Afford Anything - Q&A: Everyone Is Arguing About Roth IRAs And We Have Thoughts

Episode Date: February 18, 2025

#583: Contrary to recent discussions, Jesse has concluded that a traditional IRA is the smarter way to go for most people once marginal tax rates are factored in. Is he missing something?   An anonymous caller is four years away from early retirement but she’s unsure if her portfolio allocations are in the right place. How and when should she start converting equities to cash? Luz is confused about how to handle company stock options. Is there an ideal spread between the exercise price and the stock price? And, what should she do once the stocks are exercised? Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode. Enjoy! P.S. Got a question? Leave it https://affordanything.com/voicemail For more information, visit the show notes at https://affordanything.com/episode583 Learn more about your ad choices. Visit podcastchoices.com/adchoices

Hey, Joe, if your marginal tax rate today is high, but in retirement, your effective tax rate is going to be a lot lower. Do you think that's a case for bucking conventional wisdom? Ooh, I don't like the premise of your question. Because, you know, there are people who would say if your marginal tax rate today is high, but your effective tax rate and retirement is lower, then why contribute to a Roth? Why do it? Hmm. Very interesting. I know you well enough to know.

that, hmm, signifies the restraint that comes right before a rant. Me? I don't rant. We will see whether or not that statement is true in the next few minutes. Welcome to the Afford Anything podcast, the show that understands you can afford anything but not everything. Every choice carries a tradeoff and that applies to your time, money, focus, and energy. This show covers five pillars, financial psychology, increasing your income, investing, real estate, and entrepreneurship. It's double eye fire. I'm your host, Paula Pant. Every other episode, we have

answer questions from you, and we do so with my buddy, the former financial planner, Joe, Saul C-Hi. What's up, Joe? What's up, Paula? You know, we're two months away from tax day. Yeah, we're kind of in early tax season, I would say. Exactly. Yeah, it's the beginning of tax season. And so naturally taxes are on people's mind. And that leads to this question about Roth now or Roth later from Jesse. Hey, Paula and Joe, this is Jesse from Seattle. I recently started listening to both of your podcast and I've enjoyed listening so far. A couple weeks ago, a listener named Vaughn called in to ask about the benefits of Roth over traditional accounts. You discussed the value of being able to cram more tax-free money into a Roth, given that both traditional and

Roth accounts have the same annual contribution limits. One thing I think is missing from this discussion is the difference between marginal and effective tax rates. And that's something that I've heard financial planners, Cody Garrett and Sean Mullaney, discussed pretty comprehensively during interviews with other podcasters. Just as an example, my effective tax rate in retirement, which if current tax law remains the same,

will likely be much lower than my highest marginal tax rate, which is 22%, unless tax rates go up, precipitously. So I went through these calculations, and it seems like I'm much better off contributing to a traditional account, which reduces my tax obligation today by 22%, and then putting any additional funds in my brokerage account. The money in the brokerage account will be taxed comparatively by a much lower long-term capital gains rates, which are actually 0% for single earners up to 48,000, 350, and then for couples up to 96,000. thousand, 700 in 2025. But if I was investing solely in a Roth, that would have me pay a higher

marginal tax today so that I could pay nothing in taxes in the future, which seems like that trade-off doesn't seem as good to me. So for people with a high savings rates, especially, who are planning on living on 60% or less of their current income, it seems like traditional IRAs and 401ks are a much better deal. I guess my question is, am I missing here? Is there something about my logic that is incorrect? Looking forward to hearing your response and thanks for the excellent show. Jesse, thank you for the kind words and also for listening to both of our shows. If you called in just a little bit earlier, you and I may have had a beer in Seattle. Maybe we did have a beer together in Seattle because Paula, about a week

and a half ago, I was in Seattle speaking at the retire meet conference and we did a meetup of friends of personal finance. So let's dive into this. The first thing I think I need to say is you do you because you're the one that has to sleep at night with your financial plan. If you've done what sounds like a bunch of calculations and you're happy with what you came up with, it's far better than taking my word for it. So I love the fact that you're not taking somebody's word for it.

you're diving in and getting into this conversation around traditional versus Roth. I've often said in the past, I've said this about the efficient frontier. I can't stand it when somebody's choosing between Paul Merriman portfolios or Rick Perry portfolios or J.L. Collins portfolio. Don't take somebody's word for it. Understand how these quote experts got where they got. Because when you look under the hood, there's a reason each of them chose to go the way that they chose to go. So I love the fact that you're doing, you're doing that. I'll echo that and say, I've, I personally have met with a financial planner and disobeyed the advice that he gave me. Specifically, I met with a financial planner and he told me not to pay off

any of my mortgages because I had very low interest rates. This was during the ZERP era. He said, you're young, you've got low interest rates, keep the leverage. And I went, Thank you, but no. But what I love about that, because I love advisors who will give me very good advice that challenges what I'm going to do. Yeah. And I still have the right and the ability. And I should because I'm the CEO of my personal financial situation to say no. Now, what's funny about that particular instance, Paula, I would keep that advisor on my staff.

Yeah. Yeah. I would totally keep them. Keep bringing this stuff that I'm not going to do. Right. Yeah. It's sound advice. And I understand the logic.

but in my personal case, I had other reasons for wanting to pay those off, so I did. Let's dive into what you and I said about the Roth versus traditional. Yes, both of us are Roth stands. I recently spoke to a couple of people that are in innovation at Microsoft, and you'll hear the interview soon on the Stacking Benjamin Show if you listen to my podcast. But one thing I loved that one of these people said, Paula, was the key to the key to anything is to look at your plan and figure out where the assumptions are. Where have I assumed more than I should have maybe assumed? Because this is where the key lies. And what I love about

this advice completely is this echoes all the CEOs, all the smart people I've met who love this advice that was popularized by Carol Dweck, which is having a growth mentality. I think it's a growth mentality to say, where am I wrong versus defending my position, right? You get on social media, everybody's defending their position, whether it's about politics or whatever. And nobody's asking, where could I actually be wrong here? And maybe not even wrong. Maybe what's the other person acknowledging that I'm not? Or what am I under billing that they have is the biggest piece of the argument in their head. So it's not just about right or wrong. It's also about what are my biases? Paul and I both, first of all, we're neither one of us, I think. I'm not going to speak for you, Paula,

but I don't think either one of us are Roth only all the time. But my bias, my heavy bias is, tell me when I shouldn't do the Roth, because otherwise I'm doing the Roth. Right. My bias is toward the Roth and then talk me out of it. Right. Roth has opt out rather than opt in. Exactly. So number one, I'm not anti-Jessie what you're doing. And I don't think that Paul is either. And by the way, I've never met anybody in the afford anything community who like got to retirement and went, I didn't make it because I screwed up the Roth versus traditional decision.

You're going to be okay. You're going to be okay either way. Let me tell you what I'm solving for that is different than what you're solving for. You're basing your decisions now. All these calculations you did. time you spent is based on the fact that stuff is going to stay the same. Joe, the moment that you said, see where the assumptions are within your calculation, I was like, 10 bucks says this is where Joe's going.

I think I know where Joe's going. And I've been doing this between financial planning and financial media. I've been doing this, Paula, for over 30 years. The constant is it doesn't stay the same. It does not stay the same. So you can do as many calculations as you want, and they're going to be wrong. And so instead, I take the viewpoint that a big time financial expert, Ed Slot, takes. I really appreciate his point of view.

And I'll tell you why in just a second. But Ed says it's just a simple math problem to look at the debt of the United States and look at the tax rate today. In fact, you look at the first moves that this current administration has made to try to lower the obligations of the U.S. government. it is a math problem because everybody knows it is a math problem that either we have to do what the administration seems to be doing now, which is cutting back federal workers, cutting back federal programs. And at some point, we might have to do the other one, which is raise revenue, might have to raise rates. And if we look at rates today, if you go back and you look at the last 150 years of tax rates,

federal tax rates and especially focus on the last hundred years because that's more modern times, our rates are pretty damn low right now. I mentioned the ZERP era earlier. It's almost the equivalent of during that low interest rate era, everyone getting so accustomed to it that in salient memory, in recent memory, we got anchored to that as the new normal. And so then when mortgage interest rates became historically normal, which is 6%, 7%, every, Everyone felt that that was high because it's an aberration of where we were in the 2010s. But historically speaking, it's actually normal. So, Joe, what you're saying is that's kind of analogous to where we are with tax rates.

Right now, tax rates are historically speaking, very low. And they might historically renormalize at some point. Yeah. Any move that you make is going to be a bet, right? It's going to be a bet. You're betting with your calculations. The tax rates are going to stay the same. I actually choose not to bet.

With my Roth assumption, I'll back down that statement just a smidge, but I'm going to stick with it for right now. I'm choosing not to bet. And what do you mean by that? You are solving, Jesse, for tax optimization. Tax optimization, to me, is a trap. It's 100% a trap. And the reason is, throughout my career, whenever anybody has stuff optimizes and the government changes the rules. They were in my office then going, how do I get out of this optimized position,

which now is Fubar, because I overoptimized for the way stuff used to be versus the way it is now. I don't want to fall into over optimization traps, which is why I love what we call the tax triangle. It has nothing to do with calculations. It's an about assumption that things are going to change and that's the only constant. And you know what? And I also know with the tax triangle that if I try to, to some degree, balance out my triangle, no matter what the hell the government does, no matter what happens to tax rates, I've got money in these different pots that I can pull from so that I don't have to be making these bets. I don't want to make bets.

So rather than optimize for a point in time analysis, you're optimizing for flexibility so that you have the ability to stay nimble no matter what the government does. Absolutely. 100%. Now, let me back that down. There is one bet that I'm making. I feel very lucky, Paula, because you and I get to talk to a ton of experts nonstop. It is the fun and what we do, by the way.

I love the fact that I get to just have the curiosity of a 12-year-old with these super smart people and ask them all the questions that I probably wouldn't ask them because I'm too much of an introvert outside of the microphone. But because I have the microphone, I'm like, oh, Paul, let me ask you one more thing. And the thing that I am betting on, and I know where my assumption is, my assumption is that the government's not going to come back and tax the Roth later, that they're going to come up with some way to get at this money, right? Now, the cynical Joe has always thought, like, I don't really trust Washington.

I can imagine them going, oh, you know what, there's this huge pot of money, Paulist, over here, that we said tax free. there's got to be a way that we can get around that. Without exception, every one of the people that are closer to this than I am have said, that's going to be the last thing they touch because it's becoming like Social Security. You know what? Nobody screws with Social Security because it's the number one social program in America. And you've got to have some real guts, right? So they're building a moat around Social Security and they're touching everything else. and we will see them, and this is what tax experts have told me, we will see, in all probability,

Washington continue to go after other things before they go after Social Security because it is such a big social program. Roth IRA has becoming the same. There's a ton of money in Ross, and we are constantly adding more and more and more money at a faster rate per year that we were adding the year prior. So because we're adding so much to this pot, just imagine the outpouring of anger that will happen when people go after that pot. So could it happen? Absolutely. But that's my assumption. I know that's my Achilles-seal. Yeah, I think it's far more likely that if the government were to go after the Roth, they would go after new contributions. They would change the rules related to new contributions, but any existing contributions, the terms would be grandfathered in. But, you know, Joe,

that's an interesting way of looking at the question because we could reframe the question from the opposite perspective. Imagine that you were a federal official and your job was to figure out how to get the most amount of tax revenue for the government. Would you rather be tapping a few billion dollars worth of traditional accounts or would you rather be tapping a few billion worth of Roth accounts. From a federal official's point of view, they know that they're getting tax revenue from the trad accounts, and they know that they've made a huge giveaway with the Roth accounts. The assumption is that they can't take back. Well, what they've done is they've sped up. What the government does like is the fact that they have sped up the process of us paying

tax, right? What we're telling people to do by putting money in a Roth is go ahead and pay the tax now. That fills government coffers today. Sure, it's at the expense of tomorrow, but where we're at federally with the debt situation, the doomsday clock just ticked another second off. I don't know if you guys read about that the last couple weeks. We're now at 80-some seconds to go until doomsday. I don't know what that even means. But all of this mortgaging, I don't know. And is it an assumption? Sure it is. There are some cases where the traditional path is a better path. If you look at the recent changes, very, very recent changes, secure 2.0 changes to the financial aid situation, money in a traditional 401k may be more

advantageous than money in a Roth 401K. So if you're in a position where you are looking at the possibility of financial aid, you want to know how that program works. But just generally, Right, but that's hyper-specific. Yeah, I'm still going to bias toward the Roth, and there's certainly going to be exceptions to everything, right? So our point isn't hard and fast Roth all the time. And I haven't heard what Sean said, and I respect the hell out of Sean. I would love to have heard that conversation. I've spoken to Sean many times. I don't think he and I disagree a ton. So I don't know what exactly you're referring to with Sean's discussion on this.

topic. But I think that we all have biases. And Paula and my recommendation would be to bias toward the Roth and then talk yourself out of it. And if you're high enough, if your income tax bracket is high enough and you think tax brackets are going to be much lower when you're retired and you're willing to bet your money on that, then you do you. And I'm 100% Paula, not against that. You know, going back to that earlier thought exercise of what would you do if you were a government official and you wanted to maximize tax revenue? I mean, heck, from that point of view, I'd be trying to tax the dividend income inside of a Roth. That's some ordinary income tax right there. So when you think of it from that point of view, when you put yourself in the other

party's shoes, it's a framework that allows you to see how powerful the benefit that you are getting is. But Joe, I think the most compelling thing that you said is when you described that experience as a financial planner of seeing all of these clients come into your office who optimized for a point-in-time situation. And the problem with point-in-time optimization is that by designing so heavily forward, you're one specific circumstance, you remove the flexibility to be prepared for any scenario. Can I give you one more reason why bias toward the Roth that has nothing to do with money?

It has to do with living more life because our goal isn't to optimize our money. Our goal is to live more life. There are interesting behavioral things that happen around taxes, especially with people in our community. the people I adoringly call my money nerd friends, right, like me and like you. Money nerds, we obsess about this stuff that 90% of people don't and generally we're better off for it. But in the area of taxation, I think we have a problem. What's interesting about annuities, and I'm going to bring this to 401k here in a second, do you know what's interesting about annuities? The way annuities are taxed. Annuities are taxed. Last in first.

out. What does that mean? If you buy an annuity, an annuity is a tax shelter, but when you put money in this tax shelter, it's going to grow because it's usually burdened with tons of fees. It doesn't grow that fast, but it does grow. And over time, you get this nice icing layer of taxable money on the inside of an annuity that you have to dig through before you get to the money that's not tax, the money that you put in it. That's not tax because you already paid tax on the money when you earned it and then put it in the annuity. So much money stays in annuities. So much money stays in annuities. And when you ask people why they left the money in the annuity, the reason they left the money in the annuity was they didn't want to pay the tax. So they either took the money from someplace else,

they didn't do the thing. The traditional 401K I've found has been very much the same. is as we're watching baby boomers now take money out of traditional 401ks. We watch Gen X really struggle with this as they're beginning to reach that age. I believe that if your money's in a Roth, you're much more likely to take the trip. You're much more likely to do the experience. If you're worried about what's the tax on this money going to be every time you reach for money, you're going to do less. that also increases my bias toward the Roth, because I find Paula, especially for my money nerd friends, tax is getting the way of experiences. And we end up going, maybe I'll do that later when tax rates are more favorable, which is almost always the wrong decision.

Right. This is a great question though, Jesse. You know what? I love it. I love it because I love the, you know, dig it a little deeper, Joe. How do you and Paula think about this? Like, how do we think? And I love some of the truisms we talked about today. Challenging your assumptions like this Microsoft innovation person just said to me, I think it's such a huge thing, Paula. It is so huge. What are the assumptions I've made around this decision and challenging yourself to find those? And challenging yourself to find those. I think it's such a huge. It is such a huge, Paula. It is so huge. What are the assumptions I've made around this decision? And challenging yourself. And challenging yourself to find those. What are. What are. What are. What whether you stick with your decision or not, I believe, gives you a better and stronger outcome because you went through that exercise. Yeah. The reality is the federal debt is currently at its highest peacetime level in U.S. history. We have never during peacetime had such high debt, and our debt-to-GDP ratio has more than tripled since 2001. And that's for two reasons. It's rising spending and it's declining revenues. Both of those need to get addressed. That means the revenue side has got to come up.

So bracing for a future with higher taxes and preparing ourselves for that seems to be the prudent approach. Well, and this goes back in line with every financial planning discussion you and I have had. My approach, usually Paula, Paula, is exactly that. prep for the worst hope for the best but when i see a financial plan with these laughably optimistic projections that's when i go oh man i think we need to back that down and i'm generally optimistic by nature yeah same but not in my financial planning because i love it if i can make it as a pessimist well then shucks world shucks i can do it and then i can even make it's a pessimist well then i can even more optimistic.

This is so rated G. You've actually said the word shucks. Oh, shucks. Well, shucks. Jesse, shucks, thanks so much for the question. Oh, Jesse. God love you. Up next, we're going to hear from a caller who is about four years away.

She and her wife are four years away from becoming work optional. But before they reach work optionality, they need to figure a few things out, some things related to their asset allocation, some things related to their Roth conversions. They need to fine-tune the plan in these years leading up to work becoming optional. So what should they do? We're going to answer that next. 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.

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Hi, Paula and Joe. This is Anonymous. First, thank you so much for all that you do for the community. I've been a faithful listener for several years now. And while I love Paula's interview episodes, my favorites are still the question episodes with the two of you. My wife and I are in our mid-40s and roughly four years out, we think, from work optional. We both currently work full-time with a gross income.

of about 150,000 together. We have a net worth of about 1.6 million and zero debt. Our net worth is broken down by 400,000 in our paid-for-home, 900,000 in retirement accounts, 22,000 in a taxable brokerage investment, 24,000 in HSA accounts, which we maxed out in do not touch, and 100,000 in cash, mostly in a Vanguard plus high-yield savings account. We continue to put money into our workplace retirement accounts, but we've moved what we used to be putting into, maxing out our Roth IRAs to our brokerage investments for the time being because we didn't start early enough building up investments outside of retirement accounts that will bridge the roughly nine-year gap that will have between work optional and when we can start tapping retirement funds at 59.5.

We will continue to invest in the workplace retirement accounts and also be putting as much as we can into our taxable brokerage account for the next four years. If the market averages 8%, we should have enough in the brokerage account to allow us to step away from work completely, although I might still work part-time or do some contract work as I enjoy what I do, and I'm afraid I might get bored if I walk away completely. What we're trying to figure out now is how to think about adjusting our investment allocations over the next four years. We have migrated toward the efficient frontier in the past couple of years in our retirement accounts, but are not super confident in when or how much to move some of those investments and which ones to bonds and or additional cash allocations. And perhaps we

need to put some of what we're investing in the brokerage account into bonds instead of equities, but we just don't know for sure how to think through the allocations and the timing. We believe that we'll need 50 to 60,000 per year to start out with, adjusted over time for inflation. We will be doing Roth conversions during that time that we step away from work to help us with taxable income for using the open market health insurance subsidies, assuming that I'm not working part-time. And we can also lean on Roth contributions if needed for the last couple of years. We do already have about 185 in Roth contributions that are accessible, but for now our goal is not to touch any of that, if at all possible, prior to 59.5. Anyhow,

we would love some feedback for our situation. Thanks so much. Anonymous. Thank you for the kind words, and thank you for a great question. I can't wait to dig into it, but Paula, you and I have a tradition, which is that every anonymous person gets a name. And, well, what are we going to call anonymous? In order to name anonymous, I started looking into famous people who have retired or gone work optional in their mid-40s. Predominantly, these are known actors, actresses, Doris Day retired at the age of 46. But one that caught my eye that's a little bit more modern, Cameron Diaz. Wow.

Yes. Cameron Diaz revealed to Gwyneth Paltrow on a podcast that she decided to retire at the age of 46 from acting because she found it was just too stressful and she needed to take a step back and focus on her own life. That was back in 2018. She was 46 back in 2018. So now that she's been retired for a while, she's stepping back into the spotlight and taking on some new projects. So I think she's a really good example of work optionality. We're at 46, she took a step back, took a breath, took a few years to regroup. Now, seven years later, she's like, you know what, I've had a break. I'm actually looking forward to getting back into the public spotlight. Let's go. That's awesome.

I think this anonymous caller should be Cameron. Okay, so let's go, Paula. What are we going to tell Cameron? Cameron, so your questions, you asked about how to reallocate towards bonds or cash or cash equivalents as you get closer towards withdrawal. You asked about asset location. You talked about money that's going into a taxable brokerage account. You mentioned you're going to be doing Roth conversions. So what I hear specifically are questions about asset allocation and asset location. And what all of that ties into more

generally are questions about how to prepare for withdrawal. And what I will say is, withdrawing assets can certainly be more complex than accumulating. Like, accumulating is the fun part. And with accumulation, you can't really get it wrong. Everybody likes to debate about ways to optimize accumulation, but at the end of the day, so long as you are accumulating, so long as you are contributing and accumulating, you're not getting it wrong. Making just positive steps forward. Exactly. And so withdrawal is really where the strategy has to come into play a heck of a lot more.

A couple of things that you're doing that I really like. One is, as we talked about in the earlier answer, you have a good tax triangle built out. You've got money in taxable brokerage accounts. You've got some money in an HSA account, which has maximum flexibility. You've got plans to do Roth conversions. So I like the approach that you have taken already. One thing that I noticed is you said that you've redirected what you used to put into Roth IRAs

towards your taxable brokerage account. I would continue putting money into Roth IRAs because you have the option of withdrawing the principal contribution without any taxes or penalties. The gains on it, of course, need to stay in the account. but the principal contribution you can remove at any time, and so that can be part of the money that you rely on during your work optional period.

I'm happy to hear that you've already shifted your retirement accounts towards the efficient frontier. Joe, you and I have been beating that drum for the last few months now. Have we? And Cameron did it before we even started talking about it. She says that over the past few years, we've shifted our retirement accounts towards the efficient frontier. So I'm happy to hear that. What I would do is first lay down a plan for how much of your

cost of living is going to come from drawdowns versus how much of your cost of living is going to come from any type of part-time or contract work. There seems to be, and of course this is quite natural, a little vagueness, a little uncertainty around how much part-time work you'll be doing and what the expected compensation from that will be. But with a cost of living of between $50,000 to $60,000, the first thing that I want to solve for is, does half of that come from part-time work? And the other half come from portfolio withdrawals? Are we talking about a 50-50 split here? Are we talking more about a 70-30 split? And if it's 70-30, in which direction? And, And will this be constant over the span of time between when you become work optional and when you turn 59 and a half?

Do you expect it to be relatively consistent, adjusted for inflation? Or do you think that you will, for the first few years of being work optional, completely go sabbatical, taper down, and then gradually ramp up again after you've had a year or two to take a break? Paula allocation-wise, I think there's two different ways she can go. She could either use her efficient frontier-based portfolio. In that portfolio, if she's far enough down the efficient frontier, in other words, it's the risk level is low enough. It's going to give her some bond exposure. When she does her reallocations every year, that will have her selling off some monies

from stocks into bonds as she's consuming some of the bond portfolio. There are people that don't like to do that initially because if you retire and start with drawing money on the unluckiest day ever, you end up with sequence of return risk that you're attacking your portfolio right at the time of greatest risk. So that's why people hesitate to do that. And frankly, I do too. But it is something that if you're looking at the market. it's when you first retire and things have been going very well.

In your first several withdrawals, there's no issue. That's a fine way to do things. And it actually is a very simple way to do things because now you have one pie chart of your investments. You can very easily just rebalance, but there is that Achilles heel. The other way to do it in a way that I think I prefer is this two bucket approach. the two bucket approaches, I have my bucket that I'm going to spend money out of, and that is maybe the next five-year bucket. And then I have the rest on the efficient frontier, right?

And that will make sure that you have enough money available outside of most market conditions. I may put some money in jitty maize or treasuries, like a low-risk bond fund to try to get the return up a little bit. but generally you're going to be pretty much in safe waters with that money. The way that I like to do that, by the way, is I like to backfill. I take a reasonable life expectancy. I make sure I have enough money in the efficient frontier to cover those later years. And then the early years, rather than carve out a piece of my portfolio, from now on, maybe I'm saving into that short-term bucket. I let the money that I've already saved ride and build.

and now I build the short-term cash over these last few years. The downside here is that you're going to give up potentially a lot of return doing it this way. For accounting purposes, though, and for ease of mind, it's so much easier to have a short-term bucket and a long-term bucket. And some people even go three buckets, which I think introduces the level of complexity that you don't need. But if that makes you feel more comfortable, then you could do short-term and mid-term and a long-term bucket. Well, it seems to me that she's starting to approach something akin to a three bucket because they have $100,000 in cash. Right.

And their cost of living is going to be between $50,000 to $60,000 and some portion of that will be supplemented by some type of part-time or contract work. Let's just assume, for the sake of hypothetical, that they'll make $2,000 a month through part-time or contract work. 2000 net to them after taxes. If we assume 24,000 a year comes from part-time work, then that means, depending on if their cost of living is 50K a year, that would be about half.

If it's 60K a year, it would be around a third, a little over a third. When we take that into account and we look at the fact that they have $100,000 in cash already, they've got the first three years covered. In theory, if they didn't want to pull any money out of their portfolio, they could theoretically live on that cash for three years. Now, I'm not suggesting that they do that because, of course, it's always advisable to have an emergency fund to maintain some cash reserves. But it strikes me that the fact that they functionally have about three years' worth of cash on hand is already naturally setting them up for a three-bucket approach. Yeah. Or she's got the short-term bucket mostly taken care of and she can continue then very confidently putting money in the efficient frontier. I do like two versus three though. I just think three gets a little cumbersome. There's something else that she said that I'd like to also address, which is that because of the early age that they're thinking about work optional, that retirement funds don't allow her to take money.

money before that specific time, you actually can get your money before that time and you can do it without penalty. The issue is, is that you have to follow some very specific IRS rules. So if somebody- You're agreeing to SEPP-72-T? Yeah. So if somebody has over-optimized, and this is what happens a lot with older people, they stuff so much money into that traditional 401K, the classic 401K, and now it's all pre-tax and they feel like they can't get at it. They have to use 72T to get the money out if they decide to retire early. There actually is good news around that.

While you have to follow very specific rules, once you get it set up and it's rolling, it feels like a pension. And so you then can calculate every year exactly how much money you can count on, which makes it very easy then to budget. The bad news is if you want any serendipity in your life that you're going to just jaunt off to the Maldives for a vacation. I don't even know where that came from, but it sounds good to me right now.

You can't do it because you're set on that pension number and you can't take more than that out. But there are certainly ways to do it. And while it can be a little bit restrictive, I haven't seen it be as much of a burden as people think that it is to get money out. I mean, don't get me wrong. I'm glad that the financial intelligence work. is spread the word that you want to wait and you want to save that money. But truly, if you've

done a good job of saving and a lot of people in this community have, you can set up this 72T. What's cool about that too is that it doesn't have to consume all of your assets. You can segregate part of your retirement assets and 72T that number and then have the rest on a flexible, going to use it later number. So what I like doing sometimes in this situation, Paula, is solve for a number. I want to set up as a like a pension of my own to come out of this account and then segregate that amount of money into a separate IRA, 72T that money to give me this cash flow. And then the rest of it, I'm saving for later and I've got money in other buckets that I can supplement that with.

And I can get that money. So Cameron, if you're willing to do a little bit more in-depth financial planning and you're looking to increase your income streams in the early years, I wouldn't have that off the table. You know, Joe, you mentioned sequence of returns risk, and one of the methods of managing sequence of returns risk is for the bucket of money that you are planning on tapping in early in retirement, bringing down the level of risk that that bucket is exposed to for the first few years and then ratcheting it back up.

Hitting that gear shift. Right. Back up into our higher gear. And it's counterintuitive because conventional wisdom says that your allocation should get more conservative as you age. But it's actually almost like an inverse bell curve. Your allocation, your risk level takes a dip right at retirement, but then it jumps back up again because the deeper you are into retirement, the more risk you can take on.

because of the fact that you have avoided sequence of returns risk at the beginning. This always, by the way, if you're listening to this and it makes no sense to you, I have to tell you until I dove into the research, maybe it was the same for you, Paula. It didn't make any sense to me either. I'm like, risk now versus risk tomorrow versus risk yesterday. Like, who the hell cares? And you go very deep into the weeds. And it does matter. Right. I didn't think about the fact, though, Paula, that they already have $100,000 in cash. Right. Because what I see with that 100K is that they're already sort of doing that. Totally are. Right? Yes.

They've already really got that covered. That plus the fact that their home is paid off, they're already derisking those first few years. And so, sure, there might be a portion of their portfolio that would cover, let's say, years three through six that they might want to de-risk just a bit, right? Take that little bucket that would cover years three through six and shift that more into bonds. But they really have the capacity to continue to stay aggressive and to continue to stay on the efficient frontier with the bulk of their portfolio,

certainly anything outside of those first five or six years, because of the fact that they have cash covering those first three. This is the time Jesse was talking about spreadsheets and modeling text brackets today versus text brackets later. and I mentioned that I'm not in love with that because it assumes we know what the future will be. In this case, I do love doing this kind of year by year model. If I spend X amount of money per year, what is that going to do to my portfolio? I love these what if scenarios.

So this is a case where I would look at specifically what is the maximum lifestyle I can live and have a fairly reasonable feeling that I'm going to be okay. Just so I know whether I'm going to spend that money or not, I know what my constraints are. I know where I've done too much. If an opportunity rises and I want to spend more money, I know exactly what that is. I also want to know that if I decide to take work or I don't decide to take work, what that means for my long-term viability, my ability to stay retired, does it? Is there anything that'll be helpful there?

And the reason I like that metric is I can then more accurately decide based on my needs whether I need to take this job or not. So if I'm offered an opportunity and they tell me what the amount of money is, that's going to have a huge implication on my quote-unquote retirement, but I don't love the job. That puts me in a quandary, but I might still take the job because it's going to have a huge impact down the line. On the other hand, if I don't love the job and it's just okay,

but I'd be okay without it, I can sit and wait for a better opportunity. I don't have to take it. This is a case where I love these if-then scenarios. If this happens, then what else? And also we call them what-if scenarios too. What if I do this? What if the stock market does this? What if tax brackets do this?

And Jesse, back to you, I also like that. If you want to play with tax rates, play with what if tax rates go up by X? What if tax rates go up by Y? like do those what if calculations as well if you really want to get uber nerdy on Roth versus traditional right and you know Joe you mentioned spreadsheets but there's a lot of software out there that can well sure handle many of these types of projections projection lab is one bolden b-o-d-in used to be called the new retirement calculator financial mentor has a bunch of retirement calculators on his website including one called the ultimate retirement

calculator. There's also fire calc and there's also phi-calc between the two fire-calc is the one that I hear about more often. But the reason that I'm naming so many is because ultimately any calculator is going to be constrained by the assumptions placed inside of it. And I mean that at two levels. There are the assumptions that the developers bake into it as well as the assumptions that the user inputs. partially, that's a reason why it's useful to use a lot of them, right? To use a half a dozen and look at the broad spectrum of outputs so that you can see the range. You can spot any strange outliers and try to figure out what was it that made that one an outlier. You can look for commonalities.

I feel like it's like a stress test. Right. Let's put my retirement through a bunch of stressful conditions and see what happens. Yeah. Cameron, I think you sound like you're already doing everything right. You're invested along the efficient frontier. Plenty of cash. That is maybe my favorite part of what you've lined up so far. You have enough cash to be able to survive sequence of returns risk. Because when you retire or when you go work optional, sequence of returns risk is your biggest threat. And you've already amassed enough cash to be able to withstand. that. Yeah, I think the two of them have put themselves in a very enviable position. So nice, nice job of saving, great job of diversifying, wonderful attention to debt management. Right. Those are all going to work in your favor from here on out. Absolutely. So congratulations, Cameron. And if you have any additional questions, anything at all, please, please call back. Let us know.

Keep us updated. Next, we'll hear from Luz, who's looking for a device on how to handle stock options and company stock. Our final question today comes from Luz. Hello, Paula and Joe. Love the show. Let me get right to the question. As part of my bonus package, I get stock options every March. And I was wondering how big the spread between that exerciable price and the actual stock price should it be before I exercise these stocks.

And once I exercise them, should I keep the stocks in my brokerage account? or sell them off. Additionally, I have restricted stocks that become vested every bonus cycle. Should I keep those stocks or sell them to buy other stocks from different companies? Since I already have 9% of my investment portfolio for only my work company stocks. Additional information about me, I'm 31 years old. I have about 92K in my Roth 4-1K. I have a student loans about $8k. They're subsidized, so very low interest rates. I have a card loan of $8,000 and at an interest rate of 4%.

I have about $10K in savings, and I own my own house with an interest rate lower than 3%. And I do have some credit card debt about $6K, but right now it's in a promotional period of zero APR, given that my partner started his own company two years ago, and I have become the breadwinner of the household during this time. These numbers are only mine since we haven't combined finance yet until we are officially married and have premium in place. So I was just wondering what your advice would be in terms of, you know, stock options and these company stocks that become vested every cycle. can't wait to hear your answer.

Thank you so much for the question. Paula, I love this question because, as always, we're working on a theme here where in at least two of our three answers, we don't start off by directly answering the question. We start off with kind of the rubric of how do we think and back away. And then we answer the question. Thinking about how to think, metacognition is what the show is all about. This question, the answer is. answer always begins with, what is my goal? Because if I begin with my goal, I'm not going to make mistakes. Now, why is that so important in this case? When I'm talking about stock options,

so for people not familiar with stock options, I don't really own the stock. I have an option to buy the stock at a set price. And let's say the stock is trading just to keep it easy at $10 a share. and that's where my option price is. Now it goes up to $12 a share, $13 a share, $14 a share. So the cool thing, Paula, is that I can exercise my option to buy it at 10. The stock's already at 14. And cha-ching, I just made a 40% hypothetical return on my example. So even if it goes from 10 to 11, there's a 10% rate of return, which is incredible, right?

So this question is a question back when I was a financial planner. I got all the time from people because I would go into companies and help the workers understand their benefits. I was in a part of their benefits package. So I was this third party guy coming in going, hey, if I were you, this is kind of the way I think about it. And the way I think about this is exactly the way loose that I think you're thinking about it because when you said, I already have nine percent.

on my portfolio of my company stock already. So am I looking to accumulate? Am I looking to buy stock of other companies? And I'll tell you, I can't answer that question. I can tell you that pros across the board will tell you going above 5 to 10 percent of your portfolio in one company, especially the company that you already rely on for income, gets you into this danger zone, where now the standard deviation, the risk, the ups and downs that you will have because of this one company, your employer, becomes bigger than anybody would advise just from a risk management standpoint. So I'm assuming that your goal is to have a higher net worth and that you're not comfortable with more than the 9% you already have in this company stock.

Right. Maybe 10% at the most, but it represents a lot of over-concentration. and we have seen historically over and over and over so many examples of people who were employees of Procter and Gamble and then the stock crashed or worse, most dramatically employees of Enron. Yeah. And Enron is a great example because that was a huge company and very few people knew the mold that was inside of that company, the things that were happening. And so many people ended up losing their job over information. that was not commonly available. Right. So I don't want to take that risk. But let's say that you were trying to accumulate.

I'm going to start there. If you were trying to accumulate the stock, it frankly almost doesn't matter what the difference is in price because the stock's going to go where it goes. So heck, exercise it wherever you feel comfortable. Put the stock in your portfolio and now you own the stock. That is your goal. Now, riding somebody else's money as far as you can is a great strategy.

if you don't want to own the stock, right? And generally, because the market goes up about 70% of the time, over long periods of time, it usually behooves you if you're not trying to accumulate to just wait until just before the expiration date of that option and then pull the trigger on the option, because that gives the stock as much time as possible between the price that is the strike price,

meaning the price they're going to let you buy it at and the price it's currently trading at, it makes that delta bigger and bigger and bigger just because of the time value money, I want to wait as long as possible. So my answer is assuming that you don't want to accumulate more of the stock, I would highlight circle, put red beacon alarms, because you don't want to miss this date, right?

If you go one minute over the expiration date, your opportunity's gone. You can't do anything with it. It's gone. So maybe a week or two before, pull the trigger on those stocks and then diversify it according to your goals. It's the same, by the way.

You asked about RSUs, restricted stock units. Restricted stock units, you already own that stock. it is your money, but there's restrictions, and it's usually tied to the amount of years that you're going to work with the company. So this is Paula, a golden handcuffs that a company will put on you going, hey, as long as you stay for the X number of years, these are yours. But they tell you they're yours now. The way to think about them is they're not yours until that day that they become unrestricted. Right. When they become unrestricted, I want to have a financial. plan that doesn't look at the stock price, does not bet on the future, does not pay any attention

to what the market is, I want to be systematically unloading this stock at whatever clip you feel comfortable with. When you look at insider trading, where you can go to Yahoo Finance or CNBC, you can look at the board of directors and the executives at a company, you can click a button and it will tell you how these insiders are divesting themselves of stock. You know a really good financial plan when you see I got rid of 5,000 shares the first day of the third quarter, the first day of the fourth quarter, the first day of the first quarter, first day of second quarter. That's when I know there's a good financial team in this person's corner, helping them

slowly diversify out of this position. When I look at insider trading, by the way, and this has nothing to do with Lucis' question, but when I see 35,000 shares go at once and I don't see any other transactions, then I start wondering what's going on with that company because they are trading based on maybe something that they know. Is it something they know,

or is it something going on in their personal life? I don't know. But that's when I get cause for concern. I love seeing, though, this attention to divesting that you'll see with most executives. In a good financial plan, the second those RSUs become available, you go, okay, once a quarter for the next year, I'm going to sell these off. Or if there's going to be more next year, I might just do it all right now. If you want a deep dive into stock options and RSUs, episode 530, which we did with Brian Faroldi, is entirely about this topic. It's all about stock-based compensation.

Episode 530, you can go to that at Affordainthing.com slash episode 530. Where people run into trouble, and I'm sure Brian said this on the episode as well, is when you start going, well, you know, we got this new product coming out. Well, you know, taxes might change. Well, I got this raise this year. And so I'm going to make more money. So I'm just going to don't play those games. When you start playing the games of talking yourself into. deferring, diversifying because of something that might happen in the future, you run into

trouble. I mentioned earlier Procter & Gamble. And the reason I brought it up is because it is a stable blue chip company, right? It feels secure. For those of you who are unfamiliar with it, it is a company that sells a lot of ordinary household products, the types of things that you find at Target, at Walmart, at the grocery store. It's the biggest U.S.-based maker of household

goods. And it's widely considered to be a safe company, but in March of 2000, its shares plunged 30%. You had at that time a lot of people

who worked at that company, who had a ton of company stock thinking, this is Procter and Gamble. The dominant thinking was you can't get safer than that. It's a blue chip, stable, stalwart company. So you had these people who not only relied on P&G for their paycheck, but also had an enormous amount of their portfolio in their company stock. And boom, 30% for the type of company that they're not an innovative tech company that's running a lot of

risky bets. And I love that as a stable company, but let's look at some of the market leaders. I mean, let's look at an example that's close, man. If you work at Nvidia, the last few years, you're like, our stock cannot go wrong. Like, I am just going to keep loading up on my stock. I could do the S&P 500 thing, but that's crazy. We are the S&P 500. We are in video. Like, this is the thing. Why would I invest anywhere else? You can imagine people telling themselves that and then this little Chinese thing happens a couple weeks ago deep seek yeah and in one day bam the gig is the gigs may be up right yeah they just don't know 17% in one day which granted you know when you drop 17% after growing 700% you're still doing well yeah yeah you're gonna be okay

however just the thinking there is still not the thinking that that that you're want to have. No matter how market dominant when it comes to Nvidia or Procter and Gamble, they were market dominant too in their industry. Right. Exactly. And just a textbook example of a stable blue chip stock. You could say that about like Coca-Cola. Right. You know? I used to work, by the way, at a bottling plant. Oh, it was so depressing. You're welcome. Oh. Well, Luce, there's your answer. There's also your dad joke of the day. By the way, Cheryl asked me to sink her phone the other day, so I threw it in the river. She's still angry. And there's our sign that we need a sign off.

All right. I'm just getting started. What are you talking about? Lou's, thank you for the question. And best of luck with everything that you're doing, all of the wealth that you're growing. Joe, where can people find you if they'd like to hear more dad jokes? You can find me and the stacking Benjamin's crew, which includes on most Fridays, the Paula Pant at the stacking Benjamin's show. And we've got a very fun February and March coming up. We are right now arranging a discussion in the next few weeks. I don't have it booked yet. So should I jinx it?

I'm going to go ahead and jinx it because I think it's going to happen. We're going to talk to one of the top female sports agents in the country, in the world. and we're going to talk about treating your career like you're a rock star, like you are somebody who is a professional. And I see us, we don't do that enough. We don't do that enough. We don't think about, you know what, I am this amazing human being. And if I start treating myself like the amazing human being I am, how would I make decisions differently? And Molly Fletcher's your name. Molly Fletcher says, you'd make a lot of decisions differently. Wow. I can't wait to hear that interview. It's going to be awesome. But not.

as awesome as Paula Pantt winning the trivia, like just happened. Even a broken clock is right twice a day. I don't know. You certainly know your fraud prevention. I'll say that. Well, Joe, thank you for joining us once again. And thanks to all of you, the Afforder community, for being such an amazing community. If you enjoyed today's episode, please do three things. First, subscribe to our newsletter at Afford Anything.com slash newsletter. It is completely free. Second, share this episode with your friends and family.

It's the most important way you can spread the message of great financial health. And third, open your favorite podcast playing app and leave us up to a five-star review. Thank you again for tuning in. I'm Paula Pant. I'm Joe Sol C-I. And we'll meet you in the next episode. That's my ADD right there. My pest control people.

calling me. Is that your cat's job? It is.