Afford Anything - Ask Paula: How to Think About Finances at the 30,000-Foot Level

Episode Date: May 25, 2021

#318: Joe is a new real estate agent and he’s looking for ways to save. Is opening a SEP IRA a good account when you’re no longer a W2 employee? Grace has a similar concern: she’s a tutor, but she’s paid as a contractor. Should she forget about her Vanguard brokerage account and open a SEP IRA or Solo 401k? Kim is newly divorced and celebrating the freedom to make her own financial decisions. She’s struggling to make a living -- also as a new realtor -- and wants to get started with real estate...but how can she do that on limited funds? Kim also wants to know: should she move her funds from an actively managed Fidelity IRA to a Vanguard Roth IRA? Chaz is 22 and has $2,100 - $2,500 left each month to put toward savings. Where should he keep this money if he’d like to move out-of-state in the near future? Anonymous just got a raise, and while awesome, it might push her income to a level that prohibits her from making full Roth IRA contributions. Should she make a partial contribution this year, or start adding money to a Traditional IRA to do a backdoor conversion? My friend and former financial planner, Joe Saul-Sehy, joins me to tackle these questions. Let’s dive in! For more information, visit the show notes at https://affordanything.com/episode318 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to your time, your energy, your focus, your attention, anything in your life that's a scarce or limited resource. And that opens up two questions. First, what matters most? Second, how do you make daily decisions that reflect that which matters most?

Answering those two questions is a lifetime practice. And that's what this podcast is here to explore. My name is Paula Pant. I am the host of the Afford Anything podcast. Every other episode, my buddy, former financial planner Joe Saul Seahy, joins me on this podcast to answer questions that come from you, the community. What's up, Joe? What up, Paula? How are you doing? I'm great now that I'm here. And we've got five awesome questions. So you, me, questions, what could be better? Exactly. And our first question comes from Kim. Hi Paula. Thank you so much for being an inspiration and resource for women and girls everywhere. I'm a 55-year-old woman and as of January 3rd, finally divorced. After 17 years of not having a say in how my money was managed, I am now free to make these decisions and I'm not quite sure what to do. I currently have $325,000 in an actively managed Fidelity IRA. $5,500 in an investment account at Fidelity, and $65,000 in an emergency fund just sitting in a savings account.

I received $2,100 a month in child support, which will go away in five years, and I am struggling to make a living as a new realtor. I've only made about $20,000 a year for the last two years. I bought a small house and can't move out of my small town, which is expensive, because I need to keep my kids in their school district. Should I move my retirement to Vanguard and put it in a Roth and take that tax hit, or is it too late for me to do that? I'm very interested in owning real estate, but not sure how to get started with the little funds that I have. Any thoughts? Thank you so much. Kim, thank you so much for the question and thank you for being part of this community.

Huge congratulations to you for the courage that it takes to embark on this new chapter, on this new step. And you are doing a lot of things and you're managing everything very, very well. You're a brand new realtor. You're raising your kids. You're managing your money. So huge congrats to you for all of that and for everything that you're building. Here's my first question back to you. You mentioned that for the last two years, you've made around $20,000 per year working as a realtor. You also mentioned that you receive $2,100 per month in child support. This is going to last for the next five years. So between that $2,100 per month in child support plus the $20,000 income, that's a total inflow of about $44,000. Is that enough for you to live on or not? I don't know the answer to that question. I don't know

your living expenses are. I notice that your emergency fund is $65,000. I would recommend having an emergency fund that represents about 12 months' worth of living expenses. I don't know if that $65,000 is over or under that 12-month mark. So my first question back to you is, how much runway does your emergency fund get you? And if your current emergency fund gets you more than 12 months, then I might consider putting a portion of that money into an investment that has the timeline of your retirement because you're 55 years old and the most pressing need that I see for you right now is to plan for your retirement, which is around the corner. And I think on my end, Paula, the only thing that I have to add to that is that I think that

there's good news here. there's there's really no need to move anything right now. And I know when I was a financial planner, people would come into my office and would immediately say, well, I want to move this thing to this place. And I would ask why. And they would say, well, I saw on this, this forum or this place or, you know, I heard these people talking or I know this is good. It's highly rated, right?

I did my homework on it. It's good. But then I'd ask the question, how does it fit you? and the answer was often, and usually, actually, I don't know. And Kim may know, but based on the question, I don't know. I don't know if the right place is Vanguard. Now, the cool thing is she's at Fidelity right now. There's a lot of great stuff at Fidelity.

So she could even leave it at Fidelity and just change investments because there's a wide broker with a lot of different stuff. She might not have to go through. It's not a hugely painful process, but you know, it's a little bit painful. moving from one spot to another, she may not even need to do that. So I think if she begins with the goals, how much money do I need and when do I need that money, that will then drive two of these big decisions. I think it'll drive how much money do I convert over to the Roth?

Because like you, I do like that, but I don't know how much money to do it with. And then the second thing it will drive is where's the best place for this money? What's suitable for that goal? Right, right. Exactly. So her question of should I move my retirement to Vanguard and put it in a Roth, that question has two components. There's the tax strategy component, which is, should I turn my traditional IRA into a Roth IRA, despite the fact that I will have to pay an immediate tax hit? Like, that's the tax strategy component of that question. And then the other component of that question is what brokerage should it be at? And so if you separate those two out, I mean, Fidelity, Schwab, Vanguard, they're all good. You know, I don't see any reason, any pressing reason to prefer one over the other. I think if your stuff is infidelity, it's fine. You'll leave it there unless you're in love with Vanguard, in which case that would be fine, too. If your stuff is infidelity or Schwab or Vanguard, I will thumbs up any of that.

Those are, you know, those are the three discount brokerages. Well, it certainly can be a question. I mean, and by that point, you and I have been over this a few times, it is, you know, counting fees and looking at fees is an important thing. and looking at the management of your assets is an important thing, but it's going to be third or fourth down that list. The first thing is, what's the goal? How much money do I need for that goal?

How much money should I save for that goal? And then where do I put it is the next, would be the next piece after all that. Yeah. And to be clear, if she had named a different brokerage, if she named a brokerage that is known for offering higher fee offerings, my answer might be a little. bit different, but Vanguard Schwab and Fidelity, those three in particular are known as the big three discount brokerages. They're known for having very low fee offerings. And so I don't know if there's going to be a whole lot of expense ratio that you can shave off by converting from Fidelity to Vanguard.

Oh, that 0.03% will make all the difference, Paula. But to the other component, the tax strategy component of her question, which is, do I move my money from a traditional to a Roth account, if she expects that her income in the future will be higher than it is today, and today her income is about $20,000, if she projects her income will go up, then this would be a good time in her income producing life to do at least a partial Roth conversion. The only issue that I have that I think she's going to need to mull over is she also mentioned that she's interested in real estate, she works in real estate, I think buying real estate and then taking cash to pay the tax on the conversion are diametrically opposed because she may need

that cash for the down payment versus paying the tax on the Roth. So I feel like maybe you can do both, but it might be more helpful to decide which one is better for your goal. Right, which is the priority. Exactly. Because if you're going to be coughing up the same amount X either way, either that amount X is going to go to pay the tax bill for the Roth conversion or it'll go pay for the down payment. That's a very good point. I think broadly, and Joe, you and I were talking about this before we started recording, the question of tax strategy is secondary to the question of overall financial strategy. And so starting with a question of do I convert from Trad to Roth is a tax strategy question. But if we zoom out, the bigger question is when do I want to retire? how much money am I going to need at the point at which I retire? What do I need to do to get myself from point A to point B? Like, what do I need to do from now until retirement age to reach that goal? That's the number one question. And then after that, we can go to the question of other goals. So does she have goals related to sending her kids to college? Maybe, maybe not. I don't know. But any other goals that she has after her retirement is first taken care of, that's where the conversation needs to begin. Yeah, work backward. Getting away from Kim's direct question for just a moment, this is something that lately has really frustrated me about, you know, and you and I have to spend far more time on social media than I bet that I know it's more than I want to spend.

I won't speak for you, but I spend more time than I want to spend. And I see well-intentioned people leading other people astray with discussions on investment. investments that are fine investments, but I find myself, Paula, most of the time going, why are you excited about this investment for everybody when we don't know what these other people's goals are? And it may just the fights I've seen online lately about Dogecoin as an example. And the fear of missing out of, hey, there's this huge rally. I know a guy that bought Dogecoin and it went up 36% one day and he,

He's a long-time investor in other stuff. Put a little bit of money. It went up 36%. Like any long-term investor that's used to index funds, he freaked out and sold it right away, which I would have done too. Right. Like, hey, 36% a day. That's fantastic.

Yet, you know, we're all reading about people putting their entire retirement in it, which is completely ridiculous. But, yeah, but starting with Dogecoin, we're starting with Vanguard or starting with Roth conversion is stuff that we hear people talk about so often that it's very easy for all of us to fall into thinking that that's probably something I need to do. So what you're saying is all of those examples are starting with tactics or starting with product. Instead of strategy.

Exactly. So Trad de Roth is a tactic. Vanguard is a product or a product provider. It's a broker. Dogecoin product. And rather than start with product, rather than start with tactic, the starting point is to zoom out, and to quote you, start with the end in mind, zoom out and take a 30,000-foot view of what are we trying to accomplish and what are the steps needed to, what are we trying to accomplish? Where are we now and what are the steps needed to get from A to B? And then

within that discussion about what are the steps needed, that's where a more taxisement. practical discussion can come in. But I agree, Joe, a lot of times, you know, I had this conversation the other day with a woman who was really concerned about her asset allocation. Her contributions were almost nothing, but she was really worried about her asset allocation. And she was like, I don't know if I'm doing it right. Do you think I should hire a financial planner? And I was like, I think you need to make more contributions. And the way that I explained it to her, I was like, look, think of a pyramid. I know that's not in the world of finance.

That's not the best shape. But think of a pyramid. The single most important thing, the thing at the very, very top is in terms of finance, in terms of retirement planning, your contributions are that top level of the pyramid. It's the one thing that you have to focus on. And then you go a little bit further down. And sure, you can talk about portfolio allocation. and then you go even further down, and then you go to that base, and at that base, there are, and I call it the base, not because it's the foundation.

That's not the analogy or metaphor that I'm trying to draw. But I call it the base because it is a wide array of lots and lots and lots of different tactics that, you know, if you were to pull out any single one of those bricks, that brick is not the thing that's going to be holding it up. So at that base in the world of finance, you might have mileage hacking and the money that you save every year doing that. Like, sure, will offsetting your travel expenses allow you to make greater contributions? Absolutely. But at the end of the day, the tactic of mileage hacking is not what we're going for. It's that top piece. It's the contributions that we're going for.

And I'll tell you what makes that more fun. And this is neat that Kim is in this spot right now because for me, the fun piece is learning why I want it. So then when I buy, I'm not making an informed decision based on the fact that it's good or it's bad. I'm making the decision based on this is the vehicle that I know historically has gotten me where I need to go. And I can then explain to people why I own it. And the main person you need to explain it to is nobody else other than yourself. And I'll tell you why. When the market goes bad and at some point the market will go bad.

If you can't explain to yourself what your end game is with this, that's when you make mistakes. When Dogecoin inevitably falls at some point, or at least, I mean, we saw what, a Bitcoin and Ethereum last year had that big drop, right? And look at how many people just washed out and said never again. and now it's all back, and we're seeing lots of people pile into it again. For context, we recorded this episode before the May 2021 Bitcoin crash. You're going to wash out of the investment if you don't have that why behind why you own it. Because if I know that I don't have to pull this crop out of the ground for another 15 years, who cares? You know, I'm like, no, no, no.

The reason I own this thing is because it's the thing that does this for me. And I like that so much better. And it makes you so much more confident as an investor. I'll even tell you a story of something really dumb that I did my sandbox portfolio recently. I was flipping through flipboard looking at different articles online. And I saw these investments that Michael Burry owns. And for people who don't know Michael Burry, he's the guy on the movie The Big Short, played by Christian Bale, who manages a lot of money. He saw the mortgage crisis coming and loaded it.

up and made a ton of money. And he's done that with other things. So I saw all these things. And I had a little bit of money in my in cash in my sandbox account. And I saw this one mining company. I don't have any mining companies in my portfolio. I found it interesting, even though I didn't really understand why Michael Burry owned it. And I went and bought it just based on that. Michael Burry owns it. It must be good. I talk about this crap all the time. You shouldn't do it. Right. I've been doing this forever, Paula.

I've been doing this forever. And I still did it. And you know what's frustrating now? Now I own this mining company and I will tell you, I don't understand the heartbeat of the company. I don't understand why it's in my portfolio. I don't know when. Now I'm worried that I won't know when Michael Burry's going to sell it because at some

point he's going to sell it because they'll think it's the time to get out. I don't understand why it's there. So even though this mining company in the eyes of another investor is, quote, good, it's horrible in my portfolio. It is just absolutely horrible. And I think about it all the time. And I've got like $400 in it. Well, and so the lessons there are number one, don't play follow the leader. Number two, don't invest in anything that you don't understand. And number three, everything in your portfolio has a goal or a purpose. And so what is quote unquote good for one investor might be bad for another investor depending on the objective of the portfolio?

And how many times have you heard me say that exact same thing? And I still did it. Right. Right. The behavior gap. There's that that gap between knowledge and behavior that can be so hard to bridge. Part of the reason I have so many behavioral economists and behavioral scientists on this show is because such a big piece of being a good investor is bridging that behavior gap. It is so frustrating.

But the force of, I don't know if it's gambling or war. what when you have money sitting on the sidelines, at least for me. I'm like, man, we got to get this moving. I got to get this somewhere. I got to make a move. I think it's because, you know, what are the behavioral people that I think, you've talked to Daniel Crosby, haven't you? I have not.

No, I have not. Another behavioral economist. Dr. Crosby says, money is one of the only places in life that doing nothing is usually the best thing to do. Right. And as just animals, the animal in us is action oriented. If I do more, I will get further. Right, a bias towards action.

And so it is such a struggle to put the plan in place and to let things sit there instead of just, let's just move it. Let's just do something. I heard a quote earlier today. Someone said, an analyst is only as good as their biases. Yeah, and that applies to any of us, any thinker, any investor. we're only as good as our biases. And if we hold a bias towards action, then sometimes we take action when the better course of action is to not. And Kim's wondering, what does this have to do with me?

Nothing, Kim. We've strayed so far from Kim's question. Just Paula and I chatting. Pontificating about at that 30,000 foot level. So Kim, to answer your question, we don't know. Agreed. we don't know, but we know how to know and we know how you can know. And the way that you can know is by first deciding at what age you want to retire, how much money you'll need at the time of

retirement. And from those two data points, you can then work backwards to see, all right, here's where I am now, here's the amount that I want to have by this particular date or timeline. Great. Now, what do I need to do to get from current date and amount to future date and amount. And once you know that, once you've got both a date and an amount, that's your objective, then it's time to start looking at tactics. And I think the answer to should I use my money to pay the taxes on a Roth conversion, or should I use my money to make a down payment on a piece of real estate? That answer will become clear once you have the context of how much do I need for retirement,

by what date, you know, what am I trying to build and by when? Because you'll be able to see the potential returns on a piece of real estate. You'll be able to compare that to the potential lifetime tax savings that come from converting from a trad to a Roth. And then you'll be able to compare those two numbers and see how they match up to what you're trying to build. So thank you, Kim, for asking that question. We'll come back to this episode after this word from our sponsors.

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Sale ends December 7th. Our next question comes from Chaz. Hi, Paula. My name is Chaz. I'm a big fan. I am 22 years old and a recent college graduate. I graduated last June, about six months ago. Since I graduated, I was able to land a job that pays me about $70,000 a year.

And currently, I have about $8,000 in a Roth IRA and about $2,000 and various other stocks I've purchased. My question is, what should I be doing right now in terms of investing and saving? I currently live with my parents in Los Angeles. I could move out, but they don't seem to hate me. and I enjoy living with them. So I don't have any need to move out. With that being said, I have about $1,000 in bills every month.

I pay them rent, pay my car insurance, and then in food and other entertainment. Leaving me with about $2,000 to $2,500 in savings every month. My end goal is to get out of California and purchase property somewhere that's cheaper. As everything around me right now just doesn't make sense to purchase, it's very expensive. and will take years and years for me to be able to afford. So while I save up to move out of the state, what should I be doing with my money in the meantime? Should I just continue investing in Roth IRA and stocks?

I was just wondering your opinion on that. And thank you for your time. Chas, thank you so much for the question. Congratulations on graduating from college. Congrats on the job that pays $70,000 a year right out of school. That's huge. So you're very well paid. And if you continue to work in the same field,

there's at least a decent chance that you will continue to have a very high-income career. So the fact that you're making such good money at the age of 22 bodes well for your future prospects. So big congrats for everything that you are setting up right now. I love the fact that you're investing in a Roth IRA. I personally do have a bias towards Roth IRAs. And especially you're in your 20s, the beauty of a Roth IRA, and I'm sure you know this, but I'm saying it for the sake of anyone listening who doesn't know. this. The beauty of a Roth IRA is that all of the growth, all the gains, all the dividends, everything that it earns is exempt from taxes. And particularly if you're putting money into a Roth IRA in your 20s or 30s or 40s, I mean, that money's got decades and decades and decades of growth ahead. So you could be putting money into this Roth IRA right now that will grow for the next 50 years. You take it out when you're 72. And wow, now you've got 50 years of growth and gains that are tax exempt. That's powerful. So I'm a huge fan of the idea of you putting at least some of those savings into that Roth IRA. Now, to the other piece of that, how much of your savings

should you put into the Roth IRA? Well, I mean, you could max it out. You know, you're saving enough every month that if you're saving up to $2,500 per month, you can max that out and still save up for a down payment in a lower cost of living state or a lower cost of living location. I don't see those two goals as being in conflict with one another. So I'm not going to tell you that you, quote, unquote, should max out your Roth because I don't believe in being that prescriptive. But I would say if I were in your shoes, I would most likely do that unless there was some compelling reason not to.

for the rest of the money, it sounds as though you are very enthusiastic about using those savings as a down payment on a property in a lower cost of living area. So my question back to you is, how soon do you want to do that? And what is your level of enthusiasm or your level of interest in buying that rental property versus investing in stocks and other types of assets? And let me walk through both of those questions. So the reason that I ask, how soon do you want to do that is because if a goal is less than five years away, it is typically better to keep that money in cash or cash equivalence to not expose that money to volatility or risk so that that money will be on hand for you within the next five years when you need to use it. And so if you are committed to buying a property within the next five years, I would bias that money towards lower volatility investments.

I would bias it towards cash or maybe Ginny Mays or something relatively, quote unquote, safer, so that in the event of a market decline, in the event of the natural volatility that can happen, in the event of another 2008, you'll still be able to buy that home. Now, to the second question that I asked, the reason that I asked about your level of enthusiasm for buying a home versus investing in stocks and other asset classes is that it might be the case that you're interested in buying a house, but you're also really excited about stocks and you'd like to invest. And you're willing to roll the dice and you're willing to say, you know what? I want to see what I can do in the stock market. if it turns out that three years from now, everything crashes, I'm willing to defer my goal of buying a home. In other words, your liquidity needs could be flexible, if that were the case. So the heart of my question is how flexible is the goal? Because that speaks to how much liquidity do you actually need? And the question of how much liquidity do you need speaks to what kind of volatility

should the asset class that you're seeking have? Yes, it's in a lot of ways the same way we look at Kim's question, right? What are the goals and then work backwards? I'm also wondering, he didn't say anything about workplace benefits. And a lot of the time, especially if you're working for a smaller medium-sized company, sometimes the HR departments do a great job. Sometimes they don't. I used to go and speak at different companies about using their benefits well.

and most HR people would tell me that a lot of employees didn't use their workplace benefits the way that they could. So if he's not putting money in the 401K at work as an example, that may be an opportunity. And the cool thing is because he's so young, I mean, imagine getting, if we're starting from the end and I don't want to put a goal in his head, I'm just going to shine a light on something that some of my younger clients back then got really excited about, which was if I can get all my tax deferred money taken care of really early and let the financial markets take care of that. We've all seen the compounding interest stuff.

You know, the rule of 72. And if you haven't seen those before, go look those up because they're powerful vehicles that will make your money multiply. And I'm as lazy as the next guy. why not let the market take care of it so I don't have to. So if he can sock money into the 401k and into the Roth or whatever he's going to use for those long-term goals and not worry about the late late future, then he can backfill. Do you know what I mean? So he might get to 40 and say, I'm going to keep working because I like my job.

But I don't need to say for, quote, retirement, traditional retirement anymore because I did so much when I was in my 20s. Exactly. That powerful position where you realize that if you never put another penny into your retirement accounts, if you never put another penny into your 401k ever again, you'll still be sitting pretty at 65. And it seems to me that because he likes living with mom and dad, and mom and dad like having him there and he pays rent, and that just sounds, I mean, it sounds fantastic. If that truly is fantastic for everybody and he's able to save a lot of money by doing that, that could be very powerful. So thank you, Chas, for asking that question.

Best of luck with all of your investments. We'll return to the show in just a moment. For our next two questions, we're going to do something that we've never done before. Joe, are you ready for an experiment? Oh, boy. Behind the scenes, this was actually Joe's idea. You don't get to give away all the secrets. I know.

The one time I have an idea, though, I am very happy that you, you, gave me credit. Yeah, yeah. Give credit where credit is due, absolutely. I'll have an idea about once every two, three years. So our next two questions are similar enough that we are going to play them back to back, and then we are going to answer both questions in one fell swoop. So our next two questions come from Joe, no relation, and Grace.

Hey, Paula, quick question for you and or Joe. I am a newer real estate agent, and I am no longer a W2 employee. Our lives, like the lives of many others, got changed big time when the pandemic came on. So is a SEP IRA the type of account I'm looking for now that I'm no longer a W2 employee? Thanks. I really appreciate it. Hi, Paula. I've been listening to your podcast for the last year or so, and have really appreciated everything that you've done. So thank you. This question hopefully isn't too specific to my situation, but I'm a little bit in panic mode maybe. I'm wondering if I need to

reach out to a financial planner or maybe just friends who know what they're doing. But I'm wondering if I have messed up my tax planning for retirement. So I am an independent contractor. I mostly work with one business as a tutor. And so they pay me, but I, you know, file a 1099 tax form. So I'm technically, I guess, self-employed. But because of that, I don't receive retirement benefits from my employer as an independent contractor. And I don't know what to do with my retirement planning. So here's what I've done so far. I make about $88,000 a year. I put $6,000 into a vanguard traditional IRA, maxing that out, I maxed out an HSA at Fidelity. And I also created a Vanguard brokerage portfolio to invest in VT Sachs. Overall, I think there's about $70,000 in Vanguard investments, $30,000 in the

traditional IRA, about 40,000 in the brokerage portfolio, and then the 6,000 in the HSA. I'm wondering, however, if I messed up my retirement planning because I should have opened maybe a SEP IRA or a solo 401k, instead of putting the 40,000 into the brokerage portfolio, ended up putting that into the SEP IRA or the 401K. I'm not sure. I feel like a lot of the SEP IRA or the 401K. I'm not sure. I feel like a lot of stuff just is kind of going over my head. So if you could just give me some counsel and support, that would be great. Thank you. Thank you for that question, Joe and Grace. The reason we're answering both of these together is because both Joe and Grace are independent contractors and both are asking if they should open or if they should have opened a SEP IRA. But within

that answer, so let's go back to the very first question that we asked at the beginning of the episode where we answered a question from Kim. That is a question about product and product selection is secondary to strategy. Yeah. And the way that I look at this, Paula, there are five options for people who are looking at retirement plans for themselves. And the good news is, I don't think Grace messed up because of the fact that she is putting some money into a retirement account already. Can she optimize that? Maybe. So, Let's walk through the five. The first one is a traditional or Roth IRA, which Grace is already doing.

Second is a solo 401K that she mentioned. Third is a SEP IRA that she mentioned. Fourth is a simple IRA. And the fifth one is a defined benefit plan, like creating something that's like a pension for yourself. So of those five, the most complicated one and the one that we're just going to take off the table unless you're just making oodles and oodles and oodles of money and know exactly where you're going is the defined benefit plan. Don't create a pension for yourself. It's going to

need a lot of administration. It's going to be a pain to set up and administer. Let's just not even talk about that. And actually, for Joe in Grace, let's cover the simple IRA next. A simple IRA is fantastic if you have employees. So if you have some employees, the nice thing about a simple is that it works really well with a company that is a small business of a few employees, but not, but not a ton. In fact, if you've got up to 100 employees, a simple IRA can work, it's magic, leaves us three choices left that are really great for individual people. And the one that Grace did, and what would actually even make it easy for Joe, depending on how much money he makes, is the traditional or the Roth IRA. And the reason that one is first is because you can make

up to $6,000 in contributions. You could make up to $6,000. You could make up to the, is 7,000 if you're age 50 or older. And it just keeps it really simple, Paul. It keeps it super simple. So that's the baseline thing to do. Now, the other two are a little quirkyer. The solo 401k, your total contribution limit would be $58,000 or $64,500 if you're age 50 or older. In your capacity as an employee, you can have salary deferrals up to 100% of your

compensation or $19,500 as an employee. So you put those two together, 19,500 as employee, $38,500 as an employer. A solo 401k may be able to put a lot of money into. I'll jump in here real quick. One of the other benefits to a solo 401k is that you can open a Roth solo 401k, in which case the employee side of the contribution can be made as a Roth contribution. the employer side of the contribution must be made as a tax-deferred contribution. But at least a portion, you know, a sizable portion of what you put into that Sola 401K, if you choose to open a Roth Sola 401K, can be Roth, meaning that it's tax-exempt. And given the fact that the employee side has to be Roth and the employer side has to be tax-deferred,

when we talk about building out that tax triangle, there's mandatory tax diversification, tax strategy diversification in a Roth solo 401K. And by the way, for people who are wondering, like, wait a minute, but Joe and Grace are both independent contractors, what are we talking about? So when you're an independent contractor, you are the employee of yourself. And so the IRS looks at you as both the employer and the employee of you. When it comes to the sub-contribution, the numbers are slightly different. It's 58,000 as total contribution for 2021.

or 25% of the employees' compensation. The nice thing about the SEP is there's a very low administrative. Of course, both of these have very low administrative burdens. Is there one that you like better than the other? I tend to prefer the solo 401K. Yeah, personally, I prefer the solo 401K for two reasons. Number one, you can Roth it. And number two, you don't run up against the IRA pro-rador rule

when you're doing a backdoor Roth contribution to your Roth IRA. Yeah. And so for people who are like, what on earth did she just say, all right, when I said number one, you can Roth it, that is a reference to the thing that I just described, setting up a Roth solo 401K, having the employee side of the contribution be tax exempt and having the employer side be tax deferred. That's what I meant when I said, number one, you can Roth it. And then when I said number two, the other reason that I like the solo 401K is because you don't end up running up against the pro rata rule when you make a backdoor Roth IRA. contribution. So the deal is, if you want to contribute to either a traditional IRA or a Roth IRA, there are certain income limitations that you run up against. What happens to people as they earn higher incomes is that they get to a point where they no longer qualify to put money into either a deductible traditional IRA or a Roth IRA. And so when that happens, what a lot of people do is they'll put money into a non-deductible traditional IRA, and then they will move that

money into a Roth IRA, and that's known as a backdoor Roth conversion. But the rule is that you can't put all of your trad IRA money into a Roth IRA. You run up against this rule called the pro-rata rule, where you have to only move a specific proportion of your money that's, like, judged against all of your other IRA assets. And so the long and short of it is, I like this. I like this. not having IRA assets so that I don't ever have to worry about the pro rater rule. Joe is laughing at me because what I just said is an attempt to make this clear. But I think, ladies and gentlemen, welcome to retirement planning. Yes. Yes.

Welcome to the tax code. So is that clear? Paula, all I heard the whole time you were talking. Yeah. The entire time you were talking, all I heard was, Oh, I thought you were going to play Charlie Brown's teacher. Yeah, I heard that too. By the way, nerd means, obviously you're one of our, the cool peeps, right?

Exactly. In this community, being a nerd is awesome. That is not bad. And of course, the Roth IRA named after David Lee Roth. It was not. Fake news. It was named after William Roth. Ah. Yes. Fun fact. That's not very fun. Anyway, so Joe and Grace. The SEP IRA is great. The solo 401K, also great. I would open one of the two. Personally, Joe and I both prefer solo 401ks, but there will also be, I'm sure, people in the Afford Anything community who will make a passionate argument in favor of the SEP IRA. And they're not wrong either. They're very. They're both fantastic vehicles.

Open either one of them. Either one is great for independent contractors. But first and foremost, max out your $6,000, assuming that you're 49 or under, max out your $6,000 contribution to either a traditional IRA or a Roth IRA. Do that first. And then the rest of the money can go into either your SEP or your solo. And, Grace, to the question, did you screw everything up by putting it into a taxable brokerage account? No, not at all. I mean, first of all, the money is invested.

And remember the pyramid what we were talking about earlier? Which now that I think about it, maybe that should be an inverted pyramid. Maybe that would be a better structure so that that way the tip of the pyramid could also be the foundational base. Anyway. You're still thinking through your analogy. I am. I'm still thinking through the metaphor. Exactly.

Is it an analogy or a metaphor? I never know the difference. Anyway, so that pyramid slash inverted pyramid that we talked about two questions. questions ago, highlights the idea that your contributions are the single biggest determinant of your success. And so when you say, hey, I made $40,000 in contributions, did I screw it up by putting it in the wrong type of account? The answer is, absolutely you did not screw it up. You made $40,000 in contributions, and that is the single most important thing. So the rest, as you move up or down the pyramid, depending on if it's inverted or not, you know, the rest of those details, what tax

treatment should your account have, should it be taxable versus tax deferred versus tax exempt. Like those are the details that happen further down the line. But the single most important thing that you can do is make the contribution. And you've done that and that, that's where you win the game. Also, the other thing is that 40,000 in a taxable brokerage account, that's money that you have the flexibility to withdraw and spend in whatever way you choose to do so. So So if, and I'm not suggesting that you ever do that, I think there's a lot of value to leaving that in in perpetuity. But if you ever did want to draw down that $40,000, you could. You could access it without having to worry about the rigmarole that other people have to worry about if they're trying to take money out of a tax-advantaged account.

So in exchange for trading off a little bit of tax advantage, you received flexibility with that $40,000 that's in a taxable brokerage. account. And so, A, you made the contribution. B, you've got flexibility with what you do with it. So pat yourself on the back. You've done well. Joe, that series of questions got unintentionally technical. Or I guess our answers did. Well, I think the point is, is that there are lots of things to consider. And you're also going to hear about these other accounts, which is why I wanted to bring up the fact that there were five. When really, in real life, we came down to one that we thought fit very, very well for people. But I think that this is an area when you're dealing with IRS code and restrictions where there's some details you kind of got to know.

So thank you, Joe and Grace, for asking those questions. Our final question today comes from an anonymous caller. Joe, we give every anonymous caller a name. Are you feeling inspired? I am. You know why? We have a history of basing the names of our friends that call in on characters that we've seen on the last TV or movie we went to. I am back into Broad Church, which I will say, and I've said this before, is the best thing I've ever watched on TV. I've watched a lot of TV, but I don't know that I've ever had writing as good as Broadchurch,

but Olivia Coleman, who also plays the role of the queen on the crown is one of the detectives there. So I think it needs to be Olivia. Our next question comes from Olivia. Hi, Paula. Thank you so much for taking my question. First off, I just want to thank you for all the information that you provide through your podcast regarding personal finance. It's so helpful and I love your show.

My question revolves around a Roth IRA contribution. I recently got a raise, which is great, but I think it's pushing me to an end. level where I might not be able to contribute the full maximum amount for this year. I won't really know exactly because I'm so close to the range that I'll have to calculate my AGI to figure it out for sure. But I think I'm in the ballpark where I could probably make a partial contribution, but not a full one. So given that, what do you suggest I do? Should I go ahead and just do my taxes normally for next year and do a partial contribution and fill out the IRS form to calculate how much I can contribute or should I start adding money to a traditional IRA so I can do

a backdoor conversion before then. I'd love to hear what you have to say. Thank you. Olivia, thank you so much for the question. I think there's no harm in doing what you're talking about. If we're looking at the outcome, right, your goal is to put money in into the Roth IRA, certainly before 59 and a half money that goes in the traditional way has a little bit more flexibility than if you do the backdoor Roth. But if your goal is this is retirement money, I think leading with the traditional makes a lot of sense and just facilitating the backdoor Roth. Yeah. Like essentially, if you think that they're There's a chance that you might not be eligible to contribute to your Roth IRA or that you might not be eligible to contribute the full amount.

You might as well put that money into a traditional IRA and then execute a backdoor conversion because there's no harm in that. A worst case scenario, you clicked a mouse a few more times than you otherwise needed to. But it's a fairly simple process. Put the money in a trad IRA. I usually let it sit there for like 24 hours, 48 hours. And then you don't even have to do that. I just do that. I just like to do that.

And then move the money from a trad IRA to a Roth IRA. And so I basically don't see any reason not to do it unless you're brushing up against the pro radar rule, right? Unless like that, that rule would create some type of limitation as to what you could convert. But other than that case, I don't see. any harm in proactively just executing a backdoor Roth conversion, regardless of whether or not one is required. So that just in case that ends up being what's required, cool, you've done it.

Here's what's interesting about the question. Many of the questions that we've answered today are questions in which someone has asked about a tactic or a product, and we've given the answer, start with strategy. In this particular case, Olivia, you asked a question not about what to do, but rather about how to do it. So your question was, starting from the premise, I want to put as much money into a Roth IRA as possible. Given my current set of circumstances, how do I make sure that that happens? And so, Olivia, your question was about how to do something rather than what to do. And that stands in contrast to the question that Kim, Chaz, Joe, and Grace have all asked.

Which that means our answer presupposes that this is a good strategy for your situation. I'm going to give Joe credit again because he was the one who made that observation when we were discussing this behind the scenes. I'm pretty on today. Yeah, you totally are. After I told you that I stayed up to like 2.30 in the morning last night and wasn't sure I was going to be on. Joe, speaking of your wisdom, where can people hear more from you? Do you want a place? What if there were a place where you could get all of my thoughts in writing and all the

humor for no extra charge? Dun, done, done. So exciting. We just recently announced my co-author and I that, Paul, we got a book coming from Pegwin Random House. pre-orders as you know Paula super important when it comes to the book industry and making some of those charts. I'm excited to say that they actually push the book back because they think that it's going to be a book that a lot of people want to buy.

Initially, it was going to come out in September. It's ready to go. You and I have looked at some of the sample chapters. Paula is in the book. Paul is in chapter one. I am. I am. You will read the name of your favorite podcaster in chapter one.

It is, the book is called Stack, your super serious guide to modern money management. A lot of great financial planning tips walking through. A lot of the things that Paul and I talk about here, but obviously based on the name and the title, you should expect to laugh a lot as well. So it is going to come out December 28th. However, we'd love for you to pre-order it, stacking benjamins.com forward slash stacked to go there. Awesome. And I will be preordering several copies. Well, thank you very much. Cool. Thank you, Joe. And thank you so much to everyone who called in.

Thank you to all of you who are listening to this. I am thrilled that you're part of the Afford Anything community. I could not do this without you. This community would not exist. Were it not for you. So huge thanks to everyone who's listening. If you enjoyed today's episode, please do three things. Number one, make sure that you are subscribed in whatever podcast playing app you're using. Number two, leave us a review in that app. That is an incredibly important way for us to be able to draw talent and names and guests to the show so that we can have the riveting interviews that you hear on the Afford Anything podcast. And number three, please share it with a friend or a family member. That is one of the most highest impact ways that you can spread the message of personal finance, money management. and designing a life that you want to live. If you enjoyed today's episode and you want to chat about it with members of the community,

head to afford anything.com slash community. We've got a bunch of people in there talking about podcast episodes, discussing questions that were asked. We have a book club going. We have Zoom hangouts. We've got people who gather based on geography, like if you all live in the Northeast or you all live in Texas. We've got people who gather based on that.

We've got people who gather based on age, based on goals, so you can find your crowd in the Afford Anything community. Just head to Afford Anything.com slash community. All of it's free. And speaking of free, you can also subscribe to our show notes to get a synopsis of every single question that was asked plus the timestamps, afford anything.com slash show notes. Thank you so much for tuning in. My name is Paula Pant.

This is the Afford Anything podcast, and I will catch you in the next episode. Here is an important disclaimer. There's a distinction between financial media and financial advice. Financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance. All of this is financial media. That includes the Afford Anything podcast, this podcast, as well as everything Afford Anything produces. And financial media is not a regulated industry. There are no licensure requirements.

There are no mandatory credit. There's no oversight board or review board. The financial media, including this show, is fundamentally part of the media. And the media is never a substitute for professional advice. That means any time you make a financial decision or a tax decision or a business decision, anytime you make any type of decision, you should be consulting with licensed credential experts, including but not limited to attorneys, tax professional. certified financial planners or certified financial advisors, always, always, always consult with

them before you make any decision. Never use anything in the financial media, and that includes this show, and that includes everything that I say and do, never use the financial media as a substitute for actual professional advice. All right, there's your disclaimer. Have a great day. Olivia Coleman, who also plays the role of the corner. on the crown. So I think it needs to be Olivia. Didn't we recently have an anonymous Olivia?

I think we did because I think I was watching the crown then. That's right. That's right. Anthony and Olivia. Anthony, we even had a whole discussion about Anthony ampersand Olivia and how it would be an amazing brand name. You can see it. You can. I can see the logo in my mind. On a white background. Exactly. Exactly.

Nice clean lettering. Mm-hmm. San Serif font. I was thinking Ariel, but we'll fight about that later. San Serif, who uses that? I think San Serif is simply a category of fonts, isn't it? I don't know. They're like fonts without the flare.

All the fonts, none of the flare.