Afford Anything - Q&A: When a Million Dollars Feels Like a Burden

Episode Date: November 8, 2024

#556: An anonymous caller was raised to work hard, live below his means, and save. He feels undeserving of his recent $1,000,000 inheritance and struggles to spend it. What should he do? Jack bought a house with a seven-year adjustable-rate mortgage. He’s confused about when and how he should refinance out of it. What should he do? Jack is also wondering how to do the breakeven calculation between contributing to a Traditional IRA with upfront income tax savings versus a Roth IRA with deferred savings on investment gains. Former financial planner Joe Saul-Sehy and I tackle these three questions in today’s episode. Enjoy! P.S. Got a question? Leave it at https://affordanything.com/voicemail For more information, visit the show notes at https://affordanything.com/episode556 Learn more about your ad choices. Visit podcastchoices.com/adchoices

Joe, when you were a financial advisor, did you ever have clients who came into sudden wealth? I did. And it is the toughest time, Paula, because as you can imagine, you are emotional about the money. You may be emotional about the circumstances by which you receive the money or the people you received from if it was an inheritance. But heck, I mean, even if you won the lottery, Paula, it's an emotional time. And so many people listening might think emotional like, great, who wouldn't want, sudden wealth, but it is actually quite challenging. Yeah, absolutely. I think you feel this weight of responsibility to do the right thing with the money.

Well, we are going to talk today to someone who came into sudden wealth and is now grappling with what to do next, particularly because his entire life, he has been save, save, save, save, save. And now, suddenly, he's playing with different decimal points. He's playing in a pool of orders of magnitude different than anything he's ever really been accustomed to. So we're going to talk to him. We're also going to talk to a listener who has an adjustable rate mortgage that he's going to have to refinance and is wondering how to game that out. And also, we're going to have a discussion about Roth versus Trad retirement accounts. Welcome to the Afford Anything Podcast, the show that understands you can afford anything, but not everything. Every choice carries a trade-off.

And that applies not just to your money, but to your time, your focus, your energy, your attention, to any limited resource you need to manage. And that opens up two questions. First, what matters most? And second, how do you make choices accordingly? Answering those two questions is what this show is all about. My name is Paula Pant. I trained in economic reporting at Columbia and I help you prioritize every other episode we answer your questions and I do so alongside my buddy, the former financial planner Joe Salci-high. What's up, Joe? Hey, I am sitting here with a cup of luat coffee ready to go. Have you had luat coffee? I have not. What is this coffee?

Luat coffee has a better name. I think luat coffee is the marketing name. Wait, is this the Asian civet poop coffee? This is more commonly known as Weasel poop coffee. Yes. Weasel poop coffee. When I was a freelance writer, I used to be a full-time freelance writer, I wrote an article for specialty coffee retailer magazine about weasel poop coffee. It actually doesn't come from weasels. It comes from the Asian civet. Yeah. And they eat the coffee beans and then poop it out. And there's something about that digestive process that makes the coffee beans taste better, I suppose. There's two things. There's a digestive process, but there also is the animals only pick out. They're very discerning and they only pick out

the best coffee beans. It is the least acidic coffee I've ever had. As you know, because you've written about it, there are places in New York where people are paying $100 for a cup of this coffee. And I got it when I was in Southeast Asia recently. And it's amazing. It's so good. Well, I hope that you use the energy from that coffee to bring it for this first question, which comes from an anonymous caller. Hey, Paul Lundjo, anonymous caller here. I'm 32, work in accounting and make about $80,000 a year in salary. I'm single and rent an apartment where I can pretty easily afford my fixed costs of living with my salary, paid off old car, no credit card debt, no student loans. My question is more money psychology-based. My grandfather, who passed away in 2012, had set up a trust for me that I gained control of two years ago when I turned 30. The account

is worth about $1 million, with about $50,000 in a money market fund, and the rest is invested in mutual funds and single stocks. I really haven't done anything with the account, except reinvest the dividends and mostly operate as if it's not there. I've been raised to live below, my means and work and save, save, save. It feels strange to all of a sudden have a lot more wealth than my close friends, and none of them are aware of this change. And it's weird to inherit this much money because it feels unearned. I became a money nerd before I got control of the trust.

I have about $100,000 invested outside of the inherited account from my 401k, HSA, Roth IRA, and a taxable brokerage account. I max out my Roth and HSA, and with my employer match, I get up to 15% into my 401K. I'm putting aside money for a house down payment as well. That all leaves me really tight as far as money left over for non-essential spending. Knowing the power of compounding makes me want to not disrupt it and keep feeding money into the machine. Since I have no idea what my life will look like in the future, and I want to have a family and home and leave behind money like it was done for me,

It's really hard to predict how much I need, since that's so different from where I'm at now, and I always find myself on the overly cautious side with money. I didn't want to use the term Coast FI for Joe's sake, but it kind of feels like maybe that's been reached. What kind of things do you tell people once they reach that sort of critical mass with investing and maybe they can afford to back off some? Or should I keep going, since I don't know what the future is going to hold? You've had discussions with people about windfalls, from inheritances and waiting to mourn and not make rash decisions.

And now that I know that I won't go crazy with it, after that period, what do you kind of tell people whose financial life has completely changed in a positive way to help them feel safe about using that money finally? All right. Thank you. Anonymous, thank you for the question. It is such a beautiful question.

And the first thing I want to say is that your grandfather is very lucky to have a grandson like you. because there are many people who devote their lives to building a legacy for their future generations, for their children and grandchildren. But there's wide variation in how those children, grandchildren actually treat that legacy, with some squandering it, with others neglecting it, which is kind of a derivative of squandering, but not in a spendy way, just in a avoidant way, with some falling victim or prey to scams, which is perhaps one of the saddest outcomes of a legacy,

there are many, many ways that legacies can go wrong. You have had control of this for two years, and over those last two years, you have handled it beautifully. You also generally, in other arenas of your life, practice financial responsibility. So you are a well-qualified recipient of the work that your grander. father has done for you. So that's the first thing that I want to commend you on. The second thing is we have to give you a name. More important. Right. And Joe, I've got one. Oh, good. So there is this syndrome. It's called sudden wealth syndrome. And sudden wealth syndrome symptoms include feeling isolated from your former friends, feeling guilty about your good fore. And sudden wealth syndrome,

having an extreme fear of losing your money. It can cause stress. It can cause confusion. It can cause adjustment issues. There are many, many cases of people who have had to grapple with sudden wealth syndrome, people who come into that sudden wealth and have a hard time adjusting. J.K. Rowling, who famously was a single parent struggling to pay rent and then became a billionaire. in rather quick time through the success of Harry Potter. J.K. Rolling is one of many examples of someone who has suffered from Sudden wealth syndrome. Celine Dion, another example. She was one of 14 kids.

They had no money. And of course, now she has a ton. So there are a lot of examples of athletes, of actors, of musicians. One of the most prominent examples is a couple by the name of Willie and Donna Seeley. they won the Powerball in 2013. They won $3.8 million through the Powerball lottery. And they went through extreme depression and paranoia. The reality is that sudden wealth can lead to a bit of an identity crisis and a reckoning.

And it's unfortunate an experience for which the wider world does not have a lot of empathy. If you try to talk about this publicly, if you ever try to talk about it on social media, everyone's going to be like, play me the world's smallest violin. Boohoo. But it's unfortunate that people are so quick to invalidate the emotions of those with money, because people with money have emotions that are just as real. People with money have stresses that are just as real. So, anonymous. I would like to name you Stephen after Stephen Goldbart, who is the psychologist who coined the term

Sudden Wealth Syndrome. Stephen. And I like that too because by identifying what the issue is, it's easier to solve the problem. Right? The first step is identification. And I love that Stephen has identified that he's really not sure where to go from here. And like you, Paula, I love the fact that he has done nothing. Right. yet that that's the best when in doubt do nothing yeah which also paula brings up the critical

piece of information that we truly need to help out which is this maybe you could slow down like you suggested because you said it's a little tight you could change your lifestyle today you said you want to buy a house you could maybe buy the house early the biggest issue that I have, Paula, is I don't know what Stephen wants. And I think when you start with what do I want, which becomes, by the way, talking about problems, when your wants are controlled by a limited supply of assets and income, it's actually an easier question because the field is very narrow. And now Stephen suddenly has a million dollars which could every seven, eight, nine years could double. He's potentially looking at a lot, lot, lot more money than that if he saves it for later in life.

So this potentially is a $10 million problem, not a $1 million problem. So the field of what can I do becomes much more open. So I know there's a lot of people listening that'll go, oh, this is easy problem. If I had a million dollars, I would. And you don't. You freeze and you think that I'm going to do the wrong thing and I'm going to blow it. You see people blow through powerball money all the time. We read it over and over and over.

We see pro athletes who blow through their income, huge income stream only to realize later on that they made a bunch of unforced errors. And you don't want to be that person. I think it's a critically important question. Here's what I wouldn't do. I wouldn't change my lifestyle just because I can. And I kind of heard a little bit of that in the question. Should I back off my savings?

Should I back off what I do now? If you're comfortable doing what you do now and you like doing what you do now, pretending like that money doesn't exist and continuing your lifestyle if you like it, all that does is buys you flexibility in the future, which you mentioned, I might want a house, I might want a family in the future. If you just keep going the way that you're going and have this as money, that buys you flexibility, that's a great thing to do. You don't have to do anything now.

But if you've always thought, I would like to live a little bit more extravagant lifestyle today. I will take that million dollars and I will leave it invested and I'll slow down the investment into my 401k that frees up cash flow. And I can now do some of the things that I felt like I wasn't able to do before. Fine. The issue is, Paul, a lot of the time, people make these decisions in a vacuum. And I think what Stephen is feeling, rightfully so is that the Stephen Covey conundrum of the stick, right? If I do this with a stick today, the other end of the stick comes with it. If you pick up one end of the stick. If I pick up one end of the stick, there's going to be the other end that comes with it. And people forget that.

There's going to be a consequence. So if I expand my lifestyle today, I am not going to have the flexibility tomorrow. Let's go to the other side. I don't expand my lifestyle today. there is a possibility I may pass away and I never enjoy myself the way that I thought that I could have. So each side has a consequence that comes along with it. And I think this is a very serious game of which consequence am I most comfortable with when I decide to do this, which is why I think you start with what do I want to do. Given that Stephen is 32, and from what I heard in his question, His future is totally open.

He might meet somebody that he wants to marry. He might not. He sounds like he's maybe hoping for that, but that's not a guaranteed thing. So he might want to buy a home. He might want to start a family. If he does, who knows, he may or may not need IVF. He may have one kid. He may have three kids.

He may have eight kids. I don't know. There are so many unanswered questions about his life. And so I think that, as he pointed out, you hate the term coastfi. But I do think the concept is really appropriate here because I think that he can take this million dollars, bucket this as money that he will use when he is age 65 plus, and then use the remainder of his money to save for these shorter term and more ambiguous goals. So use it to lock in the far future. Yeah, exactly. Then he also has the peace of mind because there's such an emotional component of receiving an inheritance.

In theory, money is fungible. In theory, any $1 can be substituted for any other $1. But what we know from behavioral economics is that if $1 was given to you from your deceased grandfather who spent his 30s and 40s slowly building it, whereas a different dollar was given to you buy your boss in your paycheck, for which, let's be honest, you were kind of scrolling Twitter for an hour at work the other day anyway, you're going to value that dollar from your grandfather far more than you're going to value a dollar from your last paycheck. We attach emotion and value differently to each dollar, you're saying, even though

the money has no emotion. Even though money is fungible, there's a different emotional weight to different buckets of money. And so I think one of the benefits when you get an inheritance that saying, I'm going to put this into a bucket for when I am age 65 plus is that you know that it will be there for you when you are in your most vulnerable phase of life. Because it is when we are seniors that we are most vulnerable as adults. What are the two times in a human life that you have enormous vulnerability? It's when you're under the age of 10 and when you're over the age of 70. In the absence of a goal that Stephen told us, I like that strategy. I would prefer Stephen to assign what do I really want to do.

I'd still want to hear that. But in the absence of that, Paul, I love that. But here's why I love it. I love it because if you secure the future, it makes your decision-making process in the present much more value of life focused than what do I need to do to get through to tomorrow. There was a piece. I've told my story here before, but there was a time when I was just worried about the next paycheck. I couldn't think about what strategically I wanted to do with my money because I had to be so tactical. Every dollar mattered to get out of the hole that I dug

myself into. I had to assign my future income to the next day and the day after that and the day after that. But knowing that Stephen doesn't need to do that, he can make career decisions with a much more clear head, can decide on life path, much more based on what do I want to do than what do I feel like I need to do. It clearly buys so much flexibility in the present by securing the future. The other thing I like about this discussion is that because there is no time frame that this money's been assigned to, it's impossible to know if Stevens' grandfather's investments are appropriate or not. This was a question I got a lot. Hey, I got this narratives. Do you like these stocks? Do you like these mutual funds? I don't know. But once I know, Paula, what the time frame is,

then it's much easier to apply that lens to. Is this appropriate? Or should this be sold for something that's more appropriate. Right. And so by virtue of assigning a time frame to this bucket of money, and in this case, that time frame will be when Stephen is age 65 plus. It solves the asset allocation question as well. We know. Yeah. I mean, we don't know exactly what you want to do. There's some more questions there, but it certainly takes this huge field of investments and narrows it by a ton. Exactly. We know we're investing on a 30 plus year time horizon. Yeah. And again, given that this is an inheritance, the emotional heft to inherited money is the lingering question, would my grandparent be proud of the way that I handled this?

And I think anyone who takes that a bucket of money that was passed down to them and says, I'm going to preserve this for my own retirement. I think any grandparent would be proud of that, right? Absolutely. And honestly, a lot of it goes back. back to when you're in your 30s or 40s or 50s, assuming that you're healthy, you have the ability to go stand on your own two feet. Assuming that you're healthy when you're in your 30s, 40s, 50s, 60s even, you're in the prime of your life and you can go out there and make it and be a grown up.

So emotionally, it can be a little bit more difficult to think, oh yeah, my grandparents sacrificed for their entire lives. so that I could have extra padding during a phase in my life in which I'm perfectly capable of taking care of myself anyway. By contrast, if that money is saved for those more vulnerable senior years of your life, those elderly years of your life, and then you redirect the paycheck that you're making today into those shorter-term goals, buying a home, possibly getting married, possibly starting a family, maybe traveling, whatever that is that you want to do in five, ten, ten, fifteen years, you get the solace of knowing that your grandparents

would be proud of how you preserved their money. And you also get the pride of knowing that you built your own adult life through your own effort and volition. I think there's a big part of adult self-actualization in which we need to know that we build a little bit. built our own path, that we paved our own way. You look at even very wealthy children who technically don't have to work, Paris Hilton, right, could have easily not worked. She built an empire valued at over $100 million. Why?

Because she didn't want to just have a handout from her parents. She wanted to put in the 7 a.m. mornings, the conference calls, the meetings, the slack threads, like she wanted to put in the effort to build something of her own. And that is so common among even the richest amongst us. There is, I think, a very innate human need to know that this life I have is one that I built. I think on the tactical side, don't forget, though, if your company's giving you free money in terms of a match, I would still, Paula, build that in, make sure, make sure that you take advantage of any spot where there's there's free money, I wouldn't give that away. But direction, I really like where

you're going. The other thing that I will also say is even directionally, if you told me what you want, I still directionally like the bias toward what Paula is telling you, Stephen. I like the bias toward later with that money and securing later. That said, it doesn't have to be an all or nothing. You could assign part of it to now to maybe help with the house down payment or whatever it might be. You already have the 50,000 sitting in cash from the inheritance, maybe part of that. But it doesn't have to be just all one way or all the other way. But I do like the bias of what Paul is saying toward use this to secure the far future and then work back toward today and build it for yourself.

And the last thing I'll say, Joe, what you just said reminds me of a call that we answered on a recent episode from a caller who said that she was working towards work optionality. And the way that she approached it was that first she completely filled the bucket of age 60 plus. And once that bucket was filled, now she's trying to infill the bucket of age 30 through 60. Yeah, I remember that. That was great. Yeah. And that framework, that approach is, I think, a very smart one because it's life planning, taken from you start at age 100 and then you just work backwards to today and you do that incrementally

in buckets of a decade at a time. It gives you a great feeling doing that too because you know that once you reach X spot that I am very comfortable pivoting. I can be incredibly comfortable doing something completely different because I know that I get to X date the things are going to be okay. And it's funny because it isn't so much about reaching that line as it is knowing that that line exists and exactly where that line is. Or you're never going to know exactly where it is, but you get my meaning that I know it's probably going to be in 2031 or 2035 or 2050 or whatever that line is. I know, is that I'm going to be good after that date. I think a lot of people have difficulty with uncertainty. I certainly do.

just when there's something out in the air, let's say that Paul and I were having a chat and Paula says something very weird and I don't know what that means, whatever she said, I will spend the next six hours going, what do you think Paula meant? What's she mean by that? And it will drive me crazy. Joe, I said, how's the poop in your coffee? What do you mean? So I have to pick up the phone just because I don't like uncertainty.

I would like, Paula, what did it mean when you're, You said that. So I'm not alone there, though. I know that when I was a financial planner, just the certainty of, yeah, I might have to work harder or the certainty of I don't have to work as hard. Just knowing and getting rid of that is so important, I think, to the human psyche. And definitely influences our behavior. So, Stephen, I hope that was helpful. I want to commend you once again for being such a worthy recipient of your grandfather's efforts. So thoughtful with this money. Thank you, Stephen, for asking that question. And best of luck. We're going to take a break to hear from the sponsors who make this show possible. And when we return, we will tackle two questions, both from a caller named Jack.

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That's W-A-Y-F-A-I-R.com. Sale ends December 7th. Welcome back. Up next, we're going to talk about refinancing a mortgage. And after that, we're going to tackle a question about traditional versus Roth retirement accounts. So our next two questions both come from Jack. Hi, Paula. Jack here.

I'm calling in to get some advice on a soft spot I have in my personal finance knowledge. And that's concerning the area of refinancing a mortgage. So my wife and I are proud homeowners. And our first mortgage payment was June 2023. And we got an adjustable rate mortgage seven year that kicks into gear, I guess, June 2030. So we got this on a physician-assisted mortgage plan, which for your listeners out there, if they don't know about it, great option. for doctors who are going through medical education. We did $0 down, got a 4.875% mortgage rate on a $435,000 house to give you a few more

facts that maybe will help the situation. Our credit's good. It's over $800. And we could outright buy the house, but we've decided to have the money stay in the market rather than pay down the interest that we'd have to pay. We're in a good place, but basically, I don't know the first thing about refinancing. and I have been led to believe that come June 2030, I could get whacked with something way higher than 4.875% interest rate. We don't plan on ever selling the house.

We want to basically be landlords if we ever move to a bigger place or we might actually expand the house if we welcome some children and the family. But this is all to say that at some point we're going to need to refinance either by the force of the end of the seven-year period or voluntarily. and I don't really know what goes into that. So do I have to use the same lender? Should I do it now? Should I do it later? Is this something that I will have to pay closing costs for if I do it now? And I would have to do it, wouldn't have to pay closing costs later.

You can tell. I don't really know much about this. So hence, why I'm leaving you this voicemail? Thank you so much for the podcast and all the advice. And I look forward to hearing what you have to say. This is a fabulous question, Jack. Thank you so much. And it's really great, Paul.

This type of decision making I love because we often will go to work and will make very pragmatic decisions on behalf of the organization we work for. And then we come home and our emotions get involved. And we really, for this question, Jack, we want to put on our CFO hat. If I'm the chief financial officer of my company, that's the way I want to think. And so the cool thing is the CFO of your family, aka you, you've a lot, a lot, a lot, lot more flexibility than you may realize because let's say that your time runs out on the adjustable rate mortgage. Seven years comes up.

The critical thing that the CFO needs to know is if you do nothing, what will it adjust to? And that'll be in your contract. And often, Paula, as you already know, but a lot of our audience may not know, is maybe it goes up 1% per year until you do something or until it finds equilibrium, whatever equilibrium means, prime plus, whatever the thing might be that it will adjust to. There will be a cap on how high it'll go. I want to know what that is. I want to know every year that I do nothing what it goes to because if you're sitting at 4.875%, You may have another year where the interest rate is higher than it is now, but it's still lower than anything else that you can get. I seriously doubt it because even if he made that move today, there may be products, which will allow him to get fairly close to 4.875, but they're going to adjust very quickly. Like if he does an adjustable rate mortgage, Paula, that's going to adjust day after tomorrow,

right? Somebody might give him some money that is on a very short timer for a lower interest rate. Basically, Jack, what happens is the longer the period is that the company is going to loan you money for, the higher the interest rate is going to be. The quicker that you're going to repay them, or the more certainty they have they're going to repay them because it's quicker, the lower that interest rate will be. So I don't know what the interest rate is today on a one-year arm. I can see the look in Paula's face.

She's probably looking it up right now. But there are some adjustable rate products that are going to give you a lot of flexibility in terms of interest rate that allows you to, to use a football metaphor, punt the ball down the field, meaning delay my long-term decision-making until later because interest rates aren't where I want them to be. So in the next seven years, I don't know what's happening. I do know generally that right now interest rates are expected to lower

over the short run. So I'd be paying attention to over the short run, is there an opportunity for me to lock this in to a fixed rate product instead of the adjustable rate product that I have now? Is there an opportunity? So the show to answer what you just mentioned earlier, the current rate on a one year arm as of, this is actually as of a couple of weeks ago, was 7.125%. Okay. And you and I know that's going to come down. Yeah, exactly. I want to take a pause here and zoom out and give a little bit of a broad lesson on how arms adjustable rate mortgages work. Let's do it. There are four variables that you need to know. The first variable is the obvious one because it's right in the name. It is what is the period of time for which the interest rate is fixed? So Jack, you've got a seven year arm. That means for

seven years, your adjustable rate mortgage is going to stay at 4.875%. So on a seven-year arm, that interest rate, it stays fixed for seven years. On a five-year arm, the rate stays fixed for five years. On a 10-year arm, the rate stays fixed for 10 years. Three-year arm, it stays fixed for three years. You get the picture. So that is one of four variables that you need to know, and that's the most obvious one because it's right there in the name. There are other three variables that every person who's considering an arm should know. And that is the periodic increment of time that the mortgage adjusts, the amount that it can adjust per adjustment period, and that maximum cap, which Joe talked about earlier.

So, for example, and this is just a hypothetical, there might be a given mortgage that adjusts once per year. And each time it adjusts, it can go up by a maximum of 2%. This is a bit purely hypothetical. It adjusts once a year. It adjusts a 2% per adjustment period. And it can go up to a grand total of no greater than a maximum cap of 10%. That would be a hypothetical set of variables. There's the adjustment period. There's the maximum rise per adjustment period, and then there's the overall absolute max. Those are the three variables that they're going to be written into your mortgage loan documents so you can read it right there in your loan paperwork. But anyone who's considering an adjustable rate mortgage should know

all four of those variables because those four variables together piece together the full story. At any time during the next seven years and even after, once you, know how much money this is going to go up by per year and what that means for your cash flow, you can make the decision based on cash flow, based on interest rate, based on whatever's going on in your family. So as an example, if you just want to delay the decision a year and get the lowest rate possible, you may do a one-year adjustable rate mortgage. There are even products that are one year, adjustable rate, interest only products, meaning you're not going to pay down any of the principle because with the difference between 7.x, what's the one year,

Paula? As of a few weeks ago, current rate on a one year arm was 7.125%. So if you're just solving for payment and you don't like how much the payment is going up, you could do an interest-only loan. Obviously, you're not making any headway on your debt. Not my favorite product, by the way. But if you're solving for payment, you can do that. If you're solving for payoff, you can do that. If you're solving for interest rate, you can do that.

So there's going to be, Jack, a lot of levers between now and then. And when you ask about lender, I think my CFO analogy, Paula, answers that question immediately. If you're the CFO of a company, I'm going to look at all different. lenders. I'm always going to compare. It's a check. It's a free market. You are welcome to go with any lender you want to. You have no obligation to stay with your current lender. So I think knowing that the clock is ticking for the next seven years, what I would do is this. I would pay attention to interest rates. I don't know that you're going to find 4.875 again in normal circumstances in a normal market, Paula. But we have no idea what the economy is going to look like in 2030. We don't.

we don't. Maybe in 20209, we'll have a huge market crash or another pandemic or zombie apocalypse. We have no idea. But if I'm going to start making long-term decisions, where do I want to be and I want to get away from a adjustable rate mortgage, I want to use a longer-term lens of where a market's been historically. Right. And you know, a third year. I'm being slightly facetious with the zombie apocalypse. Yeah. I had no idea. Trying to underscore the uncertainty. We cannot predict. black swan events that could throw the best laid plans out of whack. But I think over long periods of time, if we look from the 1950s, let's say, to today, so that gives us 75 years-ish.

If you find something in the sixes that you can lock in long-term 30-year fixed, that's a good place to start making permanent decisions because any time interest rates have gone below six. We're in a pretty extraordinary market at that point. So if your goal is to lock in a long-term interest rate, and you get probably 6.5 or less if we get to that point, then I'm making long-term decisions. Obviously, if you can afford to make a long-term decision before that, that's at a higher interest rate and buys you more time, I don't know if I'd do that or not. I really don't know if I would do that or not or wait until we get closer to that seven year mark and maybe refinance into another adjustable rate mortgage to just keep the interest rate as low

as I possibly can until I'm ready to pull the trigger on a six point, whatever it might be. Yeah, he's got such a good interest rate, 4.875. That's the problem. He's got such a good interest rate. I would leave good enough alone. He could leave it alone for all seven years. Yeah. And probably for another, let's say it goes up by two percentage points.

He could leave it alone for eight years because now he's only at 6.875. And once again, this depends on what it does to his payment and what that means for his budget, which we don't know. To your point, he has more flexibility than he thinks he has. Yeah, I would not refi out of it for the next seven years because I don't think you're going to find anything better. I don't know, Paula. Because interest rates just generally over long periods of time below six and a half

percent are so hard to find. Let's say that three years from now, it goes to 6.25, 30 year fixed, I may make that move because I don't know how long it's going to last. I don't know if it's going to come around again anytime soon. I don't know. And so if he can get below 6.5% and by more certainty, I might do that even if he's at 4.875 and he's two or three years away. Wow.

That's the difference between me. I would not do that. I see where that's coming from based on historic trends. But if we get into an environment where interest rates start dropping, it's because the Fed is creating stimulatory activity. And that might mean a number of things. It might simply be that they have a whole lot of confidence that inflation is under control, or it might be that the economy is contracting.

And we're trying to pull ourselves out of a nosedive. So I would... I think we definitely, Paul, to your point, you and I are both saying right now the Fed, the current Fed likes to telegraph which way they're going. And I think if we get to the point that I've got a 30 year, six and a quarter ability right now, I've got that ability today. I want to look at what the Fed's kind of saying at that point as well. Because to your point, if they're saying we're either going to leave things the same or we're going to lower it, well, then I wouldn't do anything. But if we get to six and a quarter and the Fed signals that we are done lowering for the

time being, then I think historically, I'm sitting in a spot where interest rates are lower than they are than the mean is historically. And they're then just looking at reversion to the mean, the next up move would be then more likely to be up than down. I'm going to go ahead and I'm going to lock at that point. So I guess I need to know where I'm at. Yeah, I'd be reading the Fed pretty carefully. I'd be spending a lot of time looking at economic indicators because the question is, is the Fed trying to stimulate the economy because we are heading towards a recession, in which case there's a likelihood of interest rates continuing to drop? Or are we simply mean reverting? I generally, and this is you too, Paula, we generally on this show tell people, don't pretend

you have a crystal ball. Don't pretend that you do. I will say this, though, the Fed, makes it really easy. Like out of all the indicators we get. Yeah. This current Federal Reserve anyway likes to give you a roadmap of what they're thinking and where they're heading. And it isn't looking into a crystal ball. They are telling you, hey, when we meet again, we're probably going to lower.

It is not like deciding where Microsoft stock's going to go next week. If you ask me where Microsoft stock's going, I have no idea. If you just met what the Fed's going to do, I'm like, they're probably going to lower interest rates. Yeah, there are a lot of indicators that can sort of feed into that. You look at the jobs report, you look at unemployment claims, you look at- yeah, CPI. Yeah, exactly. You look at CPI. You look at R-Star. There are a lot of indicators that you can sort of pull together in order to get a much more clear picture of where interest rates are going to be headed. Yeah. But I don't think he needs to worry about that until 2030. If he just has such a good

interest rate right now that, again, I would leave good enough alone until... I think I would not. I would look at what the Fed's doing. I would, anytime I have any adjustable rate product, I want to know where safety is today. And what the trend is, is it towards safety years it away from safety. And that means, in this case, interest rates going down is safer, interest rates staying the same with the probability of trending up that I'm losing safety. And if I find that I'm losing safety, then if I'm the CFO of my company, I want to think about how dangerous it is to leave things the same. And certainly, Paula, to your point, 2030 is so far away right now.

If the trend reverses in the next few months and interest rates are headed up, I'm staying right where I'm at, right? Because it's so far away. But if it's 2020, late 2028 or 2029, I'm thinking much more about what my options are to extend that clock. Part of the question, one unknowable piece of this puzzle, is, after those seven years expire, what is the periodic term in which his rates go up? What is the duration of that periodic term? Is it a year? Is it six months? So what is it?

The other question that we don't know is how much will that mortgage rate go up in that first periodic term? And then, of course, the third question we don't know is what is the absolute maximum? What's the worst case scenario? What's that cap? Those are the three questions that would also play a role in any, year 2029 decision that he makes. One question that I may also ask of your current lender is, is there a possibility to recast this mortgage? And I don't see this a lot, Paula, on adjustable rate products. I see it much more often on fixed rate products. But I wouldn't not ask this question. I would definitely ask it. Recasting your mortgage means you're going to change the interest rate on the product without changing the length of the mortgage.

So if he gets a favorable interest rate that he wants to lock in, he may be able to have a 23-year mortgage at a fixed rate, you know, because he's already seven years in, a 23-year mortgage. So he's still on the same payment, still the same payoff time frame, not have to do the full refinance. And sometimes the fees to get that done are much, much lower. So sometimes $250, $350 to do that versus all of the pain of a refinance. Recasting a mortgage is also a question I would ask when you're looking at all of your options. I don't think in this case he'll be able to because it's an adjustable rate product, but... I'm not familiar with recasting on an adjustable only on a fixed. Yeah, I would still ask, though.

I'm guessing that the duration of his adjustment is probably one year. He didn't say that he has a 7-1 arm, but that seems to be the most... For a 7-year, that seems to be the most common. I would totally bet it's a 7-1. Yeah. But he didn't say it, so I don't... want to make that assumption. But just to broaden this out for everybody, when you are looking at a mortgage, remember how earlier I said that the mortgage is described as the fixed rate period

of time? So five-year adjustable rate mortgage keeps that interest rate for five years, a seven-year mortgage, which Jack is what you have. A seven-year adjustable rate mortgage keeps it for seven years. Well, there's another number typically after that that indicates the duration of time after which it adjusts. So if it was a 7-1 arm, for example, then it's a fixed rate for the first seven years, and then that duration is every one year. So for example, if a person has a 5-1 arm, then they know they've got that fixed rate for five years, and then that duration of time is every one year subsequently. If a person has a five arm, it's a duration of time fixed rate for five years, and then it adjusts every five years. Typically with a seven-year mortgage, those usually commonly come with seven-one arms, but Jack, I don't want to make that assumption because you didn't say that it was a seven-one arm. You said it was a seven-year, and I want to be very cautious about making any assumptions that are not stated within your question.

So I would absolutely check your loan documents, but I'm guessing you likely have a seven-one arm. That is the most probabilistic answer. What we don't know, again, is how much it will adjust in any given one-year increment of time, nor do we know what that maximum cap is going to be. However, those are knowable numbers. They're in your contract. They're in your loan documents. You can just look those up. Yeah. The answers to those two questions will, I think, resolve the disagreement that Joe and I are having right now over whether, in my view, to leave good enough alone or in Joe's view, to lock in

that bird in the hand. Well, and here's what would change my mind, Paula, as an example, if it only goes up by 1%? Yeah. If it only goes up by 1% per year, in year 8, then it's at 5.875, still much better than historical averages. The next year, 6.875, still not bad. So I almost look like he's got nine years instead of seven years where that interest rate still is pretty kick-ass. Right. When it gets to 7.875, not horrible, but not wonderful. And then certainly the next year we need it 8.875 in most normal economic circumstances. That's above average.

But not like the 80s. Yeah, it's an above-average interest rate. We could probably find better. given a one percentage point maximum adjustment per year, he may have safety through year nine, maybe even 10. Yeah. So he may have a long, long time until he truly is going to be looking at doing something. And you can see then mathematically, if it's 2%.

Yeah. If it's 2% that shortens your window for in terms of making a decision. At that point, I'm much more worried about certainty quicker. So Jack and to everyone listening, I hope that will. was a good overview of how to think about adjustable rate mortgages. And remember, the four variables that you want to look for when you are assessing any given adjustable rate mortgage. Fixed duration, adjustable duration, adjustable increment, and total max. All right, well, Jack, thank you for asking that question. And our next question also comes from you. We're going to

take one more break to hear a word from the sponsors who make this show possible. And when we come back, We will have a discussion about Roth versus Trad retirement accounts. Stay tuned. Get you and your crew to the big shows with Go Transit. Go connects to all the main concert venues like TD Coliseum in Hamilton and Scotia Bank Arena in Toronto. And Go makes it affordable with special e-ticket fares. A one-day weekend pass offers unlimited travel across the network on any weekend day or holiday for just $10. And a weekday group pass offers the same weekday travel flexibility from $30 for two people and up to $60 for $5.

yours at gotransit.com slash tickets. Welcome back. Our final question today comes from Jack. Hi, Paula. Jack here. I hope I have a straightforward question. And that's basically, what should I do next year 401K wise? Should I max out the Roth 41K? Should I max out the pre-tax 4-1K or should I do a mix of both? If it helps, I think if I did pre-tax, it would bring us down my wife and I from the 32% tax bracket to the 24%. So that's kind of the ordinary income we'd be saving, at least in the short term. Curious for your thoughts. Thanks. Okay, he doesn't know how effective tax rates work versus tax brackets.

Yeah, exactly. Which is common. Jack, thank you for the question. Remember how for the adjustable rate mortgage question, there are four variables that I need to know from you in order to be able to better answer this question. Now, for this question that you've just asked, Roth versus Trad, there are a few variables that I'm going to need to know from you. And I want to expand this answer out. So for anyone who's listening, who has a similar question, should I put my money into a Roth account versus a Trad account?

Here are the questions that I have. Number one, do you expect that in the future your income will be substantially higher than it is today? Number two, do you expect that in the future your income will be substantially lower than it is today? For example, do you at any point in the future want to take a sabbatical in which you will have either no income or substantially lower income? Do you plan to take any time off for caregiving duties? Do you have any chronic health issues that might render you unable to work for some low? limited period of time, and by limited period, I mean maybe a few years at some point in the future. Do you have a simple desire to take a year off to write a book or to drive a motorcycle across

central Europe? Do you plan on moving to a different state at either in the near future or in your retirement in which your state tax bracket will be significantly different? Do you plan on amassing investments in anything that would have passed through income. So anything that has either an LLC or S-Corp structure, do you plan on becoming a business partner in any of those in the future? Because that will substantially change your tax brackets. The reason that I'm asking all of this is because the fundamental question of Roth versus Trad, unpacking that to answer it at an individual level hinges on your assumptions about how much you are making now

relative to how much you will make in the future. Because what you're doing is you're gaming out, paying taxes at your current tax bracket versus paying taxes at your future tax bracket. Now, in the absence of those answers at an individualized level, if I were to make a broad sweeping generality, in general,

I think it's better to pay the taxes now and therefore to bias towards Roth accounts. And the reason that I think that is because in general, and again, I'm just speaking in generalities, most people tend to have income that goes up over time. Now, again, there's asterisk. If you know you have a chronic health condition that's probably going to render you unable to work for a five-year increment of time, start. in the year 2030, that's a different story. But in general, most people tend to have income that goes up over time, meaning your tax bracket will be higher over time. Most people tend to amass

greater investments as they age, which means that you likely are going to have higher income through LLCs and S-Corp, higher pass-through income from private ownership and businesses in the future than you do today. And then the part that we haven't addressed yet, but that is absolutely unknowable, what are your assumptions about where the government is going to set tax rates? If you assume that the government will raise taxes in the future, that's yet another reason to bias towards Roth accounts today. And the reason that I'm emphasizing how much of this hinges on assumptions is if you know that you are going to move to Puerto Rico or to Dubai, that's going to change the answer. If you know that you're going to be geo-arbitraging into a place where your

tax brackets are going to dramatically change, it changes the story. But in the absence of planning to move to Puerto Rico and also planning around a chronic health condition and a few sabbaticals, in the absence of that, I would bias towards a Roth. That's always generally my bias as well with regard to the government. If we think that at some point, the government, the government is going to begin addressing the debt. It's just mathematics that tax rates will go up to address the debt. They have to go up to address the debt. If we think that there's going to be another avenue that magically appears, then that may be poor. But I do like the fact that at the end of the day, Paula, this is an assumptions answer. And you have to know what the assumptions are

because when you assume something is always going to go differently than what you assumed, and then you'll be able to know the extent of the course correction you'll have to make to make up for what the change is versus what you assumed, which I like, knowing what that delta would be if I assume incorrectly. But generally speaking, I'm with you, my bias is toward the Roth, and then you will talk me toward the traditional 401K given what your circumstances are. And Jack, also, when you said that your tax bracket will go up, one thing that a lot of people don't understand, I don't know if you understand it or not, but your tax going into the next tax bracket is not the huge tax burden that a lot of people think that it is.

I have had married couples, Paula, back when I was an advisor that would come to my office and they would explain to me that one family member works and the other one stays home because all of the money that the person makes who's staying home would be at a higher tax bracket and they did the math and all that money would go toward taxes. So it doesn't make sense. And I would answer, I have great news for you. Right. You get to go to work. Right. Because tax brackets are incremental. So if we start with the lowest bracket, that fills up at the lowest rate. And then starting with the next dollar, that next dollar gets taxed at the higher rate. So if he said the words 24 and 26, that means the very next dollar is at the 2% higher rate. Right. Exactly. So if you imagine your money as a

tiered pyramid, the base of that pyramid, or I guess depending on how much you make, it could be an inverted pyramid, but the base of that pyramid has money that is taxed at the lowest possible rate. Dollar number one that you make, no matter who you are, no matter what tax bracket you're in, dollar number one is taxed at the lowest possible rate. And so it isn't as though you cross some threshold and all of your money is magically taxed at this higher amount, it's that those incremental dollars are taxed at a higher rate. So think of it as a tiered system in which this tier of money or this bucket of money has a given tax rate and this other bucket of your money has another tax rate and this other bucket of your money has a different tax rate. And so when

people say, I'm in the X tax bracket, that number, that X that they're referring to is a reference to the sliver of their money that has the highest rate. What we're really concerned about is what your effective tax rate is. And that's very easy. You go to last year's tax return to find out what it was last year. You take the amount of money that you paid in tax, which will be at the bottom of the back page for most people on their 1040 and look at the top line income that you had come in, which is at the top of the first page. Joe, I want to lay out a little bit about why I biased towards the Roth and why when answering this question in generalities, my typical answer is use a Roth account unless there is a

very specific reason not to. I can tell you mine then too. Oh, okay. All right. All right. Well, I've got two. We'll see if either of these steal your thunder. One of them is because you then are locking in a lifetime of tax-exempt growth. So all dividends, all capital gains, all the growth for the remainder of your life is completely tax-exempt. And given the power of compounding, given how much that money is going to grow, and of course, the younger you are, the longer you expect your life expectancy to be, the more that money is going to compound,

right? The greater the timeline on that investment, the more compounding you have. There's an enormous power to having a tax exemption on all of that compounded cumulative growth. So the math of that is one very powerful reason. So that's one of my two reasons. The other of my two reasons is because a Roth account functionally, allows you to make greater contributions. So think about it like this. Let's say that you have $7,000 and you are either going to put $7,000 into a Roth IRA or you're going to put $7,000 into a traditional IRA. It sounds as though you're contributing the same amount of money and you're just trying to decide, do I put the $7,000 into a Roth versus traditional account. But what is actually

happening is that a greater percentage of your money is getting invested because by virtue of putting that $7,000 into a Roth account and paying income tax on that $7,000, a greater amount of your money is going towards the funding of that contribution. There's the $7,000 contribution itself, plus there's the amount of money that you use to pay the tax bill. And so by virtue of taking that same $7,000 and choosing to put it in a Roth account instead of a traditional account, you are functionally making a greater contribution. And as we all know, it is the size of your contributions that is the single biggest determinant of your lifetime returns.

Yeah, I love both of those. My favorite way to look at the Roth advantage takes your first example, but restates it differently. Ooh, let's hear it. Which is when you make a traditional 401K contribution, every dollar that makes, you are splitting with your uncle in Washington. And it's not even your real uncle is. Uncle Sam.

Ed Slot says, yeah, not even my real uncle. But I got to split it with him. So as I make money, I'm taking the government along for the ride. And the better I do, the better Washington does. And don't get me wrong. I want to pay my fair share, but with a Roth, Paula, and this is, again, just a restatement of what you said, but I like the imagery of this. When I put money in the Roth, a dollar in the Roth, any money that dollar makes is 100% mine. It is 100% mine, assuming that I follow the

rules of the Roth, right? When I can take it out, how I can take it out, and they're very simple rules, but assuming that I just follow the simple Roth rules, it's all mine forever. And then what I like about that is we talked about all of the assumptions, all the assumptions that we make around the tax brackets and tax rates, those are all fine. But when I know that it's mine 100%, the only thing that I truly am betting on is that the rules are going to stay the same with respect to the fact that the government is not going to tax this in the future. So that's my feeling about the Roth and why I buy is toward the Roth. And it certainly makes tax planning in retirement a heck of a lot more fun. Because you get to look at the bucket of money and be like, this is all mine. So much easier.

Yeah. So much easier. Which is another reason the government also has all these provisions that allow you to use the Roth IRA for college. And I will often meet people that will say, you know, I don't like the 529 because what if my kids don't go to college. So I'm going to use the Roth as my college plan. I do not like that because I like, don't get me wrong, I like the rules around college with the Roth, but I like the retirement planning so much better with the Roth.

I would rather find a different means to pay for college and to do any of your college planning, short-term planning, whatever the planning is, leave that Roth money for later in life because you're really going to high-five yourself. that you simplified everything. Right. So, Jack, there's your answer. We both are big fans of the Roth. I would default Roth unless you have a good argument for something else.

Yeah. And if you do, have fun. Enjoy your move to Puerto Rico. Woo-hoo. And apparently, Paula, we do know Jack. Maybe a little. Ooh, we do know Jack. Look at that.

All right. Well, Joe, when you're not drinking civet poop coffee. Delicious. Where can people find you? You will find me, Paula, at the Stacky Benjamin's podcast. Do you know what's going on this week? What's going on? We are playing some of our top mentors, top guests from past episodes.

So for people that have never heard the Stacky Benjamin show, we're going Monday through Friday with some of our favorite episodes. So come join us because it's a fun week. You're having a greatest hits week. It is a greatest hits week this week. Greatest Hits week. Those are fun. Super fun, because we get to pick some of the ones that, don't get me wrong, I think we always have some great guests that bowl us over, but the ones that really made me go, wow, we're playing this week. So come find them at the Stacky and Benjamin Show.

Oh, beautiful. Well, and thank you for tuning in to the Afford Anything podcast. If you enjoyed this episode, please do three things. Number one, share it with a friend or a family member. That's the most important thing you can do to spread the message of having. strong financial health. Number two, subscribe to our newsletter, afford anything.com slash newsletter. And number three, make sure that you are following us on Apple Podcasts and Spotify and any other favorite podcast player you may have. Thank you again for tuning in. I'm Paula Pant.

I'm Joseph. I'll see hi. And we will meet you in the next episode.