Afford Anything - Ask Paula: Traditional IRA vs. Roth IRA -- What Should I Choose?

Episode Date: June 7, 2019

#197: Should Bret invest in a Traditional IRA or a Roth IRA? If Amanda gets married, how will her child support be affected? What about her student loan forgiveness? Joe is investing in bonds, which average a rate of return that’s equal to the interest rate on his mortgage. Should he switch to all-equities and redirect his bond investments into mortgage payoff, instead? Taunia has a car loan, a 401k loan, a home improvement loan, a primary mortgage, and a second mortgage. She also has an emergency fund that only covers two months of expenses, and she’s trying to save for college for her two children. What should she prioritize? Mickey has a six-month emergency fund. Should he leave it in a savings account or invest in bond ladders? David made $10,000 from a side hustle last year. Can he open a Solo 401k or SEP-IRA for his side hustle business? If so, which one should he choose? Should Andy invest in a Target Retirement Date fund, or should he split his money between a U.S. index fund and an international index fund? Former financial planner Joe Saul-Sehy and I answer these seven questions in today’s episode. For more information, visit the show notes at https://affordanything.com/episode197  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to your time, your focus, your energy, your attention, anything in your life that's a scarce or limited resource. And so the questions become twofold. Number one, what matters most in your life? And number two, how do you align your day-to-day actions in a way that reflects that? Answering these two questions requires a lifetime of exploration and practice. That is what this podcast is here to explore.

My name's Paula Pan. I'm the host of the Afford Anything podcast. Every other week, I answer questions that come from you, the community. And today, former financial planner Joe Saul Seehigh is here to help me tackle those questions. What's up, Joe? I am so excited about another hour with Paula. Ah, well, thank you so much, Joe. And you know what?

You're a podcaster. I'm a podcaster. And this first question comes from somebody who has a voice that, oh, really should be a podcaster. So let's hear our first question. This is from Brett. I have to admit that I have a financial crush on you, Paula. And my wife is okay with that if you can answer my question. Okay, we try to always max out our Roth IRA each year. But this year, I plugged into our tax software.

What would happen if I maxed out a traditional IRA rather than Roth? And for this particular tax year, if I did that, I would actually get $2,210 dollars more back. And I'm thinking, cha-ching, so is it worth it to bypass the future tax benefits of the Roth? Now, another option that my wife and I have is that I don't have to make hers and mine both traditional. I can do it with just one and still get half of that. I could get $1,105 more back. Well, I appreciate any help that you can give me. Thank you for all the awesomeness that you do, just being you. Brett, before I say anything else, please, please, please tell me that you have a podcast.

Because with a voice like yours and a personality like that, you're perfect for radio. You're perfect for podcasting. Please tell me you have a podcast. And if you don't, take that tax refund and spend it setting up a podcast. Brett, if I had your voice, I'd burn mine. Just saying. Just saying. Good question too, though, Paula.

Absolutely. fundamentally the question is Roth versus traditional which is better or should it be a blend of both? Right, right. What he's describing happens every single time, right? If Brett goes and does his taxes in any given year, he's going to get a bunch of money back right now

if he does the traditional. So do you take the bird now in the hand or do you pass it on until later? And that is the magic. There are a few factors to consider here. One is your age. The younger you are, and I'm not calling you old, but the younger you are the more advantageous being in a Roth account could be because when your money is invested in

a Roth account, all of the capital gains and dividends grow tax exempt. If you are 20 and you put your money in a Roth account and then it grows tax exempt until you're 60 or 70, that's 40 or 50 years of compounding gains. In comparison, if you are 55 and you plan on harvesting that money when you're 70, well, then that's only 15 years of compounding growth. It's not nothing, but it certainly has less time to compound that growth. So age, or more specifically, timeline to when you withdraw that money is one of the factors you should consider. Now, another factor is what you estimate tax rates are going to be and what you estimate your income is going to be at the time at which you withdraw that money. And partially, that's going to be

guesswork. There's no way to predict reliably what our tax rates are going to look like in the year 2030, 2040, 2050. Because of those two factors and because of the fact that so much of that is guesswork when you come to the second half, which is where taxes are going to be in the future, I always liked when I was a financial planner looking at what I called the tax triangle. And then there were three different corners on the triangle. One, money goes in pre-tax. And then when you come out, all of that money gets taxed. Of course, the United States, that's a 401K plan, 403B, 457 plan.

Another corner of your triangle is where money is after tax. And then money comes out tax-free. That would be the Roth IRA, like Brett's talking about, but it could also be municipal bonds. And then the third is where you get no real tax advantage today, but you get flexibility. You don't have the rules that you have with any of these other investments that you have to follow. And that would be just a brokerage account, a savings account, something like that. I like looking, Brett, at how the three of those corners of your triangle balance out. Because I do like a bird in the hand today.

I like getting money because I don't know what the future is going to be like. But I also want to lean most heavily on the one that's based on my age like Paula was talking about. So early on in life, I'll probably go more with that Roth. corner of the triangle and then later as I get closer, I'm going to stuff money and get my tax break today so that I take the bird in the hand. But I would, no matter who you are, I would take a look at the tax triangle. And Paula, when I'd sit down with people, I would show them their triangle and show them the big problem they have because the average person out there, maybe not people listening to this because they know the magic of the Roth IRA, but a lot of people will default

to that traditional IRA because do you know, happy Brett got? when you heard about how much money is going to get back right now, people go, hey, I can get more money today. I'm going traditional. And so with most people, you look at that tax triangle, they got a ton of money in that pre-tax plan. And that's going to be a time bomb when you get to retirement. The cool thing about having this more balanced is when you get to retirement, you can then, or let's not call it retirement. Let's just call it pulling money out for whatever reason. When you get to the time that you're pulling money out, you can play with tax brackets if you have all three of them. So in other words, let's say tax the tax brackets at $50,000 in the future, I might take

out up to 50 out of my pre-tax, my 401k if I'm Brett, and then take the rest out of the Roth so that now I'm living maybe high into the next tax bracket, but I'm only paying tax at the top line of that first bracket. It's kind of why I like having a little bit of each. Yeah, exactly. And there are strong arguments and strong strategies for both camps. There are a lot of people, particularly in the early retirement movement, who are advocates of putting money into traditional accounts while you work. And then upon retirement, when you have a lower income, because you're retired, executing Roth conversions at that time. So that is one strategy that's particularly popular among some people in the fire movement. Of course, where that gets into is that sometimes people retire and then discover that their income is significantly higher than they thought it would be during retirement. So being retired does not necessarily lead to a decline in income if, for example, you end up stumbling upon some type of a side hustle or a passion project that becomes lucrative. By contrast, there are others who like the approach of putting money into a Roth account for the simplicity of just not having to worry about it.

once you retire. So there are people who will favor Roth accounts for that reason. And that's the frustration right there is that even though there is a math problem here, Paula, this is one of the great problems that we can't solve based on math alone because there are too many variables coming up in the future. One of which we didn't talk about, which is what if the government changes the rules? I mean, the rules change not frequently, but they change, you know, I mean, I've been in financial media or a financial planner now 26 going on 27 years. And we've had maybe five significant changes during that time. So the rules probably will change.

And because of that, that makes the math very difficult. And another reason why I kind of like having a little bit of each, emphasizing once again, early in life, more toward the raw, later in life, more toward traditional. The final thing that I'll say is that if you do receive money back as a result of putting some of your money into traditional pre-tax accounts, then that lump sum that you get back, that $1,000 or $2,000, invest that money because that way you can allow your tax refund to become additional investment money that works for you leading to additional compounding growth and gains over the years.

It's like reinvesting your own dividend. Exactly. Not really because it was your money all along, but if you think about it that way, it's just another Hey, when you get this found money, reinvest it. Exactly, exactly. At a conceptual level, it's like reinvesting dividends, if not at the literal level. Right. I only had to say that because I know we were going to get a letter.

Joe, it's not that. I know. I do love that you call it letters as though you're receiving pieces of snail mail. Oh, they're not? I always thought that Brett typed something very disappointed, Brett. All right. Thank you, Brett, for asking that question. And again, Brett, please start a podcast because you have such a good radio voice. Yes, or don't because we don't want the competition. He would be strong competition. He would be, yeah. Actually, very seriously, not just to nerd out for a second. If you're thinking about starting a podcast, please do. I mean, you look at the size of the audience of people that listen to shows like afford anything. And then you look at the amount of people in the United States. And our audience is, while we love every single listener to this show, it's so small, Paula, when you look at the number of people, and it makes me sad.

And so when people ask, like, so what do you think about this other podcast? Do you like that? But I'm like, we need more. We need more people out there finding more people to be more responsible with their money. Like, we need this revolution to keep gaining steam. So Brett, I was kidding about competition. Please make a podcast and tell everybody you know to get better with their money. Our next question comes from Amanda.

Hi, Paula. This is Amanda from Massachusetts. I'm calling to get your opinion on whether or not I should get married. I've been divorced for seven years and I've been with my current partner for six. I have a 10-year-old son. My ex has been court order to pay child support and order to pay. have of all future college expenses. I was told that my current partner, you know, makes more than double than I do. So we would have a pretty high income bracket. And I was told by my ex that

when and if I got married, that they wouldn't be ordered to pay child support anymore, that they would refuse to help with future college expenses because it would go with my current partner and I, if we got married, our two incomes combined because my son lives in our household. So I'm facing those two future expenses if we did decide to get married. And then I also am trying to do the student loan forgiveness because I work in a nonprofit field. And I do qualify. I'm about four years away from that. So I would, I believe, lose that. So I'm trying not to think about marriage in such a financial negative way, but I keep just focusing on those things, but I want marriage to be a positive thing.

Do you have any advice for me? Thank you so much. Bye. Amanda, I don't think Paula or I have ever had anyone ask us whether they should get married or not. Have you had somebody ask you if they should get married or not, Paula? Oh, you know what? Once, there was an episode that I did with Farnoosh,

in which we spent the entire episode answering one question. It was episode 170. 17, Farnush and I workshopped one question for the entire episode. And it was a question of whether or not a person, a particular caller, was wondering whether or not she should get married. Wow. Obviously, this is beyond my pay grade. I don't know if you should get married or not. That's going to come down to you. But I do have some thoughts. The first one is, I would not be listening to your ex for advice about what's going to happen if you get married. Your ex, your ex, it just sounds like there may be some baggage in that relationship. And so I would not talk to them. I also wouldn't take my word for it or Paul's word for it. I would talk to an attorney about what really would happen.

That's your first step. However, in my experience, there's two things. Child support generally, in most cases that I have seen and that I was involved with when I was a planner, are based on the two parents and the child. and it's the support of the child. And as a parent, you've an obligation to support your child. So while your future potential spouse's income isn't irrelevant to the situation, I don't think it's going to play in as much as your ex seems to frame it as.

Also, when it comes to college expenses, college expenses, it's his child and your child. Historically, what I've seen is that's the frame of reference that the court uses, meaning that he would still want to and would probably be required to help with college expenses. But beyond that, I think you should probably go to an attorney. On the loan forgiveness piece, that one is a little more difficult. And I can see where you're coming from there as well. This is a discussion, Paula, I think, between Amanda and her future spouse. because when it comes to loan repayment,

if he wants to get married and she wants to get married, why would we change our strategy based on an income-based repayment plan or based on a loan forgiveness plan? I guess if we're close to the finish line, maybe we delay until that time. But I think that this comes down to communication with your future spouse about what the two of you want. want to do because I think this is an emotional decision as much as it is a math problem.

Joe, I'll echo what you said. In most cases, the income of the new spouse is not going to be included in the child support calculation. But that being said, talk to an attorney who will specifically look over your divorce decree or your settlement agreement and look over the specific paperwork because every couple is different. divorce is different and every state views these things differently. So talk specifically to a family law attorney in your state and show them the particular paperwork, the particular divorce decree or settlement agreement that you have signed, because that's going to be the decider of what will happen. On the second part of that, then, Paula, do you agree with me that this is a discussion between

her and potential future spouse about the loan forgiveness plan? Joe, what do you suggest that they discuss specifically? Well, I think they discuss how far away that is, because depending on the time frame of that, then that's going to, that would cloud their judgment. I mean, if they really, really want to be married today or soon, if it's a year or two in the future, then yeah, okay, maybe we wait a couple years. But if it's eight years in the future, nine years in the future, I mean, now we've got a different situation. So I think it's comparing the thirst of both of you to get married. versus the financial impact that that would have. Plus, it's never bad when you begin to make life decisions, like making these decisions

together ahead of time. I always liked it when couples would come in to see me before they got married. I rarely saw that. It was always exciting to see people starting to communicate ahead of time. And I think this is a good opportunity to just have somebody who's obviously very close to you, be on your team and help you make this decision. Absolutely. Thank you, Amanda, for asking that question, and best of luck with whatever you decide.

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Hey Paula. My name is David and I'm a huge fan of your podcast. Thank you for teaching us all so much. I've got a question that I think is kind of advanced, but I'm hoping you can answer it. My wife and I both have full-time corporate jobs where we contribute about 8% of our pay to our employer-sponsored 401ks, which ends up being well short of the 18K maximum. We also, both fully fund each of our Roth IRAs. We save over half of our income each month, and most of that savings is going towards what will hopefully be our first home purchase this summer. All that said, our problem is taxes. Last spring, we were surprised with having to pay in to the IRS in both state and federal taxes, like a few thousand dollars. In April this year, I made sure my wife and I both

changed our withholdings so that our paychecks would withhold as much as possible for taxes. The issue is that I don't think we made it to our withholding goal that our tax professional told us. On top of all this, we also have a side hustle that my wife and I do together. In 2018, this business made just over 10,000 in net income. My question to you is this. can I open a solo 401k or a SEP IRA for myself based on that side hustle income in order to reduce our overall taxable income for 2018 and not have to pay into the IRS this year? Thank you so much. David, yes, you can open a solo 401k or a SEP IRA for the earned income within your side hustle.

And that is a great way of not only deferring taxes by virtue of being able to put some of your income into a tax deferred retirement account, but also a great way to improve your savings rate and increase your investment portfolio. Only two caps you need to be aware of, David. Number one is the cap on each one of those plans. They each have their own cap. And that changes every year. It's in the IRS guidelines. And there's also a total cap that you can put into qualified plans in general. As long as you stay inside the, those markers, you're the man. Yeah. In terms of which one should you choose, should you pick a solo 401k or a SEP IRA, there are advantages to both. What I like about the solo 401k is the simplicity of knowing what the employee side of the salary deferral is. So in the year 2019, for people who are ages 49 and under, the employee side of that salary deferral is $19,000. And I, personally like the simplicity of knowing that that is just a flat number. As long as you have that much in earned income, then you can put that in as the employee. And then as the employer,

you can also put in an additional amount that's based on the compensation. So you can contribute from both hands, your employee hand and your employer hand because you are your own employer. What I like about the setup of the solo 401k is that the employee side of the contribution ledger is not a percentage of your compensation, but rather is a flat amount assuming that it is earned income through that business. I like the simplicity of that. That being said, there are others who prefer the single person SEP IRA because of the fact that they can potentially contribute more money to it. But in your case, I mean, six or one, half a dozen of the other, you make $10,000 from your side hustle. You're so under the threshold.

that it doesn't really matter which one you choose because you're not going to be bumping up against those upper contribution limits. Finally, in any given year, assuming that the account has been opened in the previous calendar year, you can make prior year contributions into that account up until the tax deadline. So up until April 15th, or in some years the tax deadline is around April 15th, some years it's April 18th. If April 15 falls on a weekend, it's the next business day after April 15, but you have up until tax filing day to make contributions for the previous year, assuming that the account itself was open prior to December 31st. Thank you, David, for asking that question. Our next question comes from Joe. Hi, Paula. It's Joe from Ontario, Canada.

I'm 32 years old and my wife is 30. and we have a combined grossed income of $118,000, and our house mortgage is our only debt, which is currently at $248,000 at a $3.1 interest rate for 25 years. In addition to our current investment strategy, which is through Vanguard ETS, with an allocation of 80% equity and 20% bonds, which accounts for $70,000 invested so far, I currently contribute towards a pension plan, which accounts for about 9% of my pay, and my wife contributes 9% of her pay, which her employer matches, to an investment plan made up of index funds. My question is, instead of investing in bonds, should I use this money towards our house mortgage instead?

Bonds are currently averaging a 3% rate of return, which is the same interest rate as my mortgage. Does it make sense to treat my house mortgage similar to a bond investment as the fixed income portion of my investment portfolio? Thanks and keep on rocking in the free world. Joe, that's a great question. There are a couple of frameworks through which you could look at this question. Now, on one hand, when you first said that your asset allocation had an 80-20 split between equities and bonds, my initial thought when you said that, given that you're 32 and your wife is sounds great. Absolutely. For given your age, that sounds like a perfectly reasonable asset allocation.

What you are suggesting essentially is going into an all-eastern. equity's portfolio in which all of your investments would be held in equities and the portion of your overall net worth that you would consider as your bond allocation would be redirected towards your home equity. If you were to do that, you would have what would be known as an all-equities portfolio. And I have an all-equities portfolio. I don't think that they're right for most people, but of course I have one for myself, so of course I see the value in them. If you do have an all-equities portfolio, however, what you need to do in order to be able to balance that out is have a strong cash allocation. So technically in all-equities portfolio, the way that people frame it is what's known as a barbell allocation, where if you think about picking up a barbell that's heavily weighted on both sides, on one hand, you're heavily weighted in all equities, but on the other hand, you're heavily weighted in cash. Now, if you are redirecting the bond point, portion of your portfolio into your home equity, then the way that you would use that home equity as cash would be through a he lock. So essentially what you're suggesting is should I have

an all-equities portfolio in which the other half of that barbell, the cash allocation, is a he-lock that I can tap from my home equity. That's basically the suggestion. I'm not sure that that's a great idea. I don't want to tell you what to do, but one of the benefits of having a properly diversified portfolio, and in your case that would right now, that's 80-20 equities bonds, is that when the market fluctuates, you can take a contrarian perspective. You can sell off some of the winners and use that money to buy more of the undervalued asset. And so the very nature of rebalancing forces you to take a contrarian position, and it forces you to lock in your gains and buy more of what's undervalued. And that's the reason that people suggest rebalancing. Rebalancing is just an exercise that allows you to be contrarian in periodic increments over time. You can't do that when your fixed income allocation is locked up in your home equity unless you actually did draw money out from a helo. in order to buy more equities when they're cheap.

But the probability of you actually doing that is not as high because you don't want to take money out of your home equity. Or most people don't. I think there's another consideration here. In Canada, he may be saving into the RRSP. And if he is saving into something that in Canada looks a lot like our 401K or a Roth IRA, it might change his tax outlook. And obviously the Roth IRA doesn't change your tax outlook today. It certainly changes things when you look long term.

But more specifically, on the short end, if he's saving pre-tax into a retirement plan and he saves less there to put that money into his mortgage, he's going to have less money available to do that. And I think he needs to know that. And then the second thing that he'd need to know is by putting less money away, that's going to be more taxable income. And I'm not an expert on how Canadian taxes work. But I do know that there could be some unintended consequences there as well, Paula.

So that sounds like further fuel on the argument for not taking the step. Yeah, but I do like two things about the way he thinks. Number one is he's looking at the comparison of interest rates. And I think a lot of people don't do that when they're looking at paying off debt versus keeping money invested. he's going, hey, I don't want to get rid of the stocks because over the long term, stocks historically have done much better than that. But my bonds not doing that much. And so I can use that percentage.

I like that thought process. I also like the fact that he's kind of asking if these asset classes really do perform as closely together as he thinks. And the short answer there is no, but they are a little bit related because bond prices are based off of T-bills. you know, mortgage rates will go up at the same time that bond interest rates go up and they'll go down. They're not the same, but there is a little bit of a link there. So I like that part of his thought process as well. Yeah, I like the question a lot. I like the creative thinking and the lateral thinking that is found in his question. So I really like the question. And I often hesitate to tell people what to do or I hesitate to give a strong recommendation because I would prefer to talk through the pros and cons of either option. I love the question. But But I think in all equity's portfolio, when you genuinely have cash on the other side of that barbell is one set of circumstances. But in all equity's portfolio, when the other side of that barbell is home equity seems, it is no longer a barbell. Yeah. There's another piece to this, which he also has to think about, and people shouldn't hear this a wrong way.

I like paying off your house. But if he takes money that was going to be in a liquid position and moves it into your house, I don't think people think about this one aspect of this, Paula. Let's say that you've got one payment left on your house, just one payment left. And for who knows what reason, we can make up 50, that he can't make that last payment. What percentage of your house does the bank claim if you don't make just that one little tiny last payment? you paid off 99.9% of your house, you haven't made that one payment. They still take away the whole thing.

And so you're taking something that's right now in a liquid position and you're moving it to an illiquid position. And that's, that, by the way, is not a reason not to pay off your house. I think people should pay off their debt. When that was first explained to me, I went, oh, man, maybe this idea of having this liquid fund on the side, if I can keep my hands off it and then use that money later on to make a lump sum payment into my, mortgage might be a better strategy from that way too, because I don't know what's going to happen in the future. What if I have a disability? What if something bad happens? Exactly. I totally agree that that's my preferred mortgage payoff strategy is to let the money accumulate, wait until it becomes a lump sum, and then wipe out the whole thing in one big check.

That way you preserve liquidity. You have the ability to use that money for other purposes if you need to or if you choose to. And you get the emotional satisfaction of just throwing a big chunk of money at a mortgage and wiping out the whole thing all at once. Yeah. It's super. And by the way, so I've been in that position with people. Have we talked about this before? How many people that I worked with personally, when they got to that point, took the money

and paid off the mortgage? You and I have talked about this before. You said almost zero. I think the number was zero. I can't remember a person. And it's funny because it really is more about how. having the flexibility in the ability to do that. And some people would then turn on a stream of income from that pot of money.

They turn on a stream so that it would make the payment. But they saw how much faster that pot grew than the mortgage declined. And they got it. I mean, and once they knew they had this money sitting there and they knew they could do it at any point, they didn't pull the trigger. It's funny that we bring this up because I am about to be there. that one person. I'm about to make a big lump sum payment. You are going to do it. Yeah, I am. But you know what's interesting is that so, well, maybe not. I was going to say being an entrepreneur kind of changes things. And I can't think of anyone I worked with that wasn't a nine to five person

that was employing that strategy. I think when you have an income stream that comes from as many different places is yours may and that you might not be sure where that's going to come from next month. It might make you a little more risk adverse and more likely to do that. Why would you do that versus just create a stream where that pot of money pays off the payment every month so you don't have to? Well, I think for me, part of the motivation is that I don't just have one mortgage. I have many mortgages because I've got all of these rental properties. And there comes a point where here's tired of having so many and you want to reduce the number of mortgages you hold. Yeah, de-leverage. Exactly. Yeah, right. Also, because I'm paying off the mortgage

on an income-producing property, the wiping out of that mortgage will lead to higher cash flow from that property. There it is. So it does create a greater income stream. Now, technically, if I would actually calculate what that income stream is, you know, the dividend relative to the lump sum payment, it's not a great one. But in the context of the reduced risk and also the greater simplicity in my life, I'm happy taking that smaller quote-unquote dividend, so to speak. I can't think of a time where we use that particular strategy on an income-producing property. So that's a good point, too. But Joe, to go back to your question, again, I really like the way that you're thinking.

I love the creative lateral thinking. But I would preserve your ability to rebalance your portfolio. and you're not going to be able to rebalance if your bond allocation is illiquid as it would be if it were expressed in the form of home equity. So thank you, Joe, for asking that question. We'll come back to the show in just a second. But first, are you tired of getting nickel and dined by your bank? And are you also tired of not earning very much interest on the money that's in your checking account? Check out Radius Bank.

They have this thing that's called Radius Hybrid Checking, which is a free high interest checking account. called hybrid checking because it combines the high interest of a savings account with the flexibility of a checking account. Now, here is the situation. According to the FDIC, as of June 2019, the national average interest rate on a checking account is 0.06% API. I'm going to link to that in the show notes. That's not good. But Radius Bank pays 1% APY on balances over $2,500 in a checking account. And you can earn 1.2% APY on balances of 100,000 and up. That is between 17 times to 20 times greater than the national average. They also don't clobber you with fees. There are no monthly maintenance fees. Your first order of checks is free. Mobile banking is free. And you get free ATMs worldwide. They will reimburse the fee that other ATMs charge you. So this is a bank that gives you freedom

from fees. Check out Radiusbank.com slash Paula. That's R-A-D-I-U-S. Bank. Bank. Bank.com slash paula, P-A-Radiusbank.com slash paula. Are you an entrepreneur or a solopreneur? Do you have a side hustle? Do you run a business? If so, you know that you're doing a lot of different things. You're balancing a bunch of tasks. And some of these administrative tasks like filing taxes, running payroll, they're necessary for your business, but they're not going to be the big things that move the needle. You could focus your energy on sales or marketing or product development. That's where Gusto comes in. Gusto makes those administrative tasks, payroll, taxes, HR, easy for small businesses.

They offer fast, simple payroll processing and benefits and expert HR support that's all in one place and that's designed for small business owners. Gusto will automatically pay and file your federal, state, and local taxes so that you don't have to worry about it. They make it easy to add on health benefits and even 401Ks for the people who work on your team. The thing is those old school clunky payroll providers. They aren't really designed for small businesses or for soloprenores or entrepreneurs, but Gusto is and it can grow with you. So let them handle that aspect of your business because you've got better things to do. You can try them for free for three months when you run your first payroll.

So try a demo for free and see for yourself at gusto.com slash paula. That's g-u-st-o.com.com slash paula. P-A-U-L-A. Our next question comes from Tanya. Hi, Paula. My name is Tanya. My husband and I are 43 years old. We have a soon-to-be 16-year-old and a 7-year-old. One of the things we have done well is starting our autopilot retirement savings at an early age. One thing we haven't done well is aggressively managed expenses and debt repayments. Due to consistent contribution, high incomes, combined income over 200k, and the magic of compound interest, we've managed to save approximately 785k. In addition, my husband has a pension with a cash balance option of 89K, which he is 100% vested.

We've also saved on and off in our children's 529 plans for a total of 33K. Our major concerns right now are low emergency funds, only two months worth, and our debt. We have one car note at 1.9% interest with 24 months left on the term, one loan for replacement windows at 0% interest at 502 per month, and we currently have three loans related to our primary residence. The first loan is against my husband's 401k and matures in 2024, and we have a 15-year-second mortgage with a 7% fixed interest rate with a payment maturity in 2029. Finally, we have a 30-year first mortgage with an interest rate of 4.5%.

We recently reduced our 401k contribution rates to the minimum amount where we get our employer match with the hopes of pushing the cash flow towards aggressive debt repayment. I'm anxious to set us on a path to becoming financially independent but feel a little despondent at our debt load and the fact that our daughter is fast approaching college. I've tried to convince my husband to downsize sooner rather than later. However, he would prefer that we wait until our daughter starts college. We are trying a bit of travel college hacking by having our daughter enrolled in a program where she will earn an associate's degree through the local community college while still in high school.

I'm concerned that all of our savings eggs are in one basket for our post-59-5 basket. Looking for your thoughts on prioritizing how we should move forward. Should we, one, focus on paying off our debts first. We could throw $2,500 per month towards debt repayment. Two, contribute to our 401k at work, Roth 411K at work for later conversion to a traditional Roth. Since we exceed the income limits for the traditional Roth now, or three, focus on building our emergency fund. We are contributing about $5.50 per month to it currently, and $150 to our kids' $529 plans. love your podcast and your insightful detailed answers so thanks in advance for helping us solve our riddle

tanya congratulations on saving a nice sum of money and i can hear in your voice as well as in the as well as in the numbers that you gave us the cash crunch and you've got a lot of things going on here are my my general thoughts well i am worried about a few things the one thing that's the one thing I'm not that worried about is your children's education. And while that's going to be personal for every family, I think you have enough things going on that I think the way to look at it is this way. The best thing you can do with your children is to make sure that they don't have to take care of mom and dad later on. So if you can take care of yourself first and then take care of your children second, it's fantastic to do both. But of the two, I would rather make sure that I'm not a bird

and then and the kids find a way. And you've already been college hacking. And there's probably more that you can do to help them in a non-financial way to help them get college accomplished. But I, out of all the things you talked about, I think worrying about college is my least worry. The biggest thing I look at is the debt. I never like a 401K loan. I mean, the past is the past. I would not have borrowed against your 401K.

That's always my last place to go get money. the 15-year loan on the house, the window replacement money. I look at these things and obviously, if you had it to do over again, I would have tried to help you build a fund to set aside money so that you could pay cash for those things in the future. Even though the windows are at 0%, I still want to pay cash because now it's hanging over your head. So I would focus mostly on the debt and your cash reserve.

I would continue to save the $500 a month toward your emergency fund, but then I would attack the debt. And to do that, I would look at your expenses, and there are three expenses that are the biggest drivers for any budget. Most people focus on these little tiny things. There's three big ones. Your housing, your transportation expense, and your food cost. We didn't talk about food costs. you have your housing mortgaged heavily.

I think then you might want to look at your vehicle and maybe make a different decision around your car, even though it's at a low interest rate, it's a depreciating asset. And then your food cost, I'm not sure what you're doing there. And then I would take as much of that money as I possibly could. And I would begin de-leveraging. The 401K loan, because you're paying yourself back with interest, presents a conundrum for me because on one end, the damage is already done the second you take the mortgage out. However, you give up opportunity cost in the market, the longer that loan is out.

However, at the end of a long expansion, and I do not like looking in the crystal ball, currently I would still prioritize that, I think, below the home equity loan that you have, the 15-year home equity loan. And I think by eliminating the car loan, the 15-year home equity, loan, you're then able to de-leverage so that at the very least, when your 16-year-old gets to college, you have some flexibility. But even more than that, for retirement, for your bigger goal of the two of you being financially independent, getting rid of that debt load, I think, is going to make it much easier. Yeah, I agree. Sell the car, get rid of that car and buy something cheap in cash, just something that runs and gets you from point A to point B. And then,

And in terms of what to prioritize, I am torn between repaying the 401k so that you can then have more money in that 401k that can accumulate compounding growth. Or I agree with you, Joe, the 15-year loan, because it has a 7% interest rate, I mean, that's a pretty significant interest rate. So I am torn between the options of repaying the 7% 15-year mortgage or repaying the 401k loan. loan. But between those two, I think I would still lean towards repaying the 401k loan. I'm so torn on those as well. I could, I could advocate that. I mean, you could hear it in my voice when I was trying to pick one. Yeah. And maybe that's the takeaway, you know, maybe between those two, Tanya, which one of those two gets you more excited about savings? Which one of those two motivates you to contribute more? Because if one of those two is bothering,

you more. Like if the loan against the 401k bothers you and keeps you up at night and therefore motivates you to make greater contributions to paying it off than you otherwise would, then pay off that 401k loan first. On the other hand, that 15-year mortgage with a 7% interest rate, I mean, that's a high interest rate on a home mortgage. And so if paying that one off is the one that really gets you going, then pay that one off first. Because as you can hear, both Joe and I are conflicted about which one of those two we would tackle first. But we both agree that one of those two is the one that you should tackle first. And don't pick them both evenly, make minimum payments to one and pile the money on the other one so that you free up cash flow more quickly.

Don't do a 50-50 split. Which whichever one you choose, go hard at that one. Yeah, I totally agree with that. The other thing that I would like to see you do, your emergency fund only represents two months worth of your expenses, I would like to see you boost that to at least three months. And maybe after you sell off your car and get a cheaper car, you might even boost it to four. But I pretty strongly feel like a three-month emergency fund should be the minimum. There's a bigger question here, though, Paula, that Tanya didn't ask that I think we need to talk about, which is window replacement loan, car loan, 15-year home equity loan, 401K loan. there's a discussions about money.

And I love the fact that Tanya called in, asked this, but these are discussions, deep discussions about money. And by the way, they don't have to start off as deep. Cheryl and I have a weekly discussion about money. What are our goals? Where are we headed? We look at the bills together. And because we do that,

I found that our debt that we had at the time that we started that, we were in real financial trouble when we started that back in the late 1990s, When we started just having those discussions, that was better than having a budget. It was better than having money tracking. And we do both of those things. Sitting down on a consistent basis and just talking about our priorities eliminates what seems to be buying things that you really can't afford now. You're looking at the future and you're mortgaging. You have already mortgaged your future the things that we're talking about paying off today.

And I would hope, Tanya, you mentioned that you and your husband had discussed possibly selling the house, but he wants to wait until your daughter goes to college. I don't know if that's a reference to waiting until the 16-year-old goes to college, which would only be two years, I'm assuming, or if that's a reference to waiting until the 7-year-old goes to college, which would be another 11 years. But if you've only got to wait two years, that's not so bad. But if we're talking about waiting until the 7-year-old is old enough to go to college before you sell. that house. I mean, it strikes me as we look at all of these loans and all of this debt that downsizing your home is the one-stop shop, like wave a magic wand solution to paying off a lot of these debts. Number one ever by far. Yeah, absolutely. All of the penny pinching, all of the eating pasta instead of bacon, that is a drop in the bucket compared to selling your house and downsizing into something significantly smaller, even moving into an apartment, if that's what it takes to just wave that magic wand, wipe out all of these debts, and put yourself into a really financially secure place.

Boston instead of bacon. That sounds deeply personal. You didn't pull those out of a hat. You've made that decision before. I can't afford the bacon. Let's go for the noodle. You're literally not bringing home the bacon. Oh, you and the honorary dad.

That dad joke. Honorary dad joke. So good. But Tanya, you're asking the right questions. Absolutely. So thank you, Tanya, for asking that question. And best of luck with all of the progress that you are on the verge of making because you've done great. You've saved $785,000.

That's super impressive. And you are going to pay these debts off and you're going to be in a really solid place. I'm excited for what comes next for you. Our next question comes from Mickey. Hi, my name is Mickey. I'm 25 years old. I have about six months of living expenses for an emergency fund. Most of that is in a savings account earning a little over 2% interest,

and I've been laddering in a small amount into Series I savings bonds, and the ones I do have are earning a little under 3% interest. I've made sure to have six months of living expenses available to me in my savings account, due to the one-year holding time for the Series I-S savings bonds once purchased. My question is, how useful all these bonds in a low-interest environment like we are in today? I saw in the early 2000s these bonds were earning over 6% at one point. You know, the difference today between my savings account and the bonds is pretty small. So my question is, should I continue to ladder in my emergency fund into Series I-s-s-s-bonds?

and then when interest rates rise sell the lowest interest bonds and buy new ones at a higher rate, or should I just wait until interest rates rise and buy then. Thanks. Mickey, thank you for calling in. Congratulations on having a six-month emergency fund. That's awesome. One thing that I want to emphasize, though, is that an emergency fund is not intended to be an investment account. If your emergency fund can keep pace with inflation or maybe even a little bit less than that, that's fine. I would 80-20 leave good enough alone and then move on with your life because you clearly have a lot of enthusiasm for managing your personal finances. I would re-channel that enthusiasm into the investment portion of your financial life and not the emergency fund portion of your financial life. and not the emergency fund portion of your financial life.

Your emergency fund is not supposed to be an investment. I loved when I was a financial planner helping people see their financial situation as if their family was a business. And I would present arguments about their family situation as if they were a business owner. And it really, it's funny when we take that away, that emotion that we get with our personal financial picture, And we think about it in terms of business decisions. We make remarkably better decisions. And here's the thing I always want as a business owner. I want myself and my employees working on the problems that are going to move the needle.

This problem will move the needle a centimeter. Right. The amount of money you will make by overthinking your emergency fund is minimal. And sure, we could talk about this and maybe make you a good 50, 60 bucks. But Paula, to your point, take that same amount of time and apply it to your overall asset allocation, making money, having a better investment policy statement, many, many more dollars in those decisions than this one. This is not something to worry about.

Yeah, absolutely. Heck, take that enthusiasm and apply it towards starting a side hustle. Let your emergency funds sit in a savings account and then throw your energy towards two hours a week of side hustling, that will make a significantly bigger impact on your finances than laddering your emergency fund into savings bonds. I get the desire of investors to want to maximize every dollar to the point that some people do the opposite of what Mickey's talking about. Mickey's maximizing the account. You and I know people that say don't have an emergency fund at all because that interest rates too low, right? Just completely. The reason you

you have an emergency fund in the first place is so that when financial markets move against you, you have some place to go that's safe. So by definition, you really don't want to maximize or flex very much your emergency fund. You just want that in a safe place so that you can be more aggressive with everything else. I'm a very aggressive investor with my money, but I have a sizable cash cushion to work from that allows me to not panic when things go south with my investments, not meaning that my investments are horrible, but that markets from time to time will go against you. I don't have to panic about how aggressive I am because I have that emergency fund in place. All I worry about, all I worry about is getting a competitive interest rate, which I think he's got.

I mean, I think Mickey's got a great interest rate when it comes competitively to that versus a money market. And then I worry about other. stuff. Absolutely. In fact, you can almost think of it this way. You pay a fee for anything you do, right? If you go to a movie theater, you pay an admission fee, you pay a ticket price in order to watch that movie. Volatility in the stock market is the fee that we pay. It's the price that we pay for admission to the stock market. And the way that we are able to withstand that volatility is by counterbalancing it with a cash cushion that has not paid that fee. A cash cushion that isn't in the game and therefore isn't getting the returns but also isn't taking that risk. By virtue of having that pot of money, by virtue of having that emergency fund, we can hold steady

when our other investments get bumpy. And so rather than thinking of the money in your emergency fund as money that's not earning any interest, think of it as the foundation or the key that is required for you to be able to earn this amazing interest or earn these amazing returns in a different bucket of your portfolio or in a different bucket of your overall balance sheet. And if that's how you look at it, then it isn't that the money in a savings account isn't making much. It's that the money in a savings account enables the returns that you make elsewhere. Thank you, Mickey, for asking that question. Our final question today comes from Andy.

Hi, Paula. My wife and I will be retiring in 2040. I am 39 and she is 37. We will be maxing out our backdoor Roth IRAs this year, $6,000 a piece or $12,000 total. My question is, should we max these out using index funds that mirror the S&P 500 and the Western European Pacific Rim Developed Nations funds? Or should we invest in a targeted retirement fund for 2040? The fees for the targeted retirement fund are slightly higher, 0.15%. versus the index funds, which are 0.05 to 0.1%. We would be using index funds, 50% domestic,

50% international, or the targeted retirement funds 100%. Thanks much. Andy, first of all, congratulations on maxing out both of your backdoor Roth IRAs. What I would do if I were you, when you think about whether you should go into a targeted 2040 retirement fund, and I'm assuming that it's a Vanguard fund, which has low fees, when you're thinking about whether to go into the Target Date 2040 fund versus the S&P 500 and international fund, fundamentally the decision that you want to make is one of asset allocation. I would not let the slight difference in fees guide your assets. allocation decisions. Because regardless of whether you choose the Target Date Fund or the S&P 500 slash

international fund, in any event, all of these are funds that have a reasonable expense ratios. And so fundamentally, I would ask yourself which of the two asset allocations that you outlined most closely matches your own risk tolerance and goals. So I would only approach this as an asset allocation question, and I would take the expense ratios off the table as you compare between the two. Because your target date fund is going to have a totally different asset allocation. Your target date fund is going to have both U.S. bonds and, if it's Vanguard, it'll have both U.S. bonds and international bonds inside of it. And so the fundamental question that you want to ask yourself is, do you want the asset allocation that's represented by that target date fund, which is

going to include a bond portion, and is also going to include a lower international exposure? Or do you want a higher international exposure with no bond allocation? Like that's really the question that we're addressing here. Yeah. And actually, Paula, my mom used to always say, let's not let perfect be the enemy a good. I don't think there's a bad decision between these two. The difference is that he's going to have to automate it. He's really asking, do I do it myself with my rebalancing in the future?

Or do I automate it? Do I hand that off to somebody? And frankly, to your point, for an incredibly. reasonable fee. I'm not a big fan of Target Day funds in general. I think that while you get there directionally, I think it's easy enough to have a portfolio that matches what you need to reach your goal to create your own diversified portfolio. Investing has become incredibly easy. And by that, I mean, the tools are online all over the place and the brokerage accounts are super easy to make trades. So between pushing maybe three or four buttons versus pushing one button, there's not a lot

of difference there. But both of these are good. I mean, there's really, don't you think? I mean, neither one of these are bad decisions. So I wouldn't let Perfect be the enemy a good. I would pick one and run. Totally agree. Thank you, Andy, for asking that question. Joe, that's our show for today. Where can people find you if they want to hear more of you? Well, I want to tell you about a new project that I have, which is called Money with Friends. Bobby Rebell and I, the show used to be called Money in the Morning, but really it was always more of a Kelly and Regis vibe, you know what? I've got Kathy Lee and Hoda vibe.

It was more us sitting around with coffee, chatting about headlines. And so we've invited some of our friends to join us. And hopefully, Paula, in the future, you'll be one of those friends who join us. Cool. I'm your friend. We got this. Please. Will you please?

So we have this cast of characters. The show comes out every Tuesday, Thursday, and Saturday that's Money with Friends. Money with Friends, downloadable anywhere where you can download a podcast. Amen. Awesome. Thank you, Joe, for coming on the show today and for tackling all of these awesome questions. If you enjoyed today's episode, please hit the subscribe or follow button in whatever app you're using to listen to this podcast. And while you're there, please leave us a review.

These reviews are super helpful in helping us book awesome guests onto other shows. And the single most important thing that you can do, not just to support this show, but also to spread the message of personal finance and financial independence, is to share this with a friend. If you know somebody who you think could benefit from listening to today's episode or any of the other episodes, share this with them. Thanks so much for tuning in. My name is Paula Pant. This is the Afford Anything podcast. I'll catch you next week. But Joe, to go back to your question, again, I really like the way that you're thinking.

I love the creative lateral thinking. I thought you were talking to me. Oh, yeah. Other Joe. Well, thank you. That is so nice of you, Paula. I like the way you're thinking, too. P.S.

I have a free e-book for anybody who's interested in learning more about rental property investing. The name of the e-book is seven expensive rental property investing mistakes to avoid, and you can download it for free at afford-anything.com slash real estate. That's afford-anything.com slash real estate. Also, I wanted to let you know that I have decided to take. a sabbatical in the month of September. Woohoo! Thank you so much for everybody who sent me a message on Instagram, encouraging me to take

this September sabbatical. So I will be, technically I'll be taking almost five weeks off. It'll be August 16 through September 23rd. In terms of this podcast, what that means is because there's, of course, that gap between when I'm not working versus the production schedule for this podcast. So what that means is that in the month of September 2019, this podcast, we, we, are going to run, well, I'm not sure what yet, but it's not going to be new material. It'll be something different. I don't quite know what, but stay tuned for the mystery. But yeah, I'll be

taking a September sabbatical. I'm going to go to Croatia, Slovenia, then I'm going to go to FinCon in Washington, D.C., and then I will cap it off with two weeks in Japan. So Croatia, Slovenia, D.C. and Japan, four places in five weeks from August 16 through September 23rd. You can follow along on Instagram at Paula P-A-U-L-A, P-A-N-T. Finally, next week we have an episode with Ken Honda. He is Japan's Zen Millionaire. So stay tuned for that coming up on the next episode of the Afford Anything podcast. Thank you so much.

These are the end-of-show announcements. I will see you in the next episode.