513 | Make Your Own Dividend | Mailbag with Rachael

25:04The money was deposited right in there and I invested it, no taxable event, no nothing. Everything was simple. Really, this should be very simple. And in a case like this, where you're paying 1 % potentially expense ratios, if you have the option to get it out of there, if you've separated service from this company, like, yeah, I think you get it out as quick as you can. So I think that's a great idea. Yeah. And I did the same thing, left an employer, got it out of there right away. A little bit different, put it in an IRA, converted it to a Roth, but that's another time. Yeah, I was in a really low income year.

25:35It was a good time to do it. I actually talked about that in the Roth versus traditional. So they want to hear more about that. Very cool. Yeah. You are nothing if not consistent on that. It's great because that's important, right? Like that's how you think about, hey, if I'm in a low tax bracket, I really should think about Roth. I really, really, really should. Thanks for listening to Chooseify and for all your support of our mission here. The absolute best way to support Chooseify is when you sign up for your next rewards credit card to use our cards page at chooseify.com slash cards. I keep this page constantly updated, so it should always be the top resource for you.

26:10Thanks for being part of our community and for your support. Okay, so let's move on. Rachel, where should we go from here? We've got a lot still. I think we're ready for dividends, if you are. Let's do it. And we talked about episode 505, which was in mid-August. That's where we talked a little bit about investing in dividends. All right, I'm going to let you kick this off. Okay, so let's dive into dividends. So we talked about this quite a bit last time, did a deep dive on dividends. We got a few questions since then, which I think warrant some clarification from us. So starting off with Ash, they ask, when we talk about living off our investments in FI, following the 4 % rule, are we talking about living off dividends or withdrawing from the principal by selling equities or mutual funds?

26:58I do not believe that investments such as low cost index funds will provide 4 % dividends. So if we start selling equities or mutual funds, how do we expect the balance to keep growing over time? Unclear to me that when we talk about market returning 6 % to 7 % per year, what exactly does that include? Can you please go over details, giving examples of how one would start withdrawing from the investments while hopefully not drawing down the principle? Ash brings up an important point that I want to hit on. So at first we have to talk about the principle. And I think we get this confused because really it's hard to define exactly what the principle is.

27:35I mean, we could say what it is, is the contributions that you put into the account. So it's the money you put into the account and then everything else is growth. Most people have no idea what they've put into the account versus what's their growth. So that's actually what we would need to find to find the principal. And by that point, the account should be worth two, three, four times that principal. So it would actually be really, really hard for you to ever cut into that principal. But I do see a lot of people who basically they hit retirement, say they have 2 million and they see that as their principle and they don't want it to go down.

28:10We have to separate returns from a safe withdrawal rate because really it's a low correlation between the two. What's important in retirement planning is this sequence of returns. We really, we can't control that. So what could happen is you retire and we retire into a bad market and the market goes down and the 2 million becomes 1.9 million if we have a bad market. And it could, that principle could go down. And there's really nothing we can do about that outside of holding it entirely in bonds, which most of us don't want to do because then we have inflation risk. So that's the first thing that I think we need to establish here is that we are looking for what is a safe withdrawal rate regardless of what the portfolio does, because there is no way to protect that principle, that initial starting balance without putting it in cash, putting it in bonds, which is not an option I don't think many of us want to do.

29:09Yeah. I think that's a great starting point. And yeah, it really gets to, like you said, there, there's some just slight misconceptions, I think about what dividends are. And I think some people think they're magical money that's totally separate from anything else. And I just look at, and I think we We talked about this in episode 505. It's just part of your overall return. It's part of your overall assets. And I don't make the artificial distinction that just because like I'm technically getting paid this, that it's somehow something fundamentally different. It's just part of our return. And we obviously got some feedback on the last episode and a guy named Brad actually wrote in and was kind of alluding to like that maybe we were saying like dividends are bad or something.

29:59And like, you know, he was saying like, even JL Collins talks about dividends from VTI and Warren Buffett. And it's like, well, yeah, I mean, listen, there's a difference. And I think this is the key. There's a difference between dividend investing. And I put that in like quotes and capital letters as a strategy, which I think Rachel is ultimately what you and I, and a lot of people of similar mindset have an issue with that the entire strategy of your investing is about maximizing dividends versus, hey, dividends are just a part of normal investing, especially when you're investing in broad-based ETFs and mutual funds.

30:40The fact of the matter is some companies pay dividends. And it's not like I'm going to turn around and say, no, I don't like dividends, take the money back. It's part of my return because in essence, they had this money on their balance sheet or in their bank account and they paid some of the company to me as an owner. That's what the dividend is. They've taken some cash and this actually gets to the heart of why I don't personally love dividend paying companies. Of all the productive things to do with that cash that they have sitting on their balance sheet, I think paying a dividend is quite literally the least productive.

31:19It is the last one that I would choose for the management of that company to do. in essence, and this is kind of like the mean part of me talking is like that company has essentially given up. They've given up on growing. It doesn't mean it's not a great company. It doesn't mean it's not a stable company. It just means they literally have nothing better to do with this money than to just hand it back to the owners and they can't grow. They can't buy other companies. They can't buy lines. They can't reinvest in the car. Like all of these things, if you stack ranked it, there would be 17 things ahead of just feebly and meekly paying it back to the owners.

31:58That is the fundamental issue. So I mean, listen, even somebody like Warren Buffett, who doesn't pay dividends, not at all, right? But he gladly and gleefully talks about the dividends that he receives from his companies. Now, obviously, does he wish that they had something better and that they could grow at a higher rate? Yes, of course, because then his overall net worth would compound at a faster rate. But he's not going to turn around and say, oh, here's this billion dollars of dividend income I just received, hand it back. I don't want it. Nobody's saying that. So anybody conflating that people like Rachel and I who think that dividend investing is not an optimal strategy and us saying we hate dividends, two totally separate things.

32:41Yeah, I think it's important to understand we don't avoid dividend paying companies. We just don't care. We just don't chase them. Because there is a risk to chasing a company with a high dividend yield. And we've actually, this isn't in theory, this isn't practice. This is a risk that we've seen happen to dividend investors, is they are actually willing to overpay for dividend paying companies. That's where we get in trouble. Because there's this other component you can't ignore. It's appreciation or depreciation of a company. And if you're willing to overpay for a share price for a company, eventually that's going to come back to bite you because that price is going to correct and you're going to lose money on that share price.

33:25So sure, you might be getting a 5 % dividend yield, but if the company loses 10%, 15 % of its value, you're negative. And that's the thing that people confuse. They treat dividends like they're bonds. So bonds work in that you've got a company where you are loaning money to them. They say, okay, I'm going to give you your$1 ,000 back. Thanks for$1 ,000. And along the way, I'm going to pay you interest. That's how a bond works. That's not how a dividend paying company works. If you buy a dividend paying company at$100 a share, there's no guarantee that it's going to say$100 and you just get your dividends on top of that.

34:01What actually happens is you have that company, they say, we're going to issue a$5 dividend from earnings, whatever. Now the share price is worth $95 and you have a$5 dividend, you have$5 in cash, you're still at$100. That's how it actually works in practice. So it doesn't get stacked on top. It's not free returns. If that was the case, if that share price stayed the same, but we just got to stack the dividends on top of that, trust me, I would be doing that. Everyone would be doing that because that's free money. We get stock-like returns with bond-like protection. We'd all be signing up for that.

34:37Yeah, you'd be card wheeling to the bank. And this is similar to what I said before about the real estate investors who think they have some magical inside information as if all the really smart people in the world, like, yeah, you've outfoxed them. Yes, you have somehow figured out to outsmart every other smart person on earth. And they're just dummies who are willingly, blissfully unaware. Like, come on, let's be real here for a second, right? So it just defies any kind of logic. Dividends are a natural part of investing in broad-based companies and broad-based funds because the reality is you invest in S &P 500, some of them are going to pay dividends.

35:15That's great. That's part of your return. And ultimately, what we're trying to do here is maximize our net worth. And do I think that going for companies that have given up on growth is the way to maximize my return? No, not at all. That's why I don't focus on dividend-paying companies. Do I think there are, Rachel, something we didn't get into last time, there are perverse incentives for management to continue paying these dividends at a constant or ever increasing rate. So like incentives rule the world, right? So when you've set up a system where your stock price is going to get pummeled by these dividend investors, you know, capital D, capital I, what do you do?

35:50You do everything you can to keep this house of cards going in some case. And we've seen that, right? We've seen people, literally companies borrow money and continue paying a dividend. And when you see that, you should realize your strategy is ridiculous, right? Like ridiculous. So let's be clear. This is not the optimal strategy, no matter what you've deluded yourself into believing. So, okay, the gloves are off. This is not the right strategy as maximizing net worth. So let's get back to Ash's question because it's a legitimate one. So 4 % rule. Are we talking about living off dividends or withdrawing from principal, selling equities?

36:26Like it's all just part and parcel of the same thing as I see it. Yeah, we're not talking about you're taking 4 % that's coming from dividends or the return is six, you're taking four. We're just talking about what a safe withdrawal rate is. That's why I said it in the beginning. And I want to say it again, we have to disconnect this average long term return of 67 % from what a safe withdrawal rate is. We're not looking at that. We're not looking at what your portfolio did. And it's up 10%. So this year, you can take six. That's not how it works. What we're saying is you can take, and it depends on when you retire, we'll say 4 % on a 30-year time horizon.

37:034 % has been shown to survive every market scenario. That's what we're saying. Now, you go into retirement, say your returns, you retire into an upmarket, returns look great. Then we can start thinking about maybe a different withdrawal strategy, giving us a pay raise. And Brad, we've actually talked about this before too. There's dynamic withdrawal strategies. that's what it's called, based off of what your returns have done. But the 4 % withdrawal rate is designed to make sure that you do not deplete your money, that you don't run out of money. And it's really what it's actually related to is sequence of returns.

37:40So it's, okay, we retire, bad market. So the worst thing that can happen in retirement is a bad first five, 10 years, which has happened before. There have been decades where the markets return nothing. And so we're trying to survive that scenario. And in order to do that, the research that was done was to say, okay, if we do 4%, if we take that from the portfolio, it will survive that worst case scenario. It's not based off of, okay, historical returns are seven. Let's give ourselves a little bit of a cushion and pull out four. We have to separate this idea of long-term average returns from the withdrawal rate because they're two different things.

38:20So no, we're not talking about living off a dividend yield. We're not talking about looking at what the portfolio has done and then deciding what we can take. We're just talking about a safe withdrawal rate, two different things. Dividend yield, again, hate to keep harping on it, but it's just nothing special. That's the point. It's not more special than appreciation. It's not something that is protecting your principal. To your point, Brad, dividends are great. We reinvest dividends. We love them, but they're just a part of return. It's dividends plus appreciation. that's what we care about. Definitely.

38:52And like you said, they are great. Nobody's complaining about them and it's just part of your return. So that's wonderful. And yeah, just kind of final words. So Ash, I think if you're asking about like actual drawdown strategies and like very specifics, I would check out episode 427. So it literally is called drawdown strategies. It was Karsten Bigurn from early retirement now and Fritz from retirement manifesto. And they each just kind to talk about different drawdown strategies because I think the nuts and bolts. So Rachel clearly was talking about like safe withdrawal rate, which I think is really the essence of this.

39:23But if you're just talking mechanics, how I would actually think about it is I think so many people get worried about like, oh, am I drawing down the principle? Am I doing this? Like Rachel said, this is a holistic strategy where really the essence is that safe withdrawal rate. So in a weird kind of reverse psychology way, I would actually just plan on selling assets for whatever amount you need to pull out and just like, keep that in the back of your mind. Like, this is just the strategy. This is just what I do. Like, there's nothing bad is happening when I'm selling shares. This is just part of the plan because I don't want people deluding themselves into thinking like, okay, I get some dividends.

40:05So then I don't have to sell shares. I have some rental, blah, blah, blah. I have some, whatever. I have some interests. Like it's all kind of the same thing. So like, I'm almost thinking of it as like, steal yourself for like the hardest part mentally, which would be, I am selling shares every year to cover my full amount that I need to live on. Okay. And once you've essentially steeled yourself for that, then you can figure out the specifics from there. But like, I'm just trying to paint a picture of it's all the same at the end of the day, you just need to take a breath and just figure like, hey, look, I understand now it's all part of the same thing.

40:41I'm just going to sell these shares and that's what I need to cover my expenses, then great. And then you can obviously get into the finer details from there. But I think, Rachel, I think that to me is the starting point. Yeah. I mean, I've heard some people say by selling your shares, you're just creating your own dividend. So we have to think about it in terms of dividends. We've got companies that can issue us dividends. But if we go in and we sell shares, you're just creating your own dividend. That's exactly what it is. But you have actually a little bit more control because you get to go in and choose where you want to take it from.

41:12You get to be the one that says, this is when I get taxed. Whereas when a company is issuing dividends, you have no control over that. That is the most brilliant way to put it. And yeah, had I had those words two minutes ago, I would have been smart enough to say exactly that you are creating your own dividend, but you're doing it with control. Whereas, right, that's get another negative of dividend investing as a strategy is you lose control and you're getting a forced taxable event. And we don't want that in the fight community. We want to be able to massage this however we want it. And what Rachel just said enables you to massage it.

41:46And like we've talked about again with Rachel and Sean Mulaney and Cody Garrett, like there's lots of interplay here with the ACA subsidies and different things. Like you want to have really minute granular control over your exact taxable income if you can. If you want to do the real advanced strategies and really, really, really win, you don't have to if you don't want to, honestly. But if you really want to, having these different options, having some money in Roth, having some money in traditional, having some potentially long-term cap gains in a taxable brokerage, not having forced dividends that are giving you less flexibility, like make your own dividend.

42:23Rachel, that's perfect. I say we close it up on that and let's move on. Okay. So this next one came in from Kiva. And the question is when discussing the difference between Roth and traditional, which is a great deep dive, you both emphasize that if the tax rate were to somehow be the same when you contribute and when you withdraw, the traditional and the Roth would be at the same rate. In essence, like it's the same decision. The actual net worth would be the same. So the tax would be quote the same, but in the traditional scenario, the growth gets taxed at that rate as well. Whereas in the Roth scenario, the growth is never taxed.

42:57So even if the tax rate were the same, the resulting taxes owed slash paid would be very different unless I'm missing something. So Rachel, this gets to the heart of something that I think most people miss very understandably because it's not intuitive at all. Yeah. And I think too, it's because the way that we actually have to do this, which is mathematically correct, is not the way people actually do it in practice. Because the issue is a lot of people, they say, I have$10 ,000 to invest. Should I do traditional or should I do Roth? And it's okay, 10K traditional or 10K Roth. It's actually, it's not equivalent because you need to pay taxes on the Roth portion.

43:36So really the equivalent, let's say you're in the 25 % just for simplicity, effective tax rate, and you're contemplating traditional Roth. And again, you have 10K. So the actually mathematically correct way to analyze this is say I've got$10 ,000 for the traditional, so we don't have to pay taxes on that. Or I've got$7 ,500 for Roth, because I do have to pay taxes on those dollars. That's the equivalent. And so when we're comparing which one to do, and we're saying your tax bracket is going to stay the same, we have to understand that that's the correct starting point. We cannot compare 10K traditional or 10K Roth.

44:14So when we equal that out, now let's go forward and see what the money has done in the account. Say nine years into the future, money has doubled in both accounts. So you have 20K in traditional and you've got 15K in Roth. While the 20K in traditional, you don't actually have 20K because when you take that money out, you're still in the 25 % bracket, like I mentioned earlier, you have to pay taxes on that. So you actually have 15K after taxes, where you've got the Roth account worth 15K, you take it out, assuming it's a qualified distribution, tax-free, and you have 15K. So that's what we mean when we say if tax rates stay the same, it doesn't matter which direction you go, because it is equal.

44:56But the caveat to this is in practice, people don't actually usually do it this way, because they compare 10K Roth, 10K traditional, which actually we could argue is an advantage of Roth is that people tend to put more into Roth because they're not considering that. What you actually should be doing is if you're maxing out traditional accounts, you should actually be turning around, taking the tax savings from that and investing it if you want it to equal out Roth. That might be a little bit too advanced, but just so we understand the math here, that's how it actually plays out. I love how you described that.

45:28It's really the starting point that I think is the hard part for people. So I actually, while you were talking, I just ran this through a compound interest calculator. So I took your, your exact numbers. So let's say$10 ,000 is what we put into the traditional 401k. Okay. So a regular 401k where you get the tax deduction upfront. Okay. But then you have to pay taxes on the money when you pull it out from that 401k years from now versus again, And it's that same$10 ,000 of gross income, but you're talking, okay, realistically, because we're putting it into the Roth, and let's say we're at a 25 % rate on all of that.

46:08I think that's the numbers you use. So in essence, you're actually putting$7 ,500 into the Roth. You're making a$7 ,500 contribution to the Roth. You've paid$2 ,500 in taxes, okay? But it's really that same$10 ,000 of gross income. So what I did was in the compound interest calculator, I just put in, now we'll take case A of the traditional. Okay. So$10 ,000, I said, it's going to grow for 40 years at an 8 % return. Now that spit out a number. I'm just going to round to$243 ,000. Now I did a similar thing for the Roth side, the Roth 401k, where I put the 7 ,500 because that was our contribution.

46:52and now that grows tax-free forever is pulled out tax-free. Now, when that grows for 40 years at 8%, the final balance is 182 ,000. Now, interestingly, when again, and this was our point, Rachel, is if the tax rate, this is just a tax rate play, because if the tax rate is 25%, both at the beginning and at the end, let's say, and obviously there's nuance, but I think this is to prove the point is if you take the$243 ,000 and multiply that by 25%, or really the remaining 75%, let's say, it comes out to that exact same$182 ,000. So that's the point here, everybody. This is the key. And you've never heard this anywhere else because this is not obvious, but it becomes very clear once you've seen it on paper is if the tax rates are the same, when you put in and pull out, it makes no difference if you do Roth or traditional, none whatsoever.

47:55So this is simply a play on basically tax rate arbitrage or tax rate guesswork of are the rates going to go down? Or then again, you get into more, we're talking the highest level. This is the 50 ,000 foot view just to prove to you that this is the same, then obviously we get into the nuance of, hey, if I pull this out and it's a small amount and I'm at a lower marginal bracket, yada, yada, you know, there's all this nuance. And that's really, really, really important. I'm not trying to discount that. But just from a conceptual level, you need to understand these truly are the same thing. If you were guaranteed that the tax rate is the exact same at contribution and distribution, literally the same numbers.

48:37Yeah. Well, and I think in practice, what's important here is if you're comparing the two and if you're maxing out retirement accounts, it is important if you want to optimize this and if you're going traditional and you want to beat the Roth, that you actually do have to turn around and calculate the tax savings from contributing and maxing out traditional accounts. And then you have to invest those tax savings because otherwise it does take more dollars to max out the Roth than it does to max out the traditional. So if you really want to make it equal, you do have to turn around, take those tax savings from traditional and invest it.

49:15And when we see this happen in practice, that's one reason why sometimes the Roth gets a leg up is because people are kind of forced into saving more, not realizing that if they were to go to the traditional route to make it equal, they would have to invest those tax savings. Yes, that is a great point. And yeah, my just kind of last word for Kiva is we're not comparing like how many dollars in tax you've paid, right? Because then it becomes very clear in the Roth case, you've actually only paid$2 ,500 in tax. Okay. And in the traditional case, again, assuming you pulled it all out in one fell swoop, it was all at the 25%, you would pay almost$61 ,000 in tax.

49:53Okay. So obviously those don't sound at all alike, but the key is what is your net worth at the end, right? And that's the same. It's that 182 ,000. So, you know, I guess the argument would be uncle Sam could have invested that$2 ,500 that you paid upfront. And if that had grown for 40 years at that 8%, it would be the same 60 ,000. So it's the same money. That's what I think. Hopefully we've proven to you over the last five or 10 minutes. Like it's the same. It's the same. It's the same. It's just growing in different ways and you're pulling it out, you're taxed at different points. But again, if the tax rate is the same, it's all the same.

50:30But Rachel, you and I know it's never the same. We're just prognosticating on what is the tax rate. And that's why you say, hey, look, if I'm in the 10 % or 12 % bracket, I'm pretty confident that the right decision is going to be Roth for you. Yeah. And the other reason to talk through this and understand it is because of that question, would you rather pay tax on the seed or the harvest is just a stupid question and ignores math. So if that's what you're trying to make the decision based off of, that's just mathematically incorrect. All right, Rachel, I think we covered that one. So let's move on.

51:05We got one here from Mitch. Mitch said, I'm 42 years old and married, not five, but I'm getting closer. And then he gave some financial details. We have over 1.5 million in traditional retirement accounts. We have about 700K in liquid assets. They have a nice combined annual income, a fully paid off house, and then some 529 money, et cetera, et cetera. They have three kids. And he's wondering, is there a right time to stop contributing to our 401K slash 403B accounts? We've historically maxed them out when we could, but I am thinking about reducing our contributions only up to our employer matches and putting the rest in after-tax brokerage for more flexibility.

51:45And yeah, he's just saying, you know, thanks for any consideration you may provide, I guess. Yeah. I mean, this looks to me like a very traditional buy, right? So, you know, they have a nice household income, 42 years old. So, you know, they have some time before, let's say social security kicks in or 59 and a half, but they have some assets obviously. And now they're thinking like, all right, what's the order of operations? I think Does order of operations change at any point? I guess that to me is like what sticks out, but I'd love to hear what are your high level thoughts when you hear Mitch's question?

52:17Yeah, this is always hard when it comes to like rule of thumbs, you know, to say something like put 50 % in brokerage, 50 % in traditional or retirement accounts. I think that's really hard to give an answer like that. I do think I want to highlight that I do see a mistake quite a bit with some people who are really interested in early retirement, and they're putting everything in a retirement account and kind of ignoring that brokerage account. The big advantage of the taxable brokerage account is its flexibility. Now there's no contribution limits, there's no early withdrawal penalties that we have to worry about.

52:51So if you have a large bridge or gap until age 59 and a half, I am a fan of making sure you build up that brokerage account before you fully retire. And I thought this would be an interesting discussion because really it's, you know, you mentioned earlier with that conversation with Sean, who was a genius, by the way, about early withdrawals before age 59 and a half. And what I find in practice is you've got some people who are comfortable with that, where we're doing things like Roth conversion ladder, rule of 55, 72T, things like that. And you've got some people who that's just a little bit too complex for them.

53:28And it's actually much simpler for them to ignore all those early withdrawal strategies and just pull from a brokerage account. Now, how much do you need in the brokerage accounts varies, of course, because guaranteed income matters. How far you are away from age 59 and a half matters. I thought it might be interesting to talk about this equity glide path that Michael Kitchis actually talks quite a bit about. Maybe in a future episode, we can get into more detail on it. But I'm a big fan of it, especially for early retirees, because I talk about sequence of returns risk all the time. What that means is there's a big risk when you retire and retire into a down market.

54:05And so what we want to do is protect that first five to 10 years of retirement. So in practice, what I find with a lot of retirees is we're actually trying to stick the first, it depends, of course, I have to say over and over again, it depends, but maybe the first 10 years in taxable brokerage accounts. So it's very simple math. It's do we have 10 years of expenses there? And we can talk about asset allocation too. But that's kind of how I think through it is what's that gap to age 59 and a half if we want to go this route. And let's make sure we fill that gap by having enough in the brokerage account.

54:38And in practice, I've actually seen scenarios where we're going to spend down that taxable brokerage account and then we get to 59 and a half and that's when we get to retirement accounts. Interesting. Yeah. This is, of course, it's so situational depending on the person, obviously. So yeah, there's no way we can answer Mitch's specific question because we don't really know the details of Mitch's life. But I would echo something similar to what you said with maybe a slight distinction. So I would always set myself up to have at least five years of expenses in my brokerage account or liquid outside of my 401k and retirement accounts.

55:20Is that outside? I just want to ask out of curiosity, cash in addition, does that include cash? Is that five? Yeah, that's a great question. Yeah. There's no perfect answer to this. I just thought we could. Yeah, no, it's great. It's a great idea. I'm not even sure that I've thought about the distinction of that because I would want to essentially give myself the option to do the Roth IRA conversion last. So just as like a back of the envelope, can I cover five years of expenses outside of my 401k IRAs, 403bs, et cetera? I think it's a wonderful, wonderful question of like, how do you think about that?

55:58Does it have to be in cash? I personally don't get too bogged down in that. And that was what was so interesting actually about that episode that I mentioned before at 427 with Carson and Fritz about drawdown strategies is someone like Fritz has these really in-depth bucket strategy and he does all these things where at the beginning of the year, he moves from one bucket to another and it's the one-year bucket, the two-year bucket, the three. Like that doesn't appeal to me at all. Like I understand intellectually why he does it. And I think that's what's so cool about personal finance is like at the end of the day, we can do what we want.

56:33Most of it is psychology anyway, frankly, the way that I look at the most rational part of me, and let's be clear, there's a lot of me that's not rational, but the most rational part of me says money is fungible. So all this money is the scene and any way that I come up with some arbitrary way to like distinguish it, like whether it's sitting in cash or it's under my mattress or mental accounting, it's mental accounting. It's all the same damn money, right? Like it's just, it's all fungible. Anything that I do to like arbitrarily split it up is just some weird mental construct. I understand there's more nuance to life than that.

57:10Obviously that's just the most rational part of me. So the three-year bucket strategy and like the safeguarding, like if I have to get that kind of stuff out of the way, it would go more towards your safe withdrawal rate. I would err on the safe withdrawal side of making sure that I was locked down rather than come up with some gymnastics around, I need cash sitting in nice stacks of$100 bills in my closet just to make me feel safe at night. That's not how my brain works. I don't know. Anyway, I'm being a little tongue in cheek, obviously, but how do you think? I'll turn your exact question back on you.

57:44Well, this is why I was excited to talk about it. And probably I apologize, Mitch, the worst answer we're going to give because there's so many different strategies and routes we could take here. But I find it so interesting because in my mind, and I think I see this most of the time, maybe like 60 % of the time, people like a bucket strategy, because they tell me all the time, I want to know where my next three years are coming from next five years. And so there's even the bucket strategy. And this is the equity glide path that Kitchis did research on, where you've got that initial bucket that's three years cash.

58:18You've got the next seven years that's in bonds. So you've got 10 years fixed income or cash equivalents. And then you've got the next 20 years, if it's just a 30-year retirement in equities. And that's how he buckets it out. But you're completely right. It's a mental thing that we're doing it that way. And I find it really interesting because to me, I wouldn't want to bother with like rough conversion ladders. And I would find that more annoying than the bucket strategy. And I just like, I don't care to be taking my, my Roth account. Like it's all so personal, which is what I actually thought was really interesting with this question, because it does depend on what kind of maintenance do you want to do in retirement for a withdrawal strategy?

58:58Some people want to go in and they want to refill up those buckets, or some people want to know where their next 10 years of expenses are coming from. And they want to make sure that that's protected. Some people want to do just 70-30. They want to rebalance it to 70-30 every year. And they're going to take the expenses from whatever is up for the trailing year. Some people want to do a dynamic withdrawal strategy. Some people want to do the Roth conversion ladders. There's so many different ways to achieve retirement, achieve early retirement. It kind of depends on the hassle that you're willing to go through or say it better, what you view as a hassle versus what you view as easy to follow.

59:36So for me, I'd view the Roth conversion ladder as a hassle where I'd view the bucket strategy with the brokerage account as way easier for me to understand. And there's no right answer. That's really the gist of it. No, you nailed it. I mean, there's no right answer. And yeah, let's be clear. When I was kind of, I put my Spock hat on, Star Trek ultimate, like, okay, money's fungible, blah, blah, blah, blah, blah. But believe me, anybody, obviously, who's ever heard me talk on this podcast, like 95 % of personal finance to me is psychology and 5 % is like the actual number. So I think what is like the perfect by the book answer is very rarely the right answer for an individual.

1:00:14You need to figure out what works for you. So that is critical. But yeah, I mean, like Mitch's question, it's very hard to know. Like a question that I would ask is, okay, they have their house paid off. They have a high income. They're probably in the 24 % federal, the marginal tax bracket based on the income that he talked about here. Do you really want to give that up as a deduction? If you can max out 401ks and 403bs, that's a pretty high rate, especially like, okay, if you're talking, hey, my house is paid off. Maybe we don't have car payments I'm extrapolating here. Even with three kids, maybe our life doesn't cost all that much, we don't need to pull that much money each year just to cover our life expenses.

1:00:58Like let's say we're fi and our life only costs with a paid off house, with no car payments, even with three kids. What does your life cost? 40, 50, 60 ,000. Like that would be a pretty decent amount. That's the only amount you're pulling. And then you're at a point where, okay, well, with the standard deduction for married filing joint, maybe with some, some child tax credits, you're paying$0 in federal tax, you might actually even be able to pull. And actually, I should know this if the child tax credit is refundable or not. So that would actually change it a little bit. I think they are. I think they are.

1:01:32I think they are. So that'll kind of render moot what I was about to say, but let's assume that it's not refundable. You could actually pull more from your retirement accounts just to get your tax liability down to zero in that case. Obviously, if they're refundable, the government's going to send you the check anyway. So it probably wouldn't make all that much sense to do that. But I mean, you could essentially pull that money out. If your gross income was low enough, if your annual expenses were low enough, you could pay zero tax on this, which is really awesome. Right. And then to turn down this 24 % plus state tax deduction, like in your working years, just to have it in a different bucket probably doesn't make sense.

1:02:10But again, we don't know all the details here. Right. And that's what like Mitch and his family need to figure out is like, maybe they have other income that's coming in. Maybe they have rental income. Maybe like they're not going to be at a point where they're ever going to pay a tiny marginal tax bracket or whatever. So yeah, I mean, I understand the essence of the point, which is really Rachel. Hey, they have a lot of money in what's stuck in retirement accounts, if you will. And I put stuck in quotes and you know, okay, do we keep maxing out to the tune of whatever it is? $45 ,000 plus between the two of them in 401ks and 403bs, is that the best way to save?

1:02:49Well, I think then again, it's, okay, how much savings do we have every year? If they're talking over$300 ,000 income and you have a paid off house, you still might have a boatload of other money to save. If they have a 50 % savings rate, which I'm just making up magically, they have easily an equal amount of money that they can put in just after-tax brokerage. So like if it's me and I'm at that kind of high tax bracket, like I'm probably still putting in a lot into my tax deferred accounts. That's just how I would think. But again, without knowing the very precise details, it's hard to give any kind of rational advice.

1:03:22Yeah, it's really difficult. I mean, the important thing here is that Mitch and his family, they don't have zero in taxable brokerage accounts. When it comes to should we drop all the way down to the employer match and funnel everything into the taxable brokerage accounts? Maybe if you had nothing in there and you're wanting to retire in the next eight years and you want to be able to have that flexibility of that account there where you can always take funds out without penalty, maybe. But it does seem a little extreme because he mentions here $700 ,000 in a taxable brokerage account. So he's not in that dire situation where he really needs to build that up.

1:03:58So I'm kind of with you, Brad, on this one. I don't think it makes sense to stop all the tax deferral, the benefits you get with retirement accounts. If he wanted to pull back, again, depends on the savings rate, what he's saving already to start building up the brokerage account a little bit more. That could be an option rather than going extreme one way or the other. But I'm with you. I don't think he's in that dire situation where he's really got to redirect funds to the brokerage account and where it's worth giving up all those, the tax deferral, the tax savings from the retirement accounts.

1:04:28Yeah. And right. With the 700 ,000 and in liquid assets, almost under any scenario, basically just doing back of the envelope math, that's more than five years of expenses. So they will be able to access the money in those traditional retirement accounts through that Roth IRA conversion ladder, which is really, really wonderful. So yeah, I mean, in their case, obviously to the listener, these are big numbers, right? Let's be clear. And not everybody is in this exact situation, but if you go back and listen to what Rachel and I just said, and maybe even just have these numbers. Like still the same concept would apply to you if you're in a different situation with smaller numbers.

1:05:07Like that's the beauty of FI is like, it's a conceptual framework. And while sure, some things are different, like we said, Mitch is in a higher marginal tax bracket and you might not be, but that's the cool thing is you hear Rachel and I talk through this and you just quickly Google 2024 federal tax brackets, right? And you look, maybe you're a married filing joint. Okay. My gross income is 120 ,000. And you know, all right, the standard deduction is about 30 ,000. So that knocks you down with just total back of the envelope, nothing else that drops your taxable income down under 90 ,000. And you look at these tax brackets and you say, Oh, look at that.

1:05:48Almost all of my income is taxed in the 12 % bracket. That's my marginal bracket. My last dollar is in that marginal bracket. And actually what's really cool is the first 23 ,200 of it is taxed at 10%. So I get the first 23 ,000 and change at 10%. The rest of my money is taxed at 12%. Well, that's a different calculus than Mitch's scenario where Mitch's last dollar is in probably the 24 % tax bracket. Okay. So Mitch might have a different consideration, but everything Rachel and I just talked about applies to you as well. And I think that's hopefully, obviously we're talking about very specific questions, but the reason why we're answering these questions is because we think they're broadly applicable to everybody, right, Rachel?

1:06:29Oh, yeah. Well, we talked about this in the Roth versus traditional, but if you're in between those tax brackets where there's a big jump, so this is one of the biggest jumps in tax brackets when we go from 12 % to 22%. So I know Mitch is in 24%, but let's just say for a second he was in 22%, and he was able to get down into 12 % by making some of these retirement traditional contributions, I would think that's worth it. That's a 10 % difference in tax on those extra dollars and then marginal tax rate. I would grab that and then focus on maybe the brokerage account after that or even Roth accounts after that.

1:07:05But pay attention, and we talk about this in Roth versus traditional, pay attention when you're in between two tax brackets. See if you can get down to the next lower one. If it's 22 % or 24%, you're in between those two, less impactful. but the 12 to 22 and the 24 to 32 % is the other big one that you want to watch. Yeah. And something you said in there really quickly, I just want to hone in on. It's just those dollars. It's just those dollars that were over that amount. I think this is the key that most people really understandably, we just don't understand about the graduated income tax system that we have in the US is I think you hear horror stories of, oh, I went into the next tax bracket as if going$1 over, then magically reset the tax amount that you pay on all the prior dollars.

1:07:50It does not work that way. That is the beauty of the system. You're not penalized for making$1 over. And when you jump from the 12 % to the 22, it's not like every prior dollar, in this case, the 94 ,300 prior dollars magically get taxed at 22%. Can you imagine a system that was set up that way. It would be political suicide for somebody to set that up. So the world does not always run on logic, but thankfully this does in this case. So Rachel was saying, let's say you made$104 ,300, that was your taxable income. Well, those last$10 ,000 are taxed at 22%. So in that case, if you had extra space in your 401k or 403b in this case to contribute an additional 10 ,000, well, then you know those$10 ,000 are being taxed at the 22 % rate.

1:08:41If you put another dollar in, you're only getting 12 cents on the dollar in benefit because the tax rate is only 12 % on that last dollar, that marginal dollar. Okay. So again, mental framework, that's what we're doing here at Choose a Vi. We're trying to build a mental scaffolding that we can understand the world and personal finance. So Rachel, I love that we go over this lap because it's really, really important. And it's not obvious. It's not obvious at all to anybody. But the more we talk about it, the more we reiterate it, I think it becomes clearer. I really do. Yeah, I agree. And I like the focus on tax because it's something we have some control over.

1:09:19But to your point, we have to be careful not to let the tax tail wag the investment dog. We have to be careful not to put too much weight on tax and trying to optimize that. The craziest example of this is when we see people who say, I don't want to make extra money because I'll be in a higher tax bracket, which is why it's so important to understand how our tax bracket works and that it's a gradual system. It doesn't jump all of your dollars into that tax bracket. Otherwise, to your point, it would not be logical, although there's a lot of things that are tax code that might not be the most logical.

1:09:49This one I think makes sense. So never, never be afraid to make more money just because you're going to go on the next tax bracket. Totally agree. And yeah, A similar version of that is, oh, I need a mortgage because I need the interest to get the deduction. And especially in this day and age where we have such a massive... It's worth zero. Most people do not itemize their deductions on their tax return. They take this massive new standard deduction that has only come into play in the last handful of years. And realistically, almost nobody at this point itemizes their deductions. So that old thing of, oh, the mortgage interest deduction, yeah, it used to have some value.

1:10:32I would argue it had much less value than people thought because it still had to get over a threshold of the standard deduction, albeit a much smaller one. But in today's day and age, it's worth virtually zero. So if you're telling me you're going to pay a dollar in interest to save on taxes, but the upshot is you're actually saving zero pennies in interest on that dollar, that means you've taken that dollar and put it in a fireplace and burned it just for giggles, basically. So understanding the concept of how this works is really, really important. Yeah. It's the exact same for business expenses.

1:11:03People want to buy things because they get a tax deduction. A write-off. A write-off. A write-off. It's free money, right? It's a write-off. Yeah. Nope. It's just, you're just saving on the taxes there. Not free money. You don't get that as a credit. That's the important thing here. There's tax deduction, tax credit. Tax deduction, you're just saving on the taxes there. tax credit, you get that fully refunded. So important distinction when it comes to tax talk as well. I'm sure we could go on and on about this. Yeah, we could. And I know we're getting a little bit snarky, but we mean it in the most loving way possible.

1:11:37That is the most pernicious term in the entire English language is the write-off because you hear people, smart, knowledgeable, well-meaning people say it as if it were a 100 cents on the dollar tax credit, like you're talking about. Oh, it's a write-off. No, no, no, my friends. It is a deduction. And depending on where you are, it could be worth virtually nothing. It could be worth 10 cents on the dollar. It could be worth 12 cents. For most people, it's not going to be worth more than 24 cents on the dollar. That puts you in a very high bracket in the new income tax regime with the brackets.

1:12:13So again, if you're looking to spend a dollar in expense because you think it's some magical write-off. It's just a fundamental misunderstanding. And it's important that we correct these things. So as always, knowledge is power, Rachel. And this was a fun one. Yeah, I love this. Hope that was helpful, Mitch. But all of these are just mental frameworks, right? Where we're just talking through how we would think about it. It's important to always apply it to your own personal situation, especially with retirement planning, so many variables and factors that go into this. So you do have to customize it to yourself.

1:12:45And a thing we talked about a lot in this is the psychological component. So just because there's a strategy that you could use does not mean it's the best one for you. You have to use one, I think, that makes sense to you, as long as the math makes sense. It's not disastrous because that's always going to be the easiest to follow and implement and keep up with. Agreed. Rachel, as always, thank you for being here. Where can people get in touch with you? So you are a CFP. It's important. We always say like, this is not financial advice. You are not anyone's advice. I am technically a CPA, but let's be clear.

1:13:18Nobody wants to take tax advice from me because I'm not in practice and haven't been for a very, very long time. But Rachel, you are a practicing CFP. Where can people reach out to you? Yeah. My website is rachelcampwealth.com. My name is spelled a little weird. It's R-I-C-H-A-E-L camp, but like campingwealth.com. You can find everything on there, all my social media. I am on social media still, surprisingly, and anything else that you want to find would be on my website. Amazing. And almost certainly we'll have you back for another mailbag in the next four or five weeks. So yeah, I really look forward to these.

1:13:50Thanks again. Thanks, 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 and 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 choosefi.com slash subscribe. And it's really, really easy to get on the newsletter list right there. And I would greatly appreciate it. It's the best way to get in touch with me.

1:14:24You 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.

1:14:58Chooseify 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.

1:15:36Thank you.