Should You Stop Using a Roth 401(k) After a Certain Income? (Money Q&A)

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1:26what's up everybody and welcome to the personal finance podcast i'm your host andrew founder of mastermoney.co. And today on the Personal Finance Podcast, we're going to be diving into your questions. Now, today we have eight different questions that we're going to be getting into. And the first one is, do you get taxed when moving money from one investment to another inside the same account? The second one is, how does tax loss harvesting work? The third one is, most retirement rules I've seen state that you want to have 75 % to 80 % of your pre-retirement income? Is that before or after taxes?

2:02Number four is, should you max out your Roth 401k in the first quarter of the year because of the lower marginal tax rate? Plus, at what annual income should someone avoid a Roth 401k and do a traditional for tax purposes? Number six is, I'm putting away money for kids, wedding cars, etc. For when they get older, should I use a high-yield savings account or a brokerage account? And how do you juggle the two? Number seven is what is the best high yield ways to store an emergency fund? And number eight is how to plan for retirement with a pension. So this is an action-packed episode. Lots of stuff to cover in this episode.

2:36So without further ado, let's get into it. All right. So question one is, do you get taxed when moving money from one investment to another inside the same account? Now, this is going to depend entirely on the type of account that you're using. Because if you're investing inside a tax advantage account, like a Roth IRA or a traditional IRA or a 401k, this is going to mean that the rules are going to be very different because you can move money between investments inside of those accounts without triggering any taxes. So you can sell one mutual fund or you can sell an ETF and buy another to rebalance your portfolio.

3:12Or you can shift strategies without paying any capital gains taxes whatsoever because they are inside these retirement accounts. So this is a huge benefit to retirement accounts is the tax advantages. This is why we talk about those tax advantages so much. And we'll talk about how it applies to each account type. So with the Roth IRA, you're going to contribute after-tax dollars. And all the growth is completely tax-free. This is what we love about the Roth IRA is that tax-free growth. Because typically, if you have a long time horizon, that tax-free growth is going to be the majority. And buying and selling inside of the Roth has no tax impact.

3:46and qualified withdrawals are also completely tax-free. And so that is inside the Roth. Number two is inside a traditional IRA or a 401k or these pre-tax accounts. Contributions will be made by pre-tax and you'll pay ordinary income tax when you withdraw the money later. But buying and selling within the accounts won't trigger taxes now. And so no taxes will be triggered when you are buying and selling inside of that traditional. Then the HSA contributions are pre-tax, growth is tax-free and you can pull the money out tax-free as long as you have a qualified medical expense. And so when you're buying and selling inside of an HSA, you also will not have taxes triggered.

4:23However, there is an account where taxes will be triggered. And this is just a regular old brokerage account, a taxable brokerage account. Now, the rules are very different inside of this taxable brokerage account, where if you start making money moves in a taxable brokerage account, you need to assume that all of these events will be taxable. So anytime you sell an investment for more than you paid, the profit inside of that account is called a capital gain. So you'll hear people talk about capital gains tax all the time. Well, a capital gain is when you sell a stock inside of this account for a profit.

4:56Now, this can trigger taxes even if you immediately reinvest the money into a different stock or a different fund. Now, the good thing about capital gains is they are still taxed at a lower rate than your income tax typically is. And it's going to depend on where your income level lands to decide how much you are going to be paying. Now, it also is going to depend on how long you have been holding that investment. And so the big thing is long-term capital gains are not taxed at your ordinary income rate, but short-term capital gains are. And this is where the disadvantages for a lot of day traders or people who get in and out of stocks a lot is that you're going to be taxed a lot more than someone who actually holds onto their investments for longer than a year.

5:37So at the short-term capital gains rate, if you held the investment less than a year, you're taxed at your ordinary income tax rate. So this is significantly higher, and it's truly not an advantage for most people. This is why I don't like day trading. This is why I don't like short-term investing. This is one of the reasons why I don't like people getting in and out of stocks all the time. Instead, you need to be a long-term investor because long-term capital gains is significantly lower. So if you held for more than one year, you'll pay 0%, 15%, or 20 % depending on your income. And so depending on what your income is, that's what it'll trigger.

6:13So typically, most people will be paying that 15 % range because your income needs to be below like$43 ,000 to pay 0%, and it needs to be above over$400 ,000 to be paying that 20%. And so because of this, most people out there will be paying that 15 % capital gains tax rate. So if your taxable rate right now, on your income is significantly higher than 15%, then this is a better situation for a lot of folks out there. Now, let me give you an example of this. Let's say, for example, you buy$10 ,000 of VTI in a taxable account and it grows to$12 ,000. And then you sell it to buy SCHD, which is gonna trigger a$2 ,000 capital gain.

6:52Then you're gonna owe taxes on that gain. So what's gonna happen here? If you did this, you would owe no taxes when moving money inside of a retirement account or tax advantage account. but if you are in a taxable account, you would pay taxes on that$2 ,000 capital gain, depending on a bunch of other factors, obviously, but that's where you'd be paying money on. It's not the original 10 ,000 you put in, but it's the amount of money that your money made, the profit. And so typically when you move money around, that is what is going to happen. Now, is there reasons you should do this? We're gonna talk about those reasons in the next question.

7:25Okay, so the second question is, how does tax loss harvesting work? Now, we have had an entire episode talking through tax loss harvesting. And it is a strategy. I think if you are a high earner, or if you have a lot of money inside of a brokerage account, this is something you can definitely consider. But you have to have a decent amount of money inside of these investment accounts for it to make a big impact on your tax situation. But tax loss harvesting is basically a strategy where you sell an investment that has lost its value to offset taxes on gains you made elsewhere in your portfolio, or even reduce your regular taxable income.

7:58So here's how it works step by step. I'm going to take you through the steps of tax loss harvesting so you can understand how this works. If you sell a losing investment in your taxable brokerage account, let's say you bought a stock or an ETF for$5 ,000 and it's now worth about$3 ,000. You sell it and you lock in a$2 ,000 capital loss because it was$5 ,000. You sold it for three. You lost two grand within that transaction. So you can use that loss to reduce your taxes. So first, the$2 ,000 loss can offset capital gains from other investments that you sold at a profit during that specific year.

8:31So let's say, for example, that you sold a stock that also made$2 ,000. You bought Apple for$5 ,000 and then you sold it at$7 ,000. You had a$2 ,000 gain. Well, you can utilize this loss to offset that capital gain. Also, if your losses are more than your gains, you can deduct up to$3 ,000 of net losses from your ordinary income each and every single year. And any losses beyond that carry forward to future years. So this is going to be something where if you have a higher amount in your brokerage account, this is going to make some sense for folks who are trying to reduce their taxable income if you have some stocks that are already down over that timeframe.

9:08Now, the third part of this is then what you do is you reinvest the money in something similar, but not identical. So this keeps your portfolio balanced and avoids missing out on market gains, but you must avoid buying the same exact investment within 30 days before or after the sale, or you'll trigger what is called the wash sale rule, which disallows loss for tax purposes. So let me give you an example of this. Let's say, for example, you sell VTI for a$2 ,000 loss. So VTI is the total stock market ETF. Now to avoid that wash sale, you go buy something similar like SCHB, which is a dividend ETF, and you maintain exposure to the market, but you now have a$2 ,000 loss that you can reduce your taxes.

9:49If you went and sold VTI and then went and bought VTSAX, which is basically the same fund, one's just an index fund and one's an ETF, that would trigger the wash sale rule. It would be a problem, but you got to make sure that you are buying something that is similar, but not the same. And so that is really, really important when you are doing tax loss harvesting. Now, tax loss harvesting can save you real money in taxes, but especially in your really, really high income years. But again, you have to have really high income for this to really make sense. And you have to have a decent amount that you're making in your portfolio.

10:17Otherwise, it is a waste of time. If you have a$10 ,000 portfolio and you don't have a high income this year, it is not worth your time to try to figure out how to tax loss harvest. Instead, you need to utilize other strategies to grow your income and then go and get more money in that portfolio. Then you can utilize strategies like this. But for some folks, it is a waste of time. And then for others, it can make a lot of sense. It just depends on your specific situation. Now, if you want to talk through tax loss harvesting with someone, your CPA or a certified financial planner can both help you through those processes to figure out exactly where you need to land for your personal situation.

10:50And that's the way I would approach this if you are interested in utilizing tax loss harvesting. And again, this is one of those things like rebalancing, tax loss harvesting. Both of those two things are going to matter a lot more as your portfolio grows. But early on in the early stages, it's not going to matter as much for most folks. Great question. And let me know if you have any other questions on that. And check out the entire episode if you haven't, where we talk through tax loss harvesting. Question three, most retirement rules I've seen state that you want to have 75 to 80 % of your pre-retirement income.

11:20Is that before or after taxes? So that 75 to 80 % retirement income refers to your gross pre-tax income before retirement. But the goal is to replace your after-tax spending needs in retirement. So let's break this down. Now, if you make$100 ,000 before taxes while working, the rule says you might need $75 ,000 to$80 ,000 before taxes in retirement. But the key is in retirement, your taxes will often be lower because number one, you are no longer paying payroll taxes, things like Social Security and Medicare on wages. Number two is you might be in a lower income tax bracket, depending on your certain situation.

11:58Number three is you may have tax advantage withdrawals from something like a Roth IRA, and your housing and family expenses may go lower too, depending on who is in your house. If you have kids, they go off to live on their own, those types of things. So a number of different factors could come into play that would cause your taxes to be lower. And so that's one thing. Now, I am not the person to say 75 to 80 % of your pre-tax income. I am more of the type of person that would really want you to get closer to how much you're spending right now. So you have extra money on hand in order to be able to utilize that for your interests, because what a lot of people don't factor in in retirement is their interests.

12:33They don't factor in inflation and they don't factor in the third thing, which is healthcare inflation. That is a very important thing to make sure that you are monitoring. So really, for most people, I would rather you over plan than under plan when it comes to the number that you need. Now, why does this 75 to 80 % rule typically exist? Because for most people, you don't always need to replace 100 % of your income, but you can plan on this as we get closer. And this is why, because A, the argument is you're not saving for retirement anymore. So you're not putting more money into these retirement accounts.

13:04Instead, you are going to be living on that money. And so you can reduce that by 20 % if that's the case. You're likely done paying your mortgage, but some people still have a mortgage in retirement, which is partially my argument here. And you don't have work-related expenses like commuting and meals and those types of things, but you're going to have other interests that are going to pop up and your kids may be out of the house. So those four reasons are why people argue the 75 to 80 % rule. I am more so trying to be conservative when it comes to this, where I think you really need to consider making sure that you get closer to the number that you're at.

13:37I don't love reducing your spending number just because you're in retirement. Now, some people will argue with me about this. I am just more conservative when that final number comes up because I want your plan to be bulletproof. I want your retirement plan to be bulletproof. And I don't want you to have to figure out ways to earn extra money in retirement because you did not plan accordingly. So 75%, I think, is way too aggressive. 80 % is maybe a little bit closer. And really, I would rather you get there at another number as well. But yes, this is based on pre-tax income, and it is designed to reflect your actual lifestyle needs post-retirement.

14:10So in Master Money Academy, for example, we have a spreadsheet that we have been going through that is going to show you. And it basically will take all of our members in there. We have our beta members in there right now. It is taking them through, hey, here is exactly how much money you're going to need in retirement. And then here is you can adjust this inflation rate. You can adjust healthcare inflation. You can look at social security. If you're going to have rental income, you can factor those numbers in as well. And so inside master money Academy, we have this spreadsheet that kind of takes you through all this entire process.

14:39And this is super, super helpful when planning on retirement, because you need to really update this every single year in order to make sure that you are still on track for that number, because you're going to make adjustments to this. You're going to make adjustments to that retirement number. And so over time, this is going to shift and change. And so that's why you need to keep continuously updating it year over year. That's part of our plans over in Master Money Academy too, is we kind of take you through all the steps you need to be taking. And that is one of the big ones is making sure that you are readjusting that retirement number.

15:08It's very important to make sure you get it right and get as close to possible as you can. It's very hard when you're in your 20s, when you're in your 30s to know how much you're actually going to be spending. And so reviewing it yearly and tweaking it yearly is really what is going to be the big, big difference maker. So really, really good question. Again, if you have any other questions, please let me know. And if anybody is interested in Master Money Academy, it is coming down the line. We're going to be launching it to everybody else outside of our beta members in October. So get ready for that.

15:35We'll announce it on the podcast. We'll announce it on social media as well. But it is coming down the line and we are really, really excited for that. Question four is, should you max out your Roth 401k in the first quarter of the year because of the lower marginal tax rate? Now, the short answer and upfront here is yes, it can be a smart move to do that if your cash flow allows it and you're in a lower tax bracket at the start of the year. So at the beginning of the year, you've likely received maybe a bonus or raises or commissions, or you've been saving over the course of the previous year.

16:08Maybe you maxed it out early and now you've been saving it throughout the year to be able to max out again the next year. And so if that is the case, then your marginal tax rate is temporarily lower, which means you're paying less taxes now than you might later on in the year. Now, I am always for getting dollars invested sooner rather than later. So if you're sitting on cash and you're saying to yourself, well, I saved up this cash from the previous year. I just need to figure out what to do with this. I would get the ball rolling on that cash because overall, it's just going to be better to get it moving in the market earlier.

16:39We've talked about lump sum investing versus dollar cost averaging. Most of you out there need to be dollar cost averaging, just taking a portion of your paycheck every single month. But if you have a lump sum of cash on hand, it is much better to take that lump sum, invest those dollars and watch those dollars grow than to just keep them sitting in cash. It's better to get them moving. So if you can do it at the beginning of the year, it is much better. It's not going to make a huge, massive difference, but it is a more optimal way to look at your dollars because the sooner you get them moving, the better off you'll be.

17:05And it can also help you in a tax situation. Now, a Roth 401k is funded with after-tax dollars. So if you're in a lower tax bracket at the time of contribution, you're locking in a lower tax costs now and enjoying tax-free growth and withdrawals later. So let's say you're in a 12 % bracket in Q1, but in Q4, you're earning more. And now you're in a 22 % bracket. If you contribute early, you're effectively paying 10 % less tax on the same money going into your Roth, which is a big long-term win, especially since the Roth grows tax-free. So I think that's something for a lot of people to consider.

17:36And so when does this strategy work well for some folks, if they want to think through this and do some of these advanced strategies, if you expect to earn more later in the year. So if you get a bonus at the end of the year, or you get commissions or a raise, and if you're not paycheck to paycheck and can front load those contributions, it's really important to make sure you're not hurting your cash flow within your budget every single month or getting yourself into debt or any other trouble. Instead, you want to make sure you're not hurting your cash flow. And then lastly, you're trying to maximize tax efficiency and take advantage of compound sooner.

18:05So all these things are little tweaks that you can make to maximize your tax situation. It is not going to be a life changing thing, but it is something that you can definitely do if you are willing to do a little bit of extra work. And if you already have the cash on hand, why not? There's no reason not to do it up front. Now, there are a couple of things to watch out for is the no employer match after you hit the annual limit. So many companies match contributions per paycheck, not annually. So if you front load your Roth 401k and hit that $23 ,500 limit, you might miss out on your free match money later on in the year.

18:36So some employers offer a true up match, but many do not. So you need to check on that specific plan before you make a move like this. And then there's also cashflow risks like we just talked about. So maxing out early means big deductions from your paycheck up front. So make sure you have enough margin to cover your expenses. And that is a big one. So if your employer offers a true up match and you're in a lower tax bracket within this specific year, maxing out your Roth 401k and Q1 can be an excellent move. But if not, you might want to spread out contributions evenly to maximize employer matching while still contributing to your Roth early and often.

19:08So that's kind of the way that I would look at it is the match is a big factor in this equation. And just making sure that you look at your plan and understand how your plan works is a huge, huge differentiator. So really like that you're thinking about this though, really like the detail that you have when it comes to making sure that you look at this and we'll continue to talk about this stuff if there are any other changes. All right. So there has been a, another data breach and we report on these typically every time they happen. And this is one that I think a lot of people need to go make sure that they are freezing their credit and doing a couple of other things if they are someone who has used TransUnion in the past.

19:44But TransUnion had another data breach that occurred in late July. And there is approximately 4.4 to 4.5 million US consumers impacted. And what was exposed was their names, their dates of birth, unredacted social security numbers, which is the big one. The social security numbers is the one that I think a lot of people need to make sure to look and see if they've ever used TransUnion. Contact details and reason for customer transactions plus their customer support ticket messages. And hackers claim they stole over 13 million records total with roughly 4.4 million tied to US consumers. And the breach is believed to be tied to a wave of Salesforce related attacks impacting multiple major firms.

20:26And so Salesforce has had a number of issues, including the Google one that we reported on recently. but this is something I think a lot of people need to take into consideration. If you have ever used TransUnion in the past, they could have your names, your dates, and your social security numbers. And this is obviously extremely sensitive. And so there's a couple of things that you need to do. One is obviously freeze your credit. We talk about this all the time is to make sure you go to the major credit bureaus and freeze your credit. Also, make sure you enroll in free credit monitoring. And you could do this with TransUnion.

20:56They have identity protection services that is offered by them as well. Making sure you watch your financial accounts is the third one and just monitoring them on a daily basis for the next couple of months. And then be aware of any phishing attempts that could come after you because if they have your information, they could be doing phishing attempts and then removing your personal information from the internet. And this is a big one for a lot of folks who don't do this, but because they have this data and this information, they can either go to a data broker now and get the rest of your information.

21:23So let's say, for example, they got your social security number and your name. Well, they can go to a data broker and buy your address and all the other information that is available with that data broker. And they can take that information and go open up credit cards in your name or student loans in your name, those types of things. And so that is where I would go to a service like Delete Me to get your personal information removed. Now, Delete Me by far is my favorite service that I have used to do this. They will remove all your personal information from data brokers out there so that data brokers can't go and sell your information to criminals like this who steal your information from other websites that you've used.

21:58And so it's really, really important to make sure you get your personal information removed from the internet because that is one of the most impactful things that you can do so someone can't get a hold of the rest of your information who has bad intentions. So if you go to joindeliteme.com slash PFP20, you can get 20 % off Delete Me and I absolutely love Delete Me because it saves me so much time. So go to joindeliteme.com slash PFP20 and make sure that you sign up for Delete Me to get your personal information removed. It is very, very important for most people out there. And again, breaching your credit is huge, making sure you have that credit monitoring through TransUnion where they're offering it for free right now.