Afford Anything - Ask Paula: The Dangers of Frugality

Episode Date: July 7, 2021

#326: Anonymous is struggling with being too frugal, possibly to the detriment of her health. I mentioned in a previous episode that I struggled with frugality for a long time. She wants to know: in what ways was frugality a hindrance or an asset, and how did I get myself out of such a frugal mindset? John and his wife aren’t sure how much they should contribute to their daughter’s Ohio 529 plan. They want her to graduate from undergrad debt-free, but they imagine she’ll get help from scholarships and that she’ll work as a teenager. How much is enough? Rafael just got a job as a 1099 sales associate and is wondering how the heck to calculate what he’ll owe in taxes. Rafael has a second question: he opened an account at Vanguard in December 2020 and noticed that he could still contribute to that account for the first few months of 2021. Which year should he have focused on contributing to? Elizabeth has two rental properties: one that’s paid off and profitable, the other which shows a loss. If she put her profitable rental into an LLC, could she still combine the rent from both properties? My friend and former financial planner Joe Saul-Sehy joins me to answer another round of questions. By the way, if you have questions on business, money, trade-offs, financial independence strategies, travel, or investing, be sure to leave them here and we’ll answer them in a future episode. 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 focus, your energy, your attention, anything in your life that's a scarce or limited resource. Saying yes to something implicitly means. You're saying no to all other opportunities. And that opens up two questions. First, what matters most to you?

Not what does society say should matter most. But what is truly a priority in your life, no matter how weird it may be? That's the first question. The second question is, how do you align your daily, weekly, monthly, annual decision-making in a way that reflects that which matters most? Answering these two questions is a lifetime practice, and that is what this podcast is here to explore and facilitate. My name is Paula Pan.

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, joins me to answer these questions. What's up, Joe? Hey, Paula, what's happening with you? You know, I realize in the intro, I always say, and today you're here, when in fact, every episode in which I answer community questions, you're here. Which is my honor.

Thank you so much for asking. And today, though, I brought along our posse, Paula. Yes. So Cooper the cat is sitting right next to me. I've also got two cats that are sitting at Tazzi is sitting. Yeah, Azra sitting behind me. Tazi is sitting in my feet. So we've got two humans, three cats, and five questions.

Hey, Joe, do you want to know what those five questions are? I've been wondering since I got here. Well, here's what we're going to talk about. An anonymous caller is struggling with being too frugal. This is something that isn't talked about enough. so we're going to discuss that. John and his wife want their child to graduate from undergrad debt-free, but they're not sure how much to contribute to her 529 plan. Rafael got a job as a 1099 sales associate. He's wondering, what are the tax implications of being a 1099 worker? Also, he opened an account

at Vanguard. He also has a second question related to retirement accounts and deadlines. We're going to discussed that as well. And finally, Elizabeth has two rental properties, and she also has some tax-related and business structure-related questions about those rentals. We're going to tackle all of that right now, starting with Anonymous. Joe, we give every anonymous caller a nickname. What should we nickname? I have an idea, actually. I know I've just asked you that question, but I really have an idea with this one. Okay. All right. All right. Well, Anonymous, I hope you know that I mean this all in good fun. And if you don't know who this references, I encourage you to read the Wikipedia page on this person. But I would like to nickname you Hetty Green.

And once we hear your question, I will explain who Hetty Green was. Let's hear your question. Hi, Paula. You mentioned in your May 11th episode how you grew up steeped in the traditions of frugality. I really identify with that struggle, and I'm still trying to overcome the negative aspects of that, such as avoiding doctor's visits by saying, I'm sure it'll be fine. It'll heal on its own. Could you talk more about what obstacles you encountered, such as when your frugality was a hindrance and also how you overcame that?

Could you also mention any cases where your tendency towards frugality was an asset to you? Thanks, and I love the show. Hetty, I love that question. And I know I promised that I would describe who Hetty Green is and why I thought she was a perfect name for you as an anonymous caller. and I'm going to discuss that at the end of my answer. But first, first I want to answer your question directly. I strongly relate to what you're describing, the challenge of being frugal to the point where it's harmful.

So the example that you gave of not wanting to go to a doctor because you don't want to pay the deductible or pay the co-pay, you hope that something will heal on its own. That's a perfect example of when frugatial, can be a hindrance. I was very much raised in the traditions of frugality. We were, and this is, I think, true of many immigrant families that I've seen. You know, we were the family that we never bought Tupperware. We just reused empty yogurt containers. In fact, we still do. We were the family that never went to restaurants, except once a year on my birthday, we might go. We had coupons

for everything. My mom, when she was buying groceries, was very aware that bananas were cheaper at one store and bread was cheaper at the other store. It was certainly an asset to be that frugal. It allowed my parents who didn't come to the United States and didn't start earning an income in U.S. dollars until their 40s. My dad didn't open a retirement account until he was 50. And so it allowed them to overcome that late start in life and build a good middle class life and a stable retirement despite not opening a retirement account until the age of 50. So that was the value of an incredibly frugal disposition. But time and time again in my life, that frugal disposition has come back to bite me and I have had to actively unlearn some of the, excesses of frugality, those times when I push frugality too far. And I'll give you a couple of

examples. When I was in college, my family, my parents sold our childhood home. I had the opportunity for the cost of a $200 airline ticket to fly back and see that home for one last time and be the person who clears out all of the stuff from my old childhood bedroom. I did not do that. I didn't want to spend $200 on an airline ticket. So not only did I not. see my childhood home for the last time. Not only did I not say goodbye to it, but also in the process of that move, all of my journals got lost. Years of journaling, middle school, high school, all of those journals that I painstakingly wrote and kept, all of it got lost. And if I could pay $200 right now to have that back, if I could pay $20,000 right now to have that back, I absolutely would.

That's an example of where frugality just came back to bite me. During the pandemic, a lot of people, you would hear people struggle with the idea of not flying home for Thanksgiving or not flying home for Christmas. I never flew home for Thanksgiving. It just, it wasn't a thing. Why would you pay that much money for a four-day trip? None of that made sense. Another example, the cost of paying lawyers, some legal forms that legal documentation that I should have created and that I didn't, and that later ended up coming back to bite me in the butt in a big way, and that later ended up resulting in new legal bills that were many orders of magnitude greater than what an ounce of prevention would have saved me from.

Those are all examples of times when frugality has haunted me. And in fact, when I think about the growth of afford anything over the last 10 years, How reluctant I've been to reinvest back in the company. How reluctant I've been to upgrade my equipment or bring on new employees. I often wonder if I've grown too conservatively, too slowly, if, again, this tendency towards frugality has impeded my ability to reinvest back into growing a business. And so in case after case, you know, what I've just outlined are you, use cases in the arena of health, in the arena of nostalgia, in the arena of business growth

and development, in the arena of legal protection. Oh, the thing I hadn't mentioned, spending money on a therapist, you know, in the arena of psychological health or mental health, I mean, in all of these arenas, my reluctance to invest money or spend money into things that could genuinely benefit my life has come at the cost of, of, of, of, you know, and I'm not, of, being a detriment to my life. And so that's my caution about adopting a mindset that is too frugal. Frugality can truly hold you back in multiple verticals of your life. And that said, I know that overcoming too much frugality is easier said than done because at the core of being too frugal, for me, was an incredible lack of self-confidence.

I was not confident in my ability to earn more money. And so given that I didn't believe in my ability to earn, it meant that I had to clutch on to what I had because I felt like what I had was so scarce, so limited, and I was so incapable of being able to make more. And so for me, a large part of overcoming frugality required developing the self-confidence to know that I can make more.

So that's my overcoming understanding story. It's so funny how different we are and from the outside looking in as I and maybe a lot of the other people hanging out with us today, Paula, I was exactly the opposite. I always thought that I could throw money at something and it would solve the problem. And what I found was that the idea of affording anything and not everything was what came back to bite me in the 90s when I realized that, because I had no financial plan and no spine with my money that I was wasting tons of money on solving little problems. And then when big problems came along, I didn't have any resources to do that. So it was exactly the opposite.

And coaching people, though, with money, as I listen to you talk, I look back over my career and I think about how many people have been in the space where both of you come from and I think I think this idea that I just go back to of beginning with the end and and working backward leads you to investing versus spending and and let me define that if it has to do with your health and she made such a great analogy there by saying this will just go away a trip to the doctor is investing in your health you're putting your dollars towards you continuing to be on this earth because maybe it isn't something and that certainly is something where you want to have the best pro in your corner letting you know that it might not go away.

But to get there, I had to start with Paula, what do I want to be? And I actually had a coach take me through this, this idea of what age do I think I'm going to die and put myself a year before that and how do I want people to think of me? Like if I look back on my life, what do people think? And I thought, I want to be valuable in my community. I want to be a resource for my family. I want to be somebody that my friends can come to. I don't want to worry about money. I want to be able to do what I want to do. But it built these things that I really cared about. And I realized for me to be those things, being healthy was something that I had to invest in. I was going to have to invest time and I was going to have to invest resources. And that meant for me, as a guy in his 50s, finally getting a colonoscopy three years late, making sure that I have my annual physical and my annual checkups, right? I even hired a diet coach, which is something that I wouldn't have done. Oh, I just hired a diet coach a couple of weeks ago. It's fantastic. Yeah. Well, no, let me redefine that. It's horrible. And Jesse, if you're listening, I hate your guts.

But I love Jesse. I absolutely love Jesse because I have gone. from 200 pounds to 190, 191. So only nine or 10 pounds, but I have to tell you my eating habits, my energy, my, the way I feel all the time. And the fact that during COVID I maintained, when studies show so many people gained so much weight and the fact that I did not,

I didn't lose weight last year, but I didn't gain any, I will tell you that specifically because I invested in my health. But I had to start thinking about it that way. I think that for people that I coached that were overly frugal, we had to build that bridge from, this isn't frivolous spending. This is what you told me you wanted. And this is the best way to get that thing that you really want.

And you know what? People that I worked with that were really frugal still struggle with it. Really, really struggle with it. But that was for me from the outside looking in and coaching people, that was the only real method I found to begin bringing. breaking through that mental barrier. Right, right. I mean, excess frugality is, it's practically disordered spending, when it's taken to an extreme. When an obsession with not spending money comes at the cost of your health, your relationships, your happiness, your ability to grow a career, your ability to make an impact, when it becomes obsessive, it's a terrible, terrible thing.

Hedy, I'm not suggesting that you are struggling with that level of extremism, but there certainly might be someone listening to this show who is. And is that where you mentioned therapist? Is that where having somebody to talk to about it comes in, Paula? I certainly think that can help. The challenge is... Going? Paying for it.

The challenge is that when you struggle so much with frugality, the last thing you want to do is pay for a therapist. When you're excessively frugal, you're unwilling to spend money in a way that improves your life. And so again, we go back to all the different verticals that I mentioned, that I gave anecdotal examples of physical health, mental health, emotional nostalgia and family relationships, holidays, and connection with other humans. Here's a confession. I, for five years or so, never went to the dentist for a tooth cleaning because I don't have dental insurance and I just didn't want to pay. I easily had the money, but I just didn't want to pay for a cleaning out of pocket.

So it was a really big deal to me when I finally cared about my mouth enough and cared about my health enough to say, hey, I am going to spend this money. Oftentimes when we hear in the popular press or in the mainstream media, when we hear people attack discretionary spending, what they're truly attacking is thoughtless, unconscious spending. Don't do what I did. Don't get to the point where you're not willing to fly home to spend Thanksgiving with your family because you don't want to spend the money on the airline ticket. Because then you look back on the last five Thanksgivings and you realize that you haven't seen anyone you care about for all of those previous Thanksgivings.

That was something that really struck me during the pandemic, seeing how much people struggled with missing just one year. And I thought to myself, wow, how many years have I missed for the sake of saving a few hundred dollars in airfare? I had the same thought from the exact, not exact opposite, but from my point of view as well. When I went through that exercise of a year before, I think I'd pass away, how can I be a resource for the people around me if I don't know them? And so then spending time with family became very valuable because I realized that that was incredibly important to me. We'll close this out with a description of who Hedy Green was. And again, I encourage you to look up her story because she's a fascinating character.

She lived in the mid-1800s at a time when women typically were not active investors. By the 1880s, she was known as the Queen of Wall Street. She was an incredibly skilled investor. She began investing during the Civil War and continued into the early 1900s. She was known as the Wizard of Finance, and she was referred to as the richest woman in America. At the time of her death, which was in 1916, her net worth was estimated at between 100 million to 200 million in 1916. So that would be the equivalent of between $2.3 billion to 4.7 billion in 20,000. And particularly for a woman to build that type of fortune in that era was astounding. The reason that I bring up her name right now and what, unfortunately, history has tended to

remember her for is not her prowess as an investor, but rather her incredible frugality. On a day-to-day basis, she was known for eating mostly only oatmeal, which she was refused to warm up on a stove. She would warm it up on the office heater, office radiator. She wore such old, dower clothing that people also referred to her as the witch of Wall Street. And her son, Ned, suffered a leg injury. She refused to pay for a doctor. And so she insisted that Ned only get treated at a free clinic. And it took so long for them to be able to find a free clinic that by the time he was able to find one, his leg had to be amputated. That was the extent of how frugal she was, quite literally frugal to the point where her son suffered an

unnecessary amputation. Her own apartment was unheeded. She, other than warming up oatmeal on the radiator, she didn't eat hot food because it would have increased her fuel bill. She developed a hernia in old age, but she refused to have an operation. She instead just, just used a stick to press down the swelling. She died at the age of 81, and she now is in the Guinness Book of World Records as the world's greatest miser. So was she an incredibly talented investor? Absolutely. But what was it all for? And how does history remember her? So that is the story of Hetty Green. Wow, that was a bummer of a story to end on. But there's a happy ending here.

There is happy ending. What's the phrase? The past does not equal to future. So Hetty Green's past is not our Hetty's future. Exactly. You make your own future. Exactly. She is simultaneously an inspiration and a cautionary tale.

So thank you, Hetty, for asking that question. And best of luck with overcoming underspending. We'll come back to this episode after this word from our sponsors. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the fintech hustle that got them named one of America's most innovative

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That's W-A-Y-F-A-I-R.com. Sale ends December 7th. Our next question comes from John. Hey, Paula, this is John from Cincinnati. I want to thank you for all that you do, and I always appreciate your in-depth analysis. My wife and I are having trouble determining how much to contribute to our daughter's Ohio 529 plan, and we would greatly appreciate any insight you might have.

Our daughter is currently two and a half years old, and there is $17,000 in the account, and we currently contribute $500 a month, and it is all invested in the Vanguard 500 index option available through the Ohio 529. My wife and I both have pension jobs that are secure. We have no plans to retire early. we both have Roth IRAs and we fully fund a 403B and a small taxable account. Currently, we have $110,000 in cash. Our only debts are my student loans, which I am on course to qualify for public service loan forgiveness in early 2023, and our mortgage, which has a monthly payment that is

less than 7% of our monthly take-home pay. We want our daughter to graduate from undergrad debt-free through some combination of the 529, any scholarship she may have, and her working as a team. I had the privilege of graduating undergrad debt-free, and we would like our daughter to have that same privilege.

Thank you very much for your time. John, thank you so much for calling with that question. And I am also from Cincinnati, so always great to hear from another Cincinnati. And I love your goal of establishing enough savings such that your daughter can graduate from college, undergrad, debt-free, and I love that you're thinking about this now when she's two and a half. Essentially, the money that you are saving in a 529 plan is money that assuming she does not take a gap year,

assuming she goes straight from high school to college, this is money that will be spent in the next 15 to 19 years over that four-year time span. Part of the challenge in answering the question of how much you should contribute to the 529 given this goal is the underlying question of what will college cost in 15 to 19 years? And that is a number that we can do our best to estimate, but ultimately is very hard to predict. What we know is that historically, the rise in the cost of college has outpaced inflation.

In fact, significantly outpaced inflation. Will college costs continue to rise at that same rate? Or will college costs rise at a slower rate? I think it's fairly safe to say that the cost of college probably will not rise at less than the rate of inflation. But if you assume that the cost of college will go up by somewhere between, say, 3% as an inflationary estimate to 6%. It's been as high as 7. Yeah. So.

Right? So it's somewhere within that window. And that doesn't, for people who are listening, who might think, oh, the difference between 3% to 7%. How big is that? When you're talking about that type of a difference annually compounding year over year for 15 to 19 years, that's a lot. Now, that being said, that also is a reference to the sticker price of college. And that's the other component of your question, John, is how much of the sticker price is she going to end up paying? Because often people don't pay the sticker price.

They have scholarships. They have grants. They have work study programs. there are all kinds of non-loan-related opportunities to cover part of that cost. I discuss all of that in order to highlight how any answer that we construct will be built on a foundation of premises and assumptions, and that those assumptions should be continually updated year over year because those assumptions are essentially a fancy guess. I think that's why you have to take the wide world of colleges and universities and change the

parameter because there is so big a difference between in my backyard Texas A&M Texarkana, which is one of the least expensive state colleges in the nation versus a private Ivy League education. And you have to, I think, you have to start with a target. and I would work on the target, find out what that number is, and then back that number down. $500 a month, some people are thinking, wow, that's crazy. Well, $500 a month while doing the math is pretty ugly and a good number to save toward college. And I worry like you, though, if the target is an affordable state school, that there may end up being too much money in the 529 plan. Certainly a great thing, but we don't want to have to pay additional penalties if we don't

have to. There are other avenues. Money in a Roth IRA can be used for a college education without penalty, the interest that that money earns. The issue there is I really, really like that money for retirement. And so when people tell me that they're not going to invest in a 529 plan, they're going to just put money in their Roth IRA, I want to make sure the Roth IRA has enough money in it to give you tax flexibility later on. Joe, to clarify, when you say money in a Roth IRA, you are not referring to simply pulling out the principal contributions. You're talking about specifically the growth that that Roth IRA creates.

Yeah, because the growth is where penalties exist, right, in a Roth IRA. So that's where you really need to be careful is pulling out the growth. But one of the exceptions to some of the Roth IRAs, A rules is college education expenses. So we can use that growth toward that, but I don't, but I don't like doing it. So I would start, number one, with the end of mine, work backward to how much do I need to save and what rate of return do I need to get on that money. And like you said, I think it needs to beat six or seven percent historically over long

periods of time, which is why, based on the information John gave us, I think he's in a great place. I think an S&P 500 fund with that much time to go is fantastic. I do think that by the time that kids get to high school, you're going to want to, this is a horrible cliche, but you're going to want to start landing that plane, right? You're going to want to move from the S&P 500 down toward more of a cash position. So you're not trying to withdraw money at a time when the market's down. So you're going to want to start moving back.

Also, John, around the time that your daughter begins high school, I would cease contributions into a 529 plan because the value of that 529 is tax deferred growth. And by the time she enters high school, the timeline to withdrawal is going to be between four to eight years, four years to cover freshman year costs, eight years for senior year costs. And so the compounding value of those tax deferred gains is condensed based on the fact that that timeline is so short. You know, money that you're putting in there right now has a long time to accumulate tax-deferred growth. Money that you put in there when she's in high school isn't really going to accumulate a whole lot of tax advantage. But it will be subject to penalties if you use that money for anything other than qualified education.

expenses. And so the cost-benefit balance that those scales flip as she draws nearer and nearer to her college entrance date. Right now, investing in a 529 plan has greater benefit than cost. By the time she gets to high school, I don't know if the tax benefits would be worth the penalty risk. Yeah, sacrificing the flexibility, which gets to the question, much to put in, even if we have a target, I still think that even with whatever target you have, Paula, going above two-thirds of that target, maybe. Maybe you might be able to talk me into three-quarters of that target. I think putting 100% of whatever the target school is into a 529 plan is a mistake.

Because if for some reason any of those factors that you or I mentioned earlier change, now we have the risk of penalty where there didn't need to be one. Now, if you have outside resources, there are some things that we can do. We can talk about that later. But first, to finish this, I also like using a good 529 plan whenever anybody tells me they're using a 529 plan like John did and talked about the Ohio one. I immediately go to this website. It's a free website called Savingfor College.com. There's a map of the United States there.

I clicked on Ohio. And you know what? On a scale of one to five graduation caps for residents and non-residents, the Ohio, college advantage 529 plan gets five caps meaning the cost are low the returns historically are competitive and when I look at the options there are three age-based options five risk-based options using vanguard funds and dFA funds and if you know anything about dFA funds wow just vanguard and DFA in your 529 plan, those are some good,

solid, responsible investment companies. So John's saving and do a great 529 plan. He's saving a good amount of money. I don't know if he's putting in too much or not enough, but I think I would begin with a solid target, back that down to today based on an inflation rate that maybe a little high,

six, two-thirds to three-quarters into that position, and then the other third or quarter into just a flexible fund that you may pay some tax on. But I think sometimes, and you and I have talked about this, a fair amount, Paula, that we get so obsessed with tax optimization that we forget that there is so much awesomeness around flexibility. And so I love having some money just in a brokerage account. And sure, maybe I'll pay tax from time to time on a dividend. or a capital gain, but I can use that money whenever and however I want to. So to John's core question, which is how much should he save, you know, John, neither of us can

give you a specific number. We can't tell you a given monthly amount. We can't tell you a given target because that's going to depend on your target of what sticker price of school you're aiming for. Are you aiming for an in-state public college or university at the in-state tuition rate? Are you aiming for the sticker price of a private college? You know, what type of sticker price are you aiming for? That's question number one. And then question number two is, what assumptions are you going to make about what that sticker price will be in the future? And once you've done that calculation, then you subtract out your assumptions for, essentially what you want your daughter to contribute. You mentioned both scholarships and working as a teen.

So let's say that you want your daughter to contribute maybe 20% of that or 30% of that, right? So then you subtract out that amount and then that number that's left over is your target. And then, as Joe said, you put two-thirds of the target into a 529 plan and the other one-third of a target into an investment vehicle that gives you more flexibility. There's another really cool piece of this that I alluded to earlier, Paula, which is, what if he saves 100% into the 529 plan and all that money doesn't get spent? You want to talk about that for a minute? Well, then you find a nephew or niece or, or it could be grandchild.

Or grandchild, yes. I mean, this money and this is cool, if John and his family end up having other. resources and don't need to pull this money out and pay the penalty. The only way to get around the penalty is to make it a de facto John's family education trust. And the way you do that, John, is that you can take classes. Maybe you want to take cooking lessons or even golf lessons, flight school, go back and take English creative writing courses, whatever it is.

If it's at an accredited institution of higher learning and it qualifies, you just need to check into that, you may be able to change the beneficiary to yourself, to your spouse, and use it yourself for those things for higher education. Or if you have grandchildren, you can gift it to your daughter. And then your daughter's children become the new beneficiaries and they can continue to pass it down. So there's exciting opportunity. And Paula, to your point, it could be a niece. It could be a nephew if you want to do that. But even if you just want to keep it in the family, I think all the time about taking more photography classes. If I do that at Texas A&M here locally, I could use my 529 plan money for that too.

So it isn't all bad if you oversave into the 529 plan. Right. It just puts restrictions on how that money can be spent without penalty. Yeah. So thank you, John, for asking that question. We'll come back to the show in just a second, but first, our next two questions both come from Raphael. Hi, Paula. Thank you so much for your podcast. I feel like I've regained a lot of the control that I used to have when I was younger around my finances, and I really appreciate all of the information that you hand out freely to people like me. So thank you so much for that. I had a question regarding taxes on 1099 income. I recently got a new job as a sales associate, and I'm hired as a 1099 contractor, and I was looking around on the internet, and apparently I need to find my net income by subtracting my costs like food and transportation and all of that, yada, yada. And then once I have my net income, I'm supposed to multiply it by 0.9,2, 3.4.

5% to find my actual taxable income. But that seems a lot for somebody who's only 22 and doesn't really know what they're doing. So I just decided to put 20% of the income I got from that job aside in a separate bank account so that when the time comes to pay taxes on it, I would have money set aside. Is 20% overkill? Just wondering. Thank you. And then I also had another question that I wouldn't have if it weren't for you. So thank you so much. I also recently opened a Vanguard account. Yay me.

And I opened it December 28th or something of last year, 2020. And because of that, they gave me a couple of days, or a couple of months, actually, into 2021 to continue contributing to my 2020 account for that year. And I'm about 23% of the way through that. And I was just wondering if you also recommend that I just max that out as hard as I can until the time comes when the deadline is there, or if I should just focus on actually being able to max out 2021. I think I know what you're going to say to that, but I'm kind of new to this investing thing. I just turned 22. I don't really know how to handle finances all too well.

But I would love your input. And thank you so much for sharing all of your wisdom. I'm with us. Yay you, Raphael. That is awesome. Yay him, Paula. Woo! 1099 work and a vanguard fund, a retirement account.

This is big moves, big moves. Absolutely. And all at 22. These are great questions at 22. Exactly. Raphael, these are great questions at 42. So, hey, amazing. Absolutely.

So, Raphael, to your first question, I love the fact that you're not over engineering it. As soon as you were like, and then multiply by 0.9-2. I was like, oh, no, no, no, no, no, no, no. Because I think that your instinct was correct. Just pick a ballpark round number, put that amount into savings and use that to pay your quarterly estimated taxes. So here's what you do. I was at 1099 for many, many years. Go to EFTPS.gov. We will link to that in the show notes. You can subscribe to the show notes for free at afford anything.com slash show notes. So, go. go to EFTPS.gov, set up an account there so that you can pay your estimated quarterly taxes. Then, whenever you get paid, set aside a certain percentage of your income, and we'll talk

exactly in a moment what that percentage should be, set aside a certain percentage of all of your 1099 income into a savings account. That savings account goes to your EFTPS payments. This way, rather than paying once a year to pay your 1099 taxes, you'll be paying quarterly. and that's going to help keep you on track. After you've been a 1099 worker for some time, it will also, by virtue of paying quarterly, reduce the risk that you will get hit with late fees, which can happen if you've been a 1099 for multiple years

and the government decides that you should have paid estimated taxes. The estimated tax setup, estimated quarterly tax setup, is not only a great way to budget. It is also, later down the road, it will be a great way to avoid IRS fees and pay. penalties. So it's a win on both fronts. Now, how much money should you set aside? This is going to depend on your effective tax rate. If you can get a copy of last year's tax return, you will see two numbers. If a CPA prepared it for you, which you're 22, so probably that didn't happen. But for

everybody else who's listening, if you had a CPA prepare your taxes for you, then the CPA will be able to tell you two different numbers. One is what's called your top marginal tax bracket. and that is the highest percentage of tax that you pay. The other number, and this is the more important one, is what's called your effective tax rate, and that is the tax rate that you pay across all of your income once everything gets weighed out against each other. You know, once all of your income from different brackets,

gets averaged together, once all of your credits and your deductions, once the whole recipe has been put together and everything is baked, your effective tax rate is how it all works out in the end. If you, Rafael, used some type of tax planning or tax processing software, if you know what your effective tax rate is, then assuming that your income this year will be similar to your income from last year,

you can look at that effective tax rate and use that as a rough ballpark. I'm not saying it's going to be exact, but that is a good starting point as to ballpark. how much you might want to set aside for your federal taxes. If you don't know what that is, or if that all sounds super overwhelming, then here's an even simpler, even easier, but even more rough ballpark answer, which is, if you don't make a whole lot of money and you're in a low tax bracket, set aside between 20 to 25%. If you're in a higher tax bracket, set aside 30%.

Don't forget, depending on what state you live in, you will also have to pay state taxes, unless, of course, you live in a state that doesn't have state income tax. So depending on where you live, Google whether or not your state has state income tax. And if it does, Google what the tax rate is and set aside an estimate for that as well. That's the reason, Raphael, that I don't recommend over-engineering it, because a CPA can run these calculations for you. If you try to run it yourself, it gets really complicated and messy very quickly.

to the conversation that we previously had about the struggles of being overly frugal, there were definitely years where in my zeal for frugality, I tried to do everything myself, I tried to run these calculations myself, I completely missed the mark. I ended up either overpaying and then not having that money to be able to pay my bills or invest, or I ended up underpaying and then having to pay penalties. I mean, it just, you know, not getting help from a CPA was a giant mess. Now, you're 22, you've got one 1099. I'm not suggesting that this is something that you need right now, but I'm saying this more

for the sake of everybody else who's listening, that if you want a precise calculation, go to a tax professional to get one. If you're okay with just making a rough ballpark estimate, then what I've just explained are some very, very broad general guidelines for how to make an extremely broad estimate. The benefit to a broad estimate is that it is simple and you can do it yourself. The drawback is that you might end up either saving more or saving less than you should. And if you're going to err on one side or the other, it's better to err on the side of saving more. Speaking of broadening, broadening this topic out, what does 1099 income actually means?

It means the person who is sending you money is treating you as if, you are a separate company. So because of that, that's where you can start digging into the expenses related with your company, with whatever this pursuit is, and make sure that you separate those dollars from other money, because it's going to make it very, very clean for you if you do that, and incredibly messy if you don't. So what I like doing is either opening up a separate bank account that's affiliated with whatever this job is. And even beyond that, maybe having a separate credit card that expenses run

through. But definitely being able to show very cleanly that these are my business expenses, these are my personal expenses, will make it easy then on tax day for you to do what you mentioned in your call, which is to take business-related expenses and write those off. And writing it off, by the way, contrary to what, if people have watched shit's the popular show. David at one point thinks that writing it off means that it's all free. So, hey, they're just going to write all this stuff off. It doesn't make it free, but it does mean that you're not going to pay tax on that portion of the money that you're paid. So you're going to want to dig in more to what business expenses you can write off. And some of those

will include mileage or depreciation on your vehicle, might include some of the things. if you're in an office setting, some of your office supplies, maybe a portion of your computer expense, that's where I think, Paula, it might be valuable time to dive into your good friend, Google, and find out what things you can run through your business legally and avoid some of the tax headache later. The other benefit is that because you are an independent contractor, that opens up the door for retirement accounts that you can open as an independent contractor. Does that lead to our answer to question two?

Ooh, it does. Dun-da-d-d-dun-d-dun-done. So... Was that your segue music? I guess. I suppose it was. I put zero thought into that. But yeah, that's my segue music.

Steve is just sitting back with his feet up now because you're taking care of business. So, Raphael, to your second question, what you're describing is a retirement account that you opened with Vanguard, and retirement accounts have certain deadlines for contributions that you make that count towards a given tax year. And those deadlines are typically the tax deadline of the following year. So in your case, you opened a retirement account, probably an IRA or a Roth IRA, in the year 2020, and you had until the tax filing deadline in 2021 to make contributions that could be attributed to your 2020 contribution limit. At the time that we're recording this,

and by the time this episode airs, we're past the tax filing deadline. But this is important to know for future years, my take is that anytime you have the opportunity to make a contribution to a retirement account and then assign that contribution to the previous year, rather than the current year, you may as well take that opportunity because every year's contribution limit is use it or lose it. So in the year 2020, you could make, as a 22-year-old,

you could make a contribution of up to $6,000 into an IRA or Roth IRA account. If you don't max out the account to the tune of that full $6,000, you don't get a carryover. There's no like roll over credits, a roll over minutes. It's just gone. How great would that be, though? I know that would be amazing. I'd be like, you know what I was two. Right. The bad news is you're 50. The good news is you haven't saved a dime into these things and you have the last 50 years worth of the stuff you could fill. Right. Wouldn't that be great? If your dad would have been able, if your parents, you talked about your parents before, your mom and your dad able to 50 fill all the previous years, bam. That would be incredible.

Yes. Come on, government. Everybody write your congressperson. Yes, exactly. But unfortunately, that's not how the system works. And it probably won't ever work. Yes. So unfortunately, that contribution limit is use it or lose it. And given that there's no reason not to use it, you might as well. Even if you don't end up maxing out your contribution limit in the year 2021, heck, there's no disadvantage to assigning that as a year 2020 contribution. Actually, let me put an asterisk on this. The only time that there would be a disadvantage is if you are in a significantly different year-over-year tax situation. So if your taxes are going to be very different between the year 2020 and the year 2021, okay, that would be the reason. But Raphael, in your case, it doesn't sound like there's any major activity going on. You're not, for example, you're not selling a business and paying massive taxes.

on the sale of that business. And you didn't suddenly go from being a student making 20,000 a year to a highly paid professional straight out of grad school making 150,000 a year. You know, you didn't make that year over year jump. There's nothing in your life right now that's going to make your tax treatment in the year 2020 significantly different than your tax treatment in the year 2021. So for you, I would say assign it back to 2020. For every, everybody else who's listening, I'd say default to assigning it to the previous year unless your tax treatment between the two years will be very different as compared to one another. So thank you, Raphael, for asking that question.

Our final question today comes from Elizabeth. Hi, Paula. Longtime listener, second time caller. I love your show and all of your advice. My question has to do with rental property and LLCs. Basically, in a nutshell, my husband and I turned our first house, which we bought in 2009, into a rental property when we bought our second house in 2015. The second house, we completely gutted and renovated.

And while doing this, we were able to live on site in a carriage house that is above our detached garage. So since moving into the main house, we now rent out that carriage house. So we have like these two rentals. For years now, we've been talking about putting the rental house into an LLC, but we've yet to do so. And when we file our taxes, our carriage house rental shows a loss that helps to offset our rental houses positive income. And just a side note, the rental house does not have a mortgage. We actually paid it off. So there's no interest to deduct or anything. like that. So if we put the rental house into an LLC, will we then not be able to combine the rental house and carriage house rent for tax purposes? I'm not really clear what happens when you create an LLC for a rental property when tax time comes around. So any thoughts or advice? And as always, thanks for all that you do. Elizabeth, thank you so much for asking that question. So here's the deal. single member LLC, which is what you're talking about creating, when you form one of those,

it basically doesn't do anything to your taxes. The deal is a single member LLC is a pass-through entity, meaning whatever income or expenses your LLC makes, it passes through to your personal income statement. So it is not like forming a C-Corp, an LLC is a pass-through entity. And so the reason that real estate investors or some real estate investors choose to create one is for the purpose of asset protection. It's for a layer of protection in case there's a lawsuit, for example. But the tax treatment that each property is going to have is not going to be affected by whether you hold this property in your name or your LLC, which is a pass-through entity, holds this property. The key lesson here, or the key takeaway, is to think of an LLC as a structure that has

passed through tax treatment. And that is very, very different than a structure that is not a pass-through tax treatment, a structure that is taxed as a company. The only question I have for you, Paula, that might help her with these two separate properties when she's looking for tax breaks, right, where the LLC is not a tax break in itself. But what about a management company that manages these two properties and having things flow through a company that manages the properties? Would that be helpful? Yes.

Yes, that would be helpful. And that's a very good point, Joe, because what you've just said here is you're getting to the root of her question. So her question presupposed the answer. Like the root of her question is, how do I? design more advantageous tax treatment of my properties. But the way that she phrased the question was to presuppose the answer, which was, doesn't LLC do it?

And so you make a very good point, Joe, in that I answered her question at face value, and you did a very good job of getting to the root of what she's asking, which is, wait, the heart of her question, how do I create greater tax advantage for my properties? Expanding your portfolio and having a higher level of involvement in your properties, such that your properties would merit an input of enough hours that it would then be, based on the hours that you put in, be considered active income versus passive income. That would be another way that you could get better tax treatment on those properties. So there are a lot of different ways. If the question is, how do you tax optimize for your rentals, there are a lot of different approaches that you could take.

A very good resource for this is NOLO has. as a great guide to landlord tax deductions. We will link to it in the show notes. You can subscribe to the show notes for free at afford anything.com slash show notes. But that is an excellent menu of all of the different ways that you can tax optimize

your rental property portfolio. So thank you, Elizabeth, for asking that question. Joe, we did it. I can't believe we're done already. We have made it through another great round of questions. two humans, three cats, five questions. We did it.

Just like that. Efficiency. And you know what's disappointing is that I don't know about your two, but Cooper's sleeping here on the job, which is very disappointing. You think that if there's three of them and two of us, Paula, they do some work. But nope, you and I have to do it again. They're doing the work of being cute. Yes, obviously.

But then again, so are we. We have a face for radio. Joe, where can people find you if they'd like to hear more of you? How about you and me together in a different setting, which is pretty exciting. We've got something new happening at my show, the Stacking Benjamin's podcast. And that is we are now going to record live on Mondays at 5 p.m. Eastern. And this is not, by the way, a pitch for either my Facebook group or my newsletter. But until this company goes public, which Paula, you and I've talked about this, sometime in the next month, Fireside will just be an open app for everybody.

Until then, you have to get an invitation from us. And the only place that I can put those is in my newsletter. So stacking benjamins.com forward slash stacker or our Facebook group, which is the stacking Benjamin's basement, Joe's Mops basement. So if you just put in stacking Benjamin's basement Facebook group, we're going to list it there. but Paula Len Penzo, OG, my co-host, we are going to, for the first time ever, do shows where you can be a part of the show. So we have a roundtable discussion and you can give your take if you're with us in the virtual auditorium. Also, we have this crazy trivia contest that Paula always seems to be behind on until the last minute. So you can help Paula win our trivia contest.

So that'll be Mondays, 5 p.m., most weeks, Mondays, 5 p.m. Eastern time. You do the math on wherever you are. You can hang out with Paula and me and the rest of our band of Mary characters. Excellent. And it's always a great time recording those shows. We left. Slash going live with these shows now. I know. That's a little intimidating, though, isn't it? It is. It is. So for years as background, I have been part of the stacking Benjamin's crew for years. And I've gotten used to the fact. that it's always pre-recorded, which means that we can do as many takes as we want. We can screw up and call mulligans and have, you know, have those doovers. And now, for the first time ever, we're going live.

And I think it's funny that the show itself is funny. If you've listened to it, we think it's funny. We have fun. But it gets even funnier whenever we stop recording for who knows what reason. And so now we're going to be recording the whole thing. So hopefully the humor and the fun. And of course, the good money lessons, right? to think it's a fun show, but it's also an intelligent show. And it depends on the week. Sometimes

it's not that intelligent. But usually we try to make it a good, crunchy money discussion that we can argue about. I didn't realize people were supposed to learn something from your show, Joe. Easy. Very intelligent show. Well, thank you so much for tuning in. If you enjoyed today's episode, please do three things. You know what? I take that back. Do four things. Number one, subscribe to our show notes. Go to afford anything.com slash show notes. And you'll never guess what you'll find synopsies of every single one of these episodes, you'll get timestamps of all of the questions. So if you want to skip ahead to some question, you can quickly and easily do that. When we interview guests, you'll get a write-up of that interview. All of that is available

for you for free. Affordanthing.com slash show notes. Number two, please hit the follow button in whatever app you're using to listen to this show, Apple Podcasts, Spotify, Pandora. However you like to listen to this, make sure you're following us. Number three, while you're in that app, please leave us a review. And number four, most importantly, please share this with a friend or a family member. Thanks again for tuning in. My name is Paula Pant. This is the Afford Anything podcast, and I will catch you in the next episode.

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