense ratios. Right. And now we're seeing to that point, fidelity applies. pressure. Fidelity with those funds that are zero. So-fi with kind of a weird zero thing going on that says we're not promising these are going to be zero forever, but hey, they're zero now. Pretty soon, you're going to go invest with some company and they're going to cut you a check. How great is that? That'll never happen. I shouldn't say it'll never happen because the second I say it'll never happen, somebody's going to come out with a way for that to happen.

Well, in that case, you should say it'll never happen so that somebody comes out with it. Let's do it. The Murphy's Law of that'll never happen. Hey, Vanguard, that'll never happen. Speaking of Vanguard, our next question comes from Anonymous, and it's a question about Vanguard, my favorite brokerage. But before we get to that, we're going to pause to hear a word from our sponsors, and when we return, let's talk investing. Hiring is challenging, but there's one place you can go where hiring is simple, fast, and smart.

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Welcome back to the show. This next question comes from Anonymous. Hi, Paula. This is Anonymous. I'm your podcast listener from podcast number one, and it is still my favorite financial podcast. I have for you and hopefully Joe, a couple of questions about retirement accounts.

I have an IRA account that I transferred from OTIAA to Vanguard. Now I have 403. be from my work at Vanguard also. So basically all my retirement savings are with Vanguard. I like Vanguard and completely happy with it. Now I want to open a Roth IRA account for my wife and Vanguard would be my first choice. But is it wise to have all our retirement savings with the same company? If I would decide to open it somewhere else like Fidelity, Charles Schwab or Tiro Price, which one would you and Joe recommend. Thank you very much. Anonymous, thank you for calling in and thank you for being a fan since episode number one. I do not see any issue with all of your investments being consolidated

at one brokerage, and in this case that brokerage is Vanguard. As long as your investments are in passively managed index funds that are well allocated, then there's no issue with keeping all of your money under the same brokerage house. What I would be concerned about is how that money is invested. I would be concerned about the asset allocation. But housing it all under one institution, I don't see any problem with that. So I don't think that you need to open up accounts at multiple institutions. In fact, that can actually often be a worse idea because when you have money that's split between all of these different institutions, it becomes harder to track. And then it's easier to move to a different home, forget to update

at your address. You no longer get the statements if you are still getting paper statements. You forget about the account. You don't rebalance. Four years passed by. You suddenly, you know what I mean? There are so many things. There's so much more to manage. You forget to send in a 1099 interest form to the IRS from one of your many brokerage accounts when you do your tax reporting. And then you end up paying a penalty because you just have so many different accounts at so many different brokerages that you just forgot to cobble together all of the tax reporting forms because there are just so many to keep track of. That's what happens when you end up, like, unfortunately like me, I have accounts freaking everywhere. So tax time is a nightmare because I'll be getting statements from Robin Hood and

from Vanguard and from Charles Schwab and from Smarty Pig, Sally Mae Bank, and from Radius Bank. And, you know, and I'm getting all of these statements coming in from everywhere. and it's so easy for one to fall through the cracks and for me to then get a letter from the IRS saying, hey, dummy, you forgot to report this one. Now here's your penalty. So don't do what I do and unnecessarily overcomplicate your life. Keep everything at one brokerage. Yeah. The thing that a mentor said to me back in the early days of my career, he said when you go on a road trip do you have one dashboard or five you only want one so you can very quickly see where everything's at the one area caution you if you do go active and to paula's point there's really no reason to do that if you do go active a lot of the time the analyst pool

at a company they may use many of the same metrics they may fall in love with the same companies they may make the same mistakes so if you're using actively based investments back before exchange trade of funds, I was very worried. If you had called me in 1995 and said you wanted everything at one spot, I would have these bells going off saying there could be some problems there. However, today, it's much better. The second part of his question, Paula, was about which one is better. If he did open it up with another company. If you're not going to be at Vanguard, where should you go? Every company he mentioned is one of the good guys. That's as far as even TIA that he rolled it from. very low cost,

101-year-old company. So T-Role Price, TIA, Charles Schwab Fidelity. He mentioned those. All good guys. Yeah. Vanguard, Charles Schwab and Fidelity, those three brokerages in particular

have a reputation for being the three cheapest ones, meaning the expense ratios that they offer, are quite low. And as we mentioned in the last question, Vanguard and Charles Schwab often have an arms race to the bottom where they just try to undercut one another when it comes to expense ratios

on their passively managed accounts. So I'm a big fan of all three of them. Honestly, I like the, in terms of the website, I like the user interface at Charles Schwab better. I just think that their website is easier to navigate. It's more intuitive. But the reason that I recommend Vanguard over Charles Schwab is because Vanguard is organized as a co-op, meaning it's member-owned, whereas the others are not. That's really the winning, criteria among a group of very, very good candidates. And the other two, they also have a reputation for being extremely low cost. I mean, TIA is organized as a nonprofit and has very, very, very low cost products and

attention to detail. And TRO Price has always had a reputation of being a very cost conscious, extremely inexpensive company, whether it's passive funds or active funds. Yeah, I'm not very familiar with TRO Price, but I keep my H-R-R-Priest, but I keep my H-R-E-R-E-Rest. My HSA bank funds, I keep that in a TIA investment account. As you can imagine, I get a lot of tax forms every April. That's just coming in from everywhere. I forgot I had a TIA Kreff account until you mentioned it, actually.

Now that you mentioned that, yeah, I do. That's where all of my HSA bank funds are. But all those are good, Anonymous. I like them all. And it's funny that he specifically talked about those because, and we won't go into it, But there's five million bad ones. He just didn't say one. I mean, we're not saying, no, do it anywhere.

Just those ones he mentioned were all favorites. Yeah. So thank you for asking that question, Anonymous. Our next question comes from Diego. Hi, Paula. My name is Diego. I've been a listener of your podcast for about six months now. I've learned a lot, and I really appreciate everything you do.

Today I have a question about life insurance. I currently have a 20-year term policy, which is very affordable. My wife and I only pay $35 each a month for a million dollars coverage for each. I have a financial advisor helping me out, you know, plan for retirement and plan for my kids' education and everything. And he's advising me to give that term life insurance policy and get a whole life insurance policy and get a whole life. insurance policy. He's saying that because of my age, I'm 32 years old, and my income, it's one of the best products I can get. Our household income is about $200,000 a year. So I would like to know if you think whole life is something that you're recommending my situation, just to give

you a little bit of history of my finances. I am completely debt-free, except for my home, which I'm trying to pay in the next 10 years. I also, I'm also investing on a 529 investment plan for my kid. He's 10 months old. We give about $200 a month. I have maxed out my simple IRA. I invest about $500 a month on a Schwab account for, you know, on stocks, ETFs and different things that you teach. And then my wife is also part of the pension plan in her job, which she'll be getting the benefits in about 20 years or so. Again, I appreciate every. you do and I hope to hear from you soon. Diego, I would run as far away from that financial planner as you possibly can.

There are only a limited number of instances in which a whole life insurance policy makes sense. Number one, if you have a portfolio or an estate that is worth several million dollars and you are worried about estate planning, you're specifically worried about estate transfers and the tax consequences of that estate planning, you can use whole life insurance within estate planning, but only if you have many, many, many millions of dollars, it only becomes relevant at that point. So assuming that you are not worried about transferring a multimillion dollar estate, then it is not appropriate for you in this circumstance. Number two, if you want to be cryonically frozen upon your death and you do not have,

I'm totally serious, Joe, I can see you laughing at me. No, I'm completely serious. If you want to be cryonically frozen, frozen is not technically the scientific technical term, but if you want to be cryonically preserved and you do not have enough money within your estate to be able to pay cash for that, then a whole life insurance policy would be a good option in that particular circumstance just until you have enough money within your estate that you could pay cash or pay out of your estate for your cryonic. preservation. I have a third one to jump on there with that I've seen some people do too. And that is, if you have a specific bequest, you know, some charity that you really like, but you don't have the money to give them as much as you want now, but you will later, you could use a policy like that with the charitable institution or whoever the beneficiary is of X amount. And sure, if you do the math, you might, if you live for a long time, be able to give them more money. But if you know exactly how much it is, you could use a life insurance policy for that as well. And then, you know,

there are a few people that, and he didn't say how much money he has. They're getting older, that 20-year policy is going to go away, and they might end up for whatever reason needing life insurance forever. That almost never, ever, ever, ever, ever happens. And it almost never makes sense. I'll tell you my first thought, why would run away, though? Well, why would you run away from this financial planner. I would run away because he's calling you to ask the question. The second that your advisor starts giving you advice that you think that you need to double check over and over again means that they did not do a great job of giving you the information you needed to make a good decision. The advisor in my estimation is not about the recommendation.

It's about giving you the information so that you can make a decision. I'll give you an example. some good advisors who are in my corner when they tell me to do something, they will point to publications. They will show me what I need to read. They'll make sure that I've got the best information at my fingertips. And the fact that you came here for information versus from that advisor tells me that you two aren't on the same page anyway. And you know what?

I think it's for a good reason because, Paul, I'm with you. I would run like, like heck. I would not take this recommendation. Yeah, I would get as far away from that advisor, delete their number, block their number. And if you are looking for a good financial advisor, number one, I would recommend only going to a fee-only financial advisor. And when you interview that person, the question, the number one question that you ask is, do you have a fiduciary duty to me at all times? Ask exactly that question in exactly those words, do you have a fiduciary duty to me at all times? And the second thing, because we've seen this before, get what's called the ADV, which means it says that in writing.

Because we've had horror stories, Paula, you and I and my co-host is Stakey Benjamin's OG about people, people saying, oh, yeah, I'm a fiduciary. And they're like, well, can you show me that, well, I call myself a fiduciary. I'd like to be a fiduciary. I always work in your best interest. That's what I mean by fiduciary. No, that's not what it means. It means that legally you have this thing called an ADV that says that that's exactly what's happening. So get it in writing.

Absolutely. You can also ask, are you duly registered? People that have dual registration, sometimes they're fiduciary. Sometimes they're not. As an example, when it comes to products outside of insurances, maybe, they're not. But if they get commissions for insurances, they rep one insurance company, they might be changing hats in the middle of a meeting. So you're going along and they're doing everything in your best interest and all of a sudden they switch hats on you and you didn't see it coming. Right. So you can be in a meeting with a particular financial advisor and for a portion of that meeting, they are acting as a fiduciary.

And then for another portion of the exact same meeting, they're not. And then for another portion of the meeting they are. It's the weirdest legal loophole I can possibly imagine, but somehow that's legal. I'll give you a very close example. That's the kind of advisor I was when I was a financial advisor. And let me tell you what I did. So when it came to insurance, I would tell my clients, we would figure out how much insurance you need together. We'd sit at the table and we figure out that part because figuring out the numbers in that area, I was a fiduciary. once I went over to product, then I said, here's what I'll do.

I'll run some quotes through the insurance company where I get a commission. But now that we've agreed on what the number is that we need, and we've agreed that this is exactly the type and what we're going to do, I mean, I want to be very clear with my clients when I was changing hats. There is a group called the XY planning network. They specialize in financial planners for Generation X and Generation Y. and they have a list of fee-only financial planners with fiduciary duties. I mean, don't just blindly go with anybody who's on their list. Do your due diligence ask those questions that we've just named, but the XY Planning Network is a good place to start.

There is also an app called Guidevine, which is a place where you can preview advisors. I like Guidevine because you can go in and watch videos like your speed dating and get a feel for the relationship ahead of time. And those may not all be fiduciaries, and you're still going to have to ask them some questions. But I like the fact that because people get intimidated. And I like that you get to kind of see what this person's like before you walk into an office blind. I remember when I'd meet with people for the first time, Paula, that was awful for all of us. They didn't know me.

I didn't know them. And I like Guidevine because they do a nice job of making that introduction a little easier. Nice. The Tinder of Financial Planners. I'm sure that Raghav, the guy that created Guidevine, is going to use that now. We are the Tinder. Swipe whichever way. I don't know what they're going.

Swipe that way. So thank you, Diego, for asking that question. And good luck firing your financial planner. We'll come back to the show in just a second. But first, do you run a small business or a side hustle? And you're not sure exactly what to do about paying and filing. your federal taxes, state taxes, local taxes, how do you handle 1099 miscellaneous contractors? What are the reporting requirements? What are the forms that you need to send?

Well, Gusto is made for small business owners who want to deal with things like filing taxes and running payroll. So if you have a side hustle or you're a solopreneur or you have a small business, they can help you with all of your payroll processing, your reporting. Basically, they handle payroll, taxes, and HR support for small business owners. So if you want to get set up for the new year so that you can start the new year totally organized, check out this special deal. You can get three months free when you run your first payroll, but only if you use my link, gusto.com slash Paula. That's g-U-S-T-O.com slash Paula to get three months free. Gusto.com slash paula.

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Framebridge.com promo code afford anything. Our next question comes from Steve. Hi, Paula. This is Steve. I love listening to your podcast and I have a question about diversifying in my portfolio. I currently have a Roth IRA through Fidelity. Within that, I have mid-cap, small-cap, and international index funds. Is it considered diversification if all these funds are through Fidelity? Thanks for your help.

Steve, fantastic question. And if they are passive, no, it doesn't matter because you're not worried about the management team. But if they're active, then yes, I would have them in different places. And we can go into detail a little bit more than that. You can still have all of your assets at one of these companies. You can buy different active funds through fidelity and have all your one fidelity statement or through Charles Schwab. You can have different company stuff.

You can have different passive funds through a Charles Schwab as an example. That almost great IVV that I mentioned where I thought I was clever and I wasn't, you could buy that through Charles Schwab. You can buy it through Fidelity. And I bet you can buy it through Vanguard. So you can buy stuff from these different companies and still have them on one statement. But if it's passive, don't worry about it. Go with the least expensive thing.

Oh, yeah, that's a good point. My Robin Hood account, I have Vanguard held in my Robin Hood account. Right. So, yeah, you can, I mean, if you really just wanted to have some fun, you could load up your Vanguard account full of Schwab funds. And then you could load up your Schwab account full of Vanguard funds. make your head explode. You know, there's no reason why you couldn't do that. Right.

That is financial nerd humor right there for the way. That's exactly what that is. Why did you do that, Paula? Because I thought it was funny. Only us, only our audience would think, that is hilarious. It is hilarious. And that's why we're all so fun at parties. Well, thank you, Steve, for asking that question.

Our next question comes from Marlene. Hi, I'm calling about life insurance. I'm 56 years old. I'm self-employed. There's a lot of options out there for life insurance, a lot of circumstances. So I'm really confused who to trust and where to start. I'm pretty sure I don't want term. We have two adult kids. They're early 30s, late 20s. We own a home. We have property and expenses. I'm thinking I should probably. go for the highest affordable plan. My husband has life insurance through his employer, and it is enough to cover funeral expenses for him, and it may be a little left over. And I'm not sure if the insurance goes with him when he retires in 2020, he'll be 56 then. So a little confused there. What life insurance is ideal for self-employed, retired, or employee with no benefit? And how different should the individual plan be when married? Do kids need to be beneficiaries with spouse in the plan in case of losing both parents in an accident? Or does that just need to be stipulated in trusts? Thank you very much.

So my first question is, why do you want life insurance? Because the purpose of life insurance is to make sure that anybody who relies on you for their cost of living will not be left in a bad position upon your death. But at 56 years old, with adult children, I'm guessing that not many people rely on your income to support their basic cost of living. And if that's the case, then life insurance isn't really necessary. I mean, Joe, do you agree? Yeah, I agree. I'd start with the end of mind. Sometimes people make an assumption that, hey, I need life insurance. My husband's getting ready to retire. I'm self-employed. We're probably going to lose his insurance. By the way, they will lose his insurance. I've never seen a company where it's not term insurance. So they lose

his insurance and they think, well, I've got to go buy life insurance outside of it. So start with the end of mine. That's the first piece. And then the second piece on beneficiaries is there's two different ways that you can look at it. One way, and you'll see this on the form, way, if you pass away, it goes to your heirs, that beneficiary. That might be if the beneficiary is married, it would be their spouse. If they're not married, but they have kids, it would go to their kids. The other way, which I believe is called per sterpes, that way, it stays among the beneficiary. So let's say they have three kids, one passes away.

The other two children will take their portion instead of it going to their beneficiary. So it will stay with those three individual beneficiaries if one passes away. So instead of going to the beneficiary of the beneficiary that passed away. That's right. Yeah. Those are two options on every beneficiary form. Just read the beneficiary form and you'll see both those options and decide for you, do you want to keep it among your children or do you want their beneficiary to get their things? The only problem occurs if the person doesn't have any beneficiaries and they don't have a will, then what happens is that person's portion will immediately then go into probate.

And then it will probably go to the other two kids, depending on what state they live in, but it becomes a mess. But if everybody has families, if they're adult children that all have families of their own, most people will just have it go to their beneficiaries, beneficiaries. One other thing that I'll say in terms of as you decide upon your beneficiaries and you're thinking about both your spouse and your children is while you do want to make sure that your spouse has enough money that they can live and support themselves for the rest of their life, you also don't want to be in a position in which you assume that all of your spouse's assets will go to the children. But then upon your death, the spouse gets remarried and then their new spouse, ends up with the bulk of the estate, leaving the kids with nothing or very little. I've seen that happen before. The mom died first, and so all of her assets went to the father.

The father got remarried. He passed away, and his second wife ended up with the bulk of the assets. They had three children. Those three kids ended up with basically nothing. It is happening, and it's not basically nothing, but there is a similar thing happening over Tom Petty's estate right now. Oh. children not getting along with stepmom and Tom's passed away and there is some there's some language in Tom Petty's estate that's ambiguous and it's really causing problems. Wow. So that is definitely something that you want to think about balancing the desire to make sure that your spouse has enough to live and that your spouse doesn't end up in a difficult position upon your death, balancing the need for that with the need to make sure that. that your children will not be left with nothing.

But back to the original question, just for a moment, in your 50s, life insurance is starting to get pretty expensive, which is why that why is the first thing to solve. What do you want to have happen when you pass away that your assets will not cover? And then look at the cost of insurance and say, is the cost-benefit analysis bent in my favor enough that it makes it a worthwhile transaction. Thank you, Marlene, for asking that question. Our final question is from Katie. And before we play it, I just want to make a quick comment. We answer between 12 to 15, maybe 18 at the most questions per month. We receive quite a number

more than that. And so between when a person asks a question and when we answer it, there's typically a three-month or four-month lag time. And That will make the first few words of Katie's question make a lot more sense. With that being said, here's our final question, which comes from Katie. Hey, Paula. As you know, tax season is upon us. My husband and I were fortunate enough to make $150,000 in 2018. We have one rental property that produced $2,000 and rent money received. This is unusually low as we had to evict one tenant and perform a complete renovation on the house.

We had a total of $8,000 in expenses between repairs and upgrades. When I gave our tax information to our accountant, she said that since we made over $150,000, that we were not able to deduct any of our losses and that the losses would carry forward to the next year. The problem is if we continue to make over $150,000, then we won't be able to deduct any expenses until we sell the home or make less money. I understand that our upgrades would be depreciated over time, and I also understand that we can't deduct more than $2,000 in expenses since that was the only amount of money we received. With all of that being said, I do have a few questions. Have you ever ran into this situation where making over $150,000 doesn't allow you to deduct any rental expenses? I've studied many

different real estate investment blogs and I've yet to find this topic. And I feel like I'm missing out on some big real estate secret. My next question is, if this is true, are rental properties a good strategy for people who hopefully will continue to make over $150,000? And my final question, what are some good ways to get my taxable income down? Should I change my 401K contributions to traditional instead of Roth, which is what they're currently at? Any guidance. can provide would be much appreciated. Thank you so much and I love the show. Katie, first of all, congratulations on your rental property. Rental properties are considered passive income and therefore the losses on a rental property is considered a passive loss by the IRS. So the first thing to know

is that the way that the IRS looks at active income is different than the way that it looks at passive income. Active losses can offset active income and passive losses can offset passive income, but those two buckets can't cross over, meaning that your passive losses can only offset your passive income. That's another way of saying that if you have losses on a rental property, then those losses can offset the income that comes from that rental property because that's all considered a passive gain and a passive loss. Those losses on that rental property cannot offset active income that you've earned at a day job because they're just two separate buckets. So when I say that rental property income is passive income, that's not just my opinion.

That's the way that the IRS designates it. Now, when it comes to the $150,000 issue, if you have a modified, adjusted gross income in excess of $150,000 and you claim that you, quote, actively participate in your rental property based on IRS standards of what it is to have that as active income, then after you earn $150,000, you get phased out of being able to deduct higher losses. So you can deduct up to $25,000 in rental real estate losses per year as long as you have a modified adjusted gross income of up to $150,000,

and you meet the IRS criteria for materially actively participating in your business, in your rental property business. Now, in order to meet that criteria, you have to spend a minimum of 751 hours per year working on your rental property business, which means if you think about 40 hours a week times 50 weeks a year, that's 2,000 working hours a year, that means that you need to spend approximately one third of your working hours per year working on your rental property business. I highly doubt that you do that, which means that I highly doubt that you had passed the IRS standard for, quote, materially participating or actively participating in your rental property activity anyway, which means that this whole thing is a moot discussion because unless you're spending more than 751 hours a year working on your rental property business, then you wouldn't qualify for your rental activity to be counted as active income. So the fact that you only have $2,000 in passive gains means that you can only deduct $2,000 this year as a passive loss, but you can absolutely carry it forward. Remember, your rental property income is not a personal itemized deduction. Even if you're holding your rental properties in your own name, it's still not a personal itemized deduction. So your passive losses can be carried over to future tax years.

So if your tax advisor is telling you that because your modified adjusted gross income is higher than $150,000, that means that you can't take losses. What they're referring to is that you don't qualify for the special rule that lets you deduct up to $25,000 of losses from rental real estate in which you actively participate. But unless you spend more than 751 hours on your business, then you don't qualify for that anyway. And so it's moot. So I would make sure that your tax preparer knows that you're not spending 751 hours a year on your rental property business because given the fact that you're not, this is a passive activity anyway. And therefore you don't meet the standards of active participation. Oh, and so then the second half of your question, which was, is real estate still a good option for people who make more than $150,000? Yeah, absolutely. Spend your time making more than $150,000 rather than spending one-third of your time actively working in the business. So don't actively work in the business. Don't do the repairs yourself. Don't be the person swinging the hammer. That's not necessarily a good use of your time. Given the fact that you make more than $150,000, and given the fact that you cannot deduct up to $25,000 in losses in a given year the way that people who actively participate in the business can,

a great use of your time would be to focus on your day job where you make all of your money and then treat rental properties as a passive business, not as an active business. So the long and short of it is losses are only limited by your income if you are trying to meet the metric of active participation. As long as you don't actively participate in the business, then it's a great opportunity. Thank you, Katie, for asking that question. That is our show for today. Joe, where can people find you if they'd like to know more about you? You can find me, and you can also find Paula with me every Friday over at Stacking Benjamins. But I'm also there Monday and Wednesday.

And then Tuesday, Thursday, Saturday, I'm at Money with Friends, which you can watch on our Facebook page, which is Facebook.com forward slash IStack Benjamins. Well, thank you, Joe, for joining us once again. So fun, as usual. Great questions, everybody. Nice job. That is our show for today. Thank you so much for tuning in. If you enjoyed today's episode, please do three things. Number one, most importantly, share this episode with a friend, a family member, a coworker. If you know somebody who has a question that's similar to something that you heard here, share this episode with them. That's a single most important thing that you can do in order to spread the message of financial independence, personal development, personal finance, living a better life.

by becoming a better version of yourself. So please, if you like today's episode, share it with the people that you know. Number two, please hit the subscribe button or the follow button in whatever app you're using to listen to this podcast. And number three, please leave us a review. These reviews are incredibly helpful for allowing us to book excellent guests. You can go to Afford Anything.com slash iTunes to go to the page on the Apple Podcast website where you can leave us a review there. You can hang out with others who are in the Afford-Anything community by going to Afford-A-N-A-N-A-Fa-Fa-Facebook. That'll take you to our group.

And as always, if you want to chat with me, you can do so by following me on Instagram at Paula P-A-U-L-A, P-A-N-T. Big thank you to our sponsors, HelloFresh, OpenFit, Simple Contacts, and ZipRecruiter. Thank you for supporting the show and for a complete list of all of our sponsors and the special deals and offers and discounts that they give. You can find that all at afford anything.com slash sponsors. A few additional notes. First, thank you to everybody who participated in our fundraiser drive for charity water. We raised over $20,000 for charity water. That money has been sent to Sierra Leone, where we, the Afford Anything community,

are sponsoring the development and the building of multiple clean water projects. This money will bring clean drinking water. to several communities in Sierra Leone, we'll be bringing somebody from Charity Water back onto the show in a few months once we have more details about the project, but I just wanted to say thank you to everybody who supported it. And I think this is a wonderful example

of how the fire community and the afford anything community can come together to do some incredible things in this world and create an impact that stretches far, far beyond what we may have previously ever imagined. So thank you for that. As a reminder, I will be on sabbatical for the month of September. So mark your calendars. There will be no new content coming from the Afford Anything podcast in the month of September 2019. We will still be airing shows that month. I'm not

entirely sure what we're going to do, but I'm thinking it'll be a combination of interviews that I've done on other podcasts, as well as some replays of our favorite episodes. In fact, if you have a favorite episode that's deep, deep in the archives that you would love for us to play again, to introduce to the new members of our community, hit me up on Instagram and let me know what episode you vote for, what you enjoyed. What have been your favorite episodes on this show so far? Again, I'm on Instagram at Paula P-A-U-L-A, P-A-A-A-N-T. Thanks again for being part of this community, and I will catch you next week. By the way, my lawyer says that I need a disclaimer, so here we go.

Don't listen to a word I say. And don't listen to anything, Joe says. Don't listen to anything that you hear on this podcast. This is purely for entertainment purposes. Basically, imagine that this is the least funny comedy show that you've ever listened to. We are not professionals. We barely can brush our teeth in the morning. And so we don't hold ourselves out to be experts or really for that matter even adults.

Give us the same amount of respect that you would give, say, a goldfish. And always, always consult with a real grown-up before you make any decisions. That means consult with a tax advisor, consult with a lawyer. consult with a financial planner, consult with people who actually have credentials and who know what they're talking about because that is definitely not us. All right, you've been warned.

You've been warned. You've been warned. You've been warned. You've been warned. You've been warned.