Afford Anything - Ask Paula: Should I Househack or Pay Off My Student Loans?

Episode Date: January 25, 2021

#297: George is torn between paying down his student loan debt (which he deferred) or buying a househack. Which is better for his long-term goal of reaching financial independence? Mario is curious to know: is his two-fund portfolio at a 90/10 split is a good asset allocation for his Roth IRA? Hanan wants to figure out if a backdoor Roth IRA conversion will work for her. She also wants to investigate whether a Vanguard Institutional 500 Index Trust and a Vanguard Institutional Total Bond Market Index Trust are ideal. Are trusts different from index funds or mutual funds and if so, how? Vivian is worried about bridging the gap between when she retires and when she claims Social Security. Will her plan of doing a Roth conversion ladder work out the way she hopes? Lastly, June and her husband netted $400,000 from the sale of some golden parachute ISOs. They want to help their children pay for college and are trying to figure out how to strategically use this money. Should they pay off their home, buy rentals, fund 529s, or Roth their 401ks? My friend and former financial planner, Joe Saul-Sehy, joins me to answer these five questions. Enjoy! For more information, visit the show notes at https://affordanything.com/episode297 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 any limited resource that you have to manage, like your time, your focus, your energy, your attention. And that opens up two questions. First, what matters most? What's most important?

Second, how do you align your decision-making to reflect that? Answering these 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, we answer questions that come from you, the community. And today, former financial planner Joe Saul Seahy is with me to answer these questions. What's up, Joe?

Oh, he's with you. I love that guy. I know. Isn't he the best? Oh, that's me. What a coincidence. Wait a minute. I'm great.

How are you? I'm excellent. It's been a heck of a morning already. It's not even 11 a.m. and I've already gotten attacked by one of my pets. I have completely rewired my whole home. Oh, I just flew back from Indianapolis. I was under contract on a duplex.

I know, right? So yeah, I went under contract on a duplex that I thought I was going to buy. Went through the property with multiple contractors and inspectors and took a look at the whole thing. Decided I was going to go through with it. Got a text from a contractor with some extra information. Ended up having to pull the contract at the last minute. So I've had a heck of a 48 hours. So besides that, you've done nothing.

I know, right? Just sitting around. Just watching some Simpsons. Well, the good news is you get to hang out with five fun people today. You and I have already listened to their questions. We've got some fun. We got some nerdy stuff today, Paula. Some super nerd.

Let's get started. Absolutely. So the first question is one. It's a theme that we hear a lot. And it goes to the theme of evaluating your priorities, what's more important, A or B? You know, it goes to that theme of tradeoffs. And so that first question comes from George. Hi, Paula. This is George calling in from Southeast Michigan. I'm 24 in weighing the opportunity cost of paying down student debt versus investing in a house hack.

I make $76,000 per year, and I have $130,000 in federal student loans, $26,000 in my name, and $104,000 to my parents. I have a three-month emergency fund, no revolving debt, and invest in my workplace 401K. With the CARES Act student loan payment deferral and 0% interest, I have deferred making student loan payments from March through December, instead depositing this money into a not-so-high interest savings account. I'm considering between two options. Option A, use the $20,000 I will have saved towards entirely paying off my highest interest rate student loan, 7.2% interest with 8 years remaining. Option B, use the $20,000 as a down payment and a $300,000 duplex house hack, leveraging a 3% interest rate FHA loan.

Option A would free up $200 in monthly cash flow, speeding up my debt avalanche and saving me from the loan interest. Option B should decrease my monthly rent by around $200. I would also start building equity sooner. Both options keep my emergency fund intact and my employment is stable. Fundamentally, if I expect to see greater than 7.2% return on this $20,000 over the next years, is it better to invest in the pay down debt? My long-term goal is reaching FI by age 60, with a diversified income stream from my 401k and multiple rental properties. I'm eager to get

started on this path, but I'm cautious about investing while still carrying responsibility for six figures of debt. Thanks for expanding my knowledge of personal finance these past two years and introducing me to financial independence. I also really appreciated your timely pivot to address COVID-19 related topics. I look forward to hearing your thoughts. George, thank you for being part of the community. Thank you for the question. And right off the bat, congratulations, you're 24 and you earn $76,000 per year. So whatever it is that you do for work, that's very impressive. I didn't know anybody who was making that kind of money at the age of 24. I knew very few people who are making that kind of money even at the age of 30. So the fact that you

have such a high income right out the gate says to me very good things about your future career. trajectory. The fact that you're making that kind of money in southeast Michigan, in terms of cost of living adjustment, we're not talking about a New York salary. We're not talking about a San Francisco salary. So the income that you're making says to me great things about what you will be making in the future and the career prospects that you have moving forward. So in terms of your question, let's talk through these two options. First of all, the amount of student loan debt that you have is higher than an amount that reasonably might be forgiven. There's talk about potential student loan forgiveness that might be or might not be coming down

the pipeline depending on what the people in Washington, D.C. decide to do. But even if that does happen, which it may or may not, the maximum amount that's being floated is significantly less than the amount that you hold. And so to that end, I think we can, in your particular case, it's worth having this conversation about paying off $20,000 of your $130,000 in student debt, given that even if there is some forgiveness, that forgiveness is not going to be the full $130,000. And I say that for the sake of everybody else who's listening, because there might be other people who are listening to this who only have $20,000 worth of student debt. who are asking the same question in their own lives. They are also asking, should I pay off my

student loans or should I put this money towards buying a house hack? So I want to throw that message out there that this conversation that we're having with you is specific to the fact that your loan balance is based around the fact that your loan balance is higher than any amount that might reasonably be forgiven. Given that and given the fact that the interest rate on the $20,000 portion of your student loan is high enough that if you were to put that money in an index fund hypothetically, there wouldn't be a great enough gap between the interest rate you're paying on that loan and the potential returns that you could make over the span of the long term. There isn't a great enough gap that you could reasonably arbitrage that, given those two facts,

there is a very strong case to be made for paying off your highest interest rate student loan. Now, if you were to do that, you would, of course, then have to continue to rent for a longer period of time. But that rent that you would be paying, as you mentioned in your answer, would cost you an additional $200 per month. And if you would, if you would, you would, you would, were to be able to save another $20,000 in, let's say, for the sake of example, 12 months, then we're talking about a delay in terms of buying this rental property of a year, meaning the cost of that delay in terms of the additional rent that you're paying at $200 a month. The cost of that delay is $2,400.

So if you are essentially paying $2,400 in additional rent to delay buying a rental property by another year so that you can have that savings in your student loan. I think there's a powerful case to be made for that. Now, granted, there's a bunch of unknown factors that we can never predict. We don't know how quickly the properties are going to be appreciating in your area. Will that same $300,000 duplex cost $320,000 a year from now? We don't know that. And that is forecasting. And so to that extent, it is unknowable. But given the high interest rate on that $20,000 portion of your student loan, I think there's a powerful argument to be made there. That said, you know, just to play devil's advocate, you could also argue that you could use this money as a down payment on a duplex,

lock in the cost of that duplex right now, get yourself in there, get some tenants in there, and then work on paying off a portion of your student loans, certainly to play devil's advocate, I can see where you would make that argument. But the caution that I would issue is that when you purchase a property, you have more than just the down payment to worry about. You're going to need cash reserves for that property, you know, for any unexpected repairs, maintenance, vacancies. You're going to need upfront money associated with moving into that property.

You know, there's all kinds of expenses that come with the purchase of a new property, even when you're trying to do it as cheaply as possible. Like, I'm not talking about getting fancy. window treatments, you know, like I'm not talking about anything crazy like that. But at a certain point, you know, you're going to need a lawnmower. And those types of expenses, they sound small, but they add up, even when you're trying to do it as frugally as possible. So the purchasing a duplex will cost more than just the down payment. And that's where my thoughts on this, Paula, spring from is that I think my role here isn't to decide which one for George. It's to explain what the

downsides are. And I think you already explain the downside of one of those, which is paying off the debt first. I think the downside of the other one of more leverage, I think we should also explore, because the thing that I love about real estate is that you can buy real estate using leverage. And so in up markets, real estate investments create more winners. But in down markets, the over leverage, Paula, get flushed out faster, right? So down markets seem more bitter. I'm looking at you 2008. And up markets are full of tons of people saying, and Paul, you're going to roll your eyes

because you see this all the time. All of these sharks telling you that real estate is exactly where it's at and they've got something to sell you that is this just, oh, the number of just scammy real estate people out there. I can't stand them. Oh my. It drives me nuts. It's, I call them the scamberg gurus.

Because they're driving their scammer guineas posting those pictures. Oh, I can't stand it. And they're selling these like $20,000 weekend workshops. where they teach you how to borrow as much money as possible, and, you know, other people's money. Yes. Oh, good. Vomit in my mouth.

The miracle of OPM. So leverage can be a negative thing. And leverage under the wrong conditions could sink everything for you. So I look at it that way. I think so in my mind, the more secure thing to do is to say, yep, I can make more money on if I invest this in real estate. state, but I'm going to make sure my foundation is solid and I'm going to just wipe out that debt. I see all kinds of broke professors that argue against paying off debt, but man,

when I was working with really wealthy people, they paid down debt. By and large, most of them paid off debt. And mathematically, it doesn't make a lot of sense. He's early on in this journey, which, which by the way, on the other side, because now I'm going to talk through the other side of my mouth, because on the other side, the thing is. The thing is, you know, I like better about getting involved with real estate is not the ROI that you can calculate. It's the non-calculatable ROI, which is the quicker you get in there and mess stuff up because you're going to mess up everything, no matter how many great people like Paula you have in your corner, you're going to mess stuff up. My son is 25 years old, owns three rental houses, is in the process of buying

his fourth right now. He feels extremely different about contractors, about wholesalers, about where to get your money from, completely different than he did when it was in his head and he was listening to great stuff. He got all these ideas about how it worked. And then he went and he implemented and he found out, Paul, it was slightly harder than he thought it was. It was a little different that he thought it was. And he loves it, but he's made a lot of mistakes. And this fourth property he's buying at 25, which is amazing. And I haven't, dad and mom haven't, I haven't helped him with anything. He did it all by himself. But the education he's had that way. And he has that at 25. That for me is the bigger ROI of getting started. Because by the time he's 30, he's going to be a ninja, Paula.

He's going to know so much by the time he's 30. It'll be amazing. Yeah, I tell my students that all the time, any time that you're trying anything for the first time, whether it's playing tennis or driving a car, anything that you are doing for the first time, you're a beginner and you're going to go through that beginner learning curve. And the same is true with investing in real estate. You're not going to be great at it or fluent or fluid or graceful the first time that you do it. You're going to go through that landlord learning curve. And so, yeah, I totally agree with you. the younger, the younger you are when you go through that, the more years you have in the future to handle it with the skill set of somebody who has experience.

Yeah. So I like that. I would just go in with my eyes open knowing that if he decides, if you decide George to take on more leverage, there can be unforeseen things that come out of the blue that you can't predict that can really, really make things difficult for you. You mentioned, you know, a lot of broke professors will argue that that paying off debt doesn't mathematically make sense. In Georgia's case, with a 7.2% interest rate on 20. It totally makes sense to pay off his debt. Yeah. I mean, I think even academically on paper, there's just not enough room to arbitrage there. So on paper, it makes sense to pay off a 7.2% interest rate debt. It would be different if that debt had like a 3% interest rate, right? That's the rate of a rate. inflation, but 7.2, that's, that's high enough that even on paper it makes sense. Locked in 7% return. Exactly. Exactly. And on top of that, you know, I would save up more money before buying a

duplex. I would save up more than just, just the down payment. Like, I would certainly save at least enough to have strong cash reserves, you know, at the time that you enter into the deal. The other thing I like about paying off the debt is he has $200 more cash flow. And as you said, you're going to need a lawnmower or you're going to need to pay a 14-year-old. You're going to have to do something. And there are so many. Every house I purchased, Paula, the people at Home Depot by week two know me by name. Yep.

Like, Joe, you're back. They don't call me Joe, though. They call me profit margin. I don't know what that's all about. Yeah. Yeah, there definitely been many, many months where I'm like, why do I even bother having a paycheck? Why don't I just send it directly to Home Depot? Just put this toward my next visit. I'll be there shortly.

Yeah, exactly. Yeah. But tons of stuff, as you know, comes out of nowhere. I love that. Bigger cash reserve, more cash flow. It's a good interest rate. That said, I would get started, George, on that journey as fast as possible. Yeah. So I guess we did really pick aside and answer his question without answering it. We explored the pros and cons, but I think it's fairly clear where both you and I come down on. All right, so thank you, George, for asking that question. Our next question comes from Hanan.

Hi, Paula. I hope you're doing well. First, I want to thank you for everything that you have created through Afford Anything. So your podcast, online community, and your real estate class have all been really, really beneficial to me over the past six months as I've continued to learn about personal finance as well as think about how I can get to finance. independence. Today I have two questions regarding retirement funds. The first is around selections I currently have in my 401k. My 401k is through my employer and Merrill Lynch is the platform. And so I currently have 80.5% of my assets in a Vanguard Institutional 500 index trust. The symbol is VLCSP. And I have the

remaining amount in a Vanguard institutional total bond market index trust. The symbol for that is BT BMK. The risk listed for both of these options is that the investment options are not mutual funds and that they are not publicly traded or listed on exchanges. And my question is, how much do these funds differ from a, for example, Vanguard S&P index. fund itself. So essentially, what is the difference between a trust and let's say an index fund or a mutual fund? What are the real implications of that? And are the trust less than ideal or basically the same thing? My second question is about a Roth IRA. So I'm currently 28 years old. I make about $100,000 and I therefore am able to open a Roth IRA.

in the more straightforward way. And I recently did just this. My question is really in anticipation of hopefully making above the income limit in the next year or two, which I believe I'm on track to do. And so I wanted to know if the backdoor Roth IRA conversion will look any different for someone like me who already has a Roth IRA open. Are there anything I should be planning for or considering ahead of time, or will this conversion process look similar to the way that it would if I didn't have an account already open? Thank you. I look forward to hearing your answers.

Thanks to that question, Hanan. And I'm going to tackle the first part of that question because back when I was a financial planner, I would also go in and speak at different companies about how their 401ks worked. And often inside of a 401K, they'll have something that looks like a mutual fund, smells like a mutual fund, but it's a little different like you're talking about. It's a trust. And actually, it follows, this fund follows the mutual fund close enough that they use the same ticker symbol.

The only difference that I know of is that because it's a trust, and not the same mutual fund that you would buy from Vanguard off the street is the fact that your firm can then either be charged a different fee or the people running the 401k can charge you a different fee, depending on how they decide to work that. So I'll tell you, if you work at a big company, you're probably getting it maybe even a little cheaper than you would if you bought it on your own. If you work for a small company, you're probably paying for it through the knows versus if you bought it if you bought it on your own. Does that really matter in the big scheme of things? No. I've heard people before say, you know what? My 401k has a lot of fees in it.

I'm not going to use my 401k. Are you kidding me? It's the best place to save only because behaviorally the money is taken away from you before you even see it. How great is that? And certainly the key to getting wealthy is getting money saved. And certainly if you have a 401k available, especially on the pre-tax side, you can't use a deductible IRA as an example, depending on how much money you make. If you make under a certain income, you may be able to also deduct an IRA. But for a lot of people, you can't. So for those people, especially, you want to use the 401k if you're using the pre-tax option. So in the fine print with the risks, the risk that this isn't a mutual fund, maybe. I can't think of a time, Paula.

where that was really a risk. They're using this trust thing, though, to charge fees a little differently. Hmm. So the takeaway that I'm hearing is that the fees within a trust are going to be different, but if this is the option that you have in your 401K, take it because it's better than not. Yeah. And there's really nothing for you to worry about that's different than a mutual fund. Hmm. Excellent.

To the second part of your question, so first of all, congratulations on being 20, still being in your 20s, being 28 and earning six figures. That is enormous. And like I said to George, in our earlier question, when you are making a high income in your 20s, that bodes very well for your future earning prospects throughout the rest of your life, throughout your 30s, 40s, 50s. Setting yourself up with a high income at an early age indicates big things for you down the road. So big congratulations on having that great income at an early age. Big congratulations on being attentive enough to personal finance that you are listening to a personal finance podcast so that you know how to manage this money. There are, you know, earning is half of the journey and managing it

and saving it is the other half. And I'm sure you've probably seen colleagues, co-workers, friends, maybe even family members who are making good money, but they haven't given any thought to managing it. So the fact that you're doing both is incredible. To your question about a Roth IRA, good news. Don't worry, that is an extremely normal situation. It is very, very commonplace for people to have Roth IRAs and eventually for their earnings to grow to the point where they are phased out of eligibility to contribute to a Roth IRA in the traditional way. And when that happens, people who have existing Roth IRAs then later in life have to start making backdoor Roth contributions. Same thing happened to me. I had a Roth IRA that I made contributions to in the normal front

doorway for many years. And then eventually my income grew to the point where I had to start making backdoor Roth IRA conversions. So without having statistics on the, the number of people who do that, I would guess that that is the majority of cases. I would guess that the majority of cases, people start with front door contributions and then later transition to backdoor. The only thing that you need to know is, and I'll just outline the process, when you start making Backdoor Roth contributions, here's how it's going to happen. First, you're going to open a traditional IRA. Then you're going to make a contribution into that traditional IRA account. Now, technically, this contribution is not going to be eligible for a tax deduction.

So the phrasing around it is that you're making a non-deductible traditional IRA contribution. But what that means at a logistical or administrative level is simply that you make a contribution into a traditional IRA account. The fact that it is non-deductible is something that gets dealt with on the tax filing side. It's not a different account. It's not a specific type of account. So you make a contribution, a non-deductible contribution, to a traditional IRA account, and then either online or on the phone, you convert that money, you essentially transfer that money from the traditional IRA account into the Roth IRA account.

And that's that. It's that simple. So it's literally just a matter of putting money in an account and then transferring that money. So the good news is the fact that you have an existing Roth IRA is not going to affect your eligibility to make backdoor contributions. The one thing that you do want to be aware of is something called the pro-Rata rule. And in the show notes, which will be available at afford anything.com slash episode 298, I'm going to link to a couple of articles that explain the pro-Rata rule. But to keep it simple, there are some guidelines around the total amount of assets that you can have in all IRA accounts, such as a simple IRA or a SEP IRA. There are rules that would affect you if you have a high volume of assets in those types of accounts.

I don't think that's going to affect you because from what you've said, it doesn't sound as though you have any of those accounts. It doesn't sound as though you have a simple IRA, a SEP IRA, or even a traditional IRA. So you probably don't have to worry about it, but I'm saying that for the sake of anybody else who's listening, who does have a simple IRA or a SEP IRA, you're going to want to read up about the pro rata rule. So again, we'll link to those articles in the show notes. Those are available at afford anything.com slash episode 298. Long story short, the key takeaway is that having a Roth IRA account that you have made front-door contributions to is totally normal and will not affect your conversion process. So thank you for asking that question, Hanan, and congratulations on everything that you're doing. We'll come back to this episode after this word from our sponsors.

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My husband and I were able to sell out of some golden parachute ISOs, and we vetted about $400,000. We sold the stock so that we could diversify out of that asset, and also for college funding purposes. We're a little late to the college funding game because I thought it was the senior year that mattered for FAFSA and expected family contribution purposes. But it's actually the end of your oldest child sophomore and beginning of junior year, which for us, because our kids are 10, 12, and 14, is the 2022 tax year. So for FAFSA student aid purposes, our expected family contribution is 20% of our annual income and 5.64% of our assets for 10 years, which ends up being a by about 40% of our net worth that's not protected. So the protected things that are not affected by your expected family contribution are our home equity, the value of our retirement accounts, the value of any small business, money in 529s, personal assets like clothing and cars, and life

insurance cash value, plus a small asset protection allowance of $9,900 a year. Our home has $200,000 mortgage, which we haven't paid off because it's a 30 year at three and a half. percent. Our retirement is maxed out every year, and my husband has just started making catch-up contributions because he turned 50 this year. But almost all of that is in pre-tax income, and we have hundreds of thousands of dollars in it. My husband's small business is just getting started, and my law firm is too, so they may eventually have value, but do not at the moment. We hope to keep $100,000 in cash for our emergency fund, and $300,000 is remaining in the stock, plus we have another set of ISOs that do not have much value now, maybe $50,000. And we obviously don't have control over the value of those stocks,

which so far the one has gone up really high, about 20 to 30 percent a year. We definitely planned us by our first rental property or two with some of this money. We will definitely start a donor advised fund with some of it as well. But we're trying to figure out what to do with the rest of the money while still preserving that $100,000 cash, which we already have outside of the $400,000. That $100,000 is not coming from this money. We're trying to decide if we should do a $529. We have a $10,000 tax deduction starting next year and here in the state of Michigan. None of our income is here yet, so we can't do it this year.

But we only have one year to do that, at least with this money. So we don't know if we want to do more than that $10,000. We could also pay off our home, which is at a low interest rate, but then again, so will our rental properties be? That's $200,000. We could also ross some of our 401ks. just so we have cash in five years. That is retirement money, but because of the unknown value,

which could be a huge amount of value, for our ISOs, we will get hit with that 5.64 asset percentage on those funds, and we may not have the cash to pay that out of pocket for college, because neither of those ISOs is liquid. We shouldn't need to use those Roth IRAs if we choose this option, but we'd like to have the ability to do so,

and we can use some of that $400,000 to pay the tax. if we want to do this next year. Or should we buy more rental properties? My understanding is that rental properties show a tax loss for the first few years because of depreciation, and we could really use to get our income down, and that would also affect our assets, which would really help. We don't mind having student loans because we can always help our kids pay those off later, but we can't fix our retirement later. So if you have advice, we'd really appreciate hearing it. We have $400,000, and we need to know if we should buy more rentals, put more money in 529s, pay off our home, our ransom of our 401ks, and use this money to pay the taxes.

Love your podcast and look forward to hearing what you have to say. Thanks. June, first of all, thank you so much for calling in. Thank you for being part of the community. And kudos to you for all of the research that you've done. The fact that you are so well versed in all of this, you know exactly what's happening with regards to the FAFSA, with regards to its requirements. You have clearly done a ton of research and a ton of thinking around the strategy, the game plan, the end goals.

You know your numbers. You are in an excellent position to lay down the foundation of a very strong financial planning conversation. So big congratulations to you for everything that you've done to have an amazing grasp of your personal situation as well as the rules of the game around you. because learning the rules of that game is one of the, that's one of the major steps that Joe and I, that you and I both frequently work on when we're talking to beginners. And June, you've clearly already nailed that. So congrats to you on that. Now, Joe, you sent twins to college. Talk a little bit about your experience and how that can inform June's thinking. I think I set my hair to college too, because if you look at pictures of me before and after

college, that's a lot less hair after that. But seriously, this was by. My favorite part of financial planning, it is fairly complicated for everybody that found June's question to even be complicated because it is. There's a bunch of stuff going on in this FAFSA form, the federal application for student aid and the expected family contribution to things everybody sending to college should know about as well as June does. Let's start off with a few things. And what's interesting, Paula, we've got Ron Lieber who writes the Your Money column for the New York Times, actually over on stacking Benjamin's today, talking about exactly this topic. So June, if you want to hear some of the things in more detail that I'm about to say,

Ron's got it all over there for you. The first thing is this. When we look at an expected family contribution, it isn't just your assets, but it's also your income. And I'm wondering, just based on the questions that you have, is your, income low enough that any of this work even matters. I would have many clients that are in your position that would come to me and say, okay, how do I rearrange all these assets? Look at their income and I go, guess what? Your expected family contribution is still going to be through the moon. We don't have to worry about how we rearrange these assets that you have. Second, if you have $300,000 of the $400,000 sitting there that is for college, I'm wondering how close you're going to be, like which school you want your

children to go to? What exactly is the target? By the way, I also have some good news there that Ron shared with me when I interviewed him, which is that the cost of private schools, where you've seen the sticker on private schools, Paula, it looks so much more expensive than a state school. and Ron says that's not the case because at nearly all of the private schools out there, you get so much more aid that narrows the gap that you end up with something that looks not that much different than a state school. And by the way, one thing that he really likes about private schools over the big schools like Michigan State where I went is that in a smaller school, you'll have professors

teaching you instead of, I remember one of my communications classes. there were maybe 125 people in the room and there was a TA teaching the class and the professor was nowhere to be seen. So the value, he talks a lot, Ron talks a lot about the difference between value and price and the value to go to a small school may be, maybe fantastic. There were a couple of other interesting things that maybe Paul, you and I can talk about later that I found interesting but I think I think you're going to do the expected family contribution work and you're going to go do all the FAFSA work and then you're going to look at all of the ways that you can hide money and I'll give you one example that you mentioned pay off your house if you take all this money

and you pay off your house to hide it so that your expected family contribution looks better your FAFSA looks better and then for some reason you end up needing that money you're going to then have to take out a loan to get your own money back or you'll have to sell the property to get your own money back. So I'm really not a fan of taking this liquid asset that I know you're going to need over a short time for starting fairly soon and put it into illiquid places so that we might or might probably won't end up having it affect the college game all that much. The second thing you said, 529 plans with with a year and a half to go, until you get to college.

I don't think there's much efficacy in doing the 529. You're in Michigan, and I know that you get a small tax break for putting money in there. So, okay, maybe, maybe. Paula? I'll challenge you on that one. So she said her kids are 10, 12, and 14. For the 14-year-old, I don't think there's really any value in contributing to a 529 plan. For the 10-year-old, I could see that.

Yeah, quite possibly for the 10-year-old. She also mentioned that there's a $10,000 tax deduction starting this year in the state of Michigan. Well, that's one that I'm talking about. But the problem is that the tax rate, the Michigan tax rate, isn't all that big. So, sure, it's going to end up giving you something, but it's not, it isn't a ton. And then you look at what she's going to invest it in inside the 529 plan versus outside the 529 plan. Okay, for the 10-year-old, go ahead and do it. You'll get a little bit for the, for the oldest one.

maybe we do it. I don't know. It seems like we're doing a lot of work for not a very big payoff. That's what it feels like to me. It just seems like you're going to do a lot of work and get no mileage out of any of this. College is expensive. It sucks. You put on your hard hat and you go at it.

And that's not what people want to hear. But college is something to live through, Paula. That was my thought as well. She mentioned that she's starting a law firm and her husband is starting a small business. And my first thought was, that's a ton of work. Starting two people both starting small businesses. A law firm is also a small business. So you've got two people, they're both starting small businesses.

That initial startup is so much work. Going from zero miles per hour to 60 miles per hour require so much more energy than going from 60 miles per hour up to 120 miles per hour. And so the initial burst of work that's needed to begin something new is so all-consuming. You know, if she and her husband are trying to do that and raise three kids, I want to make sure they're getting a good return on their time. And so, you know, I'm in agreement with you, Joe, that I worry that some of these moves may save a little bit of money, but the opportunity cost when it comes to, you know,

serving as a distraction and, you know, consuming energy that could otherwise be spent establishing this law firm or establishing this small business, that seems like a better direction in terms of use of time, attention, energy. A 529 plan is easy enough to set up that I could justify that time. Yeah, exactly. Put the money in there. That's very quick. And also, there's one thing that I don't know with June and her husband both being in

the beginning stages, I mentioned their income levels might make all of this not really matter. But if they're in the early years, they might not be paying themselves much, Paula. And if they're not, that may change the entire game, especially if this is the only $400,000 they have that really counts when it comes to the FAFSA form. At that point, then, what I do is I seriously then talk to a certified financial planner who focuses on college planning, they will run. This is what I used to do. They'll run your expected family contribution. I used to have the software. And then we take a look at what we did with that money. And if we moved it here versus we moved it there, what impact would that have?

Depending on where they're at with their personal salaries, then I might make that move. Right. Although it also depends on how the businesses are structured. If their personal salaries are low, but they're retaining earnings within the business, and the business is formed as an LLC, so they've retained earnings within it so that they can spend that money or have better cash reserves. You know, that's taxable income. It's passed through income. So it may be the case that they're paying themselves a low salary, but they have profits in

the business that they're holding year over year. And those profits then show up on their tax form because it's... It's pass-through income. Yeah. But consequently, also on the other side, if they have a bunch of startup costs and they're, they have massive losses. Yeah. Who knows?

Who knows? I don't know the answer to any of those questions. And I think those are pretty material. Right. Right. Yeah. You know, to the 529 plan, especially for the 10-year-old, I think it's a worthwhile idea. I mean, 529 plans, the tax deduction on the growth, the, you know, tax deductible growth,

is the benefit of a 529 plan. And when you have older children, when you've got a 14-year-old and it's time to start paying for college pretty soon, there aren't going to be very many years of growth there. And so the best time to open a 529 plan is when kids are young. For the 10-year-old, I think there's still probably enough time. But there's not a huge deduction that you're going to get

because there's not going to be a ton of growth that you're going to get because if you're investing money that has a, eight-year timeline to withdrawal, assuming that the 10-year-old goes to college at the age of 18, given that the timeline to withdrawal is so near that money is going to be invested conservatively, meaning that the gains aren't going to be all that great, meaning any tax deduction on that growth is not going to be very significant. The idea that I actually did like more than any of the others is paying off their home for precisely the reason of time, attention. I mean, of everything that she's discussed, you know, paying off your home is simple.

It's not like buying rental properties, which is absolutely not something that I would do for the purpose of showing a tax loss. You buy a rental property if you want to own rental properties, but the effort that it takes to buy a good rental property, I mean, while you're also starting two businesses, forget it. Yeah, focus on your businesses. Do one or the other. The entire time that I was building my rental property investing course, I was not actively buying rental properties because I knew that I could do one or the other. I could throw all of my attention into actively shopping for rental properties or I could throw all of my attention into building out this course, but I couldn't do both simultaneously. Putting that cash into the house though, Paula,

goes directly against the liquidity she's going to need. I mean, how is she going to get, without a plan to get that money back out, unless that saves her enough money that she can then cash college, right? So if let's say she's got this mortgage that is $3,500 a month and now all of a sudden she's got $3,500 a month of free cash flow that she didn't have before, then I go, okay, we're close enough. The interesting thing about college also, by the way, and I think I may have spoken to this before, is I was surprised by the amount with my kids of cost transfer that there was. I had thought that when we looked at the retail cost of college, that that was what I had to save. Well, my son was eating at my house, and he's also eating at school. And so I'm paying for the

same eating. So I thought I had to save money toward his eating. Well, that would have been great, because then my budget would have been less and I would have had the money saved. But instead, the budget neutral position is that food on campus is the same cost as food at home. Right. So it wasn't that your grocery bill stayed the same once your son moved out. Right. Exactly. My grocery bill went down a ton. Thank goodness. It's fantastic. And I actually think, and I've said this before, I'm pretty sure I won that battle. Like I looked at the price that they was going to cost the school to feed him and I high-fived myself. I was going to win that deal. Now, in her case, she said she has a 30-year home mortgage of $200,000 at a 3.5% interest rate. No, no, it's not going to be this big number that offsets the cash flow that she would need for college. Now, she does have time on her side, but I don't think that that's enough time with a 14-year-old for her to magically come up with the money that she's going to need for a college education, which, again, comes back to the amount of money that she's of, what's the target school?

You know, what is the target school? Ron and I talked about community college for some kids. If it's a community college, maybe, yeah, maybe you could do that. Well, she has also indicated that she's open to taking out student loans. So she could pay off her home, take out student loans to help pay for her kids' college and, you know, handle it like that. I'm just not that excited about taking out new debt that's probably at a higher rate, retiring debt that's at a lower rate, to take out new debt in a couple of years that's at a higher rate. I mean, I haven't done any of that math yet, but just from a, just a gut feeling, I'm thinking that's not a great idea. The other question that we haven't addressed head on is what portion of her children's college education will she and her husband cover and what portion will the kids be responsible for?

Yeah. Are they making the decision to pay for 100% of their kids' expenses? are they going to pay only for the kids' tuition, but it'll be the kids' responsibility to pay for their own room and board and miscellaneous and incidentals and transportation and all of those miscellaneous life expenses? You know, will they pay for the first year and then the kids will have to pay for years two through four? I mean, there are all kinds of setups that different families have, and that's also going to

be part of this conversation. And that will inform the question of what do they do with their money, because, you know, do they pay off their home? Do they buy more rental properties? I mean, that will inform that question because fundamentally it informs the question of how much do they need versus how much will their kids need. Those are two separate questions. You know, my parents took the position that they would help me with a portion of my tuition, but that I would be responsible for coming up with scholarships that would pay for another portion of my tuition and starting from my sophomore year, I would have to cover all of my room, my board.

You know, I had to pay rent, utilities, transportation, groceries, all of that, starting sophomore year. So you did a job. It was stressful. You know, it was definitely stressful. But a big part of how I became so naturally frugal was I was working 20 hours a week all throughout my college experience, you know, working 20 hours a week in addition to being a full-time honor student and working full-time in the summer in order to be able to cover

my expenses. And honestly, that was a big piece of my early financial education, like having to budget, having to live on $1,000 a month and stretch that to cover rent and utilities, you know, being in that position where the $10 that you've got to spend at the laundromat every month is notable. That's something that you notice. that does teach you at an early age how to manage your money. Like you manage your money tightly because you have to. Yeah. There's a lot there.

I still wouldn't buy rental properties, June. Yeah. I still wouldn't do that. That's the thing I wouldn't do. Yeah, exactly. Exactly. I agree. Don't buy it for tax purposes.

That's letting the tail wag the dog. Yeah. Everything else is on the table depending on what the goal is. So thank you, June, for asking that question. We'll come back to this episode in just a minute. But first, our next question, comes from Mario. Hello, this is Mario from Kansas.

I invested my Roth IRA in two funds portfolio. VTWAX. It's Vanguard Tuttle World stocks and VBTLX. It's 90 stocks and 10% bonds. I'm 41 years old. Can I have your opinion in your future podcast? Thank you so much. I enjoy your work.

Keep up the good work. Thank you so much. Bye. Mario, thank you so much for that question. So I've got a couple of thoughts. First of all, your Roth IRA, you said there's a 90-10 split. 90% of it is going towards equities and 10% is going towards bonds. Now, I'll talk about a broad, general.

idea that's out there in the financial media, but I'll also then talk about how that doesn't apply to every particular person. So there's this very, very general idea in terms of asset allocation, that asset allocation should be roughly your age in bonds with the remainder in stocks or equities. And so your 41, we'll round that to 40. Under that set of guidelines, you would have 40% of your portfolio in bonds and 60% in equities. But there are people who would argue that that's far too conservative. And so there are people who would move that benchmark to be a bit more aggressive. They might say at the age of 40, why not go 30% bonds, 70% equities?

Right. So there's some wiggle room in terms of how that generalized rule plays out. But that's sort of a starting benchmark for a conversation. That being said, where that falls short and why there's a disparity between these generalized aggregate rules versus, you know, what's best for an individual situation, is that you may have other sources of retirement income that would impact the amount of fixed income allocation that you need. So, for example, if you have a job in which you have a pension plan and you know that you have the security of that pension, that's coming in, that's going to impact your desire of how much you want for a fixed income portion of your portfolio. If you have a bunch of rental properties and you have cash flow from rental income that's coming through, if you have software or books, you know, and you've got

royalties from that intellectual property, you know, that's going to, all of that is going to impact the desire that you have for the fixed income portion of your portfolio. And so without knowing the rest of your financial picture, it's impossible to say what's right for you as an individual. But I will say that just using these broad generalized initial conversation benchmarks, the stock bond allocation that you've outlined seems a little bit aggressive for your age. The other thing that comes to mind right away is that you mentioned you have total world stocks. It can be a good idea. to have a portion of your equity's portfolio in the stock of your home country.

You know, so assuming that you live in the United States, having a portion of your equity portfolio in Vanguard total U.S. stock market, and then a different portion allocated to the international market, that is typically advisable because when you have money invested in the international market, then you're subject to all kinds of various risks, including currency conversion risk, among others. And that doesn't apply when everything is in the same currency that you're buying equities in the same currency that you're earning money in and you're investing money in. And so keeping some portion of your equity portfolio in your domestic equities can be a pretty sound idea. My gut feeling on the asset allocation is a 90-10 for a guy who's just over 40 years

old is fantastic. It's a great place to be. And you look at equities by the time you get to 60 when these funds become available without penalty or loopholes or anything else, you look at that timeframe. You're going to have to do a lot of math for me. to show me where any bond exposure makes sense. The bigger thing I worry about when it comes to stock versus bond exposure is not the financial markets. It actually is risk tolerance then. Your ability to withstand the roller coaster ride you're about to go on if you up the game.

So what I'm saying is for that time frame, 100 is fine with me. It isn't fine with me when it comes to working with people, though. the markets weren't the problem, the people were the problem. And having been an advisor during two pretty horrible downturns in 2000 and 2008, I'll tell you that it's way more brutal than you think it would be if you've never been through one. You know, you get to a point where you've saved a nice sum of money, people closing it on retirement. Maybe you've done a great job of saving and you're at a million dollars and the stock market drops 40%. It's very easy to drive down the road Paula and say, I'd be okay with losing 40%. You know what? I think I'd be fine. But then when I

rephrase that, you just lost $400,000 and you don't know when it's going to come back, puts a pit in your stomach that you can't believe. People can't sleep. They have trouble eating. I had some clients that lost weight and not in a good way that started noticing that they were having some psychological issues because they told me, point blank, we were. We were are going to be a okay. And I will tell you that there's a good chance that you won't be. So when I look at it from the market's perspective, though, Mario, 90-10 from where I sit, I think that's great. But buckle up. So you're saying there's a mathematical answer and a psychological answer. Absolutely. And they're nowhere near the same, Paula. Absolutely, nowhere near the same. Fund-wise, I agree with Paula. I think the asset allocation should be focused on what your end goal is. How much money do you need? and what level of risk do you need to take? And then that will lead you to a better asset allocation. So directionally, yeah, I like it.

Could you do better? I bet you can. And what's neat is, this is the neat thing about good asset allocation. Let me tell you a couple things, Paula, that I found absolutely fascinating. Let's say that Mario added 10% small cap. Let's say small cap value index. And then he added another 10% to developing markets, right? Places like Southeast Asia bought a developing markets index.

Both of those, by the way, guys, super risky. When you look at the risk level of his portfolio, though, will his risk in his portfolio be higher or lower if he adds those two funds? Trick question. The risk in his portfolio will be lower, despite the fact that he's adding riskier assets, because of low correlation. I think it's fantastic. It's so cool that you can add riskier stuff and lower the risk in your portfolio.

Blew my mind when I first saw that. I think that's fascinating. And that's why I like starting with the end in mind. I begin with the goal and I work backward. And then I can use things like those two asset classes that I talked about. And I know, by the way, that those two, if I look at them by themselves, those are going to be the, it's not even a roller coaster. ride, it's worse than that. I mean, it is years of not making any money and then popping these huge returns and then losing a lot of money and then making a ton of money. There are some huge

gyrations, but Paula, to your point, because they don't do it at the same time. It evens out the portfolio, makes it smoother, a smoother ride. I like it. So, Mario, the takeaway is a lot of this is going to depend on you, both your risk tolerance and your risk capacity. But I think Joe and I are both in agreement, have some domestic equities in there. Yeah, agreed. Our final question today comes from Vivian. Hi, Paula. My name is Vivian. I love your podcast, and I especially love the sessions where you and Joe answer listener questions. I have a pre-retirement planning question concerning, rolling over a Roth 401k. So 60% of my 401k is in Roth post-tax money.

I have another IRA in a similar amount that's all pre-tax money. So my plan was that I was going to, when I retire in four years, I'm going to do some Roth conversion ladders. and try to get as much of my pre-tax money into post-tax money. I was not planning on taking Social Security until I'm 70, so I had like five years to do that. My plan, though, was to use some of my Roth 401K money to live on and to help pay taxes during that five-year period.

I do have a taxable brokerage account of about $100,000, and I also have cash of about $100,000. But it just worries me because I just recently found out that when I transfer my 401k Roth monies into a Roth IRA, the five-year rule starts fresh and is not triggered until I actually open up that Roth IRA. So my question is, can I open up a Roth IRA today, even though I'm over the maximum income? But I understand that that's okay because if I take part of my IRA pre-tax money and convert it, and I would just use a small amount like maybe $5,000 and $10,000 and convert it and pay the taxes on that. And then in four years, when I retire, if I can then roll over my 401k Roth portion into it, would all of those monies be available to me then in 2025 rather than having me start over? Or would I not have access to the monies that I put in in four years for another five years?

So I hope that's clear. Love what you guys do. Thank you. Thanks for the question, Vivian. Also, thanks for the kind words. Vivian's my favorite caller because she said thank you to me. So Vivian and I, no, BFFs. And Vivian, I love this idea of starting the Roth IRA now.

You definitely want to get the clock started. And I think, Paula, this is for everybody out there. There's this weird clock on the Roth that, hey, put a dollar in it today. Because if there's a dollar in it, that starts the clock on that existing Roth. and then you can work your magic after that. But wherever you're going to do it, start a Roth IRA today so that it gives you flexibility down the road. And then you're not dealing with what Vivian's dealing with, which is, okay, I got four years

and I really want this money to be available when I get there. I think there's a different way that she's not thinking about because I think doing the, so yes, Vivian, to your question, you can do the conversion ladder. That's going to be time consuming. I think it'll be totally worth it. It's a great idea. But there's one option that I might like better, which is look at how much money you're going to need in those early years that's in the Roth portion of your 401K and just leave it

there. You don't need to roll at all to an IRA. You can have your short-term money stay in the 401K, do a partial rollover of your long-term money to an IRA. and sure you've got two different accounts, but you can handle having two different accounts. That changes if you're paying huge fees in your 401K. There's some 401K plans with big companies

where you're paying just some massive fees. And for those, I'll keep my advice earlier that we gave saying, still save into those, if that's your only choice, because behaviorally, it's fantastic to save pre-tax at work. However,

I think Vivian, in your case that if you've got the opportunity to get out of there and high fees, do that as soon as you're able. Also, there's a thing called an in-service withdrawal, and you have to go to your HR people and ask them if they have in-service withdrawals. By the way, they may not know. You may end up having to call together to your 401K provider and ask them if they can do in-service withdrawals.

If they can, Paula, that might also work out really well because that means she can start moving some of that 401K money now today, even though she's still working there. So most 401Ks won't let you move the money until you separate from service. You have to be retired or be gone, quit, whatever it might be. But if they have this in-service withdrawal provision, you can then take some of your money out of your 401K, make sure you do the paperwork correctly so it goes right to an IRA so you don't to pay the tax right now, and you can begin your laddering today as well instead of having to wait until you get to retirement to start that. So I would ask about an in-service withdrawal if you have

high fees. If you have low fees, I might skip all the gyrations and just leave some of the Roth money there to get you through. If there is a broker or an advisor involved, this is important to know. some advisors are paid based on assets that are at that advisory firm. And so an advisor might be talking to you about, hey, you know what? You got to roll this to an IRA. Often, Paula, that is the number one thing to do. Usually moving it over to an IRA has so many advantages that leaving it in the 401K doesn't, that I think it's a very responsible thing to do.

However, if the advisor is asset-based, they may forget about the fact that for Vivian, it might not be the best thing. Boom, drop the mic, Joe. That's fun. That's always fun. Yeah, you just nailed Vivian's question. But that's because she thanked you. So, you know, she's your favorite caller. I could have answered all the other ones like that, but Vivian gets the special treatment. Joe, so where can people find you?

You and Ron Lieber if they are looking for more info. You can find Rod Lieber and I and our mutual friend, you're my mutual friend OG over at Stacking Benjamin's every Monday, Wednesday, Friday. Fridays you'll find Paula there hanging out with us talking about cake and making up fun things for us to do on the Stacking Benjamin show. Paula's taken over. Yeah, so I, so right now, as of this afternoon, the afternoon that we're recording this, the Afford Anything podcast has 14.8 million downloads.

And I promised on Instagram that when we hit 15 million, I'm going to make a cake. So on the topic of cake, if you find me on Instagram at Paula Pant, there will very soon be a giant cake. And I bought the cutouts for it. I went on Amazon. I bought like cake molding to form a cake into the numbers 15. Nice. So I'm about to make myself a cake in the shape of the number 15.

Red velvet? Oh, no, I was planning on chocolate. Chocolate. Yeah. Whatever. That's fine by me. Yeah. Also, keto.

It's going to be a keto cake. See, you lost me at keto. It's going to be a low carb cake. A low carb 15 million download cake. If you would. told me you're making the cake out of kale. It would have been the same thing for me. You just completely lost me. No thanks. Pass. What's the point of eating cake if it's low carb? Because it's high fat. It's still high fat. I want all the fun, but let's take a lot of the fun out.

If we could do, if I could have fun, but not that much fun, that would be, that'd be great. You still get to eat all the fat. Fat is delicious. Fat is delicious. I agree. So I'll be on Instagram making a cake. And Joe, you'll actually be doing heady and important things like interviewing the New York Times money guy. Right. Yeah, talking to him about expected family contribution. I think I'd rather be eating cake. Ron's a great guy, but I'd like to eat cake. All right. Well, one of these days, you, me and Ron will all get together and have some cake. That's a deal. Sold. Excellent. All right. Well, thank you, Joe, for being part of this once again. and thank you to the community for being part of the Afford Anything community.

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