We have another email question and we have a complaint from Christy.
(laughs) I don’t think it's a complaint, she's just supplementing one of our answers.
She goes, "Hi Joe and Al.
Love the show, especially the fact that you address tax and investing issues at the same
time and all in a very straightforward and entertaining way. Thanks.
I have a question but wanted to add something to your answer on the October 23 podcast about
the benefits of a Solo 401(k)."
So she goes to a very good explanation of a Solo 401(k).
I think we might have just shortcut a Solo 401(k) just through passing of maybe a
recommendation that we made for a certain individual.
I think our buddy Mac in Brookfield, Connecticut, about his wife being a dentist.
And she has a solo 401(k), and so she went through a lot of great benefits of a Solo 401(k).
So for those of you that don't know what a Solo 401(k) is, Al, what is that?
Well, you can actually set up your own private 401(k) if you have your own small business
and you don't have any other employees.
Now, your spouse can be an employee, that counts as one, or solo, but if it's just you,
then you can set up your own private or they call it individual or Solo 401(k), and it's
just an account - very simple.
You don't need an actuary, there are no fees to set these things up or administer
or even terminate.
So very simple, and you can put a lot of money into it.
$18,500 in 2018, and $24,500 if you're 50 and older - and that's
the employee part.
And then you can also put a little profit sharing on top of it.
You can, and that's 20% of your profits, unless you're an S-corporation, then it's
25% of your salary.
And so with that being said, you can put a lot more than $18,500 or $24,500.
You can.
If you look at the employee and employee part, you can actually put $55,000 into these plans,
assuming that you have $275,000 of comp - that's what you would need to do that.
Right. So if you made $50,000, you couldn't shelter $18,500 and $18,500.
$18,500 is a dollar for dollar contribution on any 401(k) plan.
So if you have a small business and you make $20,000, you can contribute $18,500 of almost
your entire comp - you've got to pay payroll comp, so I don't know what that computation
is, but pretty dang close to 100% of your compensation.
So what Christy was saying is that, hey, well, you guys kind of forgot to mention that you
could put a lot more into it - and she's absolutely right.
We love the Solo 401(k) for that fact, because what we see is that small business might have
a SEP plan.
So a SEP plan is just that same computation, it's a percentage of profits if I'm a solo
practitioner or a sole prop.
But if I go with a Solo 401(k) plan I can go dollar for dollar, and then I can add on
top of that, as my "match" if you will, to get more money up to that $55,000 limit.
Yeah.
And I will say one more thing, if you're a business center and you're 50 or older, you
can also do the $6,000 catch up on top of the $55,000, so you can actually put in $61,000
if you have enough income to be able to justify that.
She also went on to discuss another huge advantage is that there could be a Roth component of
a Solo 401(k), which she is absolutely right.
So you could go $18,500 into the Roth, and then you could put in the profit sharing or
the match, and you can pre-tax that thing.
So you can kind of toggle back and forth and get best of both worlds.
You can get a tax deduction and you can get a ton of money into a Roth 401(k)
or a Roth plan.
Yeah.
And I think it's important to mention, Joe, that on the employee part, you can do a regular
401(k) or a Roth 401(k), the employer part, profit sharing part, that's always pre-tax.
That's the traditional 401(k) part.
And then she goes on, "Finally, you can invest in a much wider range of investment options
including individual stocks and so on and so forth."
So that is great information.
Thank you Christy.
But now for her question.
"I have a solo traditional 401(k).
My husband is a W2 employee and has both Roth and traditional options in his 401(k) plan.
This year he started contributing half of his retirement savings of the $24,500 into
each of those after many years of contributing only to the traditional plans."
He's 50, she's 45, "we're in the 24% tax bracket filing jointly.
At current tax rates we'll likely be in the 22% bracket in retirement.
So far the vast majority of my existing retirement savings amounting to about $165,000, like
his, are traditional IRAs and traditional 401(k)s.
Would there be any advantage for me also to put someone by contributions in the Solo Roth
401(k), especially when it comes to tax diversification in retirement and given the fact that I'm
younger? I love the idea of Roth and ideally I could invest relatively aggressively in
a Roth and see a big benefit down the road, especially if tax rates go up in the future.
Should I continue to contribute to my account based on my age and diversification situation,
or should I not worry about that since we're putting half of my husband's savings in a Roth?
Obviously there are a lot of variables so this is kind of a philosophical question..."
Ooh gosh, that was close.
(laughs)
(laughs) You got it though!
I got 'er done! "...about retirement income buckets and how much the spouse situation
should inform a personal investment decision.
Thank you very much."
Wow, that's a well thought out question.
Very well thought out Christy.
Alan, let me see your calculator real quick.
So if I look at Christy, she's got $165,000 saved and she is putting $18,500 in.
She's 45 and she does that for the next 20 years at 7%, that is going to be $1.4 million.
Right. And that's not even including the employer match profit sharing.
That's not including an employer match.
That is not including her husband's contributions.
So Christy, just taking a look in the future here, if you continue to do the things that
you're doing, as long as you have a globally diversified portfolio, and assuming the 7%
rate, over 20 years that could be aggressive, that could be conservative, depending on what
you want to do.
I'm with you.
I think you're right on of looking at tax diversification.
Two reasons.
Alan's going to give you the CPA math approach.
I'm going to give you the real life approach.
You're not going to remember the tax savings that you're getting today - you're 45 years old.
You've got 20 more years, potentially, to work, and the couple of bucks you're saving
in taxes because you went pre-tax versus Roth, in 20 years when this $1.4 million is all
in a Roth versus a retirement account that's going to be taxed at ordinary income rates.
you're going to be like, "I am the happiest woman in the world!"
22% tax bracket in the future.
Well, those tax rates are going to expire.
Right.
That's how it's currently stated.
So you're going to be, probably, in the 25% tax bracket or maybe 28 even.
Correct.
Now you got $1.4 million, let's say your husband is doing the exact same thing.
He's got $1.4M. Now that's a pretty big number.
So depending on what you want, and if it's all in deferred accounts?
I love the fact that you're in the 24% tax bracket now, you think you'll be in the 22,
the 22 is actually the 25, potentially, I like 24.
I'd go Roth.
I would go full Roth on both, and then with your profit sharing component of it go pre-tax
because you have to.
Yeah, I actually agree with you 100%.
Wow.
Done.
For the same reasons.
So first of all, the CPA part of me says you're going to be in a higher tax bracket in retirement,
because that's what rates are scheduled to do.
Allegedly.
Well, that's what they are scheduled to do.
But who knows what will really happen.
But she could blow up her investments.
So that $1.4M, she could be broke.
With the assumptions.
I'm just being compliant here, Alan.
Yes very good.
OK.
Let me try to spit out my comment.
What was my comment?
Anyway so my comment is, I completely agree.
So the tax rate will likely, or at least as it's scheduled to be right now, you'll be
in a higher bracket in retirement.
But I also agree Joe with what you said, which is what we find is people that do the traditional,
they save a couple of bucks in tax, and then they spend it and they don't remember it.
And then in retirement they got all this money, they got to pay all this tax.
And so I completely agree with that thinking.
The other part of this is the employer part, you call it the match and profit share, that
part has to be pre-tax, so why don't you just do the employee part as a Roth.
I completely agree with that.
So if you look at it - I'm not sure where Christy lives.
But by putting the $18,500 pre-tax, she probably has a $5,000 tax savings.
Give or take.
If she's in a higher tax state...
I seem to remember she's in Seattle.
Seattle.
Oh, hey.
It's a little rainy.
(laughs) Yeah and there's no state tax in Seattle so it's only federal in that case.
Yeah.
And then maybe she would like to come down to San Diego with her husband to visit Joe
and Big Al, maybe ends up retiring in sunny Southern California.
And then you've got 10% on the state.
Maybe Roth might be a pretty good idea.
So she's probably saving $4,500.
You're not gonna remember the $4,500 20 years from now when you get o$1.4 million sitting
in a Roth.
Allegedly.
And you bring up a good point, which is if you're in Washington state, which has no taxes,
so you're not getting a huge benefit, just federal only.
If you do move to another state, you want a little bit more sunshine in retirement,
you're gonna be paying taxes, so you would want more money in a Roth for that reason too.
So yes, I love the tax diversification, for you saving that much, that you have excess
cash flow, you're seeing the light a little bit.
"Hey, I got $165,000," splitting that half and half.
You could do it that way.
I thought Alan was going to give more of a CPA approach to say, "well what tax bracket
are you in?"
Well she already told us.
Well no, not necessarily.
We don't know what our taxable income is, is what I meant.
I'm just going with this at face value.
Right.
So but I guess a more scientific approach could be this Christy, if you really want
to dive in the weeds and say, "well, what's my taxable income.
And then you look at, how much should I go pre-tax potentially to put me in that lower
bracket, and then put everything else ia Roth, so you can kind of toggle this that way as
well, or you could say, "I'm already saving for the future, and if I believe that the
tax code is going to stay how it's written today, that tax rates will go up and the Roth
will continue to be tax free," then that's what I would do.
Right.
And now the final point I want to say, and when she already said this, which is if there's
more money in the Roth and you have a diversified portfolio, naturally some of those components
are going to be more aggressive.
You stick those components in the Roth.
Obviously they're more volatile.
They go up and down more, but over the long term they tend to outperform and you end up
with keeping more of your investments that way.
Right.
So she's right on, she talked about asset location, putting higher asset classes in
a pool of money that's going to grow tax free.
Congratulations.
She looked at tax diversification.
She looked at current rates versus future rates.
She's saving the maximum, and then she's also doing some homework on a Solo 401(k) to say,
"there's a lot more that you can potentially do with this."
One of the best questions we ever had.
I would say if you want a job, Christy, we need advisors... (laughs)
We're looking to hire, we might open an office in Seattle Washington.
(laughs)