Q&A: The Hidden Tax Drain in Your Investment Strategy

0:00Joe, have you ever thought about living in another country? Not for an extended period of time. Our goal is, though, when Cheryl, who loves what she does right now, decides that she doesn't want to do it anymore, pick up and move from the heater that is northeast Texas during the summer and maybe just live in Portugal for a few months or every year live someplace different just for two or three months at a time, though. Ah, well, you'd probably still keep your residency in Texas then, which means there wouldn't be tax implications to deal with. Thank goodness. Yes. Well, you're not going to dodge that complexity just yet because we're going to answer a question from a caller who is moving to Brazil and is wondering what some of the tax considerations are.

0:43We're also going to hear from a caller who rebalances his portfolio every year on his birthday and is wondering what the tax considerations are when rebalancing that taxable brokerage portion, as well as just kind of what the strategy around it is. And we're going to answer a question about 401ks versus employee stock plans. Wow. All that today. All of it's a big day, Joe. Buckle up. Welcome to the Afford Anything podcast, the show that understands you can afford anything but not everything. Every choice carries a trade-off. And that applies not just to your money, but to your time, focus, energy, and attention.

1:22This 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. Every other episode, I answer questions from you, and I do so with my buddy, the former financial planner, Joe Salcihai. What's up, Joe? Wow. Sounds like we're giving people a Brazilian reasons to listen today. Oh, Steve, can we get a want-want? Come on. Oh, that was not want-want. That was good. We don't want to lose our audience before the show has even started. So we're just going to dive right in with this first question, which comes from Michael.

2:02Hey, Paula. I had an interesting question I don't think I've seen anyone cover elsewhere. So part of my financial plan is to rebalance my accounts yearly. I do this on my birthday, lack of a better time to do it. but one of the things I've been thinking about is how to do that about my taxable brokerage accounts. So in those, if I sell some of these assets to rebalance, I will be realizing capital gains and that has tax implications while I'm working. The main purpose of my taxable account is I have extra money and I have nowhere else really to put it and nothing I plan to spend it on in the immediate future.

2:35So it's just sitting there compounding until I need the money for something. So is there any advice out there for rebalancing a taxable account yearly? What I've currently been doing is I take some portion of new money that I'm adding to this account, and I use it to kind of help try and bring things closer to my idealized asset allocation. Again, I don't know if there's a better way. I've never really seen anyone really talking about rebalancing those accounts while you're still working. But I figured you might have some good advice that you could provide on how to go about that. Thank you for taking the time to listen.

3:08Michael, happy birthday. It sounds like you know how to party. I'm joking. That's exactly the type of thing this community does. That's what I love about Afforders. We find a celebration in taking care of our financial health. Absolutely. To answer your question, the two things that I would recommend doing in terms of the assets that are in your taxable brokerage account, one is make sure that they're there for a solid year. Heck, if you really want to be on the safe side and not risk it, go every year birthday plus one day and then the next year birthday plus two days. Just make sure that you're going to get taxed at the long term capital gains rate and not the short term capital gains rate.

3:50So maybe leave a safety margin of an extra day just to be on the safe side. I don't know if that's, strictly speaking, necessary. I would just do that out of an abundance of paranoia. So that's the one thing I would do. The other thing I would do is exactly what you suggested, which is rebalance by virtue of purchasing more assets rather than selling out of positions in order to avoid the tax hit. Oh, and the third thing, of course, is asset location. So when it comes to the asset allocation of your entire portfolio, locate the most tax efficient investments into your taxable brokerage account.

4:28Those are the three things. Sure. And the only thing that disturbs when people do that, Paula, is that often the money. Time out that disturbs you. Disturbs me. Wow. I get very disturbed, Paula. Geez. Very, very disturbed. All right. Sorry. Sorry to cut you off. about that recommendation. That was dramatic. Disturbs you. The only thing that I see people do when they try to be... No, no, no. Stay with disturbs. That's great. When people try to be overly tax efficient, it is often the assets that are the safest that also create the biggest tax consternation. So I will see people put safe assets into tax shelters because they don't want the dividend payout.

5:17And then it comes time to spend money and the money that is very tax efficient. It's because it's a growth fund that doesn't pay a dividend, which can be the most dangerous place to take money from. To some degree, I just have to realize that I'm going to lose some tax efficiency. There's going to be some tax friction when I have money outside of my IRA. I think what's cool is this is a good opportunity to look at your allocation and ask, does this work for me more often on the outside? I think I mentioned before the efficient frontier, maybe looking at the drift every five years. But I think that because of the fact that you want to avoid taxes as much as possible on your non IRA money, just looking at what's working and what isn't before I begin to fill in is the thing that I would do.

6:10But besides that, I love his strategy. I like the idea idea of not selling anything if possible and instead deciding what I buy and how I buy. In fact, you and I, a few weeks ago, were with our mutual friend, Nick Majuli, who wrote a great book called Just Keep Buying. And I asked him this question about which way do you like to get back to your allocation? He said, whenever possible, I like to just fill in the balances so that then I don't have to sell a thing. So I'm 100 % on board with this strategy and I don't know of a better one. Yeah, same. That's exactly how I rebalance. When I go to make contributions, I just take a look at that drift.

6:50In fact, I don't even get too specific about it. I just sort of eyeball the drift and I can usually see, all right, I need more of that asset class. And then I just buy into it. If something's down though, and I'm looking at whether I'm going to do some tax loss harvesting or if I'm going to stay with it, it's in those moments especially that I'm like, does this asset class suit me at all still? Is this still the place that I need to be? Because if I'm going to sell it for tax reasons, then I want to make sure before I buy it back and avoid wash sale rules by staying out of it more than 30 days, I'm going to clarify much more quickly whether this position even serves me in the first place.

7:32Joe, do you think my birthday plus one day is excessively paranoid? I don't. I think that's just fine. Oh, thank you. It doesn't disturb you. It does not disturb me. I don't get overly disturbed. It's a day after Paula's birthday. Yes. And I am disturbed. I mean, heck, if you keep doing that over the span of 30 years, you're going to end up like a month past your birthday. And then who knows what madness happens. Yeah, but Michael, I think you are absolutely on point. You're doing exactly what both Joe and I would do. So kudos to you. Well, up next, we're going to address a question from a caller named Sam who's wondering about how to compare a 401k to an employee stock ownership plan.

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11:12Our next question comes from Sam. Hi, Paula and Jo. I have a question about a potential job opportunity. I got an offer from a company that doesn't have a 401k plan, but they do have an employee stock ownership plan. While they said they can't guarantee any contributions into the ESOP, for the past six years, they've been contributing the maximum annual amount, which they say is 13.5%. half percent. At my current company, I get a match of five percent into my 401k. So this seems like it would be an increase. I wanted to ask what my thought process should be. What are the potential pros and cons of an ESOP?

11:50The company has been around for about 75 years and they've been doing really well, especially in the past decade. There's huge growth potential there, but I understand that there's some risk involved in this contribution only going into the company stock. So any guidance would be appreciated. Thanks for your help. Love the podcast. Sam, first of all, congratulations on your new job offer. That's incredible. And I hope that you negotiated for your pay package. I'm kind of into that. And as we all know, when you switch jobs, switching employment tends to be the best opportunity to get a big bump in salary.

12:35So I hope that this new job offer comes with that big bump in salary and that bump in benefits. But speaking of a bump in benefits, that's exactly what you're calling about. how do you compare the Trad 401k that you currently have with a 5 % match, which is an amazing match, to this ESOP? It sounds as though the company that you may be moving to is doing very well with 13.5 % for each year for the last six years, making that max. However, as you mentioned in your question, the major red flag when it comes to ESOPs is that you're getting an offer of a stock, specifically the stock of the employer who you also rely on for a paycheck.

13:21And so there's a concentration of risk because not only does your entire paycheck come from this one particular company, but now a big portion of your portfolio does as well. You can, of course, invest money into a traditional or Roth IRA. You can invest money into taxable brokerage accounts. But people who have stock-based compensation often tend to have an over-concentration of their employer stock. And when that goes well, it goes very well. And when it goes badly, it tends to go very badly. So you want to shed a lot of the realized employer stock that you have as quickly as possible. A few notes here.

14:09One is that because your new employer, assuming that you take this job, because your new employer is going to be funding this ESOP, you yourself are not going to be making those contributions, which then frees up the money that you have for making those trad IRA or Roth IRA contributions. So I don't know how much money, if any, you're contributing now to IRA accounts that are outside of your current employer. But if you accept this job, when you make that move, be sure that since you're not going to be making contributions from your paycheck, be sure that you move that money into a non-employer sponsored IRA account.

14:52A way to get that done fairly easily if your employer likes it is often you can take your direct deposit, Paula, and split it up among different places. And so if you can split your direct deposit, you can even eliminate yourself and hopefully have part of it go directly to an account that is inside of a plan so that you don't even touch it. And it feels very much like your 401k. If at the employer level, they'll let you do that. The drawback though, when we talk about these non-employer IRA accounts is the contribution limit. Very small. Yeah, it's frustrating. Yeah, exactly. I don't know, Sam, if you have HSA eligibility.

15:34If you do, you can use your HSA as essentially a de facto supplemental retirement account by virtue of contributing money into an HSA and then committing to never touching that money until you reach retirement age. Yeah, really just call it your Roth IRA, but tax-free going in, tax-free coming out retirement fund. Yeah, exactly. You can use an HSA as a functionally a substitute retirement account. That being said, not everybody has HSA eligibility. And also, particularly if you expect to have any health expenses, if you have the option to get much better health insurance plan that is low deductible rather than high deductible, heck, that's even better.

16:19I would never advise somebody to take a high deductible plan just for the sake of having HSA eligibility, especially if they think they're going to have health expenses. I love the fact, though, Paula, that she's looking at total compensation. And I think this is missed a lot of the time. Most people, when they look at a job offer, they're just looking at what is the gross pay, not what's the total package that I'm getting. So for her to consider this, I think really helps all the afforders when they're looking at different job opportunities go, okay, what benefits do I get? And how did that compare with the benefits that I have now?

16:54What's the cost of that? Because Sam's going to need to bring that to the table herself if she tries to match it. And in some ways, especially in this way, if she's going to contribute more than an IRA allows, it's going to be the same answer that we just gave to Michael, which is there's going to be some friction, some tax friction, because to save the same amount, she's going to have to put it into a non-IRA brokerage account, which I would do over and over again. She's going to have salespeople that are going to tell her that an annuity gets around all that. Don't do it. Don't do it. Don't do it.

17:27Not a great place to go. Although people will tell her, you know what you got to do? I think on my end, I think you nailed it, Paula. I think she can't because that employee stock ownership plan is not guaranteed. I don't think you can count it. Oh, well, just because past, if she's trying to do an apples to apples comparison, you want to do your plan around, can I make this work without them making the contribution? So if it's not contractual, if it's not a part of her total compensation package, they just go, Hey, the last several years in a row, we made it and our stock's done really well. So here you go.

18:05I think when it appears, it's a happy thing that way. I think if she counts it at all, that they've done this in the past and then they don't do it, I think she's looking for a world of hurt. But I love your advice around this is an apple and an orange. Loading up on employee stock isn't something that you're going to want to do anyway. So once you decide what percentage of your portfolio you want in employee stock, then anything beyond that, you're going to have to sell. And then it goes in this taxable brokerage account, again, with friction, not the end of the world. I think it's a fantastic place to accumulate money because that money is so flexible.

18:44There's going to be a lot of moving parts. Yeah. And if I can speak in defense of the taxable brokerage account, many people don't like those accounts because, of course, they are taxable. They aren't tax advantaged in the way that other retirement accounts are. But what you are, quote unquote, quote, buying with that tax bill is flexibility. It's great. 100 % love it. I'm totally with you. There have been so many times that I've recommended to people that they get just a brokerage account. I don't know, but what about taxes? Let's worry about having more money. Let's worry about having money in the right place when we need it.

19:22Much more than worrying about just optimizing for a future that may or may not happen. Right. So I think that as she looks at this opportunity and she's looking at total compensation, not only these, obviously look at the amount that they put toward healthcare benefits that will change from company to company, just how good and well-rounded the benefits package is in general. Yeah. You know, and I don't know the size, Sam, of the company that you're moving to, but particularly larger companies can sometimes have everything ranging from commuter benefits to. Costco membership, I've seen. Right.

20:05Yeah, exactly. ClassPass. Right. Yeah. Companies will sometimes offer ClassPass. Gym memberships. Yeah, precisely. So there are, particularly for large companies, just this massive range of benefits. Of course, what you trade off is you don't have, in terms of the day-to-day work experience, at a larger company, you often don't have the same level of autonomy or nimbleness that you do at a smaller company. You don't tend to have as much decision-making authority. Everything is very procedural. Often your best efforts can sometimes get stymied in bureaucracy. And so there's that company culture element as well that you need to counterbalance against these benefits.

20:51So we teach our students in Your Next Rays. I should say we are still in beta. So what we have taught our beta students as we're developing this course out, we have them create a spreadsheet where we assign a weighted value to every single one of these factors. And so if there is a non-monetary factor, for example, the perceived degree of autonomy that you believe that you will have at work, you know how much autonomy that you have at work at your current job. You have, I'm guessing, an impression of the level of autonomy that you believe that you will have at work at your new job, if you were to accept it.

21:34You then assign a numerical ranking of importance, and then you assign a second number to it, which is the scoring that it has. So basically you give it two numbers. You give it an importance level ranking. So you give it a weight, and then you give it a score. And then you do that with every single non-monetary factor, and you put these all on a spreadsheet. And it's a way of quantifying the unquantifiable. And I think that when you're considering whether or not to accept a job offer, that is as important as calculating the monetary value of your total compensation package. Because what we know from the research is that the three factors that predict job satisfaction are autonomy, mastery, and purpose.

22:26And so to the extent that you can wait for those, wait meaning in a spreadsheet, to the extent that you can assign some type of a waiting to how much autonomy, mastery, and purpose you believe that you will experience within your new role, the better of a decision you can make. What we also know from the literature is that the single biggest predictor of whether or not you like your job is your relationship with the person to whom you directly report, your direct supervisor. That is the single biggest predictor of job satisfaction, which makes sense. You have to interface with that person on a daily basis.

23:04If you think that they are belittling or dismissive, then you're not going to enjoy any job. Whenever you're considering a new job offer, you're working with this asymmetric set of information because you know the circumstances at your current role and what you have educated guesses about the circumstances at your new role. But you are making these very imperfect educated guesses about particularly factors like those interpersonal dynamics. Yeah, fit. Exactly. In fact, it's funny. We spoke with a couple of experts in this area, Paula. We spoke with Ashley Goodall about this specifically on Stacking Benjamins, Paula, and he and Marcus Buckingham had done a wonderful piece in the Harvard Business Review that even in a big company, Ashley said there's no such thing as culture at a company.

23:59And you know what culture is? The four people you work with on a daily basis. And if those four people stink, you're going to think that no matter how big the company is or how small the company is, you're going to think the entire company stinks because of those four people, which is why in Harvard Business Review and on our show, they talked about if you are a senior manager, you need to teach your lower level managers about culture and about fit and about making people feel warm and welcome and needed. Because you're totally going to think the pot of people that are around you are either fantastic and so goes the company the way you think about the people around you.

24:37And I think that's a great point that you, it's almost impossible to know that going in unless you're able to talk to the people. The hiring people know exactly where you're going to fit and you're able to talk to some of those people ahead of time to get a feel personality wise, how much you'd like them. And still it's going to be imperfect. I'm thinking about when we first came to Texarkana, we had a nice dinner with the people that Cheryl was going to be working with here in town because we moved here for her job initially about 15 years ago. And I remember one of the people at that table that I thought was kind of weird ended up being the nicest person and one of Cheryl's best friends.

25:22And one of the people I thought was really, really cool ended up being this person that we still to this day do not love. Just do, do not love. So some of these first impression feelings can even give you the wrong sense. So to your point, it is tough. Right. And some people are a little bit awkward in new or unfamiliar situations. I've known plenty of people who don't give great first impressions, but as you get to know them, they open up. That's this woman that we thought was really weird. Yeah. She's just like that when you first meet her and she still is quirky, but her quirkiness is why you love her.

26:04She's hilarious and she's so warm and friendly. Right. Right. Kind of weird in the best possible way. Right. And then by contrast, you've got other people who have the mask, right? And they wear the mask well until one day the mask slips. Right. Yikes. Yeah. And it slips mostly for people that are around them every stinking day. Yeah, exactly. And those are your close colleagues and that's your direct supervisor. It is funny, Paula, because I think what you're building here is this bridge between you and I talk about in financial planning, but bridging it to your next rage, which is this risk premium.

26:49Right. Yeah. This job can't be the same. It has to pay a bunch more because of the risk that you're taking that this might not be a fit. Well, it depends on what her perspective is on her current job. Is her current job untenable or is her current job satisfactory, but she's thinking about making a switch anyway? Because if the current job is untenable and toxic and she needs to move no matter what, even if that means running off with the circus to Antarctica. Circus in Antarctica. Yeah, exactly. All those penguin acts. Precisely. They're already dressed up in their tuxedos. That still fills me full of dread, though.