Mindy: Welcome to the BiggerPockets Money podcast where we deep dive into the different types of accounts that we talk about on every episode. This is a great refresher course for our advanced investors and a great introduction for our novice investors.
Mindy: Hello, hello, hello. My name is Mindy Jenson and joining me today is our favorite regular contributor to the Bigger Pockets Money podcast, Kyle Last. Kyle, thanks for joining me.
Guest: Thanks for having me again. This is going to be a fun one. We’ll try to keep it as exciting as accounts can be. We’ll do our best.
Mindy: Kyle and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.
Guest: Whether you want to retire early, travel the world, go on to make big time investments in assets like real estate, start your own business, we’ll help you reach your financial goals and get money out of the way so you can launch yourself towards your dreams.
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Speaker 1: Do you have a money tip for us? Email moneymoment@biggerpockets.com.
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Mindy: All right, like I said, today Kyle and I are doing an account overview where we get into the nitty gritty of what common accounts are and use cases for each one in. Can you believe in more than 400 episodes, we’ve realized that we’ve never done a true beginner account breakdown. So this is for the person just getting started or a refresher for the investor pro filled with tips from the Kyle Mask who used to be a CFP and maybe still is. I don’t know. Kyle, are you still actually a CFP?
Guest: I’m still a CFP. It was too hard to get to let it go too quick. I’ll I’ll hang on to it for a little while anyways.
Mindy: Yeah, so while he is a CFP, he’s not your CFP. So make sure you double check everything. But Kyle’s pretty smart. So, do you want to do your own disclaimer, Kyle?
Guest: That was pretty good. I yeah, I’m I’m a professional in this area, but yeah, these these are ideas. These are not specific to your situation. Everyone’s situation is super unique. We all know.
Mindy: Yes. All right. Well, let’s get started with the big one, the 401K. The 401K is an employer sponsored retirement savings plan that offers significant tax savings while helping you plan for your retirement future. With a 401K, an employee sets aside a percentage of their income to be automatically taken out of each paycheck and invested into their 401K account. and your 401K account is not automatically invested until you decide where that money should go. I think that’s really important to note. Uh, so, Kyle, what are the contribution limits this year?
Guest: That’s a great question. You threw that at me and I don’t have them pulled up at all. They’re probably they adjust every year a little bit for inflation, so they’re probably in the 19,000 and this is probably a good way to to throw this out there so that makes this more evergreen. Uh, it’s usually around 19,000 for a normal employee, but then if you’re over age 50, you have catchup contributions which come up another 6,000-ish that you can do. Uh let’s see. Mindy’s looking it up, see how close I am to to where we’re hitting.
Mindy: Yeah, so Kyle has been out of the CFP game for a minute. They raised them significantly for 2023, which is really awesome for those of us that contribute.
Guest: Oh, inflation, they inflation adjusted. Yeah, what are they now?
Mindy: 2023 contribution limits are $22,500 for regular people and an additional $6,000 if you are like me and over 50. So, I can put in $28,500. So, Kyle, how does a 401K work, you might ask? Do I have to pay taxes on it? You might ask. No, you don’t have to pay taxes on it. Well, maybe you have to pay taxes on it and yes you have to pay taxes on it. So that’s that’s a whole lot of answers that don’t make any sense at all. How does a 401K work? I work at Bigger Pockets. Bigger Pockets offers me a 401K option. I can contribute up to $22,500 because I’m 50, I can contribute up to $28,500 because there’s the $6,000 over 50 contribution catchup. Uh I just tell Bigger Pockets, I would like to contribute X number of dollars or X percentage of my paycheck every time I get a paycheck, every week, every month, every we get paid by weekly and I want to put it into my 401K account and they do it. They take it out and they put it in there. They take it out after I earn it, but before they take out taxes. So I’m not paying any taxes on this money right now. I will pay taxes in the future when I make the withdrawals from the 401K accounts. If I take that money out early, I will also pay a 10% penalty. So, I don’t take that money out early because I don’t like paying fines. So, are you taxed on it? Not now, but you’re taxed when you take the withdrawal. Now, this uh when you earn the money and then you take this money out to put into your 401K, it effectively reduces your taxable income. Let’s say you made $60,000 last year and you contributed $20,000 to your 401K, you’re only taxed on $40,000. That’s a whole lot less. I like paying Uncle Sam less. Some people think that they will be paying a whole lot less in income tax when they are retired because they don’t have any income coming in. And some people think, well, I’m just going to be so rich, I’m going to have all this income and it’s not going to matter. So, it depends. Uh Scott is a huge proponent of the Roth 401K, but we’re not talking about that right now. We’re talking about the 401K. Kyle, the 401K is named after the section of the US tax code that it comes from, which is a super nerd thing to know. There’s also some same but different types of accounts for different types of workers or employment. For instance, the 403B is almost identical to the 401K but for nonprofit organizations and some government employees, whereas the 401K is designated for for profit companies. Are there any other kinds of accounts like this? These retirement pretax retirement accounts?
Guest: Yeah, those two are the main ones, you know, 401K and 403B, 401K by far, the main one that people will hear about and is talked about by most people. There’s a few others, two of the other main ones from employee sponsored retirement plans, standpoint are a 401A, which is very specific to more of like religious organizations and it it like for instance could be a church, a synagogue, a school, if it’s charted under some sort of religious organization. Um, and the 401A, we won’t dive deep into it, functions very similarly in all intents and purposes to what Mindy just explained with the 401K. other than the fact that there’s a few provisions for especially clergy. So pastors or priests people like that that have this type of plan, that the distributions can be taken out of this plan in retirement and used for a housing allowance. Uh tax free, completely tax free, which is huge. Imagine what what’s your biggest expense pretty much through your whole life. Um it’s going to be your housing overall. So, and that includes taxes, insurance, uh principle, interest and even some utility expenses. So it’s a pretty big deal. So just keep in mind if you have a 401A or if that’s available to you, get some more information on it before you make some major decisions with it like rolling it into a different account and we can talk about that a little bit later, but just know that you need to look at things before you do anything too crazy with a 401A because there are some benefits to it and another one, same same vain is called a 457 and it’s actually what’s called a deferred compensation plan and you don’t really need to know that but it falls under a different uh IRS code section than the 401K does. And what that means is that if you leave your employer where you have the 457, you can actually take withdrawals from that before the early retirement age of 59 and a half for a 401K, if you take withdrawals 59 and a half age or earlier, you pay tax on those withdrawals if it’s a normal 401K, plus an extra 10% penalty on top of it. A 457 is not that way. You could leave your employer at age 29 and start taking those distributions right away. You can’t do it while you’re at the employer usually, but if you’ve left the employer, you can. So it’s a great account for the retire early uh cohort that that we’re speaking to sometimes. So, again, if you have that account, just know that you need to look into it a little bit more before you do something drastic with it like leaving your employer and rolling it into your new employer’s 401K to simplify things. In some instances, things like that can be okay, but you need to know what you’re doing and you need to check on it before you do. Uh so those two accounts 401A 457 are a little unique, but if you have an opportunity to have those, they are a good benefit to have the 4572, I should say because it’s not a qualified plan like the 401K is, it’s that deferred compensation plan, it can be contributed to in addition to your 401K. All that to say is you could do the $22,500 to both of them or 22 or $28,500 to both of them if you’re over the age 50. So you can really uh juice your investments for a time if you if you have the income to do so. Um there’s a few other ones out there. There’s a solo 401K which is actually one of my favorite retirement accounts. Um if you’re self-employed, get some information on how you can use those. They are phenomenal. Uh but overall they kind of fall under that 401K employer umbrella.
Mindy: Yeah, I have a solo 401K, it’s, it’s and I’m not quite sure the difference between solo 401K and self-directed Solo 401K except that uh I know that the self-directed Solo 401K, I can invest in real estate through it and it’s not subject to UBIT which is unrelated business income tax like a self-directed IRA would be if you invested in real estate that way. And because I’m a real estate agent, I have self-employment income, I can put 28,500 into there for my own self and then my company can match up to 25% of my income as a just a company park uh which conveniently enough my company does. So up to $52 or $54,000 going into my 401K every year. That’s, you know, for those of you who are math challenge, 54,000 is way more than 22,000. So, you know, you can really juice your 401K contributions and your 401K savings um if you have self-employment income, if you don’t have self-employment income, just erase what I just said because you you don’t qualify for this.
Guest: Yeah, that the other thing if I jump in here real quick, the other thing with those solo 401Ks is when you’re self-employed, you often have big income years and little income years quite a bit. Um real estate agent is a very good uh example of that. So in a big income year, maybe you do 55,000 into your solo 401K to get you below a certain tax bracket the next year. It’s 2023 and things slow down compared to 2021. So you have a lot, you know, you don’t have as much income, you don’t have as much to put away, you’re not paying as much in taxes, so you can dial it back then. You’re in you’re you are the employer and the employee, so you can control that immensely and you can save a lot in taxes that way.
Mindy: Yeah, it’s great and that is when having a tax planner can help you out having somebody who’s really knowledgeable about the different options available to you. Um with regards to the 457 plan, I have two episodes to send our listeners to episode 39 featuring Jamila Sont. She was the first person who ever introduced me to the 457 plan and you can watch my jaw drop when she starts talking about all the benefits of the 457 plan. I was like, whoa, what? And then episode 124 with the millionaire educator, uh he actually does this on purpose. He will max out his 457 and then maybe contribute to a 403B if there’s anything left over because when he leaves his teaching job and he frequently changes schools and leaves his teaching job, he will then be able to access that money. He doesn’t roll it over into a 401K, he just accesses that money at a much lower tax bracket because he’s a teacher and unfortunately, they don’t get paid very well. So I think that’s really important uh bit of advice. Don’t just roll your accounts over into an IRA or into a different kind of account. One last thing I want to say on this and I wanted to start off the whole episode with this because I do love the 401K so much. Um, I want to say when you start a new company on uh enrollment benefits enrollment, read through everything that is offered to you. Maybe you don’t know that you have a 457 plan because nobody ever told you and you didn’t read all the way through. Uh maybe you don’t know that you have a 401A option, but read through everything that’s available and see what your options are. Talk to HR and ask them questions. Go on Google and see what all of these different types of accounts are because some of these accounts can be really, really awesome for you and your financial future. Take advantage of them.
Mindy: All right, Kyle, let’s move along to the IRA. What is it and why is it different from a 401K?
Guest: Yeah, the IRA is it stands for individual retirement account and we can kind of go back over everything Mindy explained for the 401K. It’s very similar except that it’s not sponsored or held by an employer. You own it individually and you are in control of it and you can custody it or hold it at any company you want and some you might know is Schwab or Fidelity, uh TD Ameritrade, Chase all kinds of different companies e-trade. Um, and it’s just a pre tax account, has a certain limit each year that you that you are able to put into it. It’s a lot less and it it is deducted from your taxes when you file your tax return rather than it being deducted directly from your paycheck. Um, but it’s it it also functions the same way as an as a 401K in the fact that if you leave an employer and you want to consolidate, say you’ve been at several employers and you have several different 401K plans, you can roll them out of your 401K plans at former employers into a single IRA so that you’re controlling all of your money and your investments in one place and that doesn’t mean I sometimes I had uh people would get confused while I don’t want to do that because everything’s held at one company and I want to be diversified. Well, you don’t want to be diversified at different custodians. You want to be diversified within your investments. Um, so if to say that another way, it doesn’t matter if you have a 401K at company A, company B, company C and your IRA at company D, you can put all those into your IRA at company D if the fees are reasonable and you have more control over it and you can still diversify it just as well in that account. It’s a good holding account to to bring things into. Um, but again, it’s pre tax money. If you take it out before 59 and a half, you’ll pay a penalty on it and it’ll be added to your taxable income however much you take out after 59 and a half, it doesn’t get taxed uh or it doesn’t get penalized, you get taxed on it when you pull it out. Um the other thing that’s a little bit different about the IRA from the 401K and this is uh one of the things that I find clients that have built up a sizable nest egg over the years or maybe most of theirs is in real estate, but they have some of these 401K and IRA accounts that they’ve built up over the years. An IRA, all the money goes in pre tax. It grows tax free and when you take it out, you’re taxed unless you donate it directly to a nonprofit. And this is something that uh and I think I’ve mentioned this before on the show, but for me personally and a lot of my clients, this is going to be my my old man giving account. You know, this is where when I’m 72 and a half or 72, excuse me, 70 and a half is the qualified charitable distribution age 72 is the required minimum distribution when you have to start taking it out. 70 and a half, you can start sending up to $100,000 a year from an IRA account tax-free to your food bank in your local town, to your church, to Maui that just got hit by a wildfire. You can do anything that’s a a qualified charity. You can send it directly to them and then that money is gone tax free forever. So you never pay tax on it. It grew tax-free and the charity that you choose gets to use it tax free forever. You can’t do that with a 401K, but it’s pretty simple. if you have a big 401K, you can just roll it to an IRA and begin make that your old man giving account if you want to.
Mindy: So, I just looked up what are the IRA 2023 contribution limits? I don’t like this number at all. $6500 for the whole year, but the 401K is 22,000 and only $1000 for over 50. Why is it, why is it so different?
Guest: It’s just depends on when Congress put the law in for each of the accounts. So, the if you notice on both of those, the catchup contribution of 6,000 and 1000 for the IRA 1000 for the 401K 6,000, those amounts have not changed in a very long time. They’re not adjusted for inflation automatically. And the IRA, and this is, you know, I’m not positive on this if I’m going to get it completely right, but it has a different inflation adjustment than the 401K. The 401K adjusts very regularly to inflation. The IRA is, it’ll go a few years and then it’ll bump by about $500 and then it’ll bump by $500 more a few years later. whereas the 401K has really kept up with inflation and that jump that you looked up for this episode just goes right lock step with this last year’s huge inflation, whereas the IRA does not. So it’s very different calculation and it’s just when they were put into law. Um and sadly that’s just kind of a how well whoever’s in office can get along with each other and and pass things and uh help us out in with our retirement contributions and the IRA is a smaller account. So my guess is that you just kind of gets neglected a little bit more than the 401
K does.
Mindy: Well, to all the Congress people that are listening to the Bigger Pockets Money podcast, please increase the limits on both of these accounts.
Mindy: Kyle, can you contribute to an IRA and a 401K in the same year?
Guest: Yes. Oh, but, oh. Uh, I don’t like that, but. This is something that, you know, we won’t go into the weeds here, but this is something that you do need to check on to make sure that you it’s deductible. So, if you remember I said earlier when you contribute to an IRA, you deduct that from your income on your tax return, whereas the 401K, it’s pre tax right out of your paycheck. It doesn’t even show up as income when you get your W two. Sometimes they’ll put on there, hey Mindy put $10,000 into her 401K this year and then this was her income that is taxable. It’ll show that on there, but they don’t have to show that on there. Your IRA, your income will show up on your W two that you get for taxes and then you have to deduct the contribution that you made when you’re filing your taxes. And if you are at the same time covered by an employer sponsored retirement plan and your income is at a certain level, your IRA could be fully deductible, partially deductible and a phase out range or not deductible at all. So there’s a couple, there’s some nuance there that we just won’t go into too deeply here, but there’s, you know, if you if you’re making around $100,000 a year, that’s about the range where and you’re covered by an employer plan, that’s where you need to start looking if I contribute to an IRA too, is it going to be am I going to be able to deduct it? You know, should I do a Roth IRA, should I do a back door Roth IRA? some of these other things that are a little bit more advanced, but, you know, we don’t want to get into the weeds too much, but you can do both. It depends on your income and if you have a plan at your current employer as well.
Mindy: Okay, well, it sounds like that was a good number, $100,000. If you are in the $100,000 or more income bracket you should look into can you do both.
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Mindy: Well, Kyle, what do both of these accounts have in common, the IRA and the 401K?
Guest: Well, they both have a Roth side to them and we’ll just complicate things even more with that. So the Roth side is the after tax function of both of these accounts and I believe it’s named after the senator that initially put the the legislation to the floor or whatever. Mindy’s nodding yes. I should I should know this too. I’m I’m a retired CFP with my credentials still but you know, I have to caveat that I don’t don’t know very much anymore. Um, but the Roth IRA is after after tax. So you don’t get deducted on your tax return. But the difference is you’ve already paid the tax on it. It grows tax free forever and then comes out tax free and that’s a huge, huge benefit in so many ways and I’m I’m in the camp with Scott Trench on this one. There’s the nice thing about the Roth IRA and some people will argue with you. Well, I I am going to be in a lower income bracket when I retire, so if I take it out then and I already paid tax on it now, and I’m making really good money, why would I do that? You know, why do I pay why would I pay tax at a high bracket now, and I think I’m going to be a low bracket later and pay no tax on it, should flip it around, pay no tax now, and then draw it out like an IRA later on, pay very little tax because I’m hardly making any money. There’s some logic to that for sure, but you also got to look at what your goals are. One of the things that people often forget is that sometimes things come up in life where you need a bigger chunk of money. It’s not just your monthly income for retirement, but say, say a house comes up for sale across the street that the lady you’ve known there, she’s 90, she’s lived there forever and you’re good friends with her and she has like no family. The place comes up for sale needs some work and it’s going to go for a deal if you’ve got cash to buy it. Well, if you got an IRA with $300,000 in it that you’ve saved up over years and you pull that out, you’re going to get crushed in taxes on that to try whether you’re over 59 and a half or under 59 and a half. you’re going to get penalties and you’re going to get taxes because it’s going to bump you into multiple higher tax brackets, not just the tax you pay on it. It’s going to bump you into higher brackets on those larger amounts. However, if you’ve got a chunk sitting in a Roth IRA, if you’re over 59 and a half, you can cut a check and buy that house cash to, you know, if you doing a fixer flip, something, whatever opportunity it is, doesn’t even have to be real estate, that money is available to you. The other thing about a Roth IRA and this is one of the reasons I really love the account is that all the contributions are always available to you. You can always take out the contributions that you’ve put into a Roth IRA and this is why a lot of times I’ll even tell people this is if you if you really want to optimize things, put your emergency fund into here and don’t invest it aggressively until you get up above a certain amount, but why not put it in the Roth so at least the interest you earn in there is tax free because if you have an say you put $2,000 into your Roth IRA and you need $2,000 a year from now, and you invested that as an emergency fund should be invested in your Roth IRA and like a 5% high yield savings, uh money market fund or something like that. You can pull that 2000 out tax free, penalty free. The interest has to stay in there until retirement age, but that’s going to grow tax free and after age 59 and a half that interest is completely tax free. everything you put in there is. So the Roth is just this wonderful account and the 401K version of it, it’s the same as the IRA and 401K normal traditional versions. You have the lower contribution limits for the Roth IRA, the higher contributions for the Roth 401K, and you can a lot of times at employers, you’ll have the ability to do either a traditional 401K or a Roth 401K, and that can be really helpful when you start bumping into higher income brackets and you want to contribute just enough to keep you below bumping into a 10% higher income bracket and and put the rest into the Roth 401K and those are some calculations that you kind of kind of need to do, but then you have the benefit of having both of those accounts in the future is that you have some tax diversification depending on whatever need comes up. The house of across the street comes up for sale, you’ve got Roth IRA money, the the giving you want to do some giving most tax efficient as possible. do not give your Roth IRA money that way. Give it from your checking account, give it from your IRA account if you’re over age 70 and a half. Uh there’s just you can start fitting these together and the returns that you get on just the tax optimization starts to hit the 10, the 20% return just by making those tax decisions, let alone what your investments are doing in there.
Mindy: I love the Roth option, especially for the IRA. Uh, the 401K because it has such large contribution limits, sometimes I like to reduce my taxable income, sometimes I like to have the tax free growth. Um, I do try to max out my Roth IRA every single year so that I can have the tax-free growth. I would say if you, the younger you are, the more advantageous it is for you to max out your Roth options because you put it in and you’re paying taxes typically, the younger you are, the less money you’re making, so you put it in you’re in a lower tax bracket. You have longer amounts of time for it to grow tax free, and then you pull it out with no taxes paid. Whereas if you’re, you know, 50 years old and you’re just starting a Roth IRA, it’s going to grow for what, five years, 10 years, 15 years, and then you’re going to start pulling it out. You’re still going to have more than you put in in theory, past performance does not indicative of future gains, but you’re still it’s not going to grow for 30 years and the compound that you can get for 30 years is amazing. Um, but yeah, if you have the option, again, same advice applies, go through the benefits that your employer offers and see if a Roth option is available. If it doesn’t look like a Roth option is available, ask your HR department just to make sure. Um, because if that’s enticing to you, you should really take advantage of it if you have the ability.
Guest: Yeah, and sometimes if you mention it to your HR department, they it, you know, you might be among a few people that mentioned it and it might get added. So that’s a really good reason to do it.
Mindy: We’ve got a few more accounts to talk about. We’re going to these are going to go a little bit quicker because they’re pretty straightforward. The next one up is the HSA or the health savings account is a type of personal savings account that you can set up to pay certain healthcare costs. An HSA allows you to put money away pre tax and withdraw it tax-free, as long as you’re using it to pay for qualified medical expenses like deductibles, co-pays, co-insurance, uh, pharmacy and also like random other things that you might not think of like contact solution, band-aids. There is a huge list of, I think it’s like 12llion different items that you can use your HSA dollars for. Um, what some people do with their HSA dollars since they are considered triple tax advantage because there’s no tax going in, it grows tax free, and there’s no tax when you pull it out so long as you’re using it for the right things. Um, people will cash flow their expenses as much as they can and just let this account grow. Uh, I have had an HSA for multiple years. We actually, to your point, Kyle, many of us at bigger pockets lobbied the, uh, powers that be and got an HSA option because we wanted this HSA option or a high deductible account because we wanted this HSA option. That’s another thing I have to say, the HSA is only available if you have a high deductible insurance plan, health insurance plan. So, if you have a high deductible plan, the HSA is an amazing account. Um, the contribution limits are $3,850 for single people and $7,750 for a family. That means every year you can put that much into the account. Uh, I’m not sure if it’s my plan specifically or all plans once you have $1000 in your account you can start investing it in the stock market. Um I think I can invest in anything I want, so I do. I think I have Tesla stock with
Guest: Nice.
Mindy: That was courtesy of my husband of course, that’s not probably what I would choose. But, um, yeah, choose high risk, low risk, you know, whatever you need, we’re just us using it as another investment account, which, you know, is really awesome.
Guest: Yeah, I think in general, uh, it’s kind of up to the the employer on that threshold for like the how much you have to have in cash and then move it to investments. I know some you can just put in investments right away. Um I used to tell clients to have with your HSA account, um maybe two to three years of your plan’s uh deductible in the cash part of it and then the rest of it you can let ride in the investment account. you three years may be to be safe because then you know if something big happens, you’ve got the deductible in there, it’s tax-free and the rest of it is growing long term for you. But if you can cash flow like you said and that that receipt strategy of using, keeping your receipts later on to reimburse yourself after the growth has happened. Uh that that’s a very optimized strategy that uh you can dive into on some other blog posts and podcasts. you know, the Mad scientist, he does some really good stuff on some of this HSA Roth conversion. uh well written blog post that you can look up if you’re looking to dive into it a little bit more.
Mindy: Yeah, that is a great point, um, and thank you for bringing up the receipts because I I actually have a huge pile right next to me. Um I forgot to mention that.
Guest: Nice.
Mindy: Let’s move on to the high yield savings account. We hear this a lot. What does high yield mean, Kyle?
Guest: Uh this can mean a few different things, but in general, it’s just a savings account often online uh because the reason banks are able to give a higher yield or higher interest on funds that are in the account, uh oftentimes online is because they don’t have the expense of brick and mortar stores and uh employees really, uh that that makes a big difference as far as dragging down the returns that they can get back to clients. So a lot of you might have heard of these, a lot of people, you know, some of the ones that are known in the industry ally bank, discover, um, American Express has actually had good rates in the past, uh Capital One, they have like a 360 account, there’s these change over time, but if you just Google high yield savings account, you’ll find ones especially, you know, nowadays, we’re actually getting some some actual decent rates, which people get all excited about. I’m getting 5% again on my high yield savings account and I’m like, that’s awesome but you’re getting eaten by 7% inflation. So, you know, it’s, it’s all relative, but you might as well get as much high yield as you can. You know, we were complaining about a high yield savings account being 1.5% two years ago, but inflation was like half a percent. So it’s not or the the official inflation was, I guess. So, which is better. Um, you can make up your own mind about that, but that’s those are kind of things that you look for. I would suggest if you’re looking for something like a high yield savings account to be careful to not go with a bank that looks totally obscure. Um, that, uh, might be giving a high yield to try to drum up depositors because they’re maybe in a tighter financial situation. So I would stay with a bank that’s well known, you know, that’s high yield but is, you know like Discover, American Express, Capital One, like some of these big banks that are have a good online presence and a big high yield account and maybe just take the 5% high yield instead of 5.7% from this Joe weird bank in Illinois. Sorry, Illinois. That there’s no intention there. I’ll say Oregon in Oregon where I’m at. Um, you know, this this bank that from nowhere that’s offering 7.5% that makes no sense. Um, so just go with something that’s reputable, but it’s a great place for an emergency fund, awesome place to have an emergency fund, boring. Don’t put more than 250,000 in it. so if the bank goes under, you get reimbursed by the FDIC insurance. It’s pretty much, I hate using the word risk-free, but it’s about as close as you can get to that.
Mindy: I will jump in there and say if you are one of those people who wants to pay off your mortgage, rather than putting money into your mortgage, put it into your high yield savings account and then you still have access in case you need this money. You are paying more towards your mortgage. So if you get to the point where the balance in your high yield savings account equals the amount left over on your mortgage and you’re like, yep, that’s the best use of this money according to me, then you can pay it off. But right now, my high yield savings account is paying me more than my mortgage is costing me and it doesn’t make sense to me to pay off my mortgage. And of course, I’m not judging anybody who wants to have the paid off mortgage, the peace of mind is way worth more than uh, you know, the 1% difference that I’m making or whatever. But, you know, for me, I would rather be making money off of the money that I’m not putting into my house. So, that’s a that’s a good compromise in my opinion because I just made it up myself.
Guest: No, that’s that’s actually a really good point because it it’s essentially a risk free account which paying off debt is one of the only risk-free investments you can make um because it’s it’s guaranteed it’s a guaranteed return right off the bat. Um but if you’re putting into like now we have so many people with a 3% ish uh mortgage rates and now you’ve got 5% ish high yield savings accounts. Why not put it in there. you can always throw it at your, you know, it’s not going to go anywhere. you could always throw it at your mortgage at some point if you want to and the difference is you always have access to it if life hits you in a way that you aren’t expecting. It’s a lot harder to go in and access the equity of your home if life hits you unexpectedly and if you have that high yield savings account, it really you can use it immediately if you need to.
Mindy: Let’s wrap up with the brokerage account, also known as the after tax brokerage account.
Guest: Yeah, the brokerage account, um, I don’t love the name brokerage account. I usually try to tell people it’s an investment account. You know, it’s just a plain investment account. brokerage, a broker is someone who brokers things, buys, sells things, but you can really buy and sell things in any of these investment retirement accounts that that we’re talking about. But a brokerage account in the industry is just a plain investment account with no special tax advantages attached to it. You get taxed as ordinary income on things that you buy and then sell within a year and you get a 1099 that comes and shows you what you have to pay in taxes for income and for capital gains and you get the capital gains ratete, a long-term capital gains rate on things that you hold for more than a year. It’s very plain vanilla from an investment standpoint uh or from a tax standpoint as far as what you have to pay. You get that 1099 every year that explains it. But the difference with the account is that you can invest in everything that you would probably invest a 401K IRA, Roth versions of those, but you can access it anytime without any penalty. The you might get hit with taxes, so if you bought Tesla 10 years ago and it’s in a non-retirement account and you want to sell it, Mindy and uh buy something like a Geotracker or something like that, then you’re going to pay some tax capital gains on what you sell and you’re going to pay it that year, but there’s no penalty. You’d pay capital gains on uh the geotracker that you bought 10 years ago and if it doubled in value because it was rare like a beanie baby, then and you sold it, you’d pay capital gains on that. It functions tax wise the same as just about anything that you buy and sell. So, it’s a good way to have another leg of your diversification from an investment standpoint. And you can open these on your own, you can have a financial advisor open them for you, you know, you can go to like an ettrade.com and open one of these and buy and sell anything you want uh from mutual funds, ETFs, uh stocks bonds. Um It’s just a very basic account that is very similar to these other ones without the tax advantages attached to it.
Mindy: I want to give a shout out to the brokerage account and encourage everybody to not only contribute to their 401K but also to an after tax brokerage account because should you decide that you want to retire early, what are you going to do with the millions of dollars in your 401K when that’s all you have or you have 401K money, a little bit of Roth IRA money and then uh house and all your equity is tied up in your paid off house. There’s not a lot of things left to live off of. Yes, you can pull money out of your 401K, but then you’re paying taxes and penalties if you’re below a certain age, whereas if you would have diverted some of that money from the 401K into the brokerage account, then you’ve got more buckets to pull from, more options.
Guest: Yeah, definitely. And that if you can think about a lot of times people think about diversification from the standpoint of different assets, real estate, stocks, bonds, things like that. But you also need to think about tax diversification. So if you can have a brokerage account that has a certain tax characteristic to it, Roth IRA, Roth 401K, traditional IRA, traditional 401K, real estate, being able to pull equity out of a property which is tax-free, which is a phenomenaal way to uh optimize some of your income at different points. If you have these different legs of this tax diversification stool, you can piece income together, especially in early retirement. um but even in traditional retirement, you can piece together income that you pay little to no tax on pretty easily by staying within certain tax brackets and depending on where you pulled the funds from. Uh it’s very important to have that. So yeah, I’m glad you mentioned that Mindy just making sure that this is a a good piece of your overall strategy because you you don’t know where where it’s going to come in handy and what your income’s going to look like.
Mindy: Yeah, I, I love it. I love this episode, Kyle. Thank you so much for joining me today and giving such great diverse answers for all of these different types of accounts. I appreciate you so much.
Guest: It’s always fun to nerd out on accounts, the stuff optimizing, how I can pay less in taxes and uh help other people do it too. This this is cool stuff. So, yeah, thanks for having me.
Mindy: All right, that wraps up this episode of the Bigger Pockets Money podcast. He is the Kyle Mask. I am Mindy Jenson saying got to run skeleton.
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