44 Years Old, $2 Million Saved – Why They're Still Hesitant to Downshift

0:00Joe, it's been a minute. Welcome back from Europe. Well, thank you. I made it back safely. The Christmas markets, however, are devastated I'm gone because I felt like between my mom, my spouse, and I, the GDP of the EU is going to be just fine. You are single-handedly responsible for GDP growth in the EU. When you come home with seven of those Christmas market mugs and you're like, why seven? Why not one? But every single one you go to, you're like, oh, that's pretty too. You know what? We could just bring these out around the holidays because God knows I love to store crap for 11 months and bring it out for just one.

0:38Well, you've got one mug for every day of the week. That's good. It's like I'm starting my Advent mug collection. I don't know. Well, maybe. Hopefully not. Well, speaking of days of the week, I don't know how to segue that. We've got some great callers today. That has nothing to do with days of the week. Welcome to the Afford Anything podcast, the show that knows you can afford anything, not everything. The show covers five pillars, financial psychology, increasing your income, investing, real estate, and entrepreneurship. It's double I fire. I'm your host, Paula Pant. I trained in economic reporting at Columbia.

1:11Every other-ish episode, unless Joe's on vacation, I answer questions that come from you and I do so with my buddy, Joe, who has been absent for a little, he's been traveling. I have been. Welcome back. Thank you. I also kept up the dad jokes, though, just for you. So you know what you call a paper airplane that doesn't fly? What? Stationary.

1:41And with that, we will hear our first question today, which comes from Slade. Hi, Paula and Joe. This is Slade in Virginia. I have a few details I'd like you to hear to see if you could help guide me into the next steps or some reallocation of my brokerage account. My wife and I are both 44 years old and have an 11-year-old daughter. In the next five to seven years, we are both looking to downshift in our careers or find something that pays much less. We would like your thoughts on withdrawal order and allocation. We spend about$115 ,000 a year. Currently, all of our tax-deferred and tax-free retirement are allocated in about 60 % S &P 500 funds, 15 % international, 15 % small cap, and about 10 % mid-cap.

2:26We have about$1 million in traditional retirement and$370 ,000 in Roth. We also have about$36 ,000 in HSA and$75 ,000 in 529s. Our taxable brokerage, however, is worth about$685 ,000 and is split between about 85 % S &P 500 funds and 15 % small cap. Over the next five to seven years, while we continue to work our current jobs that pay well, if we want to live off our taxable brokerage after that, should we start to heavily work bonds into that allocation to de-risk? Should we consider a 72T? Looking for any guidance to help make this possible? Thanks so much. Slade, I love your question. And first of all, congratulations on building such a healthy portfolio and on having such clear, well-thought-out goals.

3:15I love the foundation that you're starting with. Personally, and Joe, we have not discussed this ahead of time, so I'm curious to see if we fall into the same camp here. I am actually not a huge fan of the 72T in Slade's situation because they have so much in taxable brokerage accounts and they've got enough time until their goal and their goal involves taking significantly lower paying work, but there's still going to be some income coming in and their annual cost of living at 115 ,000. That's a very, given the balances that he's talked about and given the whole set of circumstances that I've just outlined, a fairly achievable number.

3:57Based on all of that, I'm not a huge fan of the 72T. I think I'd like to focus on the taxable brokerage portion. What do you think, Joe? I tend to agree. Here's the one piece of information, Slade, that we don't have that would help me with 72T, which is when you talk about the difference between what you're making now and what your income stream's going to be later, I don't know what that delta is. So I don't know how much we're trying to take per year. And I'll tell you why that's important is that when it comes to 72T, one fun reason to take 72T, I like working fun into 72T because anybody who knows this knows it's not that fun, but it gives you some opportunities for some clever financial planning.

4:44So if you use some software and you look out, you project out later on with your traditional retirement accounts, there are some hurdles that you're going to need to overcome later. Number one, there's going to be taxation of your social security. And this just assumes things stay the same. Number two is there's this little thing that we probably won't get into today, but people should look it up called IRMA, which is another tax-ish hurdle that can be caused by taking too much money out of your traditional retirement account. So what I get worried about, Paula, is that the traditional retirement account might grow too big.

5:25And if it does, we might cause some tax problems down the road by not tapping it. Now, the cool thing with 72T is you can segregate your retirement accounts. Let's talk about what this is first. So 72T for people like, what the hell are you even talking about? What this question revolves around is, should I take my money in traditional retirement accounts and tap it legally and without penalty before 59 and a half? People have probably heard that you can't do it before 59 and a half. Cool thing is you can, but you have to follow some specific rules. And basically what the IRS makes you do is turn it into a pension.

6:08And that pension has to run for at least five years or until 59 and a half, whichever is longer. So at 44 years old, if Slade goes at 50, Slade will need to continue to take this, quote, pension for nine and a half years, for 10 years. If you want a super deep dive into 72T, go all the way back to episode number 94. It's funny to state a two-digit number now that we're at, what, 600 and something. But if you go all the way back to affordanything.com slash episode 94, we do a deep dive into SCP-72T. That's awesome. That's great. Well, and you know what's cool is it is like riding a bike. Once you know it, once you know it, you got it.

6:56I mean, episode 94, it doesn't matter what episode number it is because it's a training thing that, frankly, probably doesn't need to be done again. It's an evergreen topic, right? Well, that's what I meant. Yeah. It's not like the first Friday macroeconomic episode when I'm, you know, here's the inflation data. Well, you know, it's not something that changes every month. It's very steady. You can tell them just back from vacation. I use 84 words. Paula uses two evergreen topic to explain the mess of words that I had just before that. But the deal is, is that Paula, Well, I think you could use 72T in a cool way.

7:35So what most people think with 72T, and this is where people get it wrong, is that you got to take all your retirement accounts and turn it into a pension. Well, what's cool is you can segregate your retirement accounts and only use a piece of it. So I could 72T this one fund over here and not 72T these other fund. And that gives me the opportunity to build a small quote pension ish stream of income that comes out between now and age 60. I reduce my taxation after age 60 because I keep that retirement account value smaller, a little smaller. and I then am able to do some tax planning today, get the money that I need today.

8:22And that also leaves some of that brokerage money available for later, which is also pretty cool because that brokerage account represents flexibility. Now, like you, I don't think they're going to spend on all the brokerage account. I don't think they will, but I'd love to know how much money they think they're going to make and use a conservative number, how much money you think you're going to make. and then maybe see about a hybrid of I'm going to spend most of the money through my brokerage account. But then I'm also going to, because I did some projections of the future of how much money I'm going to have to take out of this later.

8:57If those numbers are problematic way down the road, I could do some cool planning at age 50 to lessen the load after 60, 65, 70, 75 years old. Yeah. I mean, so fundamentally, right, they're 44 right now. They're talking about doing this within five to seven years. Let's split the difference and say six years. They do it at the age of 50. And we're trying to plug this nine and a half year gap from 50 to 59 and a half. again with 685 ,000 in the taxable brokerage rule of 72 assuming that the market does in the next six years what it did in the last six years which we can't necessarily assume that but there's a pretty good chance that taxable brokerage account is going to be over a million by the time they turn 50.

9:48I think there's a reasonable likelihood that it'll be around a million. And so we're trying to plug in nine and a half year gap with a million bucks in taxable brokerage when their annual spend is 115 ,000, adjust that for inflation by the time they turn 50. It seems like they can, especially given that even if they earned a pretty small incomes, I think they could do the whole thing out of taxable brokerage. Oh no, they could easily do it out of taxable brokerage. My question wasn't around that. When And I said, I want to know what the Delta is. My question is, how big do I make that 72T to avoid further taxation?

10:25Further taxation down the road. Let's be clear. I'm not worried at all about making it. Slade, you're going to be fine. You're going to be great. Love your allocation, by the way, the way it is right now. I think it's fantastic. We can talk about how you switch that over. But yeah, the 72T thing, I don't like doing it generally. but in this case, because also when you talk about the rule of 72, Paula, that 1 million in a traditional account by the time he gets to 59 and a half is also going to be double. Yeah, it's going to be 2 point something million dollars sitting there. Yeah. So if we go to tax expert, I mean, uh, my friend Ed slot wrote this book, you know, the tax time bomb.

11:07I'm looking at this time bomb possibly with that traditional retirement account. So I'm just trying to diffuse that bomb and use 72T that way. Now, the good news, Slade, let's go through the good news. You could pay all these additional taxes, and I think you're still going to be fine. So this is really much more advanced planning that we're talking about, much more advanced tax planning we're talking about. You could do none of that, and you're going to be okay. You're going to be fine. So then the question comes around, what are your legacy goals? What are your really beyond your lifetime goals with your money?

11:45And that's when financial planning gets even more exciting, Paula, because Slade and his family may be able to change the world. The other thing to note, Slade, your daughter's 11 right now. Six years from now, she'll be 17. She'll be on the verge of moving out, going to college. Your annual expenses will likely drop at that time. I mean, your college expenses are going to be high, but the 529 covers that. But your day-to-day, the amount of groceries that you have to put in the fridge, the cost of clothing, the cost of all of those miscellaneous daily cost of living items, a lot of that will likely shrink right at the time that you're making this transition.

12:30So I think it's wise to plan for your annual spending to remain at 115 where it currently is. but I think there's also a decent probability that that annual spend might shrink. Yeah. Without any lifestyle change at all. Yeah. Without any meaningful feeling that it'll change. Yeah. Joe, I know you experienced that when your twins went to college. Oh my God. When my son left home, my grocery bill just shrunk by so much. University of Texas had a food program along with his dorm. And when I saw that number, I laughed. I'm like, you're going to to lose. My son will eat that and more. What's amazing is for people that know him and you've met him, Paul, he's not a big dude, not a big dude, but he could put it away in college course.

13:18So could I, but it's a whole different story. Yeah. The metabolism of an 18 year old. Yeah. Yeah. So jealous. Now I look at a Cinnabon and I gained 10 pounds. Can we talk about the switch in allocation? Yeah, let's do it. There is this problem, Slade, that I think of as the bond problem. On one hand, you hit the nail on the head, you're reducing volatility. On the other hand, you're locking in much smaller opportunities for growth. And you're also creating some tax issues if you just hit this straight forward. If you just change over some of your funds and your brokerage account to bonds, you create additional taxes and you lock in really suboptimal returns.

14:07The issue with bonds that I have is that whenever I think about a portfolio, I always think of bonds as something I'm trying to have as few of as possible while also not wrecking my ability to meet my goals. I would want to talk more about risk tolerance here and how you react to changing markets. And based on your current asset allocation, this money in the S &P 500, small cap to mid cap, your diversification looks really good to me without doing a lot of analysis, just looking at it. I think it looks great. I do think that you need to back off. So your gut feeling of, okay, the plane's coming in for a landing.

15:02I need to back it down. I think you're right on there. But how much do we back down? And how do we back it down? I think revolves again, Paula, around whether he uses 72T. Because if he uses 72T to diffuse the time bomb, that money's going to be an income stream that he has to take. Then we can do some of this volatility lessening inside of his traditional retirement account. And then we end up with kind of the best of both worlds. Now, if we don't think there's going to be a huge tax bill, if he goes through and he does this research that I'm talking about and it's not going to be a big deal.

15:42Right. Then maybe I go ahead and I put bonds in the account if we want it to be straightforward. We got a great call from Graham Slade. Hold on. Graham's going to explain. this whole thing to you later on, some foreshadowing of later in the episode. Of later in the episode. Yeah. Graham's going to give you kind of the 201 way you could do this and pay less tax. But straightforward wise, I didn't even know that's that straightforward wise. Boy, I'm rusty. Yeah, straightforward wise. Yeah, sure. Yeah. I declare that a word. But to be straightforward about it means you're going to run into some volatility.

16:20So let's go down the ladder first. The first thing you can do is traditionally value stocks have had less volatility than growth stocks. So without going all the way to bonds, right, I could take more of a value oriented tilt because during lean years, value stocks are going to go down less than growth stocks will. So remove some of the growth from your portfolio, go more toward a value bent. But we know, Paula, that utilities, utility stocks, much more conservative, but you don't have to play the bond game. When I look at sectors, the utility sector might be something that he looks at. It's kind of a halfway.

17:03I see people go full force from stocks over to bonds. And I think you can do that with some money. But I think you can also lessen the blow by moving some of your stock allocation to a more conservative stock allocation as well. Well, and I agree with you that the answer to 72T is going to play a big role in this because to your point, Joe, the drawback of 72T and the reason why I'm biased towards taxable brokerage, if you can do it from that, is because of the fact that there is a mandatory annual withdrawal. And whenever you're in a situation where you lack flexibility, you have to curtail your investments and you have to invest a little bit more conservatively because you lack that flexibility.

17:49You know, versus just a hypothetically, if your strategy was entirely to pay for your cost of living through a combination of lower paying work plus withdrawals from the taxable brokerage account, but you could adjust on an annual basis. Maybe there are some years that you make more than you did the previous year. There are some years where maybe there's a year where you decide that you want to spend that time in Bali, where the cost of living is a heck of a lot cheaper. And so you're going to have this dynamism both in your compensation income and also potentially in your expenses. right? There's going to be annual fluctuation there as there is for most people.

18:40And so with a taxable brokerage strategy, you have the freedom and the flexibility to modulate accordingly. And with a 72T strategy, you have to take at least some, whatever portion that is, what that number will be is based on a huge variety of factors. Whatever that number is, you're going to have to take it out every year. And because that is a must and that is a non-negotiable, regardless of what is happening in your life, you do have to invest more conservatively because you don't want to be drawing down from a 2008 scenario. The cool thing is, and this is what people don't know about 72T, is I can make that number fairly small.

19:19Right, right. That 72T doesn't have to be as huge as people think. I said 72T on a$2 million IRA, oh my God, that's going to be just a monster amount of money. And I don't need to take all that money out. Well, you don't have to. That's the cool thing here. So yeah, if we have more of a trickle from the faucet than this huge 72T, I'm all in favor of that. I think a good asset allocation example are foundations, charitable foundations. They are required, the ones that don't do any active work, the ones that are set up for the purpose of making distributions to other charities, they are required to distribute 5 % per year.

20:01And because of that 5 % distribution mandate, they have to invest accordingly. That's the model that comes to mind when I think about the 72T mandate. Yeah. You'll automatically create kind of a two-tier system inside of your traditional retirement accounts. You'll have some sliver of money that's made to continue to fund that I need it now machine. And then the rest of it goes to the far end of your timeline. This is the money that you're letting grow. So it's funny because you'll have your most aggressive money and your most conservative money in traditional retirement accounts. But to get this done, you have to segregate the piece that's 72T money.

20:45It makes it much easier on your dashboard to know which part is the part I'm taking money from because I literally have to have a different IRA for the 72T money than the one that I'm not 72Ting. So dashboard-wise, it's not that hard to grok. But in your head, you're like, I got my most conservative and my most aggressive money in the same what? Same tax treatment? Yes. Slade, I hope that gives you some insight and some next steps. And again, congrats on everything that you've built. I'm excited for this chapter ahead. We're going to take a moment to hear from the sponsors who make this show a reality.

21:27And when we return, we're going to hear from David, who's wondering which account to use first for college costs, 529 or 457B. We're also going to hear from Graham, who has some thoughts on bonds that actually relates to the question that we He just answered from Slade. Kevin Harlan here. Tonight, the NBA on Prime Crew has another thrilling NBA doubleheader. It tips off with an Eastern Conference showdown as Tyrese Maxey and the Philadelphia 76ers head to Madison Square Garden to take on Jalen Brunson and the New York Knicks. Then it's Western Conference action. SGA and the defending champion Oklahoma City Thunder visit Anthony Edwards and the Minnesota Timberwolves.

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25:45Welcome back Our next question comes from David. Hey, Paula and Joe. This is David down in Georgia. I have a senior in high school, and I have a question regarding which of our accounts to draw from first with his educational spending. Currently have about$60 ,000 in a 529 plan. Additionally, my wife is an educator, and we have about$200 ,000 in a 457B plan from a former employer. So theoretically, we have access to that money. My question is, should we draw down on the 457B plan first and pay the little bit of taxes on those? is that would be a taxable event and grow the 529 so that that money could be passed on to our child's progeny.

26:36Should he have some? Or should we draw off of the 529 plan first and avoid touching the 457B as long as possible? In theory, we have enough money in our other accounts based off of the great advice we've gotten from you and others in the community to where we don't necessarily need our 457B money for the purpose of retirement. But again, always nice to have options. Thanks. David, thank you so much for the call. What a great place to be in, Paula, when we have this account from a previous employer that we've done well enough saving that we don't need it. So it can be flexible money for education if we want it to be.

27:21Right. I'm actually going to answer this the opposite way of the way that I answered Slade's question. And the reason is, is I feel like the damage that it creates and the messiness that it creates when you tackle the 457 before the 529 plan outweighs any opportunity benefit that I see. So the first thing that I would do is spend the 529 plan. That's what the money's there for. That's what you saved it for. See how much of that you go through. The cool news is, is you know you have a backup in that 457 money that you don't need. So the college fund is the college fund. Spend the college fund. I'll tell you what really bothers me, Paula, is if they go with the 457 money first, you Besides the wonkiness of trying to get money out of what is traditionally known as a retirement account to spend for college, having 529 money left over afterwards, yeah, okay, I can turn into Roth money if I don't spend it, but I don't see a reason to do that.

28:33If we empty out the account, the goal's over, done, goodbye, don't have to worry about 529 at all anymore. Okay, I'm going to take the opposite argument, but I'm curious to hear your reasoning. 457 money, once you've left the job, you can withdraw it at any time. So why wouldn't you? They've got this bucket of money in the 457 that they don't need for retirement. I'm going to take that statement at face value. I'm going to trust that they've run the numbers and they know that they don't need this bucket of money for retirement. so why not take it and let the 529 become essentially part of the legacy that they pass on to their grandkids you know like a family educational trust type of a thing why wouldn't you do that with the 457 and with the 457 the cool thing is is that you can put just your son as the beneficiary okay done and we have no tax bill at the end of it like he will have if he takes it out during his lifetime.