Backdoor Roths, Mega Backdoor Roths, and Roth Conversion Ladders

Mindy:
Welcome to the BiggerPockets Money Podcast, Show Number 161, where we interview the Mad Fientist and talk about Roth IRAs, backdoor Roth IRAs, mega-backdoor Roth IRAs and Roth conversion ladders.

Brandon:
So, the match is the most important thing. If you have some money left over, then the HSA’s 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. Obviously, finding ways to increase income is great, but many people are 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 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.

Mindy:
Hello, hello, hello. My name Mindy Jensen and with me, as always, is my Costco-loving cohost, Scott Trench.

Scott:
I love always getting a free sample of your creative mind in each of these intros, Mindy.

Mindy:
I love these little comebacks. They’re not even scripted.

Scott:
Sometimes they’re scripted. That one wasn’t. All right.

Mindy:
That one wasn’t scripted. They’re only scripted when I write them and they’re always terrible.

Mindy:
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.

Scott:
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.

Mindy:
Scott, today we are bringing back Brandon, the Mad Fientist, 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 specifically, early retirement, is just really, really brilliant and I love talking to him.

Scott:
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… 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 smartest people around in synthesizing a strategy around those.

Mindy:
Ooh. You used the word “synthesizing.”

Scott:
That’s right.

Mindy:
Foreshadowing.

Scott:
Right. We’ll use the word “synthesize” quite a bit in this episode.

Mindy:
Foreshadowing.

Mindy:
Brandon, the Mad Fientist, welcome back to the BiggerPockets Money Podcast. I’m so excited to see you again.

Brandon:
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 eight or nine months, so this is great.

Mindy:
Eight or nine months? That’s a long time.

Brandon:
Yeah. We’ve been locked down over in the UK a lot harder than you guys have, I think, so we haven’t… It’s been pretty… Pretty tight restrictions since COVID came around.

Mindy:
Yeah. Well, that’s how you get rid of a pandemic, is to not go spreading it to all the people. Okay. So, today we’re welcoming back the Mad Fientist. 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 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.

Mindy:
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 the 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(k)’s 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 sixties, seventies 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 turn 60 and want to start accessing their money during early retirement, here are your options.”

Mindy:
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 401(k). Right? If you don’t have any money coming in, you can’t invest for retirement.”

Mindy:
So, I just wanted to throw that out there because I thought that was very brilliant.

Brandon:
Mm-hmm (affirmative)-

Brandon:
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.”

Scott:
So, 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 like obvious concept that 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, today, the point of today is to talk about how to use your 401(k), specifically today, and how to set up a strategy that will allow you to retrieve that money both in normal retirement and in early retirement, a strategy that involves the backdoor Roth IRA and variants of that that I think you are the master of or the Mad Fientist behind the operations of. Is that…? Is that a fair summary?

Scott:
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?

Brandon:
Yeah, that sounds great. Absolutely. Let’s do it.

Mindy:
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.”

Mindy:
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?

Brandon:
Sure. Yeah. The big difference between the two is just how they’re taxed. So, there’s things like traditional 401(k)’s and Roth 401(k)’s 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 401(k), 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.

Brandon:
So, that’s how the traditional is taxed. It’s tax-free, or 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 a traditional 401(k)’s 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 the big… That’s… That’s all the difference really is between traditional and Roth.

Scott:
[inaudible 00:09:26] One of the things that… 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. I made 30, $35,000. That’s a very low tax bracket. If I… In the absence of a lot of the Mad Fientist’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’m making Social Security income, I might be getting… I might be having income from other sources, some [inaudible 00:10:18] assets, and I’ll be withdrawing from my retirement account.

Scott:
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 this case, I would be arbitraging a high tax bracket now by deferring some of that, those taxes, and then paying them later on in the future. And so, what that… That’s kind of the… I think the simplest way to think about these tools, traditional, 401(k), 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.

Scott:
Those types of plans are often that traditional one where you’re arbitraging the high tax bracket now for the lower one later. And then the Roth and the Roth 401(k) 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 tax [crosstalk 00:11:14].

Brandon:
[crosstalk 00:11:15] Yeah, and I think that’s an important point and I think if you can make changes every year if you decide to. So, this year, COVID probably screwed up a lot of people’s income in many different ways, so if this year’s 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, you… 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?

Scott:
Absolutely. Okay, so… 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?

Brandon:
Sure. So, there’s… Yeah. This is a good follow-on from what you had just said because people who pursue early retirement tend to have higher than average incomes. I would say maybe it’s in… There’s a lot of tech people in this whole fire space. But 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-decades period of having low income and you can take advantage of that in something like the Roth conversion ladder.

Brandon:
So, as you mentioned before, if you contribute to a Roth up front, then you pay tax on that money before it goes in, which, if this is your 10 to 15-year career of higher 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.

Brandon:
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 only just… You’re not saving anymore, so you’re just living off of that money. So, that’s when you start to become taxed.

Brandon:
So, when you quit your high-paying job and your tax bracket drops, you can then start rolling it 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 its 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 were 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 early retirement as well. But even if you don’t do that, it is still… Makes sense to arbitrage that taxable decision so you’re to be taxed at a much lower rate.

Scott:
Love it. So, I’m arbitraging my income, my higher 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 working altogether and move to Scotland and I’m able to begin converting my… And [inaudible 00:15:19] drink a lot of whiskey and those kinds of things. And now I’m not earning any income, so now I can convert my 401(k), which I’m going to have to pay taxes on because it’s pre-taxed, and move that into the Roth, which I can then spend as well, the principal at least, not the gains. I can spend without any penalty at all. So…

Brandon:
Five years after the conversion. Correct. Yes.

Scott:
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 a… 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 [inaudible 00:16:05] into those higher tax brackets. And then I’m going to go 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 if 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.

Scott:
Are there any other gotchas to watch out for or folks where this may not make sense for?

Brandon:
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, yeah, 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 had 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.

Brandon:
So, I am potentially going to get to 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… That’s… But it is… But it is a risk. So, if I know what I know now, going back, I probably should have done more Roth and you just never know the future. But I just always felt at the time that I wanted to take advantage of every single potential advantage I had at that time, so that meant taking advantage of my 401(k) contribution deduction and my traditional IRA deduction, because I can’t go back to 2012 and say, “Actually, I should have contributed to my 401(k) back then.” The government’s not going to let me do that.

Brandon:
So, I… 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… So, even though, yeah, looking back on it, I should have probably done more Roth at the time, I’m happy I made that decision 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.

Scott:
Love it. And that’s a great problem and I love that you have a [inaudible 00:18:45]. You’re not prevented from doing it. You just would pay taxes that would make the shift uneconomical, right? Because you had… You have a high income tax bracket because your businesses are successful in early retirement as the owner of those businesses.

Scott:
Now, here. Let me just point out one thing, though, that you’re still not screwed, I guess. [inaudible 00:19:05] 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 and those types of things. So, it is possible that in one year, at some point you have a large amount of losses. Say, a $200,000 loss as your capitalizing a new business, you’re [inaudible 00:19:29] something else. That would be an opportunity, if your income was negative 200,000, to put in 200 thou… Roll over $200,000, literally, from this investment to the Roth.

Scott:
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 in early retirement.

Brandon:
No, you’re abs… You’re absolutely right because, yeah, it gives you options [inaudible 00:19:52] and as you’re… 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… 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.

Mindy:
Yes. Yes. Yes. All these people who complain about having a big tax bill. I’m like, “You know that means you have a big income, right?” That’s… You’re not making $25,000 a year and getting a $200,000 tax bill, income tax. You might have I didn’t pay my taxes for a while bills, but that’s a different story.

Mindy:
Okay, so, a question I get a lot is can I contribute to my 401(k) at work and also contribute to a Roth IRA?

Brandon:
Yes. Yeah. So, the… There’s income limits for contributing to an IRA, so you need to look into that, so there’s… 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 it, an IRA and a 401(k) together.

Mindy:
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… I… 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 401(k), their traditional 401(k), and also max out the Roth IRA? How do they balance that out? Is there an… Like 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?

Brandon:
Yeah. So, first I would suggest… First thing you need to do is if your employer gives you some sort of matching on your 401(k), 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 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.

Brandon:
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 money into them. But it’s still worth looking into. So, I can send you a link to that article.

Brandon:
Yeah, go ahead.

Mindy:
Yeah, I want to jump in and say au contraire, Mon Frere. 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

Mindy:
[inaudible 00:23:00] 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 healthcare 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 healthcare 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?

Brandon:
Yeah, but when I was in my career, I looked into the various plans that were offered onto 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 were just getting insurance for catastrophic coverage, then at the end of the day it actually turned 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 healthcare plan and am 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.

Mindy:
Wow.

Brandon:
So sometimes, depending on your needs, they’re okay.

Scott:
You know, Mindy and I have an interesting thing around this. So BiggerPockets has a pretty good healthcare plan, and-

Mindy:
No, BiggerPockets has an unbelievable health care plan. Maybe Scott just doesn’t understand how good health can be.

Scott:
But 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 copays, 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 only applies to folks 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.” And we’re like, “Really?” The reason we don’t have an HSA is our healthcare plan is too good. And I was like, “This is crazy, it’s cheaper, fine, sure, if you want the HSA plan, you can go.” It’s way less expensive for BiggerPockets to offer you worse healthcare coverage.

Scott:
I chose the good plan. I should have chosen the HSA plan because I didn’t have any healthcare 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, apparently with HSA.

Brandon:
I’m with Mindy, 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 didn’t want to go bankrupt because of one ill thing, but I could pay for a higher deductible if I had just had to go and see the doctor and stuff. So 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.

Scott:
Yeah, I mean that’s the privilege of working towards FI, is that even when you’re not FI, as you’re working towards it, building out that runway, you can handle a five or $10,000 deductible payment healthcare bill with those types of things. So capitalize your life so you can take advantage of these types of things, and then I got to make my shift over to HSA plan.

Mindy:
Yeah, you do, Scott, it’s too bad you didn’t have somebody you could ask about this.

Scott:
Whoops.

Mindy:
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.

Brandon:
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 amount [inaudible 00:27:21], 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 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 withdrawal as tax-free. So it’s completely tax-free in that sense, but there’s nothing to say you have to take it out when you have the medical expense.

Brandon:
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’s 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 up 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 receipts 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.

Scott:
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 set aside 100K and I make 100K, I might be paying 33% taxes on that and I might be paying another 10% penalties. I’m only going to withdrawal, what is that? 67,000, 40, no, 57,000 on that $100,00 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?

Brandon:
Correct. 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, 10 years.

Mindy:
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 the high deductible plan $2,500 charge is a little bit better. So yeah, save your receipts, when you go to Walgreens especially, but I think other grocery stores as well, when it prints out the receipts 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.

Brandon:
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 pump 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.

Mindy:
Yeah, and we’re going to get into the weeds a little bit here. Talk to your HR person, talk to your insurance provider to get specifics for your plan, but at BiggerPockets, 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 contacts, 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.

Mindy:
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 we’re talking prescriptions, and I think there’s a list of, I want to say 27,000 but it might just be making that up, but like 27,000 things that are HSA approvable.

Brandon:
Yeah, no, I just stored 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, 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 will be good to go well.

Scott:
So I love that, and I think that the HSA, I completely agree that we’ve got a cheat code here in the system 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 do some self research on managing it. Once we’ve done that, though, I’m trying to pull us back to the Roth discussion here, and those types of things.

Scott:
We just talked about the 401k versus a 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 some definitions 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?

Brandon:
Sure. Yeah, no, there’s 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 ladder, so no-

Scott:
Yeah, and I apologize, I use that interchangeably with backdoor Roth incorrectly, so thank you for correcting me on that, yes.

Brandon:
Right. So yeah, so that’s has nothing to do with any sort of backdoor.

Scott:
Yep.

Brandon:
That one’s just the straight up Roth conversion ladder. The backdoor Roth is probably simpler to explain than the mega backdoor Roth, so I’ll start there. 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 the 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 I’ll explain it and you’ll see why it’s so crazy.

Brandon:
So like I said, you make too much money to contribute directly to a Roth IRA. So the way you get around it is, 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 a 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 limits 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.

Scott:
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 in any real sense, in my opinion, and that 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? I was trying to talk to my advisor, and all that kind of stuff, about, “Could you do it for me? Can you help me?” He’s like, “No, just do this.”

Brandon:
Just do it.

Scott:
It was like, “Really? That’s the whole play here?” So anyways, yeah, I use 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.

Brandon:
That’s exactly it.

Mindy:
So what’s a mega backdoor Roth?

Scott:
And what if I want to do more than just the minimum?

Brandon:
Yeah, good segue.

Scott:
But either way we’ll lead him into the next question.

Brandon:
So the mega backdoor 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 401k, but you can do even more. So obviously there are contribution limits for IRAs, and the contribution limits for 401ks are even higher. 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.

Mindy:
Yes.

Brandon:
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 it in awhile, but somewhere around $55,000 a year is the total cap on the 401k. So that consists of your contribution-

Scott:
And if you’re married you can double that, I believe. Like if you’re a business owner, for example, and have… anyways, sorry, I’m just chiming in. There’s a silly amount of money you could put away into these accounts if you’re crafty enough.

Brandon:
Yeah, it’s a crazy amount of money, absolutely. So the total contribution consists of your contributions, your employer’s contributions, and then the after-tax contribution. So if you wanted to see how much after tax money you could put into your 401k, you would just Google total 401k limits for 2021, subtract your employee contribution and subtract whatever your employer puts in, and then anything 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 easy, let’s say you put in 20,000 and let’s just say for 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 on there. So that would mean 30,000 you could put in after tax.

Brandon:
So you’ve put in 20,000 pre-tax, and your employers put in 10,000, and then you can put in another 30,000, just again to make the 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 invert 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 paid 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.

Brandon:
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, a 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, 20 plus thousand dollars into a Roth if you have the money available to do that, and if you have the plan that allows after tax contributions.

Scott:
Okay, great. So I’m going to be selfish here because this is something that I might be able to take advantage of. So 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 that. So in my case, let’s use 20,000. I contribute 20,000 to the 401k, and then I get the 3% match as well. So I’ve got 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 roll it over immediately into a Roth.

Brandon:
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 are, whatever, 6,000, 6,500.

Scott:
Yep, 6000, yep.

Brandon:
So what you would be able to do is take whatever that chunk is, 20 X thousand, put it into your traditional 401k.

Scott:
Mm-hmm (affirmative).

Brandon:
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 the max 401k is, say, 60,000 minus your 20,000 minus whatever BiggerPockets is putting in, and it just allows you to really juice your Roth accounts if you have all that available.

Scott:
Okay, so I’m hearing this 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? What’s the professional that you call to do this? Is it an accountant? Is it a financial planner?

Brandon:
Yeah, tax accountant, an accountant who is very good at tax optimization, I would say. I luckily found a guy once, I’d had always done my taxes myself, and then I set up an S-corp and I just threw in the towel because 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.

Scott:
Wonderful. So talk to your accountant, or get one, if you don’t have one, 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 [inaudible 00:45:16] just talked about here,

Mindy:
Hundreds of thousands of tax-free dollars, let’s throw that tax-free in there, if you can do it right. This episode is airing in early January, and your tax preparer is going to 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 BiggerPockets 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-

Mindy:
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 or within your financial means to take advantage for 2020 and 2021. This is huge.

Brandon:
And I’m going to chime in here because as a really frugal cheapskate who doesn’t outsource anything, it is probably one of the best investments I’ve made actually. And even, I love this stuff. I read this stuff. I write about this stuff. And just every year I’d be like, “How do people who don’t like this stuff actually do this?” Because it’s so confusing. But now I just-

Scott:
They do it wrong or don’t do it.

Brandon:
Yeah.

Mindy:
Yeah.

Brandon:
That’s right.

Mindy:
And it’s not going to cost $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 the savings that you have in 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 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.

Brandon:
That’s exactly it because then in future years, you can compare your 1040 that you print off when you do it with TaxAct or H&R Block or whatever. You can compare that to the professionally done one and if you see numbers in weird boxes and missing numbers in other boxes and you’re like, “My situation hasn’t changed”, 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 yeah, my situation didn’t really change. And this is looking exactly like the professionally done one, just with different figures.”

Scott:
So being selfish once again here, the first thing I’m going to 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.

Scott:
So the way I do my retirement accounts outside of the wonderful world of mega backdoor Roths that you just opened my eyes to, is I just max out the contribution beginning of the year. So literally 100% of my paycheck is going. I collected 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, now’s the time. Get on the phone and get this set up before the end of the next year. And 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 the more time in the market approach with these types of things.

Brandon:
That’s absolutely right. I have an article that I wrote. I don’t even remember when, maybe 2012 or 2013 or something. A while ago, anyway. It’s called front-loading. And it’s exactly that. And I 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 and to the right. And yeah, there’s really little tiny things along the way, but overwhelming, it’s just straight up or yeah. Straight up and to the right. So that means the long-term trend is up. So putting it in earlier 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 going to be beneficial. And over a long career, then that’s going to make a sizable difference.

Brandon:
And I actually have an experiment called the guinea pig experiment where I set these two hypothetical people off starting from zero net worth to FI. And I started this maybe seven years ago. And I think they’re only two years away from FI. And I used real time market returns. And I compared two scenarios, the normal guinea pig, who just invests 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 then become a Roth conversion ladder. In 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.

Brandon:
And I don’t recall what the benefit is, but on the guinea pig experiment homepage, I break it down and say contributing to a traditional IRA instead of a Roth means that he’s four and a half percent more higher net worth than you 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.

Scott:
So first of all, where can one go and view this experiment? And we’ll link to that in the show notes.

Brandon:
Sure. Yeah. Yeah. It’s a madfientist.com/experiments. And then on the page you can find the guinea pig experiment.

Scott:
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?

Brandon:
Oh, I just pulled that out of thin air. Let me see. 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. [crosstalk 00:52:17]

Scott:
That sounds about the amount of time that your guinea pigs need their finances updated anyways, so.

Mindy:
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 00:06:27]. 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 contributions to the stock market?” He’s like, “Put it all in at once.” 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.

Scott:
But, I also get it. It’s hard to do that.

Mindy:
Oh, it is hard to do that. [crosstalk 00:53:01]

Scott:
And I can hear that advice and I still wasn’t able to do it, frankly, with some of my personal money that I got in a large lump sum two years ago. So I dollar cost averaged it, whatever it is. It’s I think a matter of investing it, but I completely hear it and understand that my emotive response to that was, I was unable to follow that advice in practice to a certain extent.

Mindy:
Well, yeah.

Brandon:
Oh yeah. Personal finances, math, but it’s also being able to fall asleep at night and not freaking out.

Scott:
Yep.

Brandon:
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.

Brandon:
But the guinea pigs, that is mathematically optimized.

Scott:
Yeah.

Brandon:
So I just looked at the homepage and the optimized guinea pig net worth is almost a hundred thousand. So let’s see, 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 mega backdoor Roth or anything super crazy. Just, yeah, some more easily accessible optimizations.

Scott:
Love it. So go check out the madfientist.com/experiments to go check that one out. And thank you for running that. That’s fantastic. You really love this stuff.

Brandon:
Yeah. It’s crazy. It’s getting so close. When I started it, I’m like, “Will I still be doing this in whatever, how long it takes to get there? And I was thinking at least 10 years and yeah, yeah. I started in 2012. So I’m getting close to 10 years for the stuff, which is crazy.

Mindy:
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?

Brandon:
Yeah, 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, 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.

Brandon:
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 so there’s ways for that to do that.

Scott:
In that case, I think a lesson here also is if you’re unsure about your income and suspect you might be having a very good year, that would be a tend to shy away from the front-loading advice and maybe wait a little longer so you have a clearer picture, just because it will save you some hassle down the line. And you’ve got a bigger, good problem to deal with than the maximizing your Roth contribution.

Brandon:
And for me, it was always minimizing hassle was a very big motivating factor. So even though mathematically I could’ve 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 March of the following year. Then that made me not front-load those accounts, even though mathematically, it would have made sense to do so.

Scott:
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 stakes, you’re just going to save yourself some hassle again of having to go through that.

Mindy:
Do I have to figure out how much money? 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?

Brandon:
Yeah. So that’s why you want to talk to a tax accountant.

Mindy:
Yeah.

Brandon:
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, you can talk to. But I really don’t think it’s that complicated, but again, I’ve never had to do it personally. And despite being interested in this stuff, 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.

Mindy:
Okay.

Scott:
So just in the context of zooming out once again, I’m thinking about I’m working towards FI and I’ve just heard about the HSA, let’s call it round to seven grand. So I put in seven grand pretax into my HSA. I put in $20,000 plus a little bit of employer match into my 401k. I also put… Yeah and these are the maximum optimal levels. And what I’m hearing as a listener is, 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. Right?

Scott:
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 trade off 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 only want to put in $10,000 or $15,000 into these accounts and you want to have some leftover for liquidity in your life, six months reserve, maybe a real estate investment? How do you think through that?

Brandon:
Yeah, so I’ll just explain sort of what my thinking was, and again, minimizing hassle and complexity. So you’d mentioned an emergency fund or having cash to deal with things that are happening this year. So the Roth IRA is actually really good for that because you can withdraw contributions at any time penalty and tax free because you already paid taxes on that money. So that’s a great place to store 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. 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.

Brandon:
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 healthcare in America is expensive. And if you are planning for standard retirement, like I suggest when standard retirement 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.

Brandon:
So then I would max out the rest of my 401k. And my last job of my career, I worked for a non-profit university. And so that was a 403(B). So if anyone out there has a 403(B), we haven’t talked about that yet, but that is just a 401k for nonprofits, pretty much. All the rules are the same.

Brandon:
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 [inaudible 01:02:14] 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 any way.

Brandon:
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 the taxable account. And he makes some really good points in there.

Brandon:
So I would just put the rest into my taxable accounts. 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 what? 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 didn’t want to make it worse, so.

Scott:
Okay. So let me just kind of roll back here a 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 there’s a couple of things to layer on top of that. But I want to zoom in here and let’s say we have a family or a person making $50,000 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 just mentioned that the Roth IRA is a great place to store an emergency account. 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? [crosstalk 01:04:43]

Brandon:
Yeah, exactly. Yeah.

Scott:
Okay.

Brandon:
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. The match is the important thing. You got to find a way to hit that match because that’s just free doubling your salary pretty much. So the match is the most important thing. If you have some money leftover, 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. Obviously finding ways to increase income is great, but many people are 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 a 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.

Brandon:
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, so.

Scott:
Yeah. So this is where I get a little controversial with some folks. But when I started out 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 for the reasons kind of we just highlighted. And I instead built up about $20,000 in five in my Roth five in… That was the limit back then. And then the rest in my savings account and used that to buy a duplex 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 than all of the ROIs with market investments inside these retirement accounts.

Scott:
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 that’s all in the context of these strategies. There’s probably some points and some specific instances where the strategies don’t apply or don’t make sense in the short run, in some cases.

Brandon:
Absolutely. Yeah, no, exactly. And it boils back down to the being personal and you were able to do much better things with that money where a lazy guy like me who doesn’t want to deal with people or buildings, it was like, “Ah, this is the best choice for me.” So yeah. No, that’s absolutely correct.

Brandon:
So in that case, if I was you back in your early days when you were 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 maxing out every single thing, but in a lot of cases that doesn’t make sense at all.

Mindy:
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-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 have to pull out my $6,000 in Roth IRA funds, but then I could put in another $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.

Mindy:
That’s going to be really great. I didn’t know about that, and this is my job. 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. You didn’t contribute to an HSA. Hey Scott, this is your job too, you should know about this.

Scott:
Yeah.

Mindy:
Now you do. I’m not trying to shame you.

Scott:
That’s the big thing. 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. 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 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 mad scientist Guinea pigs here.

Brandon:
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 mega backdoor Roth, even though I researched the heck out of it and wrote the article on it. Then I’m like, “You know what? This is too much work. I’ll just pump more money into my taxable accounts.” Yeah, as you said, the important thing is just investing and having a surplus that you’re not spending everything you earn. These are just little tweaks icing on the cake if you are wanting to really optimize and get geeky with it. Yeah, the important thing is just spending less than you earn and investing the rest somehow.

Scott:
Can you name somebody who has done every single one of these tactics perfectly right?

Brandon:
No. I don’t. No, I couldn’t.

Scott:
Okay, good. Thank you for that anyway.

Mindy:
That’s a really good question.

Scott:
It’s a pursuit of optimization that nobody is doing every one of these things perfectly. At least nobody’s doing it perfectly at first and at the beginning of their journeys.

Mindy:
That’s a good point. 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 steps …

Scott:
Neither am I.

Mindy:
Scott screwed it up left and right. He’s still making ends meet, and Brandon …

Brandon:
I wrote a post this year called My Portfolio. I think it’s like what’s in my portfolio and how I manage it. I describe how I built the portfolio based on knowing how I do things wrong, and how I always get tripped up, and all of 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. Yeah, even though you know what you meant to do, it’s still sometimes hard just going back to that dollar cost averaging thing. 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. 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.

Brandon:
Yeah, it’s just knowing yourself, knowing what you want out of life. 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. Yeah, you don’t have to use the whole toolbox every time you have printed it up and otherwise. 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.

Mindy:
Oh my God. Did you peek into our house this weekend? That’s how Carl works. It’s just everything everywhere.

Brandon:
I could imagine that’s how Carl works.

Scott:
Well, let me ask you one more question now. I’ve got my 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 rental property.” Any thoughts on that process, or that tactic, in terms of leveraging your 401k or those types of things to build wealth? The thought being, Oh, I’m paying interest to myself.

Brandon:
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 the actual mechanics of it. 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, 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’ve 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.

Brandon:
Actually, a buddy of mine just got in touch and asked if he should take a home equity line of credit to replace this roof or take it out of his 401k. I was like, I would do the HELOC with the interest rates the way they are. It’s risky to take money out of your 401k because you’re losing a lot of compounding growth. If you don’t put it back in there then that’s bad news. Obviously more debt is bad too. Anyway, 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 allow you to put money in, then yeah, I think then planning for that’s great. Yeah, just be careful that you pay it back because you’re missing out on a lot of tax-free growth potentially.

Scott:
Okay. I want to chime in and answer partially my own question.

Mindy:
Then I want to answer too Scott.

Scott:
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. No, my opinion, never use short-term debt to finance a long-term investment. A HELOC or a 401k loan are going to be typically short-term loans. They’re going to be interest-only. 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 a two or five-year loan. That is going to result in cash flow or liquidity problems for you if things are tight. If you have a huge surplus of cashflow 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.

Scott:
I wasn’t able to wrap my mind around the HELOC versus the 401k in a tactical sense. I think I agree with your assessment, that the HELOC is probably 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 3% average annual appreciation rate in your house.

Mindy:
I did this. I had a HELOC, and I took a 401k loan in September 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. 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. Then I refinanced after six months, there’s a six month waiting period. I refinanced and put the money back into my 401k.

Brandon:
That’s a good time to be out of the market.

Mindy:
Well, yes and no. I took it out in September, and then I put it back in April. If I would have pulled it out in March, and 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.

Brandon:
No, no, I know you can’t. I thought you got real lucky there, that sounded like from your timeframe.

Mindy:
I mean, it was only $50,000. It wasn’t like I had taken all of it out. 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, it’s considered a distribution. You’re paying penalties. You’re paying taxes. That’s 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. 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. 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.

Mindy:
Any loan that I am making a payment to, I am making a payment with after-tax dollars. Whether it’s coming back from me, whether 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. That’s my two cents.

Brandon:
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 question?” You guys are the experts here. This is Bigger Pockets podcast.

Scott:
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. Always capitalize your investment or your purchase with the appropriate type of debt, whether it’s short-term or long-term. 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.

Mindy:
Okay. Brandon, this has been so much fun. It’s always a delight to talk to you, and I’m super excited that you were 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?

Brandon:
Actually, no. Yeah, we skied and traveled around the mountains of the US for a month. Yeah, that was February. We got back, and we were so thankful that all the COVID stuff waited a month to really kick off.

Mindy:
I can’t wait until you come back here again. 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?

Brandon:
Sure. Yeah. Madscientists.com is the website. Yeah, I have mad scientists on social media and things because it’s a completely made up word, so I got all the social accounts. Madscientists.com is where all the financial writing is, and mad scientists is on Twitter and Facebook. I don’t think I really do anything else other than that.

Mindy:
Tik Tok, Instagram?

Brandon:
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. I have a thousand or some followers, and they’ve never gotten a single photo from me, so I feel bad. It’s just an empty account with followers. I haven’t done anything, but yeah, follow me on Instagram. You’re not going to get anything.

Scott:
@madscientists. All right.

Mindy:
Follow me for nothing at all. I love it.

Brandon:
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 lock down just really finally trying to do that. If you go to madscientists.com/album, it’s $5, and it’s some weird fancy synth music. That’s the exciting thing that I’m spending all my time doing now.

Mindy:
I’m so excited.

Scott:
All right. We’re going to try that.

Mindy:
I’m going to go download that. I mean, I’m going to go buy it and then download it.

Brandon:
That’s right. Yeah.

Mindy:
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/moneyshow161. Brandon, again, thank you so much for taking time out of your busy retirement, 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.

Brandon:
It’s always a pleasure talking to you guys.

Scott:
Thank you.

Brandon:
Great seeing you after so long and yeah, thanks for having me back.

Mindy:
Okay. We’ll talk to you soon. Bye Brandon.

Brandon:
Bye.

Scott:
Bye.

Mindy:
Okay, Scott, that was Brandon, the mad scientist who is always a delight to talk to. What’d you think of the show?

Scott:
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 tremendously value his opinion. I got some tidbits that are going to impact my own personal finances from today’s show. I hope that if you’re listening, you got a couple that at least spark some thoughts or helped you reframe how you might attack 2021 for yourselves.

Mindy:
Yeah. 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. 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. 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. It’s so easy to sit here and be like, “Oh, you should totally do this.” In real life, it’s not that easy. I just wanted 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 the 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.

Scott:
Yeah. 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. 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. 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.

Scott:
I don’t think there is a right. Brandon and I can be sub-optimal mathematically in our allocations in 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 then abundance is created and sustained. 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 inappropriate blend of freedom, creating assets, and/or I’m going to create assets or businesses. Within that context, I’m going to use retirement accounts as one of my tools. Then depending on how heavily that’s a part of my strategy, that’s when I’m going to dive deeper into the really more creative and more technical tools like the ones we discussed today.

Mindy:
Yeah. 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. 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’ve already screwed up by making a Roth IRA contribution in the beginning, and then blowing through my income. That sounds bad. I didn’t blow through it. I blew through my income projections and now I might not be eligible for a Roth IRA contribution, which again is a good problem to have. That means I’ve made a boatload of money. With this mega backdoor Roth option, I can go in and throw even more money in there. Since I have had such a good year, there’s a lot sitting in the pot right now, waiting for something to do with, so I’m super excited to be able to do that.

Scott:
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 plus month emergency fund, a house hack or two, or a live in flip or two under my belt, and a surplus, and 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. Again, while I have plenty of work to do at home, 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.

Scott:
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 retirement accounts set up than the Guinea pig without it. I do think that again, it all needs to be taken in the context of get the fundamentals right first and then layer these in as a focus.

Mindy:
Right. Even the Guinea pig who isn’t optimized, it’s still doing better than 90% of Americans.

Scott:
They’re both going to get by.

Mindy:
Maybe not 90%, 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 backdoor, all of these things we talked about today, the HSA accounts. These are things that you need to know, and we want to help you get to that point.

Mindy:
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. 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/financereview. We would love to review your finances and see what tweaks you can make to optimize your finances further.

Scott:
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 a different opportunity, or a different leverage point along the funnel. I think we’re going to have a lot of fun with those, and I think we’re going to learn a lot along the way.

Mindy:
Yep. I’m super excited for them. I’m really having a good time, Scott. Okay. Should we get out of here, Scott?

Scott:
Let’s do it.

Mindy:
From episode 161 of the Bigger Pockets Money podcast, he is Scott Trench, and I am Mindy Jensen saying, “Have fun storming the castle,” because Brandon lives in Scotland, and they have castles. That’s from The Princess Bride. You’ve seen The Princess Bride, haven’t you?

Scott:
I have seen The Princess Bride. I’ve just smiled, like what’s all this?

Mindy:
You were looking at me like what does that mean?

Scott:
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. See you later, everybody.

Mindy:
Thanks for listening. Bye.

Scott:
We’ll just ram a couple of puns through. No, it’s too late. Too little too late. Anyways. Goodbye.