Have you ever wondered what the differences are between financial account types? Well this episode is for you! Josh and Austin discuss the three main account types: taxable accounts, after-tax accounts, and tax-deferred accounts. Plus, you get a look into what investing looks like with these account types, putting money into these accounts, how to take money out of them, and of course, the dad joke of the week. Listen now!
Main Talking Points
[1:26] – Taxable Accounts
[9:01] – After-Tax Accounts
[11:00] – This “Roth” Business
[17:48] – Tax-Deferred Accounts
[24:04] – Dad Joke of the Week
[26:06] – Types of Investments for Each Account Type
[31:16] – Summary Thoughts
Links & Resources
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to the Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right, hey, hey, hey. Welcome back to the Invested Dads Podcast. The podcast where we take you on a journey to better your financial future. Today, we, Josh and I, we’re going to be taking you on that journey we talked about, to talk about different account types for your investments.
Josh Robb:
Yeah, you mean, there’s more than one?
Austin Wilson:
There’s maybe only two.
Josh Robb:
Okay.
Austin Wilson:
No, there’s a lot more than that.
Josh Robb:
There’s a lot and actually, we should say, we’re not going to actually talk about all the account types out there.
Austin Wilson:
That would be a long episode.
Josh Robb:
We’re going to talk about the main account types you will probably encounter and the differences between those but there are many different small minute account types but in general, they fall into three big categories.
Austin Wilson:
Three.
Josh Robb:
Taxable accounts.
Austin Wilson:
Yup.
Josh Robb:
Tax free accounts.
Austin Wilson:
Wait, really?
Josh Robb:
Yup, tax free accounts and then tax deferred, deferred meaning you putting it off for later.
Austin Wilson:
Wait, wait. So, we were just talking about this before we hit the record button but everything is taxed at some point.
Josh Robb:
At some point, the government wants tax.
Austin Wilson:
They want their cut.
Josh Robb:
They want something from you earning.
[1:26] – Taxable Accounts
Austin Wilson:
So, we’ll talk about how that is for each kind of segment of accounts here. Josh, first up in account types, taxable accounts.
Josh Robb:
Taxable accounts. So, they have different names to it. They can be called an individual account, a joint account, brokerage account so if you ever see brokerage in the word, usually that is a taxable account and they’re called taxable in that throughout the timeframe, they’re taxed every year. So, while you have an account open like this, you are continuously being taxed on your investments.
Austin Wilson:
In real time.
Josh Robb:
In real time. So, the way that works for a taxable account is when you place a trade, when you sell, you’re going to be taxed on the gains, on the growth on that investment.
Austin Wilson:
Right.
Josh Robb:
If you have a loss, the tax is to your benefit, you still have a tax impact from that which is a loss.
Austin Wilson:
Yup.
Josh Robb:
The other that’s taxed during that timeframe is, any kind of distributions.
Austin Wilson:
Right.
Josh Robb:
So, if I have a bond and it gives me interest, that interest is taxable. Now, there’s certain types of bonds that can tax free blah, blah, blah but if the interest is taxable, you get it when you receive it, the old tax.
Austin Wilson:
Same thing with like dividends.
Josh Robb:
Yes.
Austin Wilson:
So, if you were in a real estate investment trust, wherein they have to pay out a large portion of their income and dividends, you’re going to receive substantial percentage dividends compared to other stocks probably, that is taxable.
Josh Robb:
Yes, and so, any time there is some sort of increase in value to you, the government will try to take a portion of that in taxes. That’s kind of the best way looking at it. If it’s a gain, if it’s a dividend, if it’s interest, any kind of, “Hey, this is more money than I had before,” then they’re going to say, “Hey, I want a part …” They’ll kind of raise their hand and say, “Hey, you owe me a little bit of that.”
Austin Wilson:
Even like a mutual fund with a capital gains distribution. Same kind of thing.
Josh Robb:
Yes, and we’ll talk about that. There’s less control over that because they pick when they give you this distribution, not you. You may not even sell your mutual fund but you may owe capital gains on it because within the underlying holdings, they made some transactions.
Austin Wilson:
This is an example of a type of an account that it just does not matter, that the money is … if you pull the money out of the account or not, it is taxed regardless.
Josh Robb:
Yes.
Austin Wilson:
Like difference, and what we’ll talk about in a little bit, where you may have to take the money out for it to be taxed or whatever, this is taxable in the account.
Josh Robb:
In the account. Yes, so at the end of the year, you’ll get a tax form from whoever, whatever place that is held up, if it’s a bank or an investment firm or a custodian of some sort, they’ll send you a tax form every year that shows those transactions throughout the year, all the income of interest and dividends paid in, plus any purchases in sales so that then you see, “Okay, here’s my total tax that I owe.”
Austin Wilson:
Right.
Josh Robb:
You could offset some of those, so if I have one investment that’s doing well and I sell it and I have a capital gains, then I have another investment that’s not doing well, I could sell that and offset the two so I owe less taxes.
Austin Wilson:
Right.
Josh Robb:
So, there’s things you can do to control your taxes but either way the tax is due every year.
Austin Wilson:
Your holding period determines your tax rate on a lot of investments.
Josh Robb:
Yup.
Austin Wilson:
So typically, what these account types are really good for is if you’re going to hold something longer than a year, you can … then if you sell it at a gain or whatever, now, your dividends are still going to be taxed at short term rates but you’re … if you’re holding something more than a year, you sell it at a gain, you’re going to incur tax but at the lower long term capital gain rate.
Josh Robb:
Correct. So, anything less than a year is whatever your income tax is.
Austin Wilson:
Yup.
Josh Robb:
Anything held longer than a year, you’re paid the capital gains rate which is either 15 or 20%, depending on where you do fall in your income, in your tax bracket but either way, it’s lower than your tax bracket. Actually, in the lowest income brackets, there’s zero capital gains tax. So, if you’re very low on income, then you actually don’t pay any but it’s still shown up as a capital gain. Now, I will say some dividends are qualified where their tax is treated a little bit better as well.
Austin Wilson:
Right.
Josh Robb:
There is caveats to everything we’re talking about but I will say too, when we’re talking about that, you may say, “Well, those sound like the worst account types, always getting taxed on it.”
Austin Wilson:
Right.
Josh Robb:
Because you’re always taxed, there is really no restrictions on these account types.
Austin Wilson:
Yeah, you can take it out whenever you want for whatever you want.
Josh Robb:
You can do whatever you want with it. When it comes to contributions and withdrawals, there’s no restrictions.
Austin Wilson:
Right.
Josh Robb:
When it comes to what you hold within the account as well, they do not restrict what can be in there because they know they’re going to be paying tax along the way. So, there’s a lot of flexibility that comes with the way it’s being taxed. This is a very flexible account and a lot of people use it for shorter term goals because they don’t have to worry about any kind of penalties or excess tax if they do need to take the money out.
Austin Wilson:
As of now, aside from cryptocurrency, you can probably hold anything.
Josh Robb:
Yes. Yup.
Austin Wilson:
Now, that, even someday maybe an option but as of right now, you have to have a special digital wallet or whatever for that, but yeah, the most flexible for putting in money, taking your money out and there’s just, what you want to invest in, it’s just do what you want, so it’s open.
Josh Robb:
Yup, and so that’s great. Like I said, a lot of people say, “Okay, I’m saving up for a down payment on a house,” or something like that. This is a good account to use that for because there is no restrictions.
Austin Wilson:
Right.
Josh Robb:
Because some of the accounts we’re going to talk about that are more retirement based, you have to wait until you’re 59 and a half or else you pay an extra tax penalty on top of your normal tax, and so, with this having no restrictions, a lot of people will utilize this to do that, as well as there’s no contribution limit. So, if you’re already maxing out all the other ways to save in retirement, there’s no limit, you could put as much as you want into this type of account.
Austin Wilson:
Let’s shift gears.
Josh Robb:
One more thing before we do.
Austin Wilson:
Don’t shift gears yet, put it back in-
Josh Robb:
Here it is. The last piece of this is what happens when it goes to the next generation, when somebody inherits account like this. So, the benefit is it’s being taxed. If let’s say, like Austin said, it’s a long term holding so I have … I bought it for $100 and now it’s worth $1,000. So, I have $900 of this capital gains that, if I was to sell it, I would owe tax on that $900. Well, if I pass away and my kids inherit this, so they now have $1,000 of whatever this investment was, they get to step up to the day of my death. Now, their cost, what they purchased it for, in air quotes on a podcast, what they purchased it for is now whatever the price was on that day.
Let’s say it’s that, $1,000. Now, they owe zero capital gains tax if they were to sell it at that same day. For the next generation, it’s actually a pretty efficient way of receiving something that maybe had a lot of tax built into it, if you give that to the next generation. They can, a lot of times, not pay any of that tax.
Austin Wilson:
There are limits.
Josh Robb:
There are limits.
Austin Wilson:
That’s a topic for another day.
Josh Robb:
Yeah. When we talk through estate in another podcast, we’ll walk through some of those but the inheritance tax and all that, that’s pretty high right now. It changes a lot when the government feels like they need more money but right now, it’s pretty high that most people won’t run into some of those issues. In general, it is a nice inheritance piece because again, the next generation does not have restrictions on it. There’s no requirements on what they have to do with it and more often than not, they are going to get at least a partial step up in cost basis so that it’s at least a reduced amount of taxes they owe as opposed to the person prior.
Austin Wilson:
Right, so stay tuned for an episode where we talk about different states.
Josh Robb:
Estates.
Austin Wilson:
Estates. I see what you did there.
Josh Robb:
Estates. Yeah, which will be a very exciting one so make sure you drink coffee before listening to it so that you stay awake.
[9:01] – After-Tax Accounts
Austin Wilson:
All right, so just like we almost did earlier, we got ahead of ourselves, let’s shift into second here, different gear of account types, tax free accounts.
Josh Robb:
That sounds great.
Austin Wilson:
I think … so no tax ever?
Josh Robb:
Tax free. Free of tax.
Austin Wilson:
Free for … no tax. I like it.
Josh Robb:
Well, like we said, the government wants their tax at some point. So, tax free account types, with a couple exceptions are usually money you’ve put in after you paid tax on it.
Austin Wilson:
You already paid tax.
Josh Robb:
Then, it grows tax free and you do not owe tax on any amount that you withdraw in the future, including the gains. We’ll walk through that. The biggest ones you see is when you see the term Roth, R-O-T-H, Roth IRA or Roth 401K.
Austin Wilson:
Like Josh Roth.
Josh Robb:
Yes. Close. Different ending, but the idea there is these type of accounts you’re going to put in after tax, meaning you’ve paid your income tax on that money that you earned somehow, wherever it came from and now, when you put it into a Roth IRA or Roth 401K, from then on, since it’s already been taxed, it can grow and you will not owe tax on the money you put in nor on the growth of that money. So, going back to my example, if I have $100. I put in a Roth IRA and it grows to $1,000, I’ve already paid tax on that $100.
Austin Wilson:
Yes.
Josh Robb:
I can withdraw that $1,000 once I meet all the rules that we’ll talk about and I owe no tax. So, I got $900 of tax free money which is great.
Austin Wilson:
That’s a beautiful thing.
Josh Robb:
Yes. So, a couple examples, though, that you actually don’t owe any tax on, would be a 529 plan, is that money can go in and you usually get a tax deduction depending on your state but you can get a tax break for putting the money in.
Austin Wilson:
Right.
Josh Robb:
Then, it grows tax free and then you withdraw it tax free so that’s a great place.
Austin Wilson:
Yeah.
Josh Robb:
Then the Health Savings Account, the HSA is another example of that as well. You get a tax deduction for adding into your HSA, it grows tax free and if you use it for medical expenses, tax free.
Austin Wilson:
Or, you can even pull that out-
Josh Robb:
Or, you wait until your retirement.
Austin Wilson:
When you retire and then you only pay the income tax on your gains.
Josh Robb:
Yes and that becomes like a tax deferred account.
Austin Wilson:
Exactly.
Josh Robb:
Which we’ll talk about in a second.
[11:00] – This “Roth” Business
Austin Wilson:
Which is the next step, but we’re getting ahead of ourselves so let’s talk a little bit more about this Roth business.
Josh Robb:
Yes.
Austin Wilson:
Because it’s not like unlimited tax free growth.
Josh Robb:
Right.
Austin Wilson:
There is a lot of limits involved, because the government knows that Josh already paid tax on that hundred dollars but he only paid tax on that hundred dollars, if it’s going to grow a ton, there’s not … you can’t just have it unlimited or else, everyone is going to use this all the time.
Josh Robb:
Yes, so they put some restriction on it. They put income restrictions and they put withdrawal age limits on it and so, what they’re saying in a sense is we understand the benefit of these account types and we’re going to limit especially the high income earners from taking too much advantage of this tax free growth because a lot of times what you’ll find out is if you’re a high income earner, you have some pretty smart attorneys helping you avoid taxes in most instances. So, this benefit is not really for you, it’s for a middle class, the average person to say, “Okay, I want to put some money in and I want to get the most efficient growth as possible to help for my retirement savings.”
Austin Wilson:
Exactly.
Josh Robb:
So, some of those stipulations. I’m not going to go through the income limits because they change periodically and I don’t know when you’re going to be listening to this episode.
Austin Wilson:
So, check the IRS website and they will have the most current.
Josh Robb:
Yes. So, there is income limits and how it works though is for singles, it’s one level. If you file jointly, it’s a higher level and that applies for both people that are filing jointly but then they phase it out, so they have a low end of income and a high end of income. If you’re below the low income then there’s no restrictions, you could put up to the max in which again, changes over time. In 2020, it’s $6,000 but it goes up periodically. Then, if you’re in the in between stage, they reduce it so you may not be able to put the full 6,000 in but you can still do something in a Roth.
Austin Wilson:
Right.
Josh Robb:
Then once you hit your high income limit, then you just can’t do a Roth at all. So, again they’re targeting this, it’s created in the values for people who don’t have extremely high income.
Austin Wilson:
There’s also catch ups.
Josh Robb:
Yes.
Austin Wilson:
When you get to, closer to a retirement age.
Josh Robb:
Yes. So, when you’re 50 or over, you can do an extra amount of catch up. So again, in 2020, if 6,000 is your contribution, you can do $1,000 catch up. So, you could do 7,000 into the Roth IRA, if you meet the income limits.
Austin Wilson:
So, like Heinz Ketchup.
Josh Robb:
Yes, it’s the catch up. So, the idea though, again, is a lot of people are not doing what they need to, to save for retirement and we can … there’s stats on that, that are very depressing. The idea there is they’re giving an extra benefit. If you’re in your 50s and trying to get to a spot where retirement is a lot more stable and have a higher probability of success, they give you that extra catch up amount.
Austin Wilson:
The sad part is that it almost should be flipped because of the power of compounding.
Josh Robb:
Yes.
Austin Wilson:
It would be nicer for younger people to be able to contribute more and to go down as you get older, but we understand that yeah, the statistics for people saving for retirement are pretty poor at this point. So, Roth 401K, those are pretty new. I hadn’t heard about them until a prior life I had, it is an option in my retirement plan. So that, and we’re going to talk about traditional 401Ks in a little bit, but Roth 401Ks are … this is after tax money, out of your paycheck that then gets … put into a kind of separate account in your 401K but it’s after tax growing.
Josh Robb:
Yes. So, it’s exactly like a Roth IRA in what it does. You pay tax on the money before it goes in, then it grows tax free. It’s just in a different type of structure, it’s in your company’s retirement plan. So, the benefit there is the contribution limits are then on the 401K contribution limit amounts, so we’ll talk about that on the tax deferred, but 6,000 is what you could put in a Roth in 2020. For 2020 in a 401K, it’s 19,500. You can see, using a Roth 401K, if you want to put a lot of tax free growth in there, utilizing that gives you a lot more value in how much you can put in. Then again, if you’re over 50, you get an extra like $6,000 in the catch up as well.
So, there’s a lot of room there, I think, it’s 6,500 in 2020, this year. There’s a lot of room there. If you want to put tax free growth using a Roth piece, the Roth 401K gets you the most dollars in and then a Roth IRA is available for anybody, whether or not your company has a retirement plan.
Austin Wilson:
Exactly.
Josh Robb:
Those are the tax free growth. They’re great. On the other end, so that’s how you put money in. On the other end, how do you take money out? Since you get that tax free growth, the IRS says, this is … IRA stands for individual retirement account. So, the retirement piece in there, they’re saying, you’re not going to retire when you’re 25 years old, you’re retiring in your 60s and so, they say if you wait until 59 and a half or older …
Austin Wilson:
There’s those half years again.
Josh Robb:
I don’t know what they’re doing. There’s probably some Senator though, he’s not 60 yet. He’s like, “I want to touch some money.”
Austin Wilson:
It’s an actuarial table issue.
Josh Robb:
That’s weird. So, if you’re 59 and a half or older, you can withdraw with no penalty and since it’s in a Roth IRA or Roth 401K, there’s no tax. Once you reach that 59 and a half age, there’s no restrictions on what you can withdraw on that account. Prior to that, they give you some flexibility because they understand if you put money away, things happen, any money you put in, you can pull out. There’s a five year window for Roth IRAs that you have to wait for but other than that, you can take any money you put in, any dollars you put in, you could pull out, no tax, no penalty. Any earnings, you withdraw, you owe tax and you owe a 10% penalty.
Josh Robb:
That 10% penalty is on top of the tax. So, if you’re in the 22% tax bracket, you owe 32% for withdrawing your money before you hit 59 and a half.
Austin Wilson:
Penalties are rough.
Josh Robb:
Penalties are rough and it’s there to motivate you to grow it and invest it for retirement. Now, there are some exceptions for first time home buying for … if you’re in some sort of health crisis or any certain situations you can apply.
Austin Wilson:
I think those secondary education as well.
Josh Robb:
Yup, yup, and so, there’s certain caveats to that as well, where you can take money out and not pay that penalty. You still owe tax in almost all those situations but there is no penalty and like we saw here with COVID-19, at the beginning of 2020, they made some exceptions as well to some of these withdrawals that they extended and gave some relief to it as well. So, it’s not hard and true facts. They can be adjusted by Congress in certain situations. In general, when you’re planning on adding money, Roth IRA, Roth 401K, think long term because accessing the money can cause quite a bit of penalties.
[17:48] – Tax-Deferred Accounts
Austin Wilson:
So, we talked about taxable account types where gains and dividends are taxed within the account in real time, tax free account types, you already paid the tax on it so no worries whatsoever. Let’s talk, and our third and final category, tax deferred account types.
Josh Robb:
Deferred meaning putting it down the road which is what-.
Austin Wilson:
Putting it down the road.
Josh Robb:
Again, going back to Congress, they love doing that, don’t they?
Austin Wilson:
Why pay tax today when you can pay tax tomorrow?
Josh Robb:
Right. Isn’t that what the guy, the hamburger guy. He always said … Popeye, The Sailorman. He’s always like, “Can I have a hamburger today and pay you tomorrow?”
Austin Wilson:
I was just thinking like an Olive Oyl.
Josh Robb:
No, that was Popeye. Tax deferred, so tax deferred means that I’m not going to pay tax now but sometime down the road, I will owe tax. So, it’s kind of the opposite of that Roth IRA. A traditional IRA, which was here before the Roth IRA, traditional.
Austin Wilson:
It’s tradition.
Josh Robb:
It’s old. You put money in and you get a tax deduction, so you don’t owe tax on the money you put in to that IRA. Then, it grows, tax deferred, until you withdraw the money. From the time I put it in until the time you take it out, there’s no tax out and it grows during that time, tax free but it’s not always free. At some point, tax is due.
Austin Wilson:
Government wants their tax.
Josh Robb:
They have similar rules. They have income limitations for traditional IRA. They also have the same restrictions on the other end. If you withdraw it before 59 and a half, you have the 10% penalty on top of the tax. Those are all kind of similar. The income limits vary again and same ideas, the phase out. If you make above a certain amount, you can do non-deductible IRAs which is similar to, you pay tax on the money, it grows tax deferred and you owe tax and we pull it out. It’s kind of not ideal but for people that want at least a tax deferred growth, there’s a way of doing it, if you make too much money for those limits. High level, money grows tax deferred while it’s in there and then, you owe tax when it’s grown up. Going back to my example, I put $100 in. I’m not paid tax on the hundred dollars.
Austin Wilson:
It’s pre-tax money.
Josh Robb:
Pre-tax money. It grows to $1,000 and then when I take it out, I have $1,000 of income tax that I owe on that withdrawal.
Austin Wilson:
So, typically this is taken out of, now, what this does for you in real … traditionally, the most common example of this is a 401K.
Josh Robb:
Yes.
Austin Wilson:
If you work at a larger company, chances are the retirement option you are given for the plan is called a 401K, and you put in X percent of dollars and your company will match X percent of dollars to go on top of it. It is literally the most beautiful … it’s wonderful thing.
Josh Robb:
Free money.
Austin Wilson:
I love it. Anyway, what happens is, say you put in 5% of your paycheck and say your paycheck is $1,000, $50 is 5% of that.
Josh Robb:
Yup.
Austin Wilson:
Did I do the math right?
Josh Robb:
Yup.
Austin Wilson:
Okay, so you only take home, before taxes, 900 … your income is not 1,000, your income is $950.
Josh Robb:
Yup.
Austin Wilson:
So, your income tax is less.
Josh Robb:
Yup, if it’s not taxed, that money is not taxed.
Austin Wilson:
That money is not taxed. What it’s doing is it’s lowering your current income taxes as well, which is kind of a nice thing. Now, the caveat that I’ll throw in here is that these tax deferred savings options are, they’re really wonderful things but with the way that our economy works, and the way that our country and the fiscal and monetary policy and everything works together, it seems likely that taxes are going to be higher down the road than they are now but the benefit of that is, is that hopefully, when you’re pulling this money out, your income will be lower so you’ll be paying less tax.
Josh Robb:
Yeah, and that’s always the thought, is my post retirement income will be less than my working income and so my taxes will be lower-
Austin Wilson:
Even if the rates are higher.
Josh Robb:
Even if rates are higher, I’m probably in a lower tax bracket, getting a lower effective rate. Yup, so, traditional IRAs, 401Ks, rollover IRAs, which is when you pull money out of a 401k and then put it into an IRA.
Austin Wilson:
So, like if you went to another employer and you wanted your retirement out of your former employer’s 401K plan, you could take it to your financial advisor and say, “Hey, I want to roll this into a rollover IRA,” and they would manage it for you separately.
Josh Robb:
Correct, and there’s simple IRAs, SEP IRAs, there’s all different types of … but when you see IRA, if it doesn’t have the word Roth in front of it, it’s tax deferred.
Austin Wilson:
Got you.
Josh Robb:
403Bs, that’s a fun one. That is the same as a 401K but for nonprofits. So, a lot of hospitals operate as a nonprofit, so you see that. Schools, a lot of times universities, you’ll see a 403B.
Austin Wilson:
Yes.
Josh Robb:
It’s a 401K just for the nonprofit world, same rules apply. Then, there’s like defined contribution plans and defined benefit plans. Those are all different types of retirement plans you may run into. Defined benefit plans are a little less now. They’re not as popular.
Austin Wilson:
They were pretty much the only way to save-.
Josh Robb:
Pension, yeah, these are pension.
Austin Wilson:
So you had retirement for … until 30, 40 years ago, then that was really … you got a pension when you retire based on how long you work there and how much money you made and it’s a big complicated calculation and actuarial tables and all this other stuff. That’s uncommon nowadays, becoming more and more so every single year because it’s very expensive.
Josh Robb:
Yeah. So, a defined benefit plan … think of it this way, so they’re defining your benefits in the future or they’re saying, “Here’s what you’re going to get in the future,” which is usually some sort of pension payout like every month, you’re going to get an amount. A defined contribution plan is the other way around. They’re defining how much they’re going to add in and a lot of times, it’s a match so if you put an X amount, you’ll get X amount. That’s what it’s moving towards because defining the future benefit is hard to do especially as people are living longer and that’s what pensions have run into is, “Man, I thought people were only going to live into their 70s on average, now they’re living into their late 80s, early 90s.”
Our pension plan doesn’t have enough money to cover everybody and so that’s why you see fewer and fewer pensions is because of the cost of those. 401Ks are more of a defined contribution plan because they’re telling you how much they’ll contribute into the plan on their behalf for you and so, that’s more popular and becoming more and more the norm in what you see in large corporations.
[24:04] – Dad Joke of the Week!
Austin Wilson:
Exactly. So Josh.
Josh Robb:
Yes.
Austin Wilson:
It is a great day.
Josh Robb:
Great day. It’s raining a little bit today, but it’s all right.
Austin Wilson:
It’s a great day. I’m going to give you a gift on the screen.
Josh Robb:
Okay, I’m ready.
Austin Wilson:
It’s the dead joke of the week.
Josh Robb:
Dead joke.
Austin Wilson:
I’ve been thinking of this one for literally, a little bit of time. I found a good one. Don’t take a sip of water, you might spit it right out.
Josh Robb:
I’m ready.
Austin Wilson:
How many tickles does it take before you can make an octopus laugh?
Josh Robb:
I know the answer to this.
Austin Wilson:
Dang it, Josh.
Josh Robb:
But, I’m going to let you say it because I love it.
Austin Wilson:
Tentacles.
Josh Robb:
Tentacles. It’s a funny word, just when you think about it.
Austin Wilson:
Tentacles.
Josh Robb:
Tentacles. That’s how many tickles though and the laugh.
Austin Wilson:
It makes … so, Pirates of the Caribbean, David Jones. You can’t see it because it’s a podcast everyone but I’m doing the-
Josh Robb:
He’s doing the tentacles on the beard.
Austin Wilson:
Tentacles.
Josh Robb:
Yes.
Austin Wilson:
So, we’re debating what movie to watch tonight. We’ve watched the first … all except for the last of the Pirates movies, so that’s one option.
Josh Robb:
At World’s End. Yeah.
Austin Wilson:
At World’s or is it Dead Men Tell No Tales?
Josh Robb:
I don’t know.
Austin Wilson:
Whatever the last one is, we have it left, it’s on Disney Plus, it’s option one. The other option is Tobey Maguire, Spider Man One, which would you pick?
Josh Robb:
The classic.
Austin Wilson:
Which would you pick?
Josh Robb:
I’ve only seen the Pirates of the Caribbean, the fourth movie once, so I’m trying to remember it.
Austin Wilson:
The fourth or fifth?
Josh Robb:
Fifth, fourth, I don’t know.
Austin Wilson:
I think it’s fifth.
Josh Robb:
I think it’s fifth, maybe, I haven’t seen that one yet. I don’t know.
Austin Wilson:
It’s the one after the Fountain of Youth.
Josh Robb:
There’s one after the Fountain of Youth?
Austin Wilson:
Yeah.
Josh Robb:
Man, maybe I need to go watch that one.
Austin Wilson:
Disney Plus.
Josh Robb:
Yeah, so to answer your question, I’ll probably watch that one because I have no idea what it is.
Austin Wilson:
That is our biggest … that’s the household discussion for the evening.
Josh Robb:
Okay.
Austin Wilson:
What’s going to happen once our little one goes to bed?
Josh Robb:
I mean, you can’t go wrong with Spider Man. Any of the Spider Man’s.
Austin Wilson:
I really like the newer ones too, so those are really good like The Amazing Spider Man.
Josh Robb:
Yeah, The Homecoming.
Austin Wilson:
I’ve never seen that.
Josh Robb:
Those are good. Those are good.
Austin Wilson:
So, maybe our list is growing.
Josh Robb:
Yes, we have … if you’re watching through all the Marvel movies, like you said, you got to wait for those because they tie into everything.
[26:06] – Types of Investments for Each Account Type
Austin Wilson:
There’s so much to … There’s just a lot of movies out there. So Josh?
Josh Robb:
Yes.
Austin Wilson:
I think we should probably talk about the types of investments and the kind of overall thinking for these different buckets.
Josh Robb:
Yeah.
Austin Wilson:
Not even specific accounts but different buckets of account.
Josh Robb:
Yeah.
Austin Wilson:
So, as far as taxable account types go, you can pretty much invest in anything you want. That’s one of the things we talked about. The benefit is you can buy what you want, sell what you want, whenever you want, pull the money out whenever you want.
Josh Robb:
Yup.
Austin Wilson:
You will be taxed in real time as this stuff occurs.
Josh Robb:
Yep.
Austin Wilson:
That’s a beautiful thing. The only caveat I would say … and we talked about it is, unless you want to incur that higher tax rate then you should probably hope to hold things for at least a year.
Josh Robb:
Yeah but you have really, almost complete control of taxes in that account, because you’re never forced to do anything.
Austin Wilson:
Exactly.
Josh Robb:
Besides the mutual funds they kick out their distributions, but other than that, based on your holdings, your decisions, you choose what tax and how much based on what you do with your transactions.
Austin Wilson:
And you can hold different things and buy and sell different things at different times and offset gains with losses, and there’s a lot of flexibility that hopefully your advisor would be able to kind of walk you through as the options that … when tax time comes around. So, the only … Dude, yeah, probably best, if possible to avoid things that kick back a lot of cash your way.
Josh Robb:
Yup.
Austin Wilson:
Those are going to be taxed in real time at higher rates. Other than that, pretty much do whatever you want. Now, let’s think about tax free. So, this is like, it just says 529 plans, those kind of things. What can you invest in? Again, probably, you know, a lot of options.
Josh Robb:
Yes.
Austin Wilson:
Roth IRAs, these kind of things. ETFs, mutual funds, stocks, it’s a beautiful world, you can invest in what you want and these are great account types to invest in things that do kick off a lot of cash your way so high yielding, dividend stocks, real estate investment trusts, like we talked about have high yields. Fixed income, those kind of things, great option here because you can get that cash flow into your account and you are not taxed on it.
Josh Robb:
Yep, or a high turnover, higher turnover strategy where you’re trading in and out more often.
Austin Wilson:
Especially now with trading costs at none.
Josh Robb:
Yes.
Austin Wilson:
So, it’s not a bad option at all there.
Josh Robb:
Not that we condone day trading by any means because there’s a lot of research involved to do that, but if there was a strategy or something that you’re investing in, where there is a lot of trades, within an account like that, you’re not going to be taxed on those trades as they happen.
Austin Wilson:
Yes, so then the third bucket tax deferred, like we talked about. These are, I think like 401Ks, traditional retirement plans. You can again, probably invest in a lot of different options, but in most retirement plans, the most common is typically mutual funds. One thing that’s really easy about that is you can buy partial shares, dollar cost averaging with paychecks is very, very easy. That is probably the most common but there are often other different options in there as well. Target date funds are very common in today’s retirement plans where, if you’re coming out of college and you think you’re going to retire in 30, 35, 40 years, you can just pick the nearest target date to when you think you’re going to retire.
What it will do is be very growth oriented and aggressive in terms of equity exposure when you’re young and gradually shift over time. Now, I will put the disclaimer out there that that’s an imperfect system and it does even … and so we’re recording this in 2020. I don’t know when you’re going to listen to it, but a lot of those target date funds had a pretty rough beginning of 2020 even if they were closer to retirement.
Josh Robb:
Yeah.
Austin Wilson:
It’s not a perfect system. It’s a directionally okay system and the idea is okay, but I will warn you, they’re not perfect.
Josh Robb:
Like you mentioned, based on the types, so 401Ks, 403Bs, those that have … that are tied to your company and your employment, they’ll be choosing at least a menu of choices for you in most cases. Now, some give you the option to invest outside but more often than not, you’ll just be given a list of 15 to 20 mutual funds to choose from or ETFs, whatever they’re using. So, you can be limited, but the structure itself does not limit you. It’s just really the plan that could limit you, but rollover IRA and traditional IRA, the sky is the limit. I mean, the same is true with the other account types, you can invest in just about any type of investment structure that’s there.
Austin Wilson:
In terms of dollars, for most people who are working today, this will be the category where the majority of your retirement dollars are being held.
Josh Robb:
Yes.
Austin Wilson:
In these tax deferred account types.
Josh Robb:
Yup. Now that they have Roth 401Ks, you could get a little more but up until that point, which is really just a handful of years ago that they started offering that, you were limited to just the Roth IRA, which was again, in 2020, 6,000. So, you could see between putting 19,500 in a 401K and 6,000 in Roth, most people did end up with a lot more tax deferred money than any other bucket.
[31:16] – Summary Thoughts
Austin Wilson:
Josh, just kind of walk us through a little bit more high level thoughts on the different account types and when money is taxed and that kind of thing because they’re very different and I think that can be very confusing.
Josh Robb:
Yes. Yeah. So just kind of as a recap, taxable account types, brokerage, those that are individual, joint, those account types, they are taxed when transactions are made.
Austin Wilson:
Real time.
Josh Robb:
In real time. Roth IRAs, those are taxed when the money goes in. So, all the money is taxed prior to it being, put into this kind of account type.
Austin Wilson:
Correct.
Josh Robb:
Deferred tax account types like 401Ks and traditional IRAs, those are taxed when the money is pulled out and we’re going to talk … that’s the last piece of this whole thing. Like I said, there’s two sides to it, is prioritizing adding money in and taking money out.
Austin Wilson:
Yeah, so start with adding in.
Josh Robb:
Okay.
Austin Wilson:
How would you … now it’s different for everyone, right?
Josh Robb:
Yes.
Austin Wilson:
So, every single situation is a little bit different. That’s why it’s important to work with your advisor and determine what the best allocation for how you put in and pull out your money but as a rule of thumb, at a high level, how would you advise clients to prioritize adding money to their retirement account types?
Josh Robb:
Yeah, so again, this is high level, everybody is a little bit different and unique in this situation but in general, the first and foremost thing you do if you’re looking for retirement savings is add money into retirement plan at work if they’re offering a match.
Austin Wilson:
Free money.
Josh Robb:
Like Austin said, that’s free money, so it’s money that they’re going to add in to your account, as long as you’re contributing into it. If you don’t put anything in, they don’t put anything in, the money goes away. You don’t get it in your paycheck or anything else. It goes away. First and foremost, put in as much as you need to, to get that company match.
Austin Wilson:
So, in a prior life, I knew of that there were people who did not do that because they said they could beat it and I said, “How do you beat 100% or whatever the match is?” You can’t beat it.
Josh Robb:
No.
Austin Wilson:
Free money, man.
Josh Robb:
Even if you don’t invest, I mean, you’re just going to get, double the money.
Austin Wilson:
Cash.
Josh Robb:
Yeah.
Austin Wilson:
Number one.
Josh Robb:
Free money, put that in, then the second spot really depends on your goals. Again, we’re talking retirement savings first and foremost. So, once you get that and then the next step, in my opinion, is the Roth IRA. I talked about as long as your income fits within the income limits, and being tax free the rest of time gives you a really nice savings vehicle for long term growth, as we talk through compounding and the growth of money, to not have to worry about taxes on that growth is great, so your ending value ends up being better. As an inheritance piece, the next generation, although there’s some rules on what they can and can’t do with it, they won’t be taxed on the withdrawals. The next generation also has a nice tax break from a Roth IRA, tax free money.
So, those are the two steps and then after that, you can go back and add more money to 401K and to max that out. That’s for retirement savings. Shorter term goals, that’s where those individual taxable accounts come into because again, there’s no restrictions. So if I’m saying, “Oh, I want to save up for a car,” but it’s down the road and I couldn’t afford a little risk, I want to invest it. Okay, you don’t want to put that in a 401K. You don’t want to put that in a Roth IRA. That’s a taxable type of thing. It all depends on what your goal is, short term, long term but match first, Roth second, then you can fill up the rest after you get through the Roth. All right, let’s flip around to the other side.
Austin Wilson:
So, how do you pull that money? Yeah, so average Joe.
Josh Robb:
An average Joe says I’m now in retirement. Let’s make the caveat, we’re in retirement. So, I’ve already talked about prior to retirement, you really don’t want to touch these account types.
Austin Wilson:
True. It’s possible.
Josh Robb:
Now in retirement, I’m retired, my income is down, it’s changed. I need to start drawing out. I’m over 59 and a half now, so there’s no restrictions. What do I want to do? That really just depends on your year. If you’re going to have a year with income, so let’s say you sell a business or sell a rental house or something, where you have a large stream of income come in, I don’t want to generate more income by pulling out of my tax deferred accounts, because every dollar that comes out of there is income tax, maybe I’ll take some money out on my Roth IRA so then I don’t have any more additional tax or maybe I’ll touch my taxable account, knowing that it’s capital gains, which is lower than my income tax bracket.
Flexibility is key, and we always say the more buckets you can have between those three buckets and the more you could be spread out between those, the easier it is to plan taxes in retirement. So, really the priority is, how much room do I have in my current tax bracket, which ones will help me fill that out without going to the next tax bracket?
Austin Wilson:
Right.
Josh Robb:
So, it’s really just a fun game of saying, “Okay, this year, I could have 20,000 more of income before I jumped to the next bracket. Okay, so I can withdraw about $20,000 from my IRA.” At that point, I’m going to want to look at other ways so I’m not generating more income. It really is just a fun game but on the flip side prioritizing withdrawals just really depends on your situation year to year.
Austin Wilson:
Yup.
Josh Robb:
One year may be different than the other.
Austin Wilson:
Yeah, because even if you’re still working but you’re more than 59 and a half, if you want to buy a vacation home, it’s probably better to take your money out of a Roth because you’ve already paid taxes on it, it’s grown tax free, you’re not going to pay taxes on taking it out or penalty, because you’re old enough now.
Josh Robb:
Yes.
Austin Wilson:
So, you would then take that vacation money home out of something that you’re not, as opposed to taking money out of your …
Josh Robb:
401K, IRA.
Austin Wilson:
Exactly.
Josh Robb:
Again, this is why having a good financial advisor comes into play, especially in retirement, let’s say I’m 65 years old and I’m going to do that situation that Austin just talked about, I want to buy a house. If I withdraw too much money and my income goes … and again, 2020 about $180,000, I now just increased my Medicare premiums. Withdrawing money for a house, which is great, I just now increased my costs for my health insurance in retirement.
Austin Wilson:
It’s a double whammy.
Josh Robb:
Paying attention to where you’re pulling money from and what it’s going to do to your taxes has a big impact on all different situations, especially for someone who’s in retirement and looking to preserve that wealth for the long run, you got to be very careful. Again, having a good financial adviser is key because they can help you through those situations.
Austin Wilson: Yeah, exactly. We’re just going to rehash it again, the account types that you invest your money in and how you withdraw them is super, super important to your financial success long term. It’s really … it’s a tough thing to do on your own.
Josh Robb:
Yup.
Austin Wilson:
Josh and I want you guys to know that you we are here for you. We are here to help. So don’t hesitate to reach out if you have questions. We’re more than happy to help, but mostly, if you don’t have a financial advisor, we would encourage you to find one.
Josh Robb:
Yes.
Austin Wilson:
If you don’t have one, we want to let you know that we are available to talk to you. If you’re curious to hear more of what we do at Hixon Zuercher Capital Management, check out the invest with us tab on our website and we’ll link that below in the show notes. We work with a team of dedicated, credentialed, experienced colleagues that have worked alongside our clients for nearly two decades to help them achieve their financial goals, and we can help you too. We don’t want you to be in this alone.
Josh Robb:
I will say the one thing we didn’t talk about, and this impact some of the accounts, is the required distribution. At some point down the road, some of these account types require you to take some money out, so they do put a caveat because they’re saying it’s been growing so long, you need to take distributions. We’re going to talk about required distributions in a podcast because that takes up its own podcast by itself because of all the rules and all the crazy things that have to happen with that. That’s the other side of this whole thing is, when it comes to distributions, some of them actually forced money out at some point in time. That’s one more thing to keep in mind when you’re looking at these account types.
Pay attention, we’ll come out with that episode in a little while along with that. Again, thanks for listening. If you want to check out our website, like Austin mentioned, the invest with us tab. We also have a free gift that has eight principles of timeless investing for you. Also, if you like this podcast, you can subscribe to it. Review us on Apple Podcasts if you can. Awesome, if you do that, we love that, seeing the comments and the reviews. Also, if you have any ideas or have any questions, shoot us an email at hello@theinvesteddads.com. We love interacting with you guys, especially for new podcast ideas because we want to talk about what you guys want to know about.
Austin Wilson:
We read every email and we’ll get back to you.
Josh Robb:
Yes, definitely. So, please share this episode and again, if you have any questions reach out to us.
Austin Wilson:
Thanks.
Josh Robb:
Yup, talk to you later.
Austin Wilson:
Bye.
Outro:
Thank you for listening to the Invested Dads Podcast. This episode has ended but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review. Click subscribe and don’t miss the next episode. Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin or any podcast guests are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management.
This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk including the potential for a loss of principal. There is no assurance that any investment plan or strategy will be successful.
