Q&A: How Much Insurance Is Enough When You’re Protecting Your Wealth

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28:32Welcome back. Our next question comes from Mike. Hi, Paul and Joe. My name is Mike, longtime listener, big fan. And I have a question for you guys about Roth IRAs. I feel like I'm missing something and I can really use your perspective. So a little about me. I make$85 ,000 a year. I got married a few years ago. My wife makes about$280 ,000 a year. So quite a bit more than me. I know you and many others praise the Roth and I do too. I get the draw. But when we talk about investing, my wife and I are really unsure if the Roth makes sense for us. We're in a high tax bracket given our income. We're married, filing jointly.

29:13We currently live below our means and expect to continue that trend into retirement, meaning we expect our tax rate to be lower in retirement than it is today. We're maxing out our 401ks. We have two small children and are contributing to their 529 plans with extra support from their grandparents. I don't want to over-contribute there, but I feel pretty comfortable with our contribution levels. Aside from that, we've got about$190 ,000 primarily sitting in high-yield savings accounts. Though we've recently decided to quickly ramp up our contributions to our brokerage, mainly investing in Vanguard S &P 500 Index Fund.

29:51We're in our mid-30s and have some time, have some runway there. So I like the idea of putting it somewhere that might be able to earn a better long-term return than a high-yield savings. The brokerage seems to make sense, given that any withdrawals will only be hit with the 15 % long-term capital gains tax. And I like that it's a bit more liquid than the Roth. But what am I missing here? Should we be contributing to a Roth, given our high income at the moment and the fact that we expect our income and tax rate to be lower in retirement? I don't know. Appreciate your thoughts. Mike, thank you for the question.

30:28I love the thoughtfulness behind the question. So I have a handful of questions back to you. Number one, for the rest of your careers, do you expect your combined income as a couple, do you expect it to substantially either stay the same or increase? That's question number one. Question number two, is your goal to retire early-ish, maybe 55, 60, I'll even count 65, is that your goal? And of course, this is unknowable because I'm asking about something that's 30 years out into the future. Or is your goal, hey, we really love our jobs. We think that we'll always have some kind of an income. We have this – for us, it's about building and it's about producing and it's not even about the paycheck.

31:18We just really like doing stuff and that stuff just tends to be income producing. And so we might end up having Steve Martin's career where he's 80 years old and still starring in Only Murders in the Building, right? We might – look at me with a pop culture reference. Who are you? We might end up – right? Exactly. But I think Steve Martin is a perfect example of somebody who is very wealthy. Very much. Does not need the money. He's 80 and he's making great money starring in a show because that's just what he loves to do. So are you Steve Martin or Betty White or Warren Buffett, all examples of people who worked into their 80s and 90s and loved it?

32:03They didn't need the money. They just really enjoyed what they did, and it gave them purpose and gave them a social community, and it just kind of gave them some fun, cool projects to engage with. Is that the trajectory that you see for yourself, or do you see something different? So how do those change your equation then, Paula? I mean, why do you ask those questions? I think everybody's wondering. The thing about a Roth that is completely unknowable is what the tax rate in the future is going to be, because that is determined by the government. And we have no way of knowing who the government is going to be or what they're going to decide in the year 2035, 2040, 2045.

32:41I think you could have just stopped with, we have no way of knowing what the government will decide. End quote. 2046, 2047, 2048. Yeah, you don't need all those words. If I were Paula's editor, I would have edited the rest of that. That's the unknowable piece of a Roth. And that's honestly part of the reason that I bias towards Roth is because I like the certainty of locking in today's tax rate as opposed to the uncertainty of accepting whatever unknowable tax rate lives in the future. You could even think of it as a certainty premium. There is a certain certainty premium that I'm willing to pay in order to know that I'm locking in today's rates.

33:25But to answer your question, Joe, as to why I'm asking them about their career plans for the future, while the tax rate is uncertain, your own personal career plans and therefore your own personal income trajectory is more within your own circle of control. Yeah, monitoring and focusing on what you control. Yeah. Yeah. I think, again, to widen this lens, there's a reason, Paula, that you and I say that we are biased toward the Roth, not that it's Roth all the time. Do as much as you can, or it fits a lot of the time. And I think if we widen it even more, I think this is why people get so annoyed with some of the major names in personal finance.

34:08It's because they're speaking to millions of people, and they don't want to do damage. So what they do is they do the thing that is the law of large numbers. So Dave Ramsey, there's a lightning rod, right? Dave Ramsey gets a lot of vitriol because he's talking to millions of people and he's decided that, you know what, for the most people, Paula, debt is always bad. And so what do we get online? All these people go, well, that isn't always bad. There's a gray area to everything. But when somebody is talking to the vast majority of people, debt is bad. I think we can all agree is a good place to start.

34:43But Susie Orman, another lightning rod, having value for a dollar, folding your money in your wallet and having this value for a dollar is great stuff. But when Susie says some of the crazy stuff that I've heard come out of her mouth, again, she's talking to millions of people. And she's making a broader point that we might be the exception to. I think that's the reason why I like that you and I talk about we bias toward the Roth. because in my mind, Mike, you're not missing anything except for, I think, what the future might be. And if the future continues the way you're talking about, because you and your spouse are Steve Martin, then yeah, maybe the Roth isn't for you.

35:27I don't think there's a reason to have FOMO here. I think people do this sometimes with the HSA. There's plenty of people that make it through retirement without having an HSA. I think you can do retirement without having the Roth. Well, no, I would say if they are Steve Martin and they're going to be doing really interesting, cool projects into their seventies and eighties and those projects. And earning a bunch of money. Right. Exactly. Then Roth it up. Roth throughout the years because their income is only going to keep going up. Right. Yeah. I was backwards on that one. So if they are Steve Martin, then Roth it up big time.

36:03But if they planned a piece out of the game at 55. Well, and I think Paula, based on his question, he's thinking the latter, right? He's thinking I'm in a high tax bracket now, probably be in a low tax bracket later. What I would say is what we don't want to kill, Mike, is we don't want to kill the ability to give ourselves flexibility later on. So you don't need to be whole 100 % everything Roth. No, take advantage of the fact that you're in a high tax bracket today and get that money in pre-tax to avoid this high tax bracket today. Take the bird in the hand, as my mom says. But I might still, Paula, Roth some, Roth a little, because even though that's going to cost you today, you're building flexibility to have options in your plan down the road as well.

36:52And we don't want to forfeit that. And this is where that tax triangle comes in. A hundred percent. The other piece about the Roth is that for most people, the amount of Roth that's available to you is not that much. So for a lot of people, many people don't have access to a Roth 401k, which means your ability to contribute to a Roth account is more or less limited to a backdoor Roth IRA, which caps you at a pretty low, I think it's what, 7 ,000 right now for 2025 if you're under 49. So that caps you at seven grand. That's not a lot of money relative to the total amount that you, I'm assuming, are contributing to retirement accounts and brokerage funds.

37:34that's a fairly small amount of money. And even if you do have access to a Roth 401k, the employee portion of that contribution will be Roth, but the employer portion necessarily is required to be pre-tax. And so the other component of the Roth discussion is given the fact that Roth opportunities are so limited and the system that we live in tends to bias more towards pre-tax opportunities rather than Roth opportunities, you may as well take the Roth opportunities that you have because those opportunities are so curtailed. And you do want to build out that, Joe, to your point, the tax triangle.

38:17Yeah, have some flexibility. But if you're the exception and you do have the ability to do a Roth 401k, then maybe it's a small portion of it. I don't think you need a ton of money in your Roth position to give yourself flexibility because the game you're going to try to play later doesn't necessarily require a ton of money. You just need money above the top tax bracket you're going to be in to try to spend as much of your pre-tax money at lower tax brackets later on and then live additional life at a zero tax rate with money from the Roth. And I'll go back to the unknowable 2052, 2053. To the unknowable, we don't know what tax rates in the future are going to be.

39:03And that's a big part of the judgment call that we're making here is how optimistic or pessimistic are you about future tax rates? Slash, how important is it to you to lock in the certainty of today's rates? I truly don't think he's missing a lot, Paula. I don't think he's missing much. I don't think taking advantage of all the pre-tax is a bad thing. You know, Mike, my other question for you, when we talk about this tax triangle, I'm curious, if you look at proportionately at the assets in your portfolio, what percentage of them are in a pre-tax position versus in a taxable brokerage account versus in a Roth account?

39:44As percentages, how is that triangle formed? Because I think if you take a look at the tax treatment allocation of your portfolio as a whole across those three categories, you'll be able to see if that triangle is too lopsided, too imbalanced. And again, given the opportunity limitations of the Roth, it's common for many people to have tax triangles that are just tilted too far towards the pre-tax position. Yeah, that is the big danger, is that there's nothing on the top in that tax-free bucket. Or not nothing, but like very little. Very little. Well, nothing or very little, right. So, Mike, I hope that gives you some food for thought, gives you some questions to ask yourself.

40:34And I hope it helps solve some of the question of, are you missing out? No, no, I don't think you're necessarily missing out. As long as you've got a tax triangle built and you've got a decent balance of assets across all three points of that triangle, that's the critical part. And then if you want to lean into one of those points of the triangle a little bit more than the others, then the questions that I asked about how you see your own life playing out and what your guess is about what the government's going to do and future tax rates, those are going to influence how you lean in terms of that triangle.

41:17So thank you, Mike, for the question. We're going to take one last pause to hear from the sponsors who make the show possible. And when we return, we're going to hear from someone who is not Steve Martin. No? No, not Steve Martin. We're going to hear from not Steve Martin because we're talking to Cindy, who wants to be work optional by the age of 55. Way better than Steve Martin. Oh, that's not better or worse. We're not judging here. Steve Martin has got a great career, but being a work optional at 55, also great. 55. I'm just saying if Steve Martin's a fan of the show, then he's okay too. But if he's not, then Cindy's way cooler.

41:57Oh, okay. Yay. So you're not saying 55 versus 80 is better. I'm not judging the goals. I'm a hundred percent judging the people. Got it. You're saying Cindy is better than Steve Martin. Because she's cool enough to call in. Steve, when you call in, you can be cool too. All right. Well, when we return, we're going to hear from Cindy.

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46:14Welcome back. Our final question today comes from Cindy.

46:21Hi, Paula and Jo. This is Cindy. First, I want to thank you for answering a question I've asked earlier this year about dividend investing versus growth. I appreciate the guidance you provided. My question today is focused on building out my tax triangle and whether it's worth it to use backdoor Roth conversions. My goal is to become work optional in 10 years when I turn 55. Currently, 71 % of my $1 million net worth is in tax deferred accounts. 21 % is in taxable accounts and the remaining 8 % is in a Roth account. My new workplace allows me to transfer my rollover IRA held in a brokerage firm into the company's 401k, which would enable me to start doing backdoor Roth conversions, which I had not done previously because of the pro rata issue of having a rollover IRA.

47:09Is it worth it to transfer my rollover IRA to my 401k and give up the current investment flexibility and options I have with my brokerage firm in order to be able to do backdoor Roth conversions, knowing that I can only convert a maximum of$7 ,000 each year for the next 10 years, which would result in a minimum of$70 ,000 in my Roth accounts. But compared to my tax deferred accounts will continue to be a much smaller portion of my overall network. Thank you for taking the time to answer my question. I really appreciate it. Cindy, personally, and I'm curious to see if Joe agrees with me or not.

47:47I love the plan. I also have taken the same strategy in my own life in which I have minimized my pre-tax IRA assets. In fact, that is specifically the reason that prior to when I hired employees that afford anything, specifically I had a Roth solo 401k, and I did that so I could concentrate my assets into a 401k position, which would then give me the ability to backdoor Roth the maximum amount without facing the pro rata rule. Prior to when I hired full-time employees, I prioritized 401k over IRA for exactly that reason. And then once I hired full-time employees, that changed and I was no longer eligible for the solo 401k.

48:32And that kind of goes back to what we were talking about with the last caller. The opportunities for putting money in Roth accounts are so limited. Like once I hired employees, I no longer had the opportunity to put money in a Roth solo 401k. And so now I've got to go into a SEP IRA if I want to contribute to a retirement fund. And that necessarily has to be in a pre-tax position. So anyway, opportunities to put money into a Roth account are very limited. And now you have the opportunity to do so and to build out that tax triangle and to have more of your assets in a Roth position. So I personally love that approach.

49:08For me, I don't know what the end goal is. I mean, I just start with the end and work backwards. So, you know, I hear 8 % and I hear the fear that that's not enough money in a Roth position. And I think, is it not enough? I don't know how crazy you need to get about this. I don't have any idea. I wouldn't feel a ton of FOMO about not having enough. I like it. I'm not overjoyed like Paula is. It's yeah. Overjoyed. Good. But it sounds to me as though the big drawback, the Achilles heel of the plan is that the investment opportunities, if she were to switch into a 401k position are not as good. Which can be a big Achilles heel.

49:56Yeah. And I don't know the specifics of how sucky is the delta, right? Right. That's the question that I've got. What is the delta between the opportunities and how much of a suck factor is there? Yes. Suckiness, I think is the word that the pros use when they come up with this stuff. All the CFAs use it. It's huge. I think also there, Paula, people get confused because it isn't how good the choices are as much as it's how good are the choices that you need. So I've seen some 401ks that seemingly have sucky choices, so to speak, because there's only six, but the six that you have available are phenomenal.

50:39Give you a case in point, the federal government's 401k plan. Not many choices, phenomenal choices. The C fund, the S fund, the I fund, fantastic. Great at what they do. Amazing at what they do. But if you just look at it based on a number of choices, no, there's not a lot there. but I love what the federal government's done. Simplicity is a great answer. You have the asset classes you need. You don't need more very low expense ratios. Andy love it and performance at the same time. I think because we don't know the specifics, if it's bad because there's not many choices, that's bad. Now, if it's bad because of the fact that it's an annuity based plan, like a lot of small employers have, and they have to because they just don't have the wherewithal to administer a 401k where they cover the cost.

51:31They have to have you cover the cost. Well, then, I mean, maybe the 401k has sucky choices because the fees then get really, really, really big. And by the way, when I say annuity-based plan, I might've thrown a bunch of people off because that totally is jargon, Paula, because you won't see it as an annuity-based plan. You will see though a lot of funds that are offered by an insurance company inside of your plan and you'll see very high fees. You won't hear the words or see the words annuity-based plan anywhere. That's what industry insiders know that it is. It's when an insurance company is managing your plan and they're passing on the fees to the employee so that the employer can offer you 401k without having a lot of overhead.

52:18And so that comes back to the Achilles heel is the suckiness delta. And I want specifics on just where and why. Yeah, yeah, exactly. What is that delta? What would she be giving up? But assuming that that delta is not too wide, then personally, I love the notion of converting more money into a Roth position. I mentioned Paula that I can see the making of a spreadsheet here. Like I don't have it down in my head yet, but I can see this like crossover point. So part of that, I think also depends on her age. How long can you leave that money in the Roth position to have it grow as a Roth so that it makes sense for that to happen?

53:03I think if you're going to spend the money fairly quickly, then I think doing that doesn't make a lot of sense. If you're not going to spend that money for 30 years, then building that vault of Roth money makes more sense. Cindy, I hope that was helpful. Joe and I have slightly, I mean, complementary takes, but slightly different takes, which is always my favorite. Mine was slightly better. Is that what you're saying? I do think I'm a hair more of a Roth fangirl than you are. I think so too. And for me, the reasoning comes down to the certainty premium. A big part of that reasoning is the certainty premium.

53:44I like that. I mean, I do like the idea of building more certainty into my future that, you know what? I've already paid the tax. Don't got to worry about it. Exactly. When you look at the balance inside of your Roth account and you know, this is the money I have to spend. None of this is going to be taxed. I'm not sharing it. Right. Exactly. There is so much peace of mind that comes from having the certainty around that number. I think I like that because on a daily basis, that's the way that I like to live my life is if there's something that is a difficult thing, if I can take care of it today, so I don't have to worry about it tomorrow.

54:24I'm going to take care of it today. And to some degree, paying the tax today and getting rid of it so I don't have to ever worry about it again just feels better. Yeah. It's a bit of a gift to your future self. Yeah. There's this emotional response. And I get that it's not all emotion. There's some math there as well. But I do just generally like the idea of gifting myself less thought. I can go enjoy whatever I'm doing in the future. Right. But that said, Cindy, I truly don't know how much you're going to need there. And that could also bias whether the pro rata rule is worth fighting that and what all the experts call the suckiness factor, I think are the two big things you should be worried about.

55:10The pro rata rule and the suckiness factor. Well, Joe, we've done it again. It's amazing. Cheers. Cheers. Coffee cheers. Coffee cheers. Look at the size of this coffee mug. Wow. That is a big mug. Yeah. Proportionate to our heads. I know. Yeah, I'm drinking like double the coffee. She's got a mug the size of half her head. Yeah. Mine's like closer to a third. Well, Joe, when we're not measuring our head sizes relative to our dishware, what else do you tend to do with your spare time? Where can people find you? Paula, we got some really fun stuff coming up. Of course, we have our annual board game episode on Black Friday that we do every year.

55:52It's amazing. Don't waste money on bad board games when you play. It's a one time people play board games with all their friends and family. Every year is around the holidays, right? If you're going to play them, it's probably going to be now. We've got Kylie Primus from Games Unlimited, a store that won all kinds of awards for retailer of the year in that cottage industry. And then the following week, we've got Hannah Cole, who is an artist initially, became a tax expert and has taxes for humans. So not like complex taxes, but if just the whole thing freaks you out, Hannah has this great way of just explaining the basics so that you can start dealing with some of the things that money geeks take for granted, right?

56:39Some of these tax rules. I remember when a CPA first sat me down with a 1040 and went over it. And I finally realized, Paula, what the difference was between a credit and a deduction. Like I kind of thought they were the same thing. I could have, you know, one is a longer word, but a credit or deduction, who cares? Right. They're a massive difference. Huge difference. And when you look at them in the order of which they occur, a deduction just makes your income smaller, where a credit pays dollar for dollar the tax. Are you freaking kidding me? I want to credit whatever I can get it. So Hannah's going to do stuff like that.

57:14And then some guy, I don't think anybody knows who he is, but Morgan Housel is going to be on the show. Morgan is incredible. I've heard, but I don't know who is he? Do we know? He's a famous skier. Of course. Yeah. Morgan Housel. We're going to talk about skiing through your spending, the art of spending. The art of spending. While you're skiing. Awesome. Well, all of that is on the Stacking Benjamins podcast, available everywhere where finer podcasts are found. Only the finest. Only the finest. Well, thank you again to all of you for being afforders. If you enjoyed today's episode, please share this with the people in your life.

57:55Share it with your accountant who is helping you with building out that tax triangle. Yeah, share it with your friends in Valdosta, Georgia. Right. And share it with your legal advisor who's helping you figure out how much money is protected from lawsuits. 100%. Share it with that insurance agent that's going to help you figure out how to buy less insurance. Share it with every teenage driver that you know, because that is the most important way that you spread the message of F-W-I-R-E. Also, subscribe to our newsletter, affordanything.com slash newsletter, where we send out stuff that you don't hear on the podcast.

58:35Finally, please open your favorite podcast playing app and then open your least favorite podcast playing app. And on both of those, hit the follow button so you don't miss any of our amazing upcoming shows and leave us up to a five-star review. Thank you again for being an Afforder. I'm Paula Pant. I'm Joe Salcihai. And we'll meet you in the next episode.