457 | Mailbag: Cover Your Expenses | Rachael Camp

24:59And because there's no reliable way to pull home equity out without then further incurring costs or having to repay it, it becomes this weird circular recursive thing. So that's why we don't include it. Yeah. And of course, we can get really detailed. And there's a lot of people on Twitter that will say, well, technically, well, technically this. But I prefer for all of my estimates to lean on the side of being more conservative. So this could be an example here. Let's assume you really cannot turn your home into any form of income because there are some people who will argue that the 4 % rule actually might be too aggressive.

25:34And it's based off of historical returns that they don't expect to continue in the future. There's a lot of people out there, a lot of really intelligent people out there that believe that the returns we see going forward will actually be lower than historical returns. Now, there's a way that we can get in the weeds here and make sure that we are always using a safe withdrawal rate. And that's where we might use a variable withdrawal strategy that might be getting a little too into the weeds. But it's all to say, I like to use conservative numbers in my estimates. I don't want to mess around with can we safely retire and make sure that we don't want to run out of money.

26:11So if we're really going to stress test it, let's use numbers that we really know we can rely on. Yep. Totally agreed. So, okay. I think we've answered Shannon's just first, the most broad question. This is both retirement accounts and your, as we call it, your taxable savings, your taxable brokerage accounts, which is basically just your normal savings. I feel like that taxable thing is the worst, the worst phrasing we have in personal finance, right? But it's just the sum of all of these investment accounts. And then you think of them in total in terms of the 4 % rule. Now, obviously, Rachel, you can get into the precise nuance of, hey, we should be pulling out in this order.

26:50And there's a lot of that, but that is way beyond the scope of what we could ever answer in a three-hour podcast, right? So that's not the game we're playing here at all. We're just trying to give this broad, broad advice. So I think where Shannon goes next is about the earnings. Yeah, I want to hit on that earnings. Yeah, that's the most important thing because I suspect a lot of people have questions about that. So the other part of this here is, can we just withdraw the earnings? And I totally understand why this is a bit confusing is because if we look at the returns of a balanced portfolio, and what I mean by that is a 60 % stocks, 40 % bonds, and we look at it over 30 years, typically, you're going to see a 6 % return on average.

27:35So for people who are entering retirement, they have this balanced portfolio, they think to themselves, why can't I just withdraw 6 %? That's what I can expect for my returns. And the reality is when we dig into this, the returns, your average return and the withdrawal rate, there's actually a very low correlation between the two. So we kind of don't even want to think of them together, at least not initially at this point. Instead, we have to think about what is a safe withdrawal rate. But let's talk about why can't we rely on average returns? The reason is because of something called sequence of return risk.

28:08So yes, over 30 years, we're looking at an average 6 % return, maybe for a balanced portfolio, but that does not mean that every single year we are earning a consistent 6 % return on our portfolio. So the sequence of return risk says it's really important, the order of this return. So it's not 6 % every year, but maybe it's negative 20%, positive 10%, negative 3%, positive 12. There's a lot of volatility until we get to that point of over 30 years where an average of 6%. So that is why the average return does not line up with the withdrawal rate. Because if you were to enter retirement and enter it into a bear market, which is a down market, and start pulling out 6%, then you're really putting yourself at risk of potentially depleting the portfolio before it has time to recover.

29:02So we talked quite a bit about how powerful dollar cost averaging is going into the market when you're investing into the market. Well, it's the same reasoning when you're coming out of the market. So if you're pulling on a portfolio while it is going down, you're really going to dramatically deplete that portfolio quickly, which is why when we start, we have to use a safer withdrawal rate because the risk is we start with a poor sequence of return and the portfolio never has the opportunity to recover maybe in the second half of retirement if we too heavily pulled on the portfolio. Yeah, no, that's it's very important.

29:42And we we've certainly had Karsten who goes by Big Earn from early retirement now on the podcast a number of times though it's been a while since he's been on but he has a really in-depth it's probably 40 plus parts at this point of a safe withdrawal rate series on his website and for anybody who's really looking to dive into the nuance of that definitely head over to early retirement now and check that out i think again that's beyond the scope of of what we can do here on this mailbag but it's very important that people are considering it. Because yeah, like you said, you can sometimes get those negative 20 % years.

30:17And if that's the first year that you're early retired, well, that might impact it in a different manner than I think earn says those first five years are the most critical. And it's not to say that if you have a negative 20 % in the first year or two, that all hope is lost and you have no chance, you should just go back to work. That's not what we're saying. But there are certainly different considerations. if those first five years are much more negative than even kind of an outlying base case, basically? Yeah. And if you enter retirement in the first five years are the worst case scenario, and you don't have a plan B, you don't want to go back to work, you know, things like that, then yeah, we will probably have to use the 4 % rule for almost all of retirement.

31:00Because again, it was created to survive that worst case scenario. So there's always the possibility that you retire into the worst case scenario. So we don't want to play with that. We don't want to play with the risk of potentially depleting a portfolio during your lifetime. So that's why we're so conservative. Now, if you enter retirement into a really good market and say you're 10 years in and your portfolio's double what it was or triple what it was when you started 10 years ago, then there might be an opportunity for increasing your income at that point. But it's to your point, Brad, those first five years are so important to make sure that we don't stress the portfolio too much if we do start with the down market.

31:42And that's how this withdrawal rate was created to make sure that it can survive the absolute worst case scenario. Right. Yeah. No, that makes perfect sense. So that's, that's interesting. And I suspect we can, uh, maybe the next time we have you on, we could talk about that, which is maybe when you reassess what that withdrawal rate could be because you don't want it to be overly conservative for the entirety of your life and then wind up like many people do actually with multiples of their starting balance, but yet they're still pulling that same amount from 23 years ago because they're still scared.

32:16And I think there is clearly, I mean, as we've talked about numerous times now with the book, Die With Zero, you get one shot at this life, right? You get 80 to 90 years if you're lucky and to be fearful, especially in a situation where you've passed the major portion of the sequence of return risk, right? And you can loosen the purse strings even more. I mean, to not do that would be, there's a major opportunity cause there. So I think that's really important. So getting back to Shannon's question. So basically she's talking about these earnings and she's thinking about it in terms of maybe almost akin to like, like an interest or, hey, our accounts went up by X amount this year.

32:57Is that what we're pulling off of? And I think it's a much broader number. It's you look at your total investable net worth, right? And that's what you apply the 4 % rule to. Yeah. You almost have to be agnostic to what your returns are in the beginning. So yeah, it might be painful to see that your portfolio is returning 10 % and you're thinking, why can't I just pull off those earnings? That's because there's no guarantee that that will continue to happen. And we do want that portfolio to grow, to keep up with inflation, to support the withdrawal rate that you will need. And so it's very simply, we can't rely on assuming that that return is going to continue.

33:36That's a very dangerous assumption. And if the market worked that way of steady, consistent returns, that would make all of our lives easier and make my life much easier. But the whole reason behind this different withdrawal rate is that the market does not work that way. It is very inconsistent. It can be very volatile. So we can't rely on it to be consistent in any capacity. Yeah. Okay. I want to challenge you with something because this is something I've been thinking about. And I think it'll be fun to hear your answer because I know this is not as rosy as it sounds, but there are many people that are thinking about this now in an interest rate environment where for the first time in decades, literally decades, we're getting paid to be savers, right?

34:17So there are some online banks. I know CIT Bank is one we love. I think at the time that we're recording this, their platinum account is giving, which is like a$5 ,000 minimum, it's 5.05 % interest. And you talked about a guaranteed return. Now, is that guaranteed to be that amount forever? No, of course not. But what if somebody came to you and said, hey, Rachel, I'm at FI. I believe that I could get this guaranteed FI. I can lock this in for the next 40 years at 5%. What's your response to that? Is it, first off, that's not as rosy as it sounds? You're crazy. How would you respond to something?

34:54Because that sounds like, okay, I can preserve my capital. And then I could, in that scenario, spend that 5 % because I'm guaranteed to get it, again, for as long as you sign that contract for. Again, I'm setting up a funny hypothetical, but how would you respond to that? Well, yeah, if we have a guaranteed 5%, then we could have a conversation on that for 40 years. When we're looking at bonds and interest rates, there's interest rate risk. And that's essentially that when your bonds are due, when they come to maturity, you won't be able to invest them back in at the same or higher interest rate.

35:27So just like stocks aren't consistent, bonds aren't consistent either. So yes, we're in a great interest rate environment right now. But as we've seen historically, that does not continue forever. And you know, it depends on everything else. So how is inflation? So 5 % sounds great until we're in a 7 % inflationary environment. And now your money is losing and not keeping up with inflation. And I'd encourage anybody who wants to look at these numbers, there's FICalc.app. It's a free website you can go to and you can put in different withdrawal rates, but you can put in X percent stocks, X percent bonds.

36:03And so I've had clients come in before who were 100 percent bonds and they wanted to stay there and they wanted to just live off of the interest. And for them, They were really high net worth. It was possible, but it was still a little bit of a stress test there. And so what I did is look at the difference in your likelihood of success by just adding 20 % equities. And it went from 75 % chance of success to 100 % chance of success. So we often look at bonds as this safety and reliability. And we don't think about the risk behind them, the risk of they're not keeping up with inflation. They're not growing like stocks could potentially grow.

36:46So I always like to have this conversation where we redefine risk and say, it's actually a little bit risky to be too conservative. And just by adding a small allocation to equities, you're making your percentage chance of success here so much higher. So to me, it's worth it to look at that. Yeah, that is brilliant. That redefine risk. And I think that's so eloquently put because I've been trying to come up with that, but I always call it like opportunity costs. So it's okay. What's riskier in terms of how people think, which is, Hey, I'm going to stick my, let's say you have a hundred thousand dollars.

37:22I'm going to stick my hundred thousand dollars in my local global bank, whatever it is, you know, and, and at that time earning essentially zero interest, right? There's no risk that a hundred thousand dollars will be a hundred thousand dollars, 20 years in the future. But what people don't realize is the opportunity cost, right? Had you put that same$100 ,000 in low-cost index funds, there very likely would be volatility. And there might even be a point in those first year or two where that balance goes under the$100 ,000. But over a 20-year period, if you just look at the rule of 72, which let's assume even just an 8 % return, just for argument's take, that money would double every nine years, right?

38:02So the$100 ,000 goes to$200 ,000, which goes to$400 ,000 in 18 years. And then you still have two years left over for it to grow a little bit more. So you're talking$400 ,000 versus the$100 ,000. Now, to your point, which is riskier, right? I think people would reflexively say, but it's so safe to put it under my mattress or in freezer or in global bank a, but is it really because they don't consider opportunity costs. And I think frankly, and this is a whole separate argument. It's almost like a religious type argument of like the dividend stock investors, right? Like you, you instantly laugh and almost fall off your chair.

38:42It's like they love, it's like this cult of, Hey, I'm getting this income. And they don't think about what's actually your highest likelihood of success of, of maximizing your net worth. I think it's the same opportunity cost argument, just in a very different manner. Yeah. And actually, to the dividend point, I mean, one of the most frustrating things to see, especially on Twitter, is these dividend investors that are chasing this yield and they're telling people, look, your net worth, your financial freedom number can be much lower if you just invest in dividends because you could return maybe a 6 % dividend yield at this amount.

39:20Whereas if you're using the 4 % rule, now your portfolio has to be much higher. But it's the same explanation here of we can't just rely on those, the returns, the interest. And part of investing outside of dividend, primarily dividend companies, is going more to growth companies or small companies or mid-cap companies. And you have some more growth potential there. So you have to think about what you're giving up in return for being a 100 % dividend investor. And that's a whole nother rabbit hole that we can go down though. That was not prepared. How many financially religious arguments can we wait into in one episode?

39:58Okay. So I think we covered Shannon's question. We have a couple more and I think these will be a little bit quicker. So Alan asked, Hey, is there anything to be said for not maxing out your 401k? I've been putting in 12%, I'm assuming 12 % of his income, split between a traditional and Roth 401k that my company offers. And my company matches 4%, so it's 16 % total. I could kick it up a few percent and max it out. But instead, I've been saving$1 ,400 a month and splitting it in taxable brokerage accounts between total stock market, S &P 500, high yield, all this stuff. I just wonder if there's a strategy to having funds you can access before the age when you can dive into your 401k.

40:41I also feel like the 401k trackers try to make you feel like you need to put way more in and don't take into account things like your house being paid off with way lower expenses in retirement. They seem to compare how you're going to spend in retirement to now at, in his case, age 36. So, okay, this is awesome. And it gets into that second part about the retirement calculators gets into something I've been talking about for almost seven years on the podcast now. So, okay, Rachel, definitely two different things here, but I think they're both important. Yeah. And, you know, first of all, I want to say there absolutely is something to be said about investing outside of the 401k.

41:15For almost all of my clients, whether they want to retire early or they want traditional retirement or they never want to retire, there is something to be said about tax diversity with your accounts. So he mentioned here that he has the traditional 401k and Roth 401k. So at least he's hitting that pre-tax bucket and the tax-free bucket there. But to his point, yeah, we know a drawback of retirement accounts is that it has that age restriction on it. So I always think it's best to complement a portfolio with a regular brokerage account as well, sometimes called taxable brokerage accounts. This is one of my favorite accounts, and I think it's often underutilized.

41:54There's no contribution limits, no age restrictions. It just allows for maximum flexibility. And for many people listening here, I'm sure they're interested in early retirement. So we have to think about how are we going to bridge the gap until age 59 and a half. And that's where a taxable brokerage account can really step in and do a lot of the heavy lifting there. And then, of course, with the Roth bucket, with the tax-free bucket, we typically like to leave that last because it has the most growth potential. Everything in there is growing tax-free. So no matter who you are, there is something to be said about tax diversity and investing outside of your retirement accounts.

42:31And the buckets I like to look at are taxable, just regular brokerage accounts, pre-tax, that's your 401k, your traditional IRA, and then tax-free. That's Roth 401k, Roth IRA, HSAs even as well. When you have these different buckets, you have maximum control over your taxes. So in almost any scenario, we would prefer to be able to have some control over our taxes. This is the best way to do it, to have these different options. So I'm a huge fan of the 401k and I'm a huge fan of investing outside of the 401k too, if it makes sense. Yeah, agreed. And I think Alan's very broad question is, is there anything to be said for not maxing out your 401k?

43:11Which is almost like looking for permission to, is this okay? Is this okay in the FI community? Because I think we sometimes talk about you want to maximize the tax deductibility. It's like a control what you can control. That's how we've always talked about it in terms of, hey, if you put into traditional IRAs or 401ks, you get that tax deduction in the current year. That's controllable. Yeah, you want to max it out as much as you can. Okay, well, that's in theory, right? But I'll be perfectly honest. I've said this on the podcast numerous times. In my working career, I never maxed out my 401k.

43:47Never, not once. And I reach FI. I'm doing fine. Nothing. I didn't get struck by lightning because I did it. You know, everything's fine. So Alan, you're doing amazingly well. You are putting in 12 % yourself. You're getting a 4 % match. It's not like you're then spending that money that you otherwise would have, which frankly, if you did, you do your thing, right? Like you would spend on what you value, but in your scenario, you're just saying, Hey, look, I've made the very intentional decision not to frivolously waste this money, but to, instead of putting it in one bucket to put it in my taxable brokerage account and I'm making with eyes wide open, I'm saying, okay, I could theoretically get a tax deduction by putting this into my traditional 401k, but I want to have the flexibility and I want to have options.

44:34And that's your prerogative. That's a fantastic decision if that makes sense for you and your life. So do it. There might be a scenario where you're looking to make some other type of investment and you can't do that under the umbrella of your 401k. So in that case, then it's very obvious, right? Like maybe you want to be a real estate investor. Well, then this makes perfect sense, right? So there are always considerations here. And by no means do you have to match your 401k. So it sounds in this case, like Alan is doing wonderfully well. And I think there are some then other, there's some always ancillary questions, right?

45:09So which is like the age that you can dive into your 401k, you mentioned 59 and a half, and that's obviously the age, the traditional, I guess, by the book when you can access this. But as we've talked about in the FI community, and we'll link up a couple episodes in the show notes, there's the Roth IRA conversion ladder, which is a really interesting thing that people in the FI community especially can take advantage of. It's a little more advanced. It's not like FI 101. It's probably FI 301. But that's something that all of us should know about. And we've done a couple of case studies on that, albeit years ago, but the numbers hold up.

45:44Then I think there's what the rule of 55, there's a separately equal. Yes. Yes. So there are a bunch of these different options to access. It's not like that money is under lock and key until 59 and a half come hell or high water. There's no way you can touch it. There clearly are ways and there are more advanced ways. And I think that's an interesting thing, but it depends on your situation also. And I think to do that Roth IRA conversion ladder, you actually do need to have basically five years of expenses in your taxable brokerage account. So in this case, okay, this could actually help you because potentially, so Alan might be building unbeknownst to him, in essence, be building a Roth IRA conversion ladder for sometime 10 or 20 years down the road, which is actually really cool.

46:32And that's a scenario where you talk about control what you can control. If you have minimal income, when you make those conversions, you might wind up paying zero or very little tax on something that went in tax deferred on the front side, right? So like you might get a permanent reduction in the tax on that, that income that you had earned 10, 20 years before, which is really, really cool. So again, we will link that up in the show notes for this, but lots of interesting stuff there for sure. And then I guess just finally, I know we said we would, we would answer these questions a little quicker, but he talked about 401k trackers and I would, I would change that, I guess, to retirement calculators or trackers.

47:10I think this maybe comes down, Rachel, to like incentives on sometimes how things work in life is you always have to look at the incentive. And most financial firms get paid for assets under management. They want you to have as much assets as you possibly can with them. So maybe, and I don't want to necessarily say there's negative motive here, but it's just incentive. And good, bad, or indifferent, that's what rules human behavior a lot of times. So So anyway, I think Alan hit this exactly right, which is you shouldn't be looking at your current income for your retirement calculator. And I think this is basically financial independence 101 is what you actually need to cover.

47:52And like we've talked about really most of this episode now is you need to cover your expenses. That's the whole point of building the 4 % rule. You're not trying to replace your current income because by definition in that current income, you have a significant amount of savings. You're probably paying a higher tax rate, especially if you're at your highest income years. So, I mean, there's a lot of these things that you don't need to cover that stuff. When you get to financial independence, you just need to cover, hey, what does my life cost? So yeah, I agree wholeheartedly with Alan. I've ranted about this more times than I could count on this podcast.

48:25The retirement calculators start from the fundamentally wrong place in my estimation. Yeah. I mean, this is why I have a love hate relationship with a lot of rules of thumb. They're estimating that you're going to want to spend 80 % or 90 % of your current income, but that could look completely different than what you actually want to spend or how much your life actually costs, especially because it's not considering how expenses change as you go into retirement. That might be an increase if you really want to get to travel or some other hobbies that you actually want to spend more, or it might look like a decrease.

48:56So you really do have to customize this to yourself. The other thing with these retirement trackers is they might not be considering other sources of income. So there's times that you were retired to a part-time job or side hustle, and that should be included. Social security is often not included. They might use some assumption, but it might not be pretty accurate for your social security. Maybe you have pensions. So there's just a lot of missing variables that a retirement tracker might not take into consideration. This is why I'm such a big fan of spreadsheets. And when I started tracking my own number in my early 20s, I tracked everything on spreadsheets.

49:32And even now, as a financial planner, I do have some software that I use. I still heavily rely on spreadsheets because you can see everything that they're taking into consideration and really control all the variables where a retirement tracker might ignore a lot of important variables. Agreed. Wholeheartedly. As a diehard Microsoft Excel fan. I still have my net worth calculation on there. I totally get it. All right. So yeah, I think that was a pretty good summary of Alan's question. And again, that's really broadly applicable for so many people. So all right, let's move on. We have a question about 529s from Pradeep here.

50:06And the question is, we have two kids and I wanted to start contributing for their 529s, but I'm hearing contradicting stories about 529s and how they are weighted against the kid's financial aid and some folks recommending to start a new brokerage account on the kid's behalf. And that might get weighted less if it's on the parent's name. And Pradeep is saying that Google's throwing a lot of confusing stuff. So I hope you can give some clarity basically. Yeah. So the 529, it's going to be considered the assets of whoever the owner is. So when you open up a 529, somebody has to be the custodian.

50:43Typically it's going to be the parent. And then you're just going to name your child as beneficiary. To his point, the reason it's so important to understand whose asset is this considered is because FAFSA calculates the expected family contribution differently depending on is it the student's asset or is it the parent's. So if it's a student's asset, it's expected up to 20 % of that can be used for college expenses. Whereas if it's the parents' assets, it's only 5.64%. That's the benefit of having everything in the parents' names versus the student. So in the case of a 529, unless for some reason the student is going to own the 529 and be the custodian, it shouldn't be an issue here as far as is it an asset of the parents or is it an asset of the students?

51:29It's primarily an asset of the parents. Now, I will say This is a reason that grandparents opening up 529s and funding them for their grandchildren is such a popular method that I see because grandparents assets aren't considered at all in this FAFSA calculation. So I often see that instead of it being in the parents and of course, never in the student's name, but maybe we completely eliminate it from the FAFSA calculation and have the grandparent be the owner and to fund the 529. Of course, you have to get the grandparent on board there and they have to have a desire to contribute to education.

52:03But that is a popular method I see. Yeah, this is really interesting with the FAFSA and different types of assets, different types of income are assessed at different percentages. So anytime you can think about this ahead of time and understand the rules, right? This is another thing we do so well in the FI community is we understand the rules of the game and we plan for the future. We plan down the road. So yeah, if there are certain type of assets that, like you said, get assessed at 20 % if it's under the child's name, but maybe 5.X % in either the parents or whatever, then clearly, if that's something you can just make a different choice, then obviously that's pretty easy to think about.

52:43But you need to know the rules. So I want to back up just a quick second, Rachel, and ask you, okay, somebody comes to you and says, I'm thinking about putting money into a 529. What are the high level benefits? Why do I want to do this? And what's the potential downside? Sure. So I think a 529 can be a great account, especially if you are in a state where they offer a great state income benefit. So there's different states that you'll have to look at. And if you have a home state that offers a tax credit or tax deduction, that might make the 529 even more attractive. For example, I used to live in Indiana.

53:19Indiana offered a 20 % tax credit for funding up to a certain limit. So tax credit, not tax deduction. So in Indiana, it was like a no brainer to fund at least up to that limit. And you might have another state that just offers a state tax deduction. That's what I see a lot. So I would look at your home state, see what they offer. And then of course, once the money is in the 529, you can invest it. And so that's a great opportunity to get these funds to grow until they hit college age and it will grow tax-free. And if it's for qualified education expenses, come out tax-free as well. Now, the risk here is what if my child does not go to school?

53:57What if my child gets a huge scholarship? What if my child just goes to a school that's a little bit cheaper and we don't use the whole 529? There is a risk because any money that comes out of the 529 that's not for qualified education expenses, you're going to pay tax and penalty on it. So the risk is overfunding the 529. So one of my favorite strategies when somebody comes to me and wants to work on education savings is a combination of 529 and a taxable brokerage account. This is another point here where that taxable brokerage account with its flexibility can be so, so valuable. So we can partially fund it with a 529 and then fund the rest with a brokerage account just in the parent's name, not in the child's name, but just earmark it and keep it separate it from your other accounts and invest it for your child's education.

54:46That way they don't end up going to school. You can use the money for something else. You can still help your child with it, maybe help them make a down payment on a house or something else, but at least you're not going to be hit with that penalty and there's not that restriction there. So that combination of 529 taxable brokerage account is really powerful. 529 is becoming a bit more attractive now with the new Roth conversion rules that they put on it, where you can convert 35 ,000 of it over to Roth. But again, we want to make sure then that we don't overfund the 529 because even that, the Roth conversion, there's a limit of the 35 ,000.

55:21Okay. So that 35 ,000, is that limited per child or is it per adult, I guess, in that case? Yeah. So it's per beneficiary. Now you can't take that 35 ,000 and convert it all at once. You're still limited to the annual limit for a Roth contribution. So the annual limit is 6 ,500. You can only do 6 ,500 per year. So it's a little bit of a slower strategy that you're going to have to take to get all that money over from 529 to Roth. But of course, it's a great strategy. I mean, a Roth is a great account for your child. So it'd be a great way to set them up for success really early on. Yeah, that's cool.

55:58Okay. So right. In summary, 529 benefits are very likely state tax deduction. If you're really lucky, state tax credit, which is remarkable. Thank you, Indiana. And tax regrowth. So that's fantastic. I guess potential downsides are, hey, if you over save, if in those edge cases, there's a likelihood you might have to pay some penalty and back taxes on growth. So this is not like, hey, let's put all of our money into a 529. College is going to cost$300 ,000 a kid. Let's put that money in. You need to really think about this because frankly, how I look at it is the upside benefit is not that fantastic for me, at least.

56:38So while we put some money in 529s, we did not by any means overinvest in these things. So I think when you have assets and when you have a significant net worth, you can find the money. It's not like you're spending it, again, frivolously and frittering the money away. So that's how I have chosen to look at this. And I think to each his own, obviously, and you need to consider, do these benefits make sense for me? But I guess to move on to our final question, which actually you just tied into, which is so interesting is Jonathan asks, and this is another kind of second generation fire questions about kids.

57:12Jonathan said, my wife and I have been on this path to five for a short while, and we're really excited about where this lifestyle will take us. My biggest questions that revolve around our kids, we want to know how to start their journey to financial independence and give them a start we never had. At what ages do you recommend setting things up? Or at what age are we legally able to start a Roth IRA? Could get them credit cards or maybe a Vanguard index fund account. So yeah, I guess, Rachel, just very broadly is how can you do this stuff? If you have a client who has, let's say, 10 to 15 year old kids, are there pieces of advice that you pass along on maybe these things specifically that Jonathan asked or maybe more things generally?

57:53Yeah, I always think it's important to make sure while you're doing this, while you're building up wealth for your children, which I think is a great thing to do, that we are also coupling it with financial education. And there's different ways that we can do that too. But technically here to talk about the different vehicles, and he brought up a Roth IRA. This is one of the best ways that you can start building massive amounts of wealth for your child because you're getting money into a Roth IRA when they're at a very low tax bracket, probably 0 % taxes on everything that's going into the Roth.

58:24The very important thing here, and I'm sure Brad, you know this, is that the child has to have earned income in order to do this. So I've had prospects come in before their child was born a year ago and they said, oh, I just funded a Roth IRA for my baby. I'm looking for some other ideas. Like, OK, well, we're going to have to back up because there's a low chance that your child, your baby has any earned income. And I would be careful here as far as baby modeling and things like that and trying to stretch the definition of earned income. I think it's really hard to argue earned income until the child is a bit older.

59:01One of the best ways I see this being done is for my clients who are business owners and who can employ their children and they can track everything. They can pay them a W-2 income, things like that. And then they can match that earned income into the custodial Roth IRA. Again, though, the child has to have a reasonable job, a reasonable salary. It all has to make sense. And I would be very careful here to not try to stretch this and try to contribute to a Roth when it's hard to argue earned income for your child. Yeah. And so one follow up to that is you mentioned W-2. What if it was 1099? Like, let's say, for instance, my daughter was helping me.

59:42she actually has done this where she has helped me scan documents in. And this is clearly a business expense. And I've actually just paid her personally, or, you know, we've worked out some rollercoaster thing. She's a big rollercoaster fan. So anyway, we've got we've worked out amusement park entries. But realistically, if I were to pay her, you know, she documents the number of hours, I pay her based on the number the hour, and she gets a 1099. Does it have to be W-2 or is that sufficient? 1099 is great. W-2 is great. Even somebody, a child who is mowing lawns or babysitting and they're not getting issued a W-2 or 1099, you might even be able to do something here.

1:00:21This is where I would consult your accountants and make sure everyone is on board. But I have seen instances where a child is mowing lawns for their neighbors, not for you, not chores, but for the neighbors. And they're tracking everything. They're writing down the hours, when it happened, the date it happened, and tracking that income so that if anything were to happen, they can prove the earned income. Yeah, that is the key point. So right, obviously, you can kind of like people try to BS the baby model. Like you said, that's the perfect example you hear all the time. And let's be honest with ourselves, that's ridiculous.

1:00:53In 99 % of cases, you're clearly just gaming the system. And if you try to game the system, ultimately, you deserve whatever repercussions come to you. So you're doing that very intentionally. Okay, you have to understand what the downside is. But as you're talking about, if this is legitimate and as long as you track it, like you said, it doesn't have to even be a W-2 or 1099, but do your best to track this. And we all know there are ways to track it, right? Like you can even show deposit. Like if you wanted to go to the ends of the earth, you could show, hey, this child mowed X person lawn on Y date, and here's the money going into a bank account.

1:01:28If you actually wanted to go, So if by some freak chance you got audited on that, you have the documentation, right? And that is going to put you in about as good a position as you can possibly be. So clearly, I think we covered Roth IRA. We actually do have an article on Chooseify that we wrote a while back, but it looks like it just got updated. So it's called Make Your Kid a Millionaire, Roth IRAs for Kids. And it goes through a lot of these considerations. So we'll link that up in the show notes. But I guess the next thing that Jonathan asked about was credit cards. How do you think about credit cards for kids?

1:02:01Yeah, credit cards can make sense to start building up credit for your child, of course. And depending on who the provider of the credit card is, there's different age limits. But what you can do is make your child an authorized user on your credit card, and then they will start building up credit that way. Whether you actually give them a card is up to you, of course, but just adding them on could really help them. The important thing here is to make sure that you are a responsible credit card user. And I'm guessing most people here listening are going to be, but it's still worth saying that you don't want to actually hurt your child.

1:02:35If something were to happen, your credit were to be negatively impacted, that would negatively impact your child's credit. So you would just have to make sure that you yourself are also a very responsible credit card user. Now, when they turn 18, you can look at things like secure credit cards. Those are credit cards backed by cash. So you deposit$100 now that your child can spend$100. So it's a really safe way to start to learn and understand credit cards and start to build that credit as well. Yeah. And that's the key is, like you said, just being responsible both on your side and on their side.

1:03:09If you think you're doing something nice to them for adding them as an authorized user, but your credit score tanks, well, it's going to negatively impact them. Obviously, if you have a 850 credit rating and you add them to your oldest credit card, there's a reasonable likelihood it's going to help them. So you just need to really be smart about this. And yeah, I added both of my daughters as authorized users to one of my cards. Like you said, they have not seen the cards. They're sitting in a drawer. And in theory, that should be helping establish some credit score and credit rating for them.

1:03:42And like you also said, my plan is when they turn 18 to try to see what they can get approved for. Now, obviously, they're not going to get approved for some premium travel rewards card, but you start where you can start. We probably won't apply for a secured card first. will probably apply for, I don't know, some X card for students where it's going to be a small balance, but in a perfect world, it doesn't have to be a secured card. But if it has to be, then so be it. That's not a terrible alternative, especially if it can teach them responsible habits. And they understand they have to pay it off on time and in full every single month.

1:04:17And I think really at its essence, that's what Jonathan's question is, is how do we teach our kids this? How do we teach them personal finance? How do we teach them to do the right things? And And I think we have talked about this a lot here on the podcast, but it never hurts to just kind of just say, all right, look, if you sit your kids down and you have a five hour PowerPoint presentation, they're going to tune out within 30 seconds. But if you can build some kind of financial lessons into everyday life, I think personally, there's a much higher likelihood of success. I think if you can make it interesting to them, I mentioned before that my daughter, my older daughter is into roller coasters and amusement parks.

1:04:54And I made what I think is a super interesting presentation to her, if you will. It was an informal presentation, but nevertheless, about the company Cedar Fair, which owns 11 amusement parks and they're publicly traded. And we wound up just doing this whole deep dive on it and going to their website and looking at investor reports and her finding out how many acres of land the King's Dominion amusement park is that's right by us for potentially building more role. It was just really cool, Rachel. And it was like, she had so much fun with it. She actually went up buying shares in Cedar Fair, which is awesome.

1:05:29And like, I reached out and we, we went up meeting the general manager of our local park. Who's just this incredible, incredible woman. And we are hopefully even going to go to like the annual meeting in the future. Like, I mean, that's a lesson meeting where they are, right? Like my daughter would not have cared about me giving her these couple hours of lessons on just some generic company, but she cared because this was something of real interest to her. So that's what I would challenge Jonathan and all the parents out there is like, meet your kids where they are and try to find something that really interests them, but layer in these lessons a little bit at a time.

1:06:05Yeah, absolutely. I love that. I love that she was involved like that. And to that point, the listener also brought up a brokerage account, And this can be a great tool as well. If you have, again, a brokerage account, he said Vanguard index fund, but that's what this would essentially be in as a brokerage account. If you can have your child involved in those conversations and say, hey, look what we're investing in. Are there any stocks you want to look into? And you know, I'm a fan of index funds. I'm not a fan of individual stock picking. But in this case, that can be a really great lesson for somebody to understand exactly how they're investing and what is actually happening.

1:06:44Because when we buy a fund, we kind of tend to forget where our money is actually going. But when we buy a stock, we understand, okay, I am partial owner of this company. And if the company does well, I do well. And that's a really valuable lesson for a child, I think. And on that point of the vehicle that we will want to use, a brokerage account is a great account to use. And again, you can keep it in your name, make sure your child's the beneficiary, just earmark it for them. Because again, we're thinking about FAFSA here and what's considered the child's assets versus what's considered your assets potentially.

1:07:15And then when people are looking into these brokerage accounts, they often have questions on an UTMA account, which is essentially an account that you can set up for your child. The thing that you have to remember with UTMA accounts is that everything you put into those accounts are an irrevocable gift to your child. So you can't pull it back out. And once your child reaches age of majority, which depending on the state, typically 18 or 21 years old, that account becomes theirs. So there are some parents that when I share that with them, that actually makes them a bit uncomfortable because they're not sure, well, what if my child, I don't feel that they're responsible at 18 or 21, and I'm worried about them having complete access to this account, maybe just a little bit too early.

1:07:58And then the other part of this, which we talked on before is, well, now that is considered an asset of the child. So it could negatively impact them for FAFSA as well. So I know a lot of parents when they're looking at this, they like to do a brokerage account earmarked for their child, child's the beneficiary. And at some point in the future, they plan on gifting that over to their child, which I think is a great way to do it because you maintain control and flexibility of the account. Yeah, that is the perfect way to describe it. I love it. And yeah, so there's UTMA and then UGMA. They're two different options, right?

1:08:31But you can always find details on the precise differences. But you talked about the real important stuff, which is, hey, do you want to have this in their name? Are you comfortable with it becoming their assets at 18? Or do you want to have it in your name, but earmarked for them? So I think that's the real high level. And yeah, I think we answered Jonathan's question there pretty sufficiently. And really, again, the broader part is just the education. And I think we all need to do that in just little ways. I've found that that's the most successful just anecdotally in my own life. And again, you reach your kids where they are, but you also understand that like the biggest part here is you're trying to teach them responsible financial habits.

1:09:11And sometimes that means some boring stuff. And sometimes it means it's fun. But I think for my kids, I'm not going to try to be heavy handed with them because every kid is different. And I've noticed just between my two girls, like one of them likes to spend a little bit more. One of them likes to save a little bit more. But what I'm going to try to really impart on them is, is that savings rate from the beginning. We talked from the very first question here about, is it too late? Well, it's never too late. But that said, if you can get this right from the time you're 17 or 18, that's not so bad.

1:09:46So if you can build a life for your kid, you can help them because obviously it's their life and you don't get to dictate. But if you can help say, hey, look, if you can build a life where you start with a 30, 40%, maybe 50 % savings rate, you could spend every other dollar and you can't help but succeed at that point. So, I mean, that's actually maybe a pretty interesting mindset for someone who, hey, you're just getting out of college. You've been living literally like a college student and you don't need that much. And then all of a sudden you're making a decent bit of income. Man, if you could save 30, 40, 50 % of that and just put your financial life on autopilot, they're going to be successful.

1:10:29So that's another kind of reframe on this that I like to think about. But I don't know, Rachel, any final thoughts on the advice for kids or did we cover it? No, I think that we covered it well. To your point, I mean, so my dad, the way he set this up when I was growing up, he matched my savings. So we had a savings account and he said, whatever you put in here, I will match it. And so I think that was a really valuable lesson to learn to see your money kind of instantly grow. And then of course, it's kind of getting you comfortable with the 401k. Granted, that account did not grow too much because I constantly forgot about it or wanted to spend my money.

1:11:04But it was still a valuable lesson. And when I started my first job, I kind of remembered those lessons and I started investing right away. And I started investing really heavily. And I've kind of pulled back a little bit on how much I'm investing because I have this mentality of, well, I want to enjoy my life now. I want to spend some of this income. At the same time, because of those five, six years where I was aggressively investing, I've really set myself up for the rest of my life from just having an aggressive savings rate for five or six years. And so I'm at that point where you'd call it coast fire.

1:11:39I really just have to cover my expenses for the rest of my life. That is so freeing and it makes me want to take on more risk. It makes me want to go more aggressively with my business. So that mentality, that state of mind that I'm in now, once I realized I had hit this point, I'm so thankful to myself that I did that starting pretty early. And I know that that stemmed from some financial lessons from when I was young. That is remarkable. That is the perfect way to end the episode. Rachel, thank you so very much for being here and spending so much time with us. This was amazing. Where can people find out about you?

1:12:17Where can people get in touch? I know I mentioned Twitter, but let everybody know that really maybe a couple of ways that they can get in touch. Sure. Yeah. Twitter is mainly where I'm active. So that's camp underscore wealth on Twitter. I have Instagram camp wealth as well. I actually just started posting on LinkedIn. So if you're primarily on LinkedIn, you can find me there. And then if you go to my website, I do have a newsletter that you can subscribe to that goes out every other Thursday. I'd love to write that. So if you want to hear more from me there, that's a good place too. Awesome. And we will link that in the show notes for sure.

1:12:49Thank you again, Rachel. This is wonderful. Hope to have you back for another Mailbag in the near future. Yeah, I would love to. Thank you, Brad. Thank you for listening to today's show and for being part of the Chooseify community. If you haven't already, the best ways to get involved are first, subscribe to the podcast. So you're listening to this on a podcast player, just hit subscribe. And then subscribe to my weekly newsletter. I actually sit down every Monday and write this by hand. And I send it out Tuesday morning. So just head over to chooseify.com slash subscribe. And it's really, really easy to get on the newsletter list right there.

1:13:23and I would greatly appreciate it. It's the best way to get in touch with me. You can actually just hit reply to any of those emails and it comes directly to my inbox. So that's the way that I keep a pulse of the community and how we keep this the ultimate crowdsource personal finance show. And finally, if you're looking to join an in real life community, we have Chooseify local groups in 300 plus cities all around the world. So head to chooseify.com slash local and you'll find a list of all of those cities in 20 plus countries all across the world. And if you're just getting started with FI or you have a family member or a friend who you think would be interested, two easy ways.

1:14:01Choose a FI episode 100 is kind of our welcome to the FI community. And even though it's a couple years old at this point, it still stands up and it's a really great just starting point to get an understanding of what is financial independence? What are we doing here? Why are we looking to live a more intentional life where we save money and use it as a springboard to live a better life. And then Choose a Vi created a Financial Independence 101 course that's entirely free. Just head to choosefi.com slash fi101. And again, thanks for listening.