Q&A: $300K Settlement, Pro Rata Rule & Dividend Kings

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0:42Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at Indeed.com slash podcast. That's Indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs. Hey everyone and welcome back to the Rich Habits Podcast question and answer edition. These are our Thursday episodes where every Thursday we answer your questions as if we were going through whatever you might be going through. You can ask us questions on Instagram at richhabitspodcast. You can email us your questions on email at richhabitspodcast at gmail.com.

1:22There's a ton of different ways to get our attention, Robert. These episodes are so much fun because we get hundreds, if not thousands of questions, I feel like, on a weekly, monthly basis around here. And it's so hard to pick. And so if you've been asking questions and we haven't answered your question yet, give us some patience. There's a ton in the queue and we're just going, we're flying by the seat of our pants when it comes to these episodes, Robert. I love these episodes, but you're right. Be patient with us because our inboxes are inundated with really, really cool questions. And we want to make sure everyone understands when we do this and we select the questions, we want to select them in a way that they cover everything.

2:04because we get so many questions about the Roth IRAs or what do we do about real estate and all these things. And we want to give you well-balanced episodes of questions because we want to put ourselves in your shoes because personal finance is personal. So please be patient. We are here to serve and we love these episodes. So our first question comes from Barney. Barney says, hi, Robert and Austin. First and foremost, I want to express my sincere gratitude for the incredible content you both have been providing. To give you a bit of background, my name is Barney and I recently moved to the United States with my family from Canada earlier this year.

2:38I have a good understanding of ETFs and I've been actively investing in them for the past five years, allocating$300 per week. However, I'm not familiar with the various accounts, savings, and tax-free accounts available in Canada as I am with those in the United States. I feel a bit overwhelmed and unsure of which account to use and which one to maximize. I earn$300 ,000 per year. I've maxed out my 401k at work and I was informed that I will receive a refund for my child daycare expenses when I file my taxes, but I'm still unsure of the best course of action or where to find information about things like Roth IRAs and other brokerage accounts.

3:18Any assistance you can provide, including a link to an older podcast of if this topic was covered, would be greatly appreciated. This information would be specifically helpful for newly migrated immigrants to the land of opportunity. What a really cool ending there. I love that. Well, welcome to America. Glad you're here. Let's get started. You came from Canada, which is cool because there are a ton of Canadian investment saving retirement accounts that have, you know, a sister account here in the United States. So I'm just going to kind of rapid fire, Robert, through what I found. I'm not a Canadian retirement investment expert.

3:57So if I mess up some of these, like, give me a little bit of slack here, but this is what we've been able to find online ahead of this episode. So the first one is the TFSA. The rough US equivalent of this would be the Roth IRA. So this does those after tax contributions. Your investments grow tax-free and withdrawals in retirement are also tax-free. We think the Roth IRA is awesome. Up next is the RRSP, which is that traditional IRA. Contributions generally reduce your taxable income because the pre-tax contributions, that growth is tax deferred, and those withdrawals in retirement are also taxable.

4:36I believe this could also be done as a 401k. Specifically now you've got the group RRSP, which is the 401k, employer-sponsored retirement account often comes with that employer matching that we talk about. And then you've got the RPP defined contribution, which is another sort of equivalent to that 401k. You have the RPP defined benefit, which is a traditional pension. If you're in the United States and you work somewhere that has a pension, congrats. I feel like those are going out of style pretty quickly. I don't know many people that have that, but that RPP defined benefit is that employer promising a future retirement benefit for you.

5:15And then the RESP, which is that 529 plan here in the United States, a tax advantage savings plan for a child's education. So if I were in your shoes here, Barney, I would be looking into that Roth IRA. I would be looking, you mentioned the 401k, which is great. You're maxing that out already, which is incredible. And then you mentioned you came here with your family. I would start looking into what I can do with a 529 account. You can open one of these up on Vanguard. That's what I've done. Seed it with two or$3 ,000, get a monthly contribution rocking and rolling there. And this will grow into hopefully tens of thousands of dollars, depending on how old your children are.

5:52And you can use that money to pay for their education in the future, all tax free. Yeah, the only thing I'll add, that was a great breakdown, would be a high yield savings account. You did mention savings and they're pretty equivalent from Canada to the United States. But just make sure you always have that emergency fund in that high yield savings account. That way you're fully covered if something pops up. But everything else Austin mentioned, the Roth IRA to us is always going to be first and foremost, the most important account type you want to have in your investment strategy as you're building wealth.

6:27And also the 529 is a fantastic plan for the kids to get them set up as well. So those things all come into play. And I hope that helps. Remember, match beats Roth beats taxable. So up to the match with your employer for the free money, max out that Roth IRA back to the 401k and max that out, assuming you have autonomy, which is something you're doing. So I hope you have autonomy, which just means you can pick your investments and you're not boxed into a high fee mutual fund or a high fee underperforming target date fund. So match beats Roth beats taxable. So max out that 401k. And if you still have money left over, go throw it into a public.com.

7:10taxable brokerage account, put it into some ETFs and index funds and ride the wave. Or like I was mentioning earlier with the 529, put that extra money in a 529 account for your kids, college, and other education and their futures. Our next question, Robert, comes from Samina. Samina says, I discovered your podcast a few weeks ago. Now I listen to it regularly on my commute. I'm managing my finances and doing this has always been a source of stress, especially as my income grows. The financial space feels complicated and full of pitfalls. I'm Samina. I'm 33 years old. I'm a single female who hopes to retire at 55 with the following financial profile.

7:46I have a$350 ,000 mortgage at 4.5%. I have a$60 ,000 emergency fund. I have$91 ,000 in my current 401k and I max this out for those pre-tax benefits despite no employer match. My previous 401k has$150 ,000 in it and I I have a taxable brokerage account with$100 ,000 in it invested into ETFs in individual stocks that I will continue to grow so I can retire early. After learning about IRAs on your podcast, here's what I want to do. I expect to be eligible for a Roth IRA for a couple more years and I want to max that out instead of contributing to my current 401k. Does that strategy make sense? And I guess my follow-up to that is I want to roll over this$150 ,000 I have of a previous 401k into a rollover IRA and invest it into the index funds and ETFs you guys often talk about.

8:39But will doing this trigger any issues with the prorata rule in the future? I'm not planning to use the backdoor Roth IRA strategy as of today, but that might change as my financial literacy grows. I look forward to your advice. Thank you, Samina. Robert, you want to kick this one off for us? Yeah, I do. And then I want you to break down the pro rata rule here because that is important as this, you know, portfolio and her wealth grows. But I think, Samina, you're doing a fantastic job. You've got all your ducks in a row. I like the fact that when you think about retiring early at 55 years old, you've got that traditional brokerage account rocking and rolling with the ETFs we talk about because that's going to give you the freedom to be able to have access to those funds while that Roth IRA, your emergency fund in your previous four 401k and your current 401k are rocking and rolling for retirement, traditional retirement.

9:30The things that I would add to this right now is absolutely keep adding money into this brokerage account to make sure that you have that flexibility of this pre-tax money that you can get access to at any time. And absolutely for the Roth IRA, we would love to see you max that out every single year. At 33 years old right now, you have such a long investing horizon. And the Roth IRA is one of the most potent tools you can use to build wealth for the long term. So that would be my take. Austin, why don't you break down anything I missed and then the pro rata rule. Yeah. So you mentioned you have this previous 401k of$150 ,000.

10:08And I don't know where that's sitting at the moment, but you mentioned wanting to roll that over into a IRA, a traditional IRA, I'm assuming because the 401k sounds like a pre-tax 401k. So no tax obligations on that rollover. So I'd roll over that$150 ,000 from this previous 401k into a traditional IRA and invest it how you'd like. However, whenever you do these backdoor Roth IRAs, essentially where it gets sticky is the pro rata rule. So the pro rata rule is the IRS rule that prevents you from cherry picking only the after-tax dollars that you've put into a traditional IRA and then converting those dollars into that tax-free Roth IRA.

10:52So this matters because if you're doing a backdoor Roth IRA, essentially how that process goes is you drop it into a traditional account, you then take that 7 ,000 or I guess$7 ,500 this year, convert that into a Roth account, and then you invest the money. You can only do that assuming that that is your entire pre-tax retirement bucket. You don't have other pre-tax money sitting over somewhere else like you would here, Samina. So Samina, using your numbers here of$150 ,000 in this old 401k, as long as that money does stay in a 401k, it does not create a pro rata problem for a future backdoor Roth IRA.

11:30The pro rata calculation only looks, generally speaking here, at that traditional IRA, SEP IRA, simple IRAs, things of the IRA category, not so much the 401k category. But the issue would come up if you roll that$150 ,000 of 401k into a rollover IRA like I was alluding to. Now again, you would want to do this if you can choose your investments because I'd much rather you have this money invested for you correctly versus rotting away in a bad target date fund in some 401k that you might not have autonomy over anymore. So let's say a few years from now, your income is too high to contribute to a Roth IRA directly, and you've got to do this backdoor Roth IRA.

12:14So you'd put that$7 ,500 into a traditional IRA, and then you'd convert the$7 ,500 to a Roth IRA. At that point, assuming everything kind of stays the same here, you would have$150 ,000 of pre-tax rollover IRA,$7 ,500 of that after-tax IRA contribution for$157 ,500 total between these two contribution and this 150 before in this IRA, right? So only 7 ,500 of that 157 ,500, you know, when you kind of do the math on that, that's only 4.76 % of your total IRA money being after tax, which is that recent contribution of$7 ,500 you made. If you converted that$7 ,500 to a Roth, you can't just say, oh, I'm only going to convert this$7 ,500 contribution I made because the IRS treats that as a 4.76 % after-tax conversion and 95.24%, the difference there, as a pre-tax conversion under Form 8606, which would mean $357 of tax free, and then$7 ,143 of that after tax conversion.

13:26$7 ,143 is less than that$7 ,500 you thought was going to be in that backdoor Roth IRA. And that's where all of this starts to unwind. So here's the advice we could give you. If you think a backdoor Roth IRA is in your future, I guess would keep that money in that 401k, assuming it's invested correctly, and you still have autonomy and you can choose it and everything's fine unless there's a real compelling reason, again, the autonomy to move it into a traditional IRA, leaving you the ability now to have no money, no pre-tax dollars in a traditional IRA. It's all sitting in a 401k. And the only dollars that are pre-tax are ones that you are going to convert that same year from a traditional IRA to a backdoor backdoor Roth IRA.

14:12I know that was a lot, but like pro rata rule is really confusing. And it's why some of this stuff bites people in their butts when they do it wrong, because they come out the door of like a wrong conversion, or they didn't know the money got sent that way or something like it's just, it's kind of weird sometimes. So long story short here, Robert, don't forget the pro rata rule when you're thinking about doing a backdoor Roth IRA. I know that was long, but for everyone watching this episode and listening. It is so incredibly important. One of the hills Austin and I live on inside the Rich Habits podcast and Rich Habits Network is it's not what you make, it's what you keep.

14:47And so many people, as things get more and more complex, they try to do it on their own, Austin, and that's troublesome sometimes. And that's the importance of what we do in the Rich Habits Network is helping people navigate what they seem is so complex they can't figure out. And even for us, sometimes we have to do a lot of research to make sure that our guidance is sound because things do get more complicated as you move along. So I want to add one more thing to this as well that I forgot to mention, and that is the emergency funded$60 ,000. If it's in a high yield savings account, fine. You're making three and a half, four and a half percent.

15:25I'm okay with that, but I think 60 ,000 is a lot to have sitting if it's not in a high yield savings. So keep that in mind. Our general rule is three, four, five, six months of your total bills monthly in that emergency fund, but it's always making money through a high yield savings or a high yield cash account at public.com. So please, for anyone listening, make sure you understand the emergency fund isn't just money sitting in your checking account. It is money available to you for those emergencies, but it is still making money while you sleep. So our next question comes from Brayden T. Brayden says, Hey, Rich Habits hosts, I have come to a crossroads in my life.

16:07Call it a quarter life crisis. I've made my way into corporate sales without a college degree, making a guaranteed$70 ,000 a year. I have$10 ,000 I owe to my stepfather from a credit card debt that he saved me from, which I'm paying$1 ,000 a month. I pay$400 a month to rent,$350 a month to my truck,$700 to investing in the ETFs plus my high yield savings. I have$2 ,500 saved up and counting. I have$5 ,000 owed to a truck that I can't sell. And I just don't know why, but I want to go back to college to get a technical degree in either marine biology, which does not pay well, or a degree in nuclear engineering, which is way more economically practical.

16:48Both of them are rich in passion, but I don't know how I feel about going into student loan debt when I already have such a high paying job. I'm mainly scared of making the wrong decision at such a young age. Robert, what's your take here for our friend Brayden? Brayden, you're crushing it and I get where you're at, but I think it's a mistake at this moment until you get out of debt, you get your base built and you're up and running because you're already making great money. And the market is changing so, so rapidly right now in these engineering fields and in these marine biology fields because with AI and robotics and so many new technologies that are entering the market every single day right now, I think you should stockpile the money as much as you can, get out of debt, get everything paid off, and then reevaluate in one, two, three years down the road.

17:40Because right now you're doing such a good job at 23 years old. You have a high paying job and you're actually investing when most people in your age group are not investing or even thinking about their futures. And remember this very, very important thing that so many people get wrong. When you hear people online and influencers and people talking about follow your passion and you'll never work a day in your life. Generally, that's coming from someone that's already rich because they already have their money. They already have built their base. They're already wealthy, and then they follow their passion.

18:13When you're in your 30s or 20s or even 40s, I don't care about passion. Get the money first so you can be all the passion you want later on in life, and you never have to think about making the bills monthly because you followed a passion that took too long to come to fruition or underpays in general because it's not something that you can really build financial freedom through. So that's my take. follow the passion later, get the money now, and keep doing what you're doing. I cannot agree more. Money gives us options. If you have a ton of money at 33 and you've been grinding hard and doing your thing, you now have the option to, if you want to go get that nuclear engineering degree, do it.

18:57You have the option to work part-time and spend the other, call it, 20 hours a week working on getting this degree. But that option would not be afforded to you without the money. So I remember being 23. I'm only 30, right? Like I remember graduating from college and like looking for that job and trying to feel as if there was more to life and like escaping the matrix. I watched the matrix this weekend. It's like so interesting, but it's like trying to like build something and do something and be passionate about something like, yes, you can do those things. And I encourage you, Brayden, to find that while keeping your job.

19:30I love the$70 ,000 guaranteed. You're also in corporate sales, which tells me that that's the floor, not the ceiling, right? Maybe there's a world where 70 turns into 90, that turns into 110. And at 23 years old, that is a ton of ton of money, dude. Maxing out that Roth IRA, getting that 401k going, building up that emergency fund, getting a couple hundred thousand invested between now and 30 years old. Like there's a ton of headway that you can make by earning the 70, 80, 90,$100 ,000 in your 20s and being smart and strategic with it so that when you're in your 30s and 40s, you have the options.

20:06You have the optionality to say, hey, I'm 33, I'm 37, I'm 42, and I want to pursue these other goals and dreams. But those options would not be afforded to you without having the money in place. And the only reason you have the money is because you stuck with it in your early 20s and you just kept going and kept going and kept going. I'm not trying to stifle any dreams or tell you to not follow your passion. Maybe there's a different way to express your passion of marine biology. Maybe there's a blog you can write. Maybe there's a newsletter you can create. Maybe there's a YouTube channel you want to start.

20:34Maybe there's something. Maybe you can volunteer your time at the local, I don't know, aquarium, right? There's a lot of really cool ways that I think you can express this passion outside of I'm going to derail my entire situation, go back to school, go up to my eyeballs in debt for four years, make no money. Like it's just don't do that, Brayden. Stick to the plan. You're doing great. Stay focused. You're going to make so much money in your lifetime. I love that breakdown. Stick to the plan like Austin said, Brayden. I remember once I really was passionate about helping animals and I wanted to go do the whole animal shelter thing.

21:11But then I realized it's very, very hard to make money. So what I did is I built this wonderful career and then I started volunteering in an animal shelter so I could still give back. So always remember, get the money first, build your base and you'll be fine. Now, before we jump to our next question, got to give a shout out to public.com, the investing platform for those who take it seriously. On public, you can build a multi-asset portfolio of stocks, bonds, options, cryptocurrency, and now generated assets, which allow you to turn any idea into an investable index using AI. And it all starts with your prompt from renewable energy companies with high free cash flow to semiconductor suppliers growing revenue over 20 % year over year.

21:52You can literally type any prompt and put the AI to work. It screens thousands of stocks, builds a one-of-a-kind index, and even lets you backtest it against the S &P 500, all with just a few clicks. You can think of generated assets like ETFs, but with infinite possibilities. They are completely customizable. They're based on your thesis and not someone else's. So go to public.com slash rich habits, transfer your portfolio, and start finding and building your own generated assets on public. Paid for by public investing, full disclosure in the podcast description. So our next question comes from Kristen F.

22:26Kristen says, hey guys, my question is, what investment recommendations do you have for a 23-year-old computer science engineering student who's graduating in the spring of 2027 who recently received a$300 ,000 settlement? This young man is a gregarious person who would give you the shirt off his back. And although he's talented in math and physics, he's not that proficient at managing money. Also, he's not eager to work indoors, staring at a computer, sprouting what he calls a tech neck. That's so true. I feel like I'm growing one of those myself, Robert. Kristen says his passion is coaching skiing to underprivileged kids and organizing outdoor festive events.

23:10Is Mr. Gregarious a candidate for a spendthrift trust? I would greatly appreciate your guidance and wisdom to secure this wonderful man's future. Please let me know if you need any additional context. Sincerely, Kristen F. Robert, kick us off. He is definitely a candidate for a spendthrift trust, though that's hard to say. But I don't think it's necessary in this instance. So many times you see someone younger, they get all this money, and you want to make sure to help protect them. But in this instance, there's so many different ways. There could be a structured annuity, which is a little less stringent.

23:44There is the irrevocable trust that could possibly work depending on the relationship with the parents. And if he would agree to be able to allow them to set this up in his behalf and help him handle this money over time, the main thing is finding the best way to allow this money to grow for as long as possible. because at 23 years old, this can turn into millions and millions of dollars over a lifetime as long as it's not squandered away. So I think you have a lot of options. I don't know that the spendthrift trust would be the best option. And also you could look at real estate. There's some other things I'm sure Austin can allude to.

24:22But for me, I think the easiest way would be the structured annuity or the irrevocable trust. That would be my take. Yeah, Robert, I'm looking at a investment calculator right now. And if they put all$300 ,000 in the S &P 500 and after inflation, it compounds at 7%, right? So like 7 % is after inflation, after everything. This Mr. Gregarious at 65 will have$5.5 million, assuming he adds no more money to it. So 300 ,000 compounds into over 5 million of today's dollars, right? This is it. This is it. This is today. So really, really cool stuff there. Here's the thing. You're asking these questions because you're worried that Mr.

25:02Gregarious might squander this money, that they might want to buy a gaming setup or go travel the world and do some, who knows, right? Like I understand your concerns. And I think the hard reality is the money is already his because it's his settlement. And you can want to create these trusts. You can want to create these rules and boundaries around this person and how they spend this money. But at least how I understand the situation here, legally, you have no authority to do so unless they agree to it. So how I understand it here is this 23-year-old computer science engineer has$300 ,000 that they were given from a settlement.

25:43And that$300 ,000 is theirs. It's in their name. And they can choose to squander it. They can choose to invest it. They can choose to do whatever they want to do with it. I think the two or three pieces of advice I'd give you is this. The first piece of advice is to take it super slow. You don't need to make any big decisions quickly. And anyone that's trying to pressure you to make a big decision quickly with it likely doesn't have your best interest in mind. You might get approached by the uncle or the aunt or the cousin and says, oh, I heard you guys got this sentiment. Let me put you in a whole life insurance policy.

26:13It's going to turn into all this money in the future if you just do this one thing, but we got to act fast. We got to do it now. It's like, take your time. The kid's 23 years old. Like he's got a lot of time with compounding ahead of him. He can do nothing with this money, but let it sit in a high yield savings account for 6, 12, 18 months. And it's still going to be just fine in retirement because it gives him that opportunity to kind of like come to terms with like his new reality of having so much. So they're just like, don't make any like quick rash decisions. The second piece of advice I'd give you is interview as many people as possible about this, like surround yourself with sort of like a board of directors of advisors, right so think like accountants think financial advisors think career advisors think like all these are the different people real estate professionals that can help guide this individual with this money that that you trust and i guess the third piece of advice i'd give you is if you're truly super scared i would not do this i'd probably just convince them and by convince i mean educate them as to why 300 000 invested in the markets is smart and how it'll compound over a long period of time and make sure i mean there's a smart individual computer science degree it's it's tough right so like just show them how to put this in a taxable brokerage account and watch it compound over their lives so they have retirement figured out it's done like that's what i would do but if you are super worried about them and like things maybe aren't trending in the right direction and you don't want them to lose this money yes do the trust if they don't agree to a trust something you could maybe convince them to do is take all of it and use it to buy some real estate so that they now live in a house and that house has that 300k They have equity now inside of it sort of being treated as like a built-in savings account for this money that will grow over time with, you know, how real estate appreciates over time, but they don't have like immediate access to the money, right?