BiggerPockets Money Podcast - 161: Backdoor Roths, Mega Backdoor Roths, and Roth Conversion Ladders with The Mad Fientist

Episode Date: January 11, 2021

He’s back! Today we’re joined by a friend of the BiggerPockets podcast network, Brandon “The Mad Fientist”. Brandon walks us through advanced retirement account strategies you may have heard of, such as the Backdoor Roth, Roth Conversion Ladder, and the coveted Mega Backdoor Roth. While these strategies may sound intense at first, they’re quite simple in practice, as Brandon shows us! Many FI (financial independence) followers constantly ask the question “What’s the best retirement account to contribute to that will help me optimize my early retirement?”. While this can be answered a handful of ways, it often overlooks something very important: regular retirement. While chasing FI, it’s still possible to grow your traditional retirement accounts so you’re even wealthier later on in life! Brandon doesn’t just give various examples of each strategy, he’s tested them and has even ran experiments on his site, such as the Guinea Pig Experiment, which pits various early retirement strategies against each other. We also tackle common questions like: what should I contribute to if I have a low/high income, should I opt for a lower deductible on my healthcare plan to optimize my HSA (health savings account), how HSAs and FSAs differ, and what the contribution limits are for retirement accounts. Even if you’re not chasing FI, you’ll still be able to take advantage of Brandon’s advice. After all, he’s the Mad Fientist! In This Episode We Cover What a Backdoor Roth and Mega Backdoor Roth are Why retirement accounts are crucial when trying to retire early How low income earners can take advantage of 401(k)s and IRAs Why an HSA is a great option for high-deductible coverage The best times to contribute to your retirement accounts The art of “frontloading” and using it to capitalize on market gains And So Much More! Links from the Show BiggerPockets Money Facebook Group BiggerPockets Forums Finance Review Guest Onboarding BiggerPockets Money Podcast 18 with Mad Fientist How to Access Retirement Funds Early - Mad Fientist XY Planning Network Front-Loading - Mad Fientist HSA - The Ultimate Retirement Account - Mad Fientist Expirements - Mad Fientist BiggerPockets Money Podcast 120 with Michael Kitces BiggerPockets Money Podcast 119  Check the full show notes here: https://www.biggerpockets.com/moneyshow161 Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to the Bigger Pockets Money podcast, show number 161, where we interview the mad scientist and talk about Roth IRAs, backdoor Roth IRAs, mega backdoor Roth IRAs, and Roth conversion ladders. So the match is the most important thing. If you have some money left over, then the HSA is a great place to put it. But even if you can't max that out, then you can only do what you have to work with. Don't stress out about it. Like, obviously, finding ways to increase income is,

great, but many people are, you know, strapped with time and ability to increase income. So don't feel like you're not doing good if you can't max all these things out. It's really just sort of, yeah, just think of like all these different buckets. And when one fills up, then you move to the next bucket and you can keep filling that up and move to the next bucket. But don't stress out about trying to fill up all the buckets. Hello, hello, hello. My name is Mindy Jensen. and with me as always is my Costco-loving co-host, Scott Trench. I love always getting a free sample of your creative mind in each of these interests, Mindy. I love these little comebacks. They're not even scripted.

Sometimes you're scripted. That one wasn't. All right. That one wasn't scripted. They're only scripted when I read them and they are always terrible. Scott and I are here to make financial independence less scary, less just for somebody else. We're here to introduce you to every money story because we truly believe that financial freedom is attainable for everyone, no matter when or where you're starting. That's right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business, or figure out how to maximize this world of retirement accounts and all the details that go with it. We'll help you reach

your financial goals and get money out of the way so that you can launch yourself towards your dreams. Scott, today we are bringing back Brandon, the mad scientist for the third time. I always love talking to him because he's just a wealth of knowledge. And the way he thinks about optimizing retirement and a specifically early retirement is just really, really brilliant. And I love talking to him. Yeah, I think he's just a genius in this world of financial optimization and figuring out how all these things work together.

It's a privilege to have had him on now three times. We refer to him regularly as an expert in this. And just, you know, I think you'll find his. framework for attacking the problem of retirement accounts and then the HSA, which I really think has to be lumped in with the discussion of retirement accounts because of its advantages, as you'll see as the show progresses. I just think he's one of the, but the smartest people around in synthesizing a strategy around those. Oh, you use the word synthesizing. That's right. We use the word synthesize quite a bit in this episode.

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the Anxious Generation for Parenting Perspective, and several Arthur Brooks' audiobooks that have been excellent for mental well-being. What makes Audible so powerful as its breadth. Beyond audiobooks, you also get Audible Originals, podcasts, and a massive back catalog across business, health, parenting, and more, all accessible in one app. If you're looking to turn everyday moments into real progress, Audible has been indispensable for me over over 10 years. Kickstart your well-being journey with your first audiobook free when you sign up for a free 30-day trial at audible.com slash BP money. Brandon, the mad scientist, welcome back to the Bigger Pockets of Money podcast. I'm so excited to see you again.

Thank you so much for having me. And yeah, it's great to see you guys after not seeing any other humans besides my wife in like eight or nine months. So this is great. Eight or nine months? That's a long time. Yeah, we've been locked down over in the UK a lot harder than you guys have, I think. So we haven't, yeah, it's been pretty tight restrictions since COVID came around. Yeah.

Well, that's how you get rid of it. a pandemic is to not go spreading it to all the people. Okay, so today we're welcoming back the mad scientist. You first joined us on episode 18, where we talked about accessing retirement funds early based on your amazing article called How to Access Retirement Funds Early. I came up with that clever title. You joined us again in early 2020 when the stock market crashed for episode 119, where we talked about staying the course.

And today, I want to talk about specific. Specifically, the Roth IRA, the Roth conversion ladder, the backdoor Roth, the mega backdoor Roth, all the things that help early retirees on their path to being able to fund their retirement. But before we jump into today's discussion, I wanted to read word for word, a section from your brilliant article, How to Access Retirement Funds Early. If you haven't read this article, stop now and go read it and then come back and listen to the rest of this episode.

because this is a great, great article. But here's a part that I think people don't really think about. Standard retirement is part of early retirement. Before we dive into the various withdrawal methods, though, it's worth stating something obvious that people seem to miss. Normal retirement is part of early retirement. People have said to me that they aren't contributing to their 401 case because they plan on retiring early.

That's insane. Even if you plan to retire early, you still need money to live on in your single. 60s, 70s, and beyond. So why not pay for those years with tax deferred or potentially tax-free money? Everyone should utilize retirement accounts for standard retirement age spending, but for people who think they'll have more in their retirement accounts than they'd ever be able to use after they turned 60 and want to start accessing their money during early retirement, here are your options. Oh, maybe I should have read that last paragraph before I read it on the air. But anyway,

people need to be contributing to their retirement accounts when they have the ability to do so. Because once you don't have a job, you can't put money into a 401K, right? If you don't have any money coming in, you can't invest for retirement. So I just wanted to throw that out there because I thought that was very brilliant. Yeah, no, at the time when I wrote the article, it just seemed like, yeah, people were really hard on retirement accounts at the time for, They're like, why am I going to lock up my money for all those years when I want to retire early? And yeah, I was just like, well, yeah, early retirement contains standard retirement. So, yeah, you might as well utilize all the things that are so good for standard retirement,

even if you are retiring early. So, you know, I think that's a very obvious but yet forgotten point when it comes to these retirement accounts, this retirement accounts issue. And I think that one of the things that a lot of our listeners, and I think even Mindy and I struggle with is the amount of jargon, the language of retirement accounts and what's going on here. And this concept of the backdoor Roth, which when it's stated, it seems like it's like this obvious concept that, you know, everyone, all the cool kids, all the smart people are doing. But yet I think it's an overwhelming concept to a lot of people. So, you know, today, the point of today is to talk about how to use your 401k specifically today and how to set up a strategy. that will allow you to retrieve that money, both in normal retirement and an early retirement,

a strategy that involves the backdoor Roth IRA and variance of that that I think you are the master of or the mad fiantist behind the operations of. Is that a fair summary? And then if you agree with that, could we maybe launch into some very basic definitions 101 for people who are brand new to the concept of retirement accounts in general? Yeah, that sounds great. Absolutely. Absolutely. Let's do it. Okay, so I posted this question, or I made an announcement that we were bringing on a Roth IRA, backdoor Roth, Roth conversion ladder expert to the show. And people asked some questions. Lane said, I'd love to start simple, like very simple, the definitions and difference,

and then what is beneficial for people at different parts of the journey, getting out of debt but wanting to start simple, early, building wealth without debt, and older but debt-free and has less time before retirement. Let's go back to the very beginning of her question. What is a Roth IRA? And how is that different from a traditional IRA? Yeah, the big difference between the two is just how they're tax. So there's things like traditional 401Ks and Roth 401Ks and there's traditional IRAs and Roth.

So anytime you see the word traditional or Roth, it's just how it's taxed. So for a traditional IRA or 401K, it's tax deferred. So you don't pay tax up front. It then is allowed to grow in the account tax-free. And then when you withdraw it, you pay tax on it. And you pay your tax at normal income tax rates because you're just deferring that tax until later in your career or into your retirement. So that's how the traditional is taxed.

It's tax-deferred going in, tax-deferred growth, and then it's taxed on the way out. whereas a Roth is already taxed up front. So you pay tax on the money before you put it in. So then it's allowed to grow tax-free and you can withdraw it tax-free because you paid the tax way back in the beginning. And it's a little confusing just because the way it works with the traditional 401Ks and IRAs is because usually you do pay the tax up front just out of your paycheck as normal. but then you get that back as a deduction when you file your taxes. But effectively, it just means tax-free, going in, tax-deferred growth, and then tax coming out. So that's all the difference really is between traditional and Roth.

One of the things, if you want to simplify this or you want another way of thinking about that, suppose that I earn a very low amount of money today, maybe $30,000, $35,000. that's a very low tax bracket. In the absence of a lot of the mad scientist's magic around retirement account planning and those kinds of things, I have two choices, the traditional or the Roth, if I'm going to save for retirement. Because I'm in a low-income tax bracket at the $35,000 salary, it might make more sense, for example, to invest in a Roth because I'm not paying very much in taxes right now

with my low income. And then later in retirement, if I build wealth, I might be in a higher income tax bracket because I'll be getting social security income. I might be getting, I might be having income from other sources, some of the assets, and I'll be withdrawing from my retirement account. So I'm arbitraging a low income tax bracket now for a higher one later. On the flip side, if I make $200,000 a year, I'm in a high income tax bracket now. And at retirement, I might only need withdraw $50,000 a year, which is a lower income tax bracket. So in the flip side, this case, I would be arbitraising a high tax bracket now by deferring some of that, those taxes, and then paying them later on in the future. So that's kind of, I think, the simplest way to think

about these tools, traditional 401K, the 457 plans, the 403B plans, depending on the thrift savings plan in the military, although I think they might have phased that out recently. Those types of plans are often that traditional one where you're arbitraising the high tax bracket now for the lower one later, and then the Roth and the Roth 401K are going to be the ones where you're doing the opposite. You're arbitraging the lower income now for the higher income, the higher taxable income later. I think that's an important point. And I think if you can make changes every year if you decide to, so like this year, COVID probably screwed up a lot of people's income in many different ways. So if this year is a particularly low income year, then you may think, hey, I'm going to go with the Roth this year.

and then I'll go back to traditional next year when my income's higher and back to normal. So, yeah, this is something you can change, but yeah, your description was spot on. And that's the thing to keep in mind is, do you want to pay tax now at your current rate? Or do you want to pay tax in the future at a unknown, potentially higher or lower rate? Absolutely. Okay. So when we get into the Roth conversion or the Roth conversion ladder, can you kind of introduce that concept and why you like it and what advantages it has. And then who is it most advantageous for? Sure. So, yeah,

this is a good follow on from what you had just said, because people who pursue early retirements tend to have higher than average incomes, I would say. Maybe there's a lot of tech people in this whole fire space, but, you know, maybe higher than normal incomes. But not only that, they're also planning for decades of lower income because they're planning to stop working. So they're in a unique situation where you have this maybe potentially multi-decade's period of having low income and you can take advantage of that in something like the Roth conversion ladder. So as you mentioned before, if you contribute to a Roth upfront, then you pay tax on that money before it goes in, which if this is your 10 to 15 year career of high earning and you probably

aren't going to want to be taxed at that tax rate. So in that case, what you would do is you would contribute to a traditional IRA while you're working. So you're getting that upfront tax deduction and that great tax break, which then allows you to hopefully invest that savings in a taxable account or something else and just further compound your money. But you're getting that tax break up front. And then say in 15 years, you quit your job. So you were earning 150,000 a year and now you're only needing to live on 40,000 a year, and that's through qualified dividends and long-term capital gains and things like that, or some side income, whatever. But your income requirement is drastically lower because you're not saving anymore, so you're just living

off that money. So that's when you start to become taxed. So when you quit your high-paying job and your tax bracket drops, you can then start rolling over the traditional IRA money into a Roth IRA. And when you do that, you have to pay tax because, as I mentioned before, you didn't pay tax up front on that money and the government wants it cut. So when you move from a traditional to a Roth, you're going to pay tax on it. But again, you're going to be at a lower income bracket and lower tax rate. So that's going to be considerably less than you would have paid when you're working. And so even just doing that makes a lot of sense. But there's also the ability to get that money out before retirement age because a rollover from a traditional

to a Roth is treated differently than a contribution in that after five years of rolling that over, you can start withdrawing that converted amount out. So it could potentially fund part of your earlier retirement as well. But even if you don't do that, it still makes sense to arbitrage that taxable decisions. So you're to be taxed at a much less. lower rate. Love it. So I'm arbitraising my income, my high earning in the years while I'm working, especially while I'm earning that highest income, which is probably the years just leading up to my early retirement. Then I stop earning altogether and move to Scotland. And I'm able to begin converting my, and drink a lot of whiskey and those kinds of things. And now I'm not earning any

income. So now I can convert my 401k, which I'm going to have to pay taxes on because it's pre-tax and and move that into the Roth, which I can then spend as well, the principle at least, not the gains. I can spend without any penalty at all. Five years after the conversion, correct. Five years after the conversion. So while there's a lot to like here, and that sounds incredibly appealing, I just want to point out a couple of potential flaws. First, I want to point out this is, I think, a tactic in the path to retirement. And it really is maximized in that specific instance.

I'm going to go from earning a pretty high amount of income, relatively speaking, probably at least 75K a year to begin getting into those higher tax brackets. And then I'm going to be earning a very low amount of income in early retirement. And the plan kind of relies on that. So I don't think this is the core fundamental strategy towards early retirement, but it's a great tactic to boost it if that's your specific plan. I'm going to travel or go through a period where I really do earn very little income in the years following my departure from my job.

Are there any other gotchas to watch out for or folks where this may not make sense for? Yeah, well, just to give you an example, like how plans sometimes change. So I was full on board with this because for me, it was like I just wanted to get to that number as soon as I could. And this allowed me to really juice my investments because I was paying a lot less tax and I was investing the difference. And it allowed me to hit my goal a lot sooner, which was the whole point. for me at that time. And then ironically, after leaving work, then some of the businesses that I'd been building for the last 10 years while I was working, they started earning money. So I've never actually been able to convert any of my traditional accounts. So I am potentially going to get to,

you know, retirement age and have big, required minimum distributions potentially just because it's not making sense to convert. So, but at that stage, it's like that's, that's a good problem to have. It's not really something you're going to really cry too hard about, I don't think. So, so that's, but it, but it is a risk. So if I, if, if I know what I know now, going back, I probably should have done more rough. And you just never know the future. But I just always felt at that time that I wanted to take advantage of every single potential advantage I had at that time. So that meant taking advantage of my 401K contribution deduction and my traditional IRA deduction because I can't go back to 2012 and say, actually, I should have

contributed to my 401k back then. The government's not going to let me do that. So my thinking was like, maximize for today, take all the benefits that are available to me and lower my taxes as much as legally possible and then worry about tomorrow, tomorrow, obviously not completely disregarding tomorrow, but knowing that tomorrow is uncertain. So you can't really plan as much as you can for today. So even though, yeah, looking back on it, I should probably done more Roth at the time. I'm happy I made the decisions because I took advantage of what I had available to me then, and now I'm going to have to figure out ways to take advantage of what I have available to me now. Love it. And that's a great problem. And I love that you have, you're not prevented from doing it.

You just would pay taxes that would make the shift un-economical, right? Because you have a high-income tax bracket because your businesses are successful in early retirement as the owner of those businesses. Now, let me just point out one thing, though, that you're still not screwed, I guess, you know, you have this luxury problem, but you still may be able to do the Roth IRA one day because business owners often sometimes will have a year where they'll have a large taxable loss depending on how they capitalize the business of those types of things. So it is possible that in one year, you know, at some point you have a large amount of losses, say a $200,000 loss as you're capitalizing a new business or starting at something else, that would be an opportunity if your income was negative

$200,000 to put in $200,000, literally from this investment to the Roth. So I think it still makes sense to position yourself for this, even if you have this luxury problem of having more income than you planned for an early retirement. You're absolutely right, because yeah, it gives you options. And as you said, I'm far away from standard retirement age. So it's something, there may be opportunities to roll that over. And then, yeah, worst case scenario, you get to standard retirement age with more in your traditional accounts than you had planned. And then, you know, I don't think I'll be too sad to pay a lot of taxes then if that's the case, because then it just means that everything's gone smoothly. Yes, yes, yes. All these people who

complain about having a big tax bill, like, you know that means you have a big income, right? You're not making $25,000 a year and getting a $200,000 tax bill, like income tax. You might have, you know, I didn't pay my taxes for a while bills, but that's a different story. Okay, so a question I get a lot is, can I contribute to my 401k at work and also contribute to a Roth IRA? Yes, yeah. So there's income limits for contributing to an IRA. So you need to look into that. So if you make over a certain amount of money every year, you won't be able to get the tax deduction for a traditional IRA.

And then if you make a bit more than that, you won't be able to contribute directly to a Roth IRA. So there's contribution limits, but you can absolutely do an IRA and a 401K together. I really like that foreshadowing. You can't contribute directly to a Roth IRA. That's going to lead into my next question. But I, well, my second to the next question. I feel that the younger you are, the more opportunity you have for this amazing growth in the Roth IRA, and you should be contributing to your Roth IRA when you're younger, how does somebody who might not make enough income to max out their 401K, the traditional 401K, and also max out the Roth IRA, how do they balance that out?

Like, is there an age suggestion? because, of course, you want tax-free growth. That's better than tax-deferred growth. But at what point do you contribute to which account? Do you have any suggestions? Yeah. So first I would suggest, like, first thing you need to do is if your employer gives you some sort of matching on your 401k,

then that's just a no-brainer because you're just doubling your money instantly. So 100% return instantly, which is a no-brainer. And even if it's like they match it, like 50% of your first 10,000 contributions or whatever, if they have a match, then go for that because that's just a guaranteed return. So that's number one. The second one, which I don't even know if you guys want to get into this account during this talk, but the HSA is a fancy. There's a few little tricks that you can use to make that potentially a completely tax-free account.

The contribution limits are lower. So it's not a huge deal because you're not able to pump a ton of. of money into them, but it's still worth looking into. So I can send you a link to that article. Yeah, go ahead. Yeah, I want to jump in and say, oh, contrar, Montreherre. The amount that you can contribute as a family is $7,000, $7,200 for the HSA. So the Roth IRA 2021 contribution limits are $6,000, unless you're over 50. So the HSA is definitely something that you want to look into. If you have the opportunity, you need a high deductible health care plan and you need to not be chronically ill with a lot of medical bills. I think the HSA, I mean, it's still a great plan, but if you've got the opportunity for really great health care in the United States, as opposed to this HSA plan, I mean, if you're putting all the money into the HSA plan and then paying all of your bills with the HSA money, it's not growing for you.

So it's not as beneficial. Would you say that's fair? But when I was in my career, I looked into the various plans that were offered on to me, and I know it completely differs across the country and across employers. But the out-of-pocket maximum for the high deductible plan was pretty similar to the fancy, expensive plan. So, yeah, if you didn't have chronic problems that you're constantly needing medications or doctor's visits or ER visits or whatever, and instead we're just getting insurance for

catastrophic coverage, then at the end of the day, it actually turns out. out to be pretty similar, if not better, because I had an appendectomy during my career, and I was all freaking out actually in the doctor's office because I was like, I got this health care plan, and am I going to be on the hook for like 10 or 20 grand for this? And luckily it was only 2,500 out-of-pocket maximum, and I got taken care of. So sometimes, depending on your needs, they're okay. You know, Mindy and I have an interesting thing around this. So Bigger Pocket says, you know, a pretty good health.

care plan. No, Bigger Pockets has an unbelievable health care plan. Maybe Scott just doesn't understand how good health care can be. Basically, we have one of the top providers and 80-20 split with the employer-employee. And then it's like the Primo premium service. So you have very low co-pays, very low out-of-pocket max, those types of things. And so the plan is so good that you don't qualify for an HSA. The HSA has only applies to folks that, you know, with plans that have higher out-of-pocket maximums and deductibles. And so Mindy and some other folks were like, hey, we want an HSA plan. We're like, really? Like, we've got the plan. The reason we don't have an HSA is because our health care plan is too good. And I was like, this is crazy. It's cheaper. Fine. Sure,

if you want the HSA plan, you can get, you know, it's way, it's way less expensive for bigger pockets off you worse health care coverage. I chose the good plan. I should have chosen the HSA plan because I didn't have any health care problems or anything like that. And I would have been able to begin socking away another $7,000 a year tax-free. It would have been my savings. But what a much better advantage, even with the higher deductibles and limits there. So everybody wins. Yeah, I'm with Fendi. I would have, that's exactly what I was doing. I was always asking for the high deductible plan because, yeah, for me, insurance was just a catastrophic thing to protect against catastrophe. And I don't want to go bankrupt because of one, you know, ill thing.

But I could pay for a higher deductible if I just had to go and see the doctor and stuff. So I was I'm definitely with Mindy on that one. And yeah, I was happy I was able to sock away as much as I did during my career. Yeah. So, I mean, that's the privilege of working towards FI is that even when you're not FI, as you're working towards it and building out that runway, you can handle a $5,000 or $10,000 deductible or payment with the health care bill with those types of things. So capitalize your life so you can take advantage of these types of things.

And then I've got to make my shift over to the HSA plan. Yeah, you do, Scott. It's too bad you didn't have somebody you could ask about this. Whoops. Okay, so we will link to Brandon's article about the HSA, which I believe you call something like the ultimate retirement account or something like that. And you had mentioned that I'm not a total fan or anything. I don't stock you. You had mentioned that that could be potentially tax-free.

Let's talk about that, because I think I know where you're going with that. Yeah, so I'll give you an actual real-life. example. Like I said, I had an appendectomy. So I had an HSA and I was pumping the max in every year during my career and you can invest the money that's in your HSA. Some employers or some plan custodians require you to have some amounting, but mine didn't. So I was able to just invest everything. So I'm pumping money in and it's similar to a traditional IRA in that it's tax deferred and you would pay tax when you would pay tax, when you you take it out unless you're using it for a qualified medical expense. So for medical expenses,

it's completely tax-free. So it's tax-free going in like a traditional IRA. It grows tax-free. And then if you take it out for a qualified medical expense, it's withdrawalable as tax-free. So it's completely tax-free, and that's sense. But there's nothing to say you have to take it out when you have the medical expense. So I'm trying to think when I had the appendectomy, but it was probably, I don't know, six, seven years ago. So I had the appendectomy. I had to pay $2,500 because that was my out-of-pocket maximum, like I mentioned. And I took a picture of the receipt, and that $2,500 is still invested in my HSA, and it's just been growing ever since then. And, yeah, the markets have done really well since my appendectomy, which is good luck, I guess.

but it is grown and now I have $2,500 that I could withdraw at any time to use for anything because I have the receipt that I can match that withdrawal up with and now I can use that to fund anything during my non-working life, which is now. When I withdraw early from my 401K, I incur not only taxes that I have to pay but also a penalty in most cases. So a 10% penalty. So if I have 100K, if I've set aside 100K and I make 100K, I might be paying 33% taxes on that and I might be paying another 10% penalties. So I'm only going to withdraw, what is that, 67,000, 40, no, 57,000 on that $100,000 investment. Am I able to just withdraw penalty free from my HSA? There's no 10% penalty for early withdrawal or

withdrawal for other purposes? If you have a health expense to match it up with that you paid post setting up the HSA. So I couldn't try to claim money from a doctor's visit I had before I opened the HSA. But any doctor's visits I have since then, if I save the receipts, then I can withdraw that money tax and penalty free. And yeah, it's completely tax-free. But again, what I said before is that you don't have to do it immediately. So for me, I didn't need that $2,500 to pay that doctor bill at the time because I had other savings that I could use.

So rather than use the HSA to pay for it, immediately, I used my taxable account, checking account to pay for it. And I left that money sitting in there growing. And it's no doubt quite a bit bigger than $2,500 these days because, yeah, the market's been doing pretty well over the last five, ten years. And you don't have to just hope that your appendix goes out. You can use regular old accounts. I already had my appendectomy. In 1996, my appendectomy cost $27,000. So this is that H. The high deductible plan, $2,500 charge is a little bit better. So yeah, you can save your receipts. When you go to Walgreens especially, but I think other grocery stores as well, when it prints out the receipt, it'll say FSA right next to it. Saline solution, if you wear contacts, band-aids, feminine hygiene products. These are all FSA-approved expenses. And when it's FSA, you can get reimbursed from your HSA program.

And that's an important point. Everything I talked about right now is HSA only. The FSA is a different thing. As Mindy said, you can use it to figure out which expenses qualify. but if you open up a FSA and pop a bunch of money in it thinking that you can invest it, you're going to be sadly disappointed, I think, by the end of the year, because I think that's a use it or lose it account, and it doesn't have any of these things that I mentioned,

which is I'm so glad you brought that up because I do forget that the FSA is even out there because I just never utilized it. So, yeah, this is an HSA-only strategy. Yeah, and we're going to get into the weeds a little bit here. Talk to your HR person. insurance provider to get specifics for your plan. But at bigger pockets, I have the HSA. I have the high deductible plan. So I am not eligible for the FSA except for vision and dental. Luck would have it. I can't see anything without my contact. So I can pay for my contacts and my

vision expenses through my FSA. My daughter has crooked teeth. So I got a $6,000 braces bill this year, which was super awesome. So I was able to put money into my FSA and then at the end of the year, submit one bill and get all that money back. They just send it to me in my checking account, which is a nice little boost right before Christmas. But yeah, the FSA is use it or lose it. Our plan allows for a $500 rollover. So I think about all the expenses that I have for the next year for Vision and Dental and put in that much plus the $500 because then I can roll it over if I need to. this year. I didn't have anything to roll over. But with the HSA, it grows kind of forever, right? And then once you hit a certain age, you can start withdrawing that money even without the

associated medical bills. But start saving receipts and start taking pictures. And do you have any suggestions for where to keep these receipts or these pictures? Because, I mean, we're talking prescriptions. And there's, I think there's a list of, I want to say 27,000, but I might just be making that up. But like 27,000 things that are. HSA approvable? Yeah, no, I just store it in the cloud somewhere. So either Dropbox or Google Drive or anything, I just have a folder and store them somewhere that's not on a computer that I could lose or it could break or anything like that.

So it just gives it a little bit more security there. But yeah, it's as long as you keep it somewhere safe that you can access and then you can present to the IRS if they ask, then I think it'll be good to go. Well, so I love it. And I think that the HSA, you know, I completely agree that we've got a cheat code here in the system to where the HSA makes a lot of sense as one of the very first things you max out if you have a plan that qualifies for it. If that's something that's accessible to you and you look into and use some self-research and managing it. Once we've done that, though, we're back to the, you know, I'm trying to pull us back to the Roth discussion here and those types of things. We just talked about the 401k versus the Roth, the advantages in each circumstance. at the very high level, the situation where the backdoor Roth makes sense. That said, there's a ton of jargon that gets thrown around by, again, all the cool kids in the finance space where we've got backdoor Roth, we've got mega backdoor Roth, we've got Roth conversion ladder, we've got all these different terms. Can you walk us through kind of some definitions and of these

tactics how big of a deal or how big of a variant they really are on the backdoor Roth conversion and begin walking through when we could use them? Sure. Yeah, no, there is a lot of confusion here. So I'll start with one that I already talked about, which is the Roth conversion ladder. So that was the strategy where I said if you're retiring early, you can contribute to your traditional IRA.

And then when you go to a lower income, you can start rolling that over to your Roth and pay lower taxes on it, maybe not pay tax at all, because if your income's low enough, you may not have to. So that's the Roth conversion lab. matter. I apologize. I use that interchangeably with backdoor Roth incorrectly. So thank you for

correcting me on that. Yes. Right. So, yeah, so that has nothing to do with any sort of backdoor. That one's just the straight up Roth conversion ladder. The backdoor Roth is probably simpler to explain the mega backdoor Roth. So I'll start there. But so earlier I mentioned that when you asked me if you can contribute to a 401k and an IRA, I said yes, but there are income limits. So I said if you make a certain amount, you won't be able to make tax deductible contributions to a traditional IRA. And then if you make a little bit more, you won't be able to contribute directly into a Roth IRA. So for the people in this scenario where they make too much to be able to contribute to a Roth IRA, then that's where the backdoor Roth IRA comes

in. So it's really stupid. It's an insane loophole that is... out in the middle of everyone's faces and everybody can see it and they know it exists. And it's so blatant, but it's never been shut down. So it's so I'll explain it and you'll see why it's so crazy. So like I said, you make too much money to contribute directly to a Roth IRA. So the way you get around it is you say you want to contribute $5,000 to a Roth. You make too much, you can't contribute it. So what you do is you put it into a traditional IRA and Like I said before, if you make too much to contribute to a Roth, you already make too much to get a deduction on your traditional IRA. So what that's called is an after-tax contribution because you're putting money into a traditional IRA,

but you're not getting a tax deduction for it. So what you do is you put that $5,000 into your traditional IRA, and then you immediately roll that over to your Roth, because there's no income limits for rollovers. So you're effectively just contributing to a Roth IRA, but you're getting around the income limit by first going through the traditional. And that is the backdoor Roth. And it's just a way for people who make more than the income limit

for contributing to a Roth IRA. It lets them contribute to a Roth IRA. Yeah, this is so stupid. It really is. It's just like, oh, I'm going to put it into a traditional IRA, which really doesn't really do much, you know, in any real sense, in my opinion. And then you've rolled over into the Roth and you're good to go.

It's all after-tax dollars in the first place. So I do this and I was like, really, that's it? You know, like I was trying to talk to my advisor and all that kind of stuff about like, could you do it for me? Can you help me? He's like, no, just do this. And so it's, it was like, really? that's that's the whole play here. So anyways, yeah, I used it interchangeably with Roth

conversion incorrectly. Roth conversion is that system of rolling funds from your real traditional 401k or IRA, the tax deferred account into the Roth. This is the way for high income earners to contribute to a Roth in the first place. That's exactly it. And yeah. So what's a mega backdoor Roth? And what if I want to do more than just the minimum? So either way, we'll lead it, but lead him into the next question. So the megabacteria Roth is even crazier. And this one's less applicable to most people, I would say, just because it requires some sort of things on the employer side that may not be there. So like I said before, you can contribute after-tax money to a traditional IRA,

and that's called after-tax contributions. So you can do the same thing to a, a 401k, but you can do even more. So, you know, obviously there are contribution limits for IRAs and the contribution limits for 401ks are even higher. And there's even, so I don't even know what it is in 2020, but maybe 19,500 or something is the contribution limit for an employee or somewhere around there for a 401K. And then the employer is able to contribute money as well. But then you're able to contribute after-tax money to bring it up to something like 55, 56. I haven't checked in a while, but somewhere around $55,000 a year is the total cap on the 401K. So that consists of your contribution.

If you're married, you can double that, I believe. Like if you're a business owner, for example, and have the, anyways, sorry, I'm just chiming in. There's a silly amount of money you can put away into these accounts if you're crafty. Yeah, it's a crazy amount of money. Absolutely. So the total contribution consists of your contribution. your employer's contributions, and then the after-tax contributions. So if you wanted to see how much after-tax money you could put into your 401k,

you would just Google with a total 401k limits for 2021, subtract your employee contribution, and subtract whatever your employer puts in, and then anything that left over is the after-tax amount you could put in. So it's a similar sort of situation here where, let's say, let's just make the math, Let's say you put in 20,000, let's just say the 2021, it's 20,000 max for an employee. And then your employer puts in 10, and let's say the total is 60 cap.

I don't know what it is, but let's say 60. It's somewhere around there. So that would mean 30,000 you could put in after tax. And then, so you've put in 20,000 pre-tax, and your employer's put in 10,000. And then you can put in another 30,000, just again, to make the tax. math easy. And so you put 30,000 in the after-tax portion of your 401k, and then you do something similar to the backdoor in which you just convert that after-tax money that's sitting in your traditional IRA, which, again, it's in your traditional IRA. So it's tax deferred,

and you're going to have to pay tax on the growth that comes off of that, even though you've pay tax on the actual contribution because that's the definition of after tax, the growth is still going to be taxed when you withdraw it, say, when you're 60. So what the smarter thing to do is you immediately put that 30,000 into the 401k, but then you roll that over to a Roth 401k, Roth IRA, and then that is going to grow tax-free, and you're going to be able to withdraw all of that money at retirement age. So to simplify it, it's just a way to put another $10,000-plus $1,000 into a Roth if you have the money available to do that, and if you have the plan that allows after-tax contributions. Okay, great. So I'm going to be selfish here because this is

that I might be able to take advantage of. So I've got, we've got a 401k and a Roth 401k through our workplace retirement plan. We don't have a matching program. We have a gift. So regardless of whether you contribute, we give 3% or so to the, so let's say in my case, let's say, let's use the 20,000. I contribute 20,000 to the 401k, and then I get the 3% match as well. So I've got, let's 22, whatever, into the IRA. I can then take another 22K and put that into my Roth 401k, or I put that in after tax into a traditional and rolled over immediately into a Roth. So I think you said put an extra 22K in your Roth IRA, which you wouldn't be able to because the contribution limits for Roth IRA or whatever, $6,000. So what you would be able to do is take whatever that chunk is 20x,000,

put it into your traditional 401k, and depending on whether they allow in-service withdrawals, you could immediately convert that into a Roth, and then therefore that's protected from tax growth. So you can just have tax-free growth on that money. So it's effectively allowing you to increase your Roth contribution limit from whatever it is, $6,500, $7,000. I don't know what it is these days, but up to whatever that. the max 401k is, say, 60,000 minus your 20,000 minus the whatever bigger pockets is putting in. And it just allows you to really juice your Roth accounts if you have all that available. Okay. So I'm hearing this in real time and I'm still struggling with a couple of concepts.

So we don't have to go back and do it again. But my next follow-up question is, who does one pay for advice specific to their situation on setting these things up? Like, what's the professional that you call to do this? Is it an accountant? Is it a financial planner? Yeah, a tax accountant. An accountant who is very good at tax optimization, I would say. I luckily found a guy once I had always done my taxes myself.

And then I set up an S corp and I just threw in the towel because it was like it was already getting to be like three weeks of soul destroying work. And I was always paranoid. I did it wrong and stuff. And then when I got the S corp, I was just like, I can't do it. So anyway, I found a great tax guy. accountant who does my taxes, but he also is there to answer these questions and also introduce me to things that I may not even know about to be like, hey, you could do this and maybe save some money. So yeah, tax accountants may be the right way to go for something

more complicated like this. Wonderful. So talk to your accountant or get one if you don't have one because we just talked about if you're in a situation like that or you want to take advantage of some of these things. The stakes are thousands of dollars this year and hundreds of thousands of dollars over the course of a career if you're making decisions on the scale that bad scientists just talked about here. Hundreds of thousands of tax-free dollars. Let's throw that tax-free in there if you can do it right. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing. And if you're like most folks, it can be a little eye-opening. That's why I like

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be slammed from about February to April and beyond. Now is the time to start reaching out to tax professionals and asking, are you familiar with the backdoor Roth, the mega backdoor Roth, the Roth conversion ladder? If they're not familiar with this and this is the stuff you want information about, you need to call somebody else. The Bigger Pockets Money Facebook group has some tax professionals on there. Maybe they could chime in and share how you can find somebody like the XY planning network is great for finding a fee-only financial planner. Maybe they can share tips for interviewing some tax professionals. But call them up and see if they can help you with this.

Just because this is airing in January doesn't mean if you don't have a Roth IRA right now, you can't set it up for 2020 and contribute. You have until the tax filing deadline, which in 2021 right now is April 15th. In 2020, it got extended to July 15th or something. So who knows what's going to happen this year? Plan on making your contribution by April 15th, setting up the account and getting this all done. So you can take advantage if it's in your financial best interest to or within your financial means to take advantage for 2020 and 2021. This is huge.

I'm going to chime in here because as a really frugal cheap skate who doesn't outsource anything, it is. probably one of the best investments I've made is actually, and even like I love this stuff. Like I read this stuff. I write about this stuff. And I'm like, it always just every year I'd be like, how do people who don't like this stuff actually do this because it's so confusing. They do it wrong or don't do it. Yeah. It's not going to cost like $25,000 to get your taxes done. The money that you're spending to get your taxes done by a professional is more than made up by all of these savings that you have and the tax-free growth that you're going to get from all of these things if you're able to take advantage of them. You should definitely start talking to

somebody. And just because somebody does your taxes one year doesn't mean they have to do them every single year, especially if you don't have other companies and like straight-up taxes is straight-up taxes. But if you can use somebody's expertise to get these balls rolling, that's just going to benefit you down the road with that tax-free growth. That's exactly it. Because in future years you can compare your 1040 that you print off when you do it with Tax Act or H&R Block or whatever, you can compare that to the professionally done one. And if you see numbers and weird boxes and missing numbers and other boxes and you're like, my situation hasn't changed, then, you know, then you can know that you've done something wrong. Or if it looks exactly like

theirs, it just has different numbers in the same boxes, then you can be like, oh, okay, I think I did it right because, you know, yeah, my situation didn't really change. And this is looking exactly like the professionally done one just with different figures. So being selfish once again here, the first thing I would do after this call is ping my accountant and ask them about the mega backdoor Roth. I think if you're thinking about a Roth or a mega backdoor Roth and you're on the pursuit of FI, I just want to chime in here with, look, if you're going to do it, it makes sense to do it and to do it, I think, early in the year, in my opinion. So, you know, the way I do my retirement accounts outside of the wonderful world of mega backdoor

Roths that you just open my eyes to is I just can, I max out the contribution beginning of the year. So literally 100% of my paycheck is going, I collect no paycheck until my 401k or Roth 401K, depending on how I'm feeling about that year, is fully funded. Why? Because it gets me more time in the market in the tax advantaged account. So it seems to me that if you're interested in doing this, you know, now's the time, get on the phone, you know, and get the setup before the end of the next year. And, you know, while that can backfire in some years, like in 2020, you buy a bunch of stuff right at the beginning of the year.

And then the market tanks in March, on average, I like more time in the market approach with these types of things. That's absolutely right. I have an article that I wrote, I don't even remember one, maybe 2012 or 2013 or something a while ago. Anyway, it's called front loading. And it's exactly that. run the numbers to show that it's more beneficial because if you look at any long-term stock market chart, it's just up into the right. And yeah, there's little, really little tiny things along the way, but overwhelming, it's just straight up or, yeah, straight up into the right. So that means the long-term trend is up. So putting it in early in the year more often than not is going to be beneficial. Yeah, not every year, just like 2020 showed. But more often than not, it's,

it's going to be beneficial and over a long career, then that's going to make a sizable difference. And I actually have an experiment called the Guinea Pig experiment where I set these two hypothetical people off on starting from zero net worth to Phi. And I started this maybe seven years ago. And I think they're only like two years away from Phi. And I used real-time market returns. and I compared two scenarios, the normal guinea pig who just invest all extra money into a taxable account, and then the optimized guinea pig that takes advantage of the HSA, the traditional IRA that's going to now then become a Roth conversion ladder, and all the tax optimization articles I write about it, the optimized guinea pig uses all those, including front loading, which is, as I said, it's one of the articles that I've written a while ago.

And I don't recall what the benefit is, but on the guinea pig experiment homepage, I break it down and say, you know, contributing to a traditional IRA instead of a Roth means that he's 4.5% higher net worth than he would have been otherwise. And front loading is part of that. And it is a positive contribution to where he is over the normal guinea pig. So it definitely makes sense over a long period of time. So first of all, where can one go and view this experiment? and we'll link to that in the show notes. Sure, yeah, yeah. It's madfcientist.com slash experiments,

and then on the page, you can find the guinea pig experiment. Awesome. And then second of all, what are the stakes here? You said, four and a half percent, is that the difference in net worth

or is there a larger compounding? Oh, I just pulled that out of thin air. Let me see. I have, I do it at the beginning of every year. So even though I keep the spreadsheets for the whole year, so I can make real-time investing decisions, I don't update the guinea pig experiment homepage except for once a year because it just got to be too much updating. That sounds about the amount of time that your guinea pigs need their finances updated anyways.

Yeah. So I want to point out that none of us are financial planners, but we spoke to a financial planner who is a friend of all of us, Michael Kitsis. And we asked him this question, hey, I've got a big wad of cash. Should I put it all in at once? Or should I make separate but equal, you know, distribute or contributions? to the stock market, he's like, put it all in at once. You're never, when you get to a $10 million portfolio, does it matter if you paid $700 for your stock or $702? It doesn't make any difference now. Put it all in at once and let it grow now. But I also get it.

It's hard to do that. Oh, it is hard to do that. It's super easy. I can hear that advice, and I still wasn't able to do it, frankly, with some of my, with a personal money that I got. in a large lump sum two years ago. So I dollar cost averaged it. Whatever it is, you know, it's, I think, a matter of investing it, but I completely hear it and understand that that emotion, that my emotive response to that was, I was unable to follow that advice in practice to

assert. Well, yeah. Well, yeah. Personal finance is math, but it's also being able to fall asleep at night and not freaking out. So it's a balance. And that's why personal finance is personal, because, yeah, if everybody just did the mathematically optimal thing, then you wouldn't have blogs and podcasts and everybody would just follow the script, but it's personal, so you have to, yeah, figure out what you're comfortable with and do what you want. But the guinea pigs is, that is mathematically optimized. Yeah.

So I just looked at the home page and the optimized guinea pig net worth is almost 100,000. So let's see, it's three. So the optimized guinea pig is 367,000 and then some change, whereas the normal guinea pig is only 285,000. And as far as how that relates to when they hit FI, the optimized guinea pig will hit FI in three years and 10 months as of the first of this year. And the normal guinea pig will hit FI in five years, seven months. So it's nearly a two-year decrease in the working career of the optimized guinea pig just based on a few simple strategies. He's not even doing the megabathor Roth or anything like super crazy.

Just like, yeah, some more easily accessible optimizations. Love it. So go check out the madfcientist.com slash experiments to go check that one out. And thank you for running that. That's fantastic. You really love this stuff. Yeah, it's crazy. It's getting so close. Like I didn't like, when I started it, I'm like, well, I still be doing this and like whatever, how long it takes to get there. And, you know,

I was thinking at least 10 years. And yeah, yeah, I started in 2012. So I'm getting close to 10 years for this stuff, which is crazy. So I have a question about the income limits to contribute to a Roth IRA. If I am doing what you guys are doing and dumping a bunch of money in on January, which is what I did this year. Oh, this is actually a really personal question because I just remembered this. I have sold so much real estate this year. I have made boatloads of money in real estate

just being an agent. And I contributed to my Roth IRA in the beginning of the year. I don't know if I'm still going to qualify for Roth contributions. What happens if all of a sudden I make more money than I thought I was going to, but I already contributed to my Roth? Yeah, there's, I would look into that, obviously, before April 15th,

but even maybe look into it before the end of the calendar year, just to see if you need to undo some of those contributions. And I've never had to actually do that personally. I usually just wait. So as we said, like front-loading, I would front-load my 401K every year. Same with the HSA, because those were things that I knew I could contribute up to a certain amount.

As far as IRAs, back when I was able to contribute to, IRAs, I would always do that as I was filing my taxes because then I knew all the numbers. So I'm not exactly sure the best process for that. But yeah, if you do have an accountant, maybe talk to them and say, okay, I think I'm going to actually exceed the income limits. So I'm going to need to undo these contributions. And there's waste for that to do that. In that case, I think a lesson here also is in that, if you're unsure about your income and suspect you might be having a very good year, that would be a time to shy away from the front-loading advice and maybe wait a little longer so you have a better, a clearer picture,

you know, just because it will save you some hassle down the line. And you've got a bigger, good problem to deal with than, you know, the maximizing your Roth contribution. And for me, it was always minimizing hassle was a very big motivating factor. So even though mathematically, I could have probably earned more by contributing to those IRAs early in the year, just the peace of mind, again, personal finance, peace of mind, sleeping better at night and not having to deal with a bunch of hassle come, you know, March of the following year, then that made me not front load those accounts, even though mathematically would have made sense to do so. Yeah. So the good news is if you're going to do that, then the opportunity to do a backdoor

or a mega backdoor are going to be still available to you. It's just so you can still kind of do basically the same thing by literally just contributing after-tax dollars to the traditional after-tax retirement account and then rolling it over. So it's not really a high-est-stakes. You're just going to save yourself some hassle again of having to go through that. Do I have to figure out how much money, like I maxed it out, I think it's $6,000. So I put in $6,000. At the end of the year, do I just pull that $6,000 out or do I have to figure out how much it grew and pull all of that out? Yeah. So that's why you want to talk to a tax-exam.

because if you just have tax-free growth that's mingling in with other legitimate contribution growth and things like that. So, yeah, just if you have somebody to talk to, you can talk to it. But I really don't think it's that complicated. But again, like, I've never had to do it personally. And despite being interested in this stuff, like, I don't really research things unless I can use it personally. Because it's just not worth all the time and hassle of reading about all these rules. So, yeah, that's something I do not know. about because I've never had to do it. Okay. So just in the context of zooming out once again,

I'm thinking about, you know, I'm working towards FI, and I've just heard about the HSA, which is seven, let's call it round to seven grand. So I put in seven grand pre-tax into my HSA. I put in 20,000, plus a little bit of employer match into my 401k. I also put, you know, yeah, and this is, these are the maximum optimal levels. What I'm hearing as a listener is do that, do that, do that, and then also figure out a way to backdoor Roth or contribute to a Roth or contribute to a mega backdoor Roth. So we're talking tens and tens of thousands of dollars in contributions to these retirement accounts. But then I also want to retire early. And I know that normal retirement is a part of early retirement.

But what's the answer to how do I build? Do you have any thoughts fundamentally on how to build that wealth, how to balance that tradeoff for folks who don't have the luxury of such a surplus of money that they're able to just do all of this, so much cash that they're just infusing all of their retirement accounts optimally. What do you do if you're, you only want to put in 10 or 15,000 into these accounts and you want to have some left over for liquidity in your life, six months reserve, maybe a real estate investment? How do you think through that? Yeah. So I'll just explain sort of like what my thinking was. And again, minimizing hassle and complexity. So,

you'd mentioned like an emergency fund or having having cash to deal with you know things that are happening this year so the rothair is actually really good for that because you can withdraw contributions at any time penalty and tax free because you already pay tax on that money so that's a great place to store like a bigger emergency fund that you probably won't have to tap into but if you want it there in case you'd need to um because because then that's in there growing tax-free. And then if you did have to get a new roof or something, you could take that out and not be penalized.

So that's a great place for that. So even if you are wanting to minimize your taxes while you're working, that's a great storage account for an emergency fund. So for me personally, I would max out my 401K up to the match, like I said before, that's number one. I would then max my HSA, because again, that's potentially tax-free completely for medical expenses. And, you know, healthcare in America is expensive. And, you know, if you are planning for standard retirement, like I suggest when standard retirement does, is contained within early retirement,

your medical expenses could increase when you get older. So that's great to use tax-free money to pay for that. So then I would max out the rest of my 401K. and I worked for my last job of my career. I worked for a nonprofit university. And so that was a 403B. So if anyone out there has a 403B, we haven't talked about that yet,

but that is just a 401K for nonprofits, pretty much. All the rules are the same. And then I would look and see if I was able to contribute to a traditional IRA because like I said before, I was sort of just thing to FI just because I knew I wasn't going to stop working completely and stop earning money for the rest of my life. But for some reason, I just needed that psychological tick mark in my head, like,

oh, you don't have to work. So now you can make decisions that are not based on money. So I just really wanted that. So I was sort of racing there. So going the traditional route allowed me to get there quicker because I thought that I could then do the long Roth conversions over my early retirement and then potentially not have to pay tax on anyway. So I always went the traditional route.

So then I would look through if I wasn't able to contribute to my traditional IRA, due to income limits. I would consider a Roth, but I wasn't too bothered if I couldn't. I wasn't bothered enough to do the backdoor Roth because I didn't care. Because Jeremy from Go Curry Cracker, he has a post called Roth Sucks,

which is worth linking to. And for early retirement, he talks about how a Roth may actually not be that much better if you're planning to retire early than a taxable account and he makes some really good points in there. So I would just put the rest into my taxable account.

I wouldn't do the mega backdoor Roth. So even though I investigated it because I thought I was going to use it, I didn't end up using it because it was just too complex for me. And like I said, I want no hassle and less complexity. And the same with the backdoor Roth. I never did that either because I was like, you know, I don't want to get into any sort of issues that it's complicating my tax return because at the time I was doing it myself.

And it was already a soul-destroying process and I don't want to make it worse. Okay. So let me just kind of roll back here a little bit. So you just said, take the match first, take the HSA, then max the 401k. And really the kind of three staples of what you just kind of said and then everything. And then there's a couple of things to layer on top of that. But I want to zoom in here. And like, let's say we have a family or a person making $50 to $75,000 a year. What you just said, I think, is impractical for that. It's possible. It's possible. And many people do that. But I think that there's an impracticality to it in terms of doing that and maybe aspiring towards that first real estate investment or, you know, you just mentioned that the Roth IRA is a great place to sort an emergency account. There's nowhere in that three-step process. Is there a Roth contribution? So do you have any advice for that person who's on that bubble of being able to max out all of those things? Do you just go as far as you can in that 401K and figure it out the rest of the way?

Yeah, exactly. Yeah. So if you don't have enough to max it out, then yeah, maybe you don't even have any more to contribute than the match. Like the match is the important thing. That's like you got to find a way to hit that match because that's just like free doubling your salary pretty much. So the match is the most important thing. If you have some money left over, then the HSA is a great place to put it. But even if you can't max that out, then you can only do what what you have to work with. Don't stress it out about it. it. Like, obviously, finding ways to increase income is great, but many people are, you know, strapped with time and ability to increase income. So don't feel like you're not doing good if you can't max all these things out. It's really just sort of, yeah, just think of like all these different buckets. And when one fills up, then you move to the next bucket and you can keep filling that up and move to the next bucket. But don't stress out about trying to fill up all the buckets. And yeah, and if you have a potential real estate deal, coming up, then maybe you're going to want to just put it into a savings account. Because obviously,

if you need money within five, 10 years, putting it in stocks is not a good idea because we can see what happens in nine days in March and you don't want your whole deposit to be gone. Yeah. So this is where I get a little controversial with some folks. But when I started out with in my career, I did not contribute to retirement accounts. I did contribute to a Roth. But I didn't contribute to a 401k. I was making around $50,000 a year. And my goal was to house hack. And I saw that I took my match, my 401k match, like you say, at the company. But I did not contribute a cent to retirement accounts other than my Roth, you know, for the reasons kind of way just highlighted. And I instead built up about $20,000 in

five in my Roth, five, I think I was a limit back then. And then the rest in my savings account and use that to buy a duplex that I, where I lived in half and rented out the other half. that was, I think, a really appropriate step for me at that point in time because the ROI on that house hack was way higher than all of the ROI's, you know, with market investments inside these retirement accounts. After a year or two, though, I was able to then have enough cash where I could do both. I could begin taking advantage of the retirement accounts and I slowly stepped up my contributions over those years and began maxing those contributions out over time. So just, you know, that's all in the in the context of these strategies, there's probably some points in some specific instances

where the strategies don't apply or don't make sense in the short run in some cases. Absolutely. Yeah, no, exactly. It boils back down to being personal and you were able to do much better things with that money where, you know, a lazy guy like me who doesn't want to deal with people or buildings was like, yeah, this is the best choice for me. So yeah, no, that's absolutely correct. So in that case, if I was you, you know, back in your early days when you're just starting out, then yeah, I would definitely still hit that match because that's free salary doubling or boosting. And then from there on, then yeah, don't touch any of these accounts because you're going to be able to do far more

with your sweat equity and your real estate acumen and that thing. So yeah, again, it definitely boils down to personal. So glad you brought that up because, yeah, it's easy for people to be overwhelmed by these things and then feel like they're doing it wrong if they're not maxes, out every single thing, but in a lot of cases, it doesn't make sense at all. Yeah, I'm glad you brought that up, Scott, because the purpose of me bringing Brandon back onto the show today isn't for Brandon to say, you have to do step one, step two, step three, step four, this is the only way to do it. It's to introduce the concept of the backdoor Roth, the mega backdoor Roth, the Roth conversion ladder, to people who don't know what this is.

This mega backdoor Roth, I'm so excited. I have a self-dor. directed solo 401k because I'm a real estate agent. So I have self-employment income. I am going to look into that because I had a really good year this year and I want to take advantage of that. I'm going to pull out my $6,000 in Roth IRA funds. But then I can put in another like 30 or whatever. I'll trade six for 30 every single day or once a year. So that's going to be really great. I didn't know about that. And this is my job. So that's the whole point of bringing Brandon on is just to share these different ideas and introduce people who've never heard of this stuff or maybe have a bit of confusion to introduce them to these amazing opportunities. And you know, you didn't contribute to an

HSA. Hey, Scott, this is your job too. You should know about this. Now you do. So it's, I'm not trying to shame you, sort of. But that's the big thing is like this is about the strategy. The strategy is spend less than you bring in. widen that gap continuously, find the most advantageous ways to do that for you, and then invest the surplus optimally. And that can mean completely different things

for different people. The retirement accounts in general may not be right for you. If they are, then the backdoor Roth may not be applicable. The Roth conversion ladder may not be applicable. The mega backdoor Roth may not be applicable.

All of this jargon, don't feel like you have to use any of this. It's not critical to the success of these things. Although it does make a several-year difference if you are going to use them to do it right in your retirement per Matt Fiance's skinny pigs here. Yeah. And yeah, yeah, even if it's not applicable, even if it is applicable, you still don't have to do it. Just like I didn't do the megabacter Roth, even though I researched the heck out of it and wrote the article on it. And then I'm like, you know what, this is too much work.

I'll just pump more money into my taxable account. And yeah, as you said, the important thing is just investing and having a surplus. less that you're not spending everything you earn. And then these are just little tweaks, icing on the cake, if you are wanting to really optimize and get geeky with it. But, yeah, the important thing is just, yeah, spending less than you earn and invest in the rest somehow. Can you name somebody who has done every single one of these tactics perfectly, right? No, I don't. No. Okay, good. Thank you. You know what, that's a really good question. It's a pursuit of,

optimization, nobody is doing every one of these things perfectly. At least nobody's doing perfectly at first and in the beginning of their journeys. That's an important point to make because I know there's a lot of people who are listening to these shows and they're like, oh man, I'm not doing it right. You know what? You're listening to the show. You're doing it right. You're taking neither am I. Yeah, Scott screwing it up left and right. He's still making ends meet. and Brandon. I wrote a post this year called My Portfolio. I think it's like what's in my portfolio.

What's in my portfolio on how I manage it? And I describe how I built the portfolio based on knowing how I do things wrong and how I always get tripped up and all the psychological issues that I have with investing that I still keep, even though I know mathematically I shouldn't do them, I still keep doing them because I'm a fallible human and I'm not a robot. sadly. But yeah, so even though you know what you meant to do, it's still sometimes hard. Just going back to that dollar cost averaging thing, like, yeah, mathematically, it makes sense to put it right in. But if you have a big chunk of money, you're going to be pretty freaked out

doing that. So yeah, so I'm still constantly trying to work through my issues and automate as much as I can to take my brain out of it because if my brain gets involved, then I screw things up. So yeah, it's just knowing yourself, knowing what you want out of life, and then these things like this podcast are useful because then it tells you what's available and you can pick and choose from this toolbox to do that. But yeah, you don't have to use the whole toolbox every time you open it up. And otherwise, yeah, I don't know. I don't do home renovation, but Mindy can probably tell you if you take every tool out of your toolbox and try to use it during a day's work, it's probably going to end up pretty bad. Oh my God. Did you peek into our house this weekend? That's how Carl works. It's just like everything everywhere. I can imagine that's how Carl works. Well, let me ask you one more question now.

So I am, I've got by 401k and all that kind of stuff. And a big question we have for a lot of real estate investors is, I'm just going to borrow that 50,000 against my IRA and then use that to buy a rental property. Any thoughts on that? on that process or that tactic in terms of leveraging your 401k or those types of things to build wealth. You know, the thought being, oh, I'm paying it just to myself. That's a great question. I'm not a real estate investor and I've never borrowed from any of my retirement accounts. So I couldn't tell you like the actual mechanics of it. But it's, I guess I guess my thoughts would be if the only way you're going to contribute to those accounts is if you think that you're going to do

that. So for instance, if you're like, I know I'm going to invest in real estate, but the only way I'm going to contribute to a 401k is if I know I can take that money out, then I think that's better than not putting it in there and then not doing the real estate and being like, oh, I should have put that money in the 401k. The risk comes that you wouldn't pay that loan back or time out of the 401k is not growing tax deferred and you're not getting the benefits of having that money in there. So like anytime people, actually a buddy of mine just got in touch. and asked if he should take a home equity line of credit to replace his roof or take it out of his 401k. And like, I was like, I would take it, I would do the heat lock with the interest rates the

way they are. And because it's, it's risky to take money out of your 401k because you're losing a lot of compounding growth. And if you don't put it back in there, then, you know, that's bad news. Obviously, more debt is bad too. But anyway, so, So, yeah, those are the only two things I would say as a non-real estate investor and as someone who has never taken money out. If that thought is what's going to make you put, allow you to put money in, then yeah, I think then planning for that's great. But yeah, just be careful that you pay it back because you're missing out on a lot of tax-free growth potentially. Okay, I want to chime in an answer partially my own question. And then I want to answer too, Scott.

So I think if you're listening to this, we've done a couple of finance reviews with some certain folks, and this is a theme that comes up with a HELOC or a 401k with that kind of thing. My opinion, never use short-term debt to finance a long-term investment, which is a he-lock or a 401k loan are going to be typically short-term loans. They're going to be interest-only or they're going to be variable payments. They're going to have shorter amortization periods. When you have that, you should never think of it as more than like a two- or five-year loan, and that is going to result in cash flow or liquidity problems for you if things are

tight. if you have a huge surplus of cash flow every month and you're using this to juice your returns or slightly better out leverage or optimize your portfolio, then I think that that makes sense. But then I think you may, I wasn't able to wrap my mind around the HELOC versus the 401K as in a tactical sense. And I think I agree with your assessment that the HELOC is probably the better, the first place to look, the better place to look rather than the 401K because the opportunity cost. is lower. You can keep that money invested in your 401k versus compounding at a, what,

3% average annual appreciation rate in your house. So. So I did this. I had a HELOC and I took a 401k loan in September of 2019 because I was buying a house. I have two houses in Longmont. We weren't ready to sell the one. So we took a HELOC out on it. It has appreciated exponentially since we bought it. So I had $200,000 out of the HELOC here, and then I still was $50,000 short. So I took a $50,000 loan from my 401k and bought the house. And then I refinanced after six months. There's a six-month waiting period. I refinanced and put the money back into my 401K. That's a good time to be out of the market. Well, yes and no. I took it out in September and then I put it back in April. So I like,

If I would have pulled it out in March and then it's like when it, then it drops and I put it back in, then it would have been great. But you can't time the market. Brandon, you know this. No, no, I know you can't. I thought you got real lucky there. That sounded like from your time frame. Yeah, well, I mean, it was only $50,000. It wasn't like, like I had taken all of it out. But yes, the argument against this is that you have to pay it back before you separate from your job or within three years or whatever.

or it's taxed as it's considered a distribution. So you're paying penalties, you're paying taxes, and that's kind of an automatic thing. The other argument that people have for this is, I mean, you're missing out on the tax-free growth. You guys already said that, or the tax-deferred growth. You're paying it back with after-tax dollars. And my thought on this is I made an informed decision.

I knew what I was doing. I took the 401K loan because it was such a smoking-hot deal. on this house, I could, the gains on that house are going to more than make up for whatever I missed out on for those six months not being in the market. But any loan that I am making a payment to, I am making a payment with after tax dollars. So whether it's coming back for me, whether I'm coming back, like I'm paying back the bank, I don't think you should just take out loans willy-nilly. You should have a specific reason for it and you should have an absolute plan to pay it back well before the payback period so you're not paying taxes and penalties on that.

distribution. So that's my two cents. Yeah, halfway through answering that question, I was looking at your two faces and I'm like, how am I the one that's answering this real estate? You guys are the experts here. This is a bigger pockets podcast. Yeah, I just wanted to get your thoughts on the borrowing against it in a more general sense. But yeah, it's specific to real estate or investing. I always capitalize your investment or your purchase with the appropriate type of debt, whether it's short-term or long-term. And then I think we get into tactics about what the right capital sources, whether that's a HELOC, a credit card, which is appropriate for your grocery bill, but not your roof replacement, and so on and so forth. Okay. Well, we have gone pretty long

here today. I think we've covered a lot of topics. I think that the way this discussion went, we've answered a lot of questions from the audience, a lot of questions have been very, specific about personal situations. But I think in the context of a broad overview, we've really covered most of the questions we got from our Facebook group and those types of things. Okay, Brandon, this has been so much fun. It's always a delight to talk to you. And I'm super excited that you're able to spend time with us. I haven't seen you since January for four minutes on your cross-country trip. Did that get canceled or cut short? Did you have to come back? Actually not. No, yeah, we we skied and traveled around the mountains of the U.S. for a month.

And then, yeah, that was February we got back. And we were so thankful that, yeah, all the COVID stuff waited a month to really kick off. Well, I can't wait until you come back here again. And I'm so happy that you were able to share your time with us today. Can you please let people know where they can find you? Sure, yeah. It's madfcientist.com is the website. And, yeah, I have madfcientists on social media and things because it's completely made up word.

So I got all the social accounts. So yeah, madfaintiffs.com is where all the financial writing is. And, yeah, Madfaintest on Twitter and Facebook. And I don't think I'd really do anything else other than that. TikTok, Instagram. No. Actually, I found out I had an Instagram account. I have no photos or videos up there.

And I only found out about it five years after setting it up. And I have, yeah, like a thousand or some followers. And they've never gotten a single photo from me. So I feel bad, but I sort of like, I like the, it's just an empty account with followers. So I haven't done anything. But yeah, yeah, follow me on Instagram. You're not going to get anything, but. None of that.

At bad scientist. All right. I love that. And then the very exciting thing is the whole point of wanting to retire early is that I wanted to make weird synthesizer music. And I've spent the last nine months in lockdown just really finally. trying to do that. So if you go to Mattfindis.com forward slash album, it's $5 and

it's some weird dancey synth music and that's the exciting thing that I'm spending all my time doing now. I'm so excited. I'm going to go download that. I mean, I'm going to go buy it and then download it. That's right. This is awesome. Okay. All of the

articles that you mentioned will be linked to our show notes which can be found at biggerpockets.com slash Money Show 161. Brandon, again, thank you so much for taking time out of your busy retirement to your busy locked down retirement, making synthesizer music, to talk to us about the retirement accounts that are available for people who may want to retire early. This was super helpful.

And I know people are going to get a lot out of it. So thank you. It's always a pleasure talking you guys. It's great seeing you after so long. And yeah, thanks for having me back. Okay. We'll talk to you soon. Bye, Brandon.

Bye. Bye-bye. Okay, Scott, that was Brandon, the mad scientist, who was always a delight to talk to. What did you think of the show? I thought it was great. I think he's always a fun guy to talk to about this stuff. I think he's really smart. I think I tremendously value his opinion, and I got some tidbits that are going to impact my own personal finances from today's show.

And I hope that if you're listening, you got a couple of that at least sparked some thoughts or helped you kind of reframe how you might attack 20, 21 for yourselves. Yeah, you know, I have a couple of takeaways from this episode that I wasn't expecting. I mean, I knew in advance the questions I was going to ask him because I prepare those questions every week. But one of the things that I thought was really interesting is that both you and Brandon have not been 100% optimized in your retirement planning. And I'm not saying this to make fun of you. I'm saying this to show people who are listening, look, nobody's perfect. Nobody is going to do this 100% optimized because they're not robots, they're human, there's emotions

involved. And it's so easy to sit here and be like, oh, you should totally do this. In real life, it's not that easy. And I just wanted to point out that Brandon, who knows everything, Scott, who knows everything, are still not doing it 100% perfect. And that's okay. The fact that you're listening to this show, the fact that you're even thinking about retirement, early retirement, optimizing your money, et cetera, puts you.

head and shoulders above so many other people. Yeah, it's like what is perfection too, right? Perfection is having a very specific idea of what's going to happen in the future, right? I'm going to be in this tax bracket today and this tax bracket tomorrow. And I know what the government tax brackets are going to be. And that informs my allocation to pre-tax or post-tax retirement accounts. And then when I retire, I'm not going to earn any income or I'm going to earn a lot of income.

And I know exactly what's going to happen there. that's going to offset that. No, you can't possibly know that. So all you can do are make some reasonable, big, high-level guesses around how you want your life and your situation to develop, and then make a reasonable allocation along those lines, rather than blindly pursue perfection at an extreme cost of your finances today. So I don't think there is a right. You know, Brandon and I can be suboptimal mathematically in our allocation. and how we set up these retirement accounts and still be right in the sense that our net worth is growing and financial freedom and a position of financial freedom and that abundance is created

and sustained. So I think it's just a matter of understanding that retirement accounts are not the whole show. They're one component. They shouldn't even be the core strategy. The core strategy should be, I'm going to spend less than I earn, I'm going to increase my income, I'm going to invest for the long-term in an appropriate blend of freedom-creating assets and or I'm going to create assets or businesses. And within that context, I'm going to use retirement accounts as one of my tools. And then depending on how heavily that is, that's a part of my strategy. That's where I'm going to dive deeper into the really more creative and more technical tools like the ones we discussed today. Yeah. And I'm glad you brought that up, Scott. The purpose of this episode,

was to introduce you to the concept. We're sitting here. This is what we do every single week. And we still, neither one of us has made a mega backdoor Roth contribution. But talking to Brandon is like, oh, oh, I could do that. There's another way for me to optimize. Am I going to do that every single year? Probably not.

This year was a really good year. And I have already screwed up by making a Roth IRA contribution in the beginning and then blowing through my income, which is, that sounds bad. I didn't blow through. I blew through my income projections and now might not be eligible for a Roth IRA contribution, which, again, is a good problem to have. That means I made a boatload of money. But with this mega backdoor Roth option, I can go in and throw even more money in there.

So since I have had such a good year, there's a lot sitting in the pot right now, waiting for something to do it. So I'm super excited to be able to do that. Absolutely. But Mindy, I'll tell you what, I would rather be in the position of having a good income, a high savings rate, control over my expenses, a six, you know, six plus month emergency fund, a house hack or two, or a live-in flip or two under my belt and a surplus and not have an opt, you know, have contributed for years to retirement accounts and build a sizable position and not have optimized it than the reverse, that has started with the optimization of the retirement accounts

and not have the other fundamentals in place. So again, while I have plenty of work to do at homework that assigned by the mad scientist today for my personal financial position, I can also rest easy feeling like a lot of the other bases have been covered from a personal finance perspective. So again, I really think that as the big takeaway from today's show is that there's so much power in optimizing and leverage that you can get from being the guinea pig with the more optimal

financial or more optimal retirement account set up than the guinea pig without it. But I do think that, again, it all needs to be taken in the context of get the fundamentals right first and then begin, you know, layer these in as a focus. Right. Even the guinea pig who isn't optimized is still doing better than like 90% of Americans. Maybe not 90%. They're both going to fight. I just made that statistic up.

Yeah. Okay. Next week, I want to bring on a guest who can talk the specifics, the tax specifics of all the things that we talked about in today's episode. We're going to talk about the contribution limits. We're going to talk about how to find somebody who can help you with your personal financial situation with regards to the Roth conversion ladder, the mega back door, all these things we talked about today, the HHS. A accounts, because these are things that you need to know, and we want to help you get to that point. I want to plug our new Friday episode, Scott. I don't know if you listened to last Friday's episode. There's another one coming up this Friday. Scott and I have decided that, yeah, personal finance is personal, and we want to help you personally with your finances. So if you have a question, if you would like us to review your finances, we need a bit of information from you, but you can fill out the form at biggerpockets.com slash finance review. And we would love to review your finances and see what tweaks you can make to optimize your

finances further. Yeah, I think you're going to learn a lot from those finance reviews because we are, and there's no one right answer to these things. Everybody so far has had a different problem within their personal finances or different opportunity or different leverage point along the funnel. So I think we're going to have a different problem. a lot of fun with those, and I think we're going to learn a lot along the way. Yep, I'm super excited for them. I'm really having a good time, Scott.

Okay, should we get out of here, Scott? Let's do it. From episode 161 of the Bigger Pockets Money podcast, he is Scott Trench, and I am Indy Jensen, saying, have fun storm in the castle. Because Brandon's from, Brandon lives in Scotland and they have castles. That's from the Princess Bride. You've seen the Princess Bride, haven't you? I have seen the Princess Bride. I'm just smiling.

What's this look? I think I was looking at me like, what does that mean? I think I was more looking at you like, I'm trying to come up with a quick pun on the spot in response to that. But I'm not able to. So let's see you later, everybody. Thanks for listening. Bye. We'll just ram us a couple of puns through.

That's too late. Too little too late. Anyways, goodbye.