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🤓 Tax Planning Strategies for Early Retirees with Sean Mullaney 🎓
1.1k Plays3 months ago
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🤓 Sean Mullaney discusses Tax Planning Strategies. Sean, a CPA and financial planner, also known as The FI Tax Guy explains fundamental tax planning strategies, some advanced tax strategies and concepts, and how the financial independence community may be getting it wrong when it comes to taxes. ❌
🔑 Key Topics Discussed:
👉 Introduction to Financial Independence Tax Planning
👉 Top Five Tax Planning Strategies
👉 Reducing Taxes Through Daily Habits
👉 Tax Strategies for High-Income Earners
👉 Solo 401k and Small Business Owners
🔗 Sean’s Links:
🎥 Sean's YouTube Video: Pay NO Federal Income Taxes in Retirement!!!
📜 IRS Trade or Business Defined
🔗 David's Links:
🍏 Forget About Money on Apple Podcast
🎧 Forget About Money on Spotify
🕒 Timestamps/Chapters:
0:00 - 🎙️ Introduction to Financial Independence Tax Planning
5:21 - 📋 Top Five Tax Planning Strategies
14:07 - 🏦 Reducing Taxes Through Daily Habits
24:41 - 💼 Tax Strategies for High-Income Earners
29:30 - 🏢 Solo 401k and Small Business Owners
34:12 - 🏠 Exploring the Buy, Borrow, Die Strategy 36:45 - 🏡 Inheritance and Real Estate Strategy
46:45 - 📈 Accumulation vs. Decumulation Strategies
55:29 - 🏥 Taking Control of Your Health and Healthcare
1:01:13 - 🔍 Annuities - Risks and Considerations
1:07:54 - 📜 Tax Cuts and Jobs Act - Extension Predictions
1:10:54 - 🌟 Emerging Tax Trends and Exploration Opportunities
1:13:18 - 🧠 Critical Thinking in Financial Decision-Making
1:16:50 - 💡 Misconceptions About Roth IRAs and Traditional Accounts
1:20:22 - 🌅 Proactive Healthcare Approaches for FI Community
🎧 Listen & Subscribe: Don’t forget to subscribe to "Forget About Money" for more insightful episodes featuring experts who guide you on achieving financial independence and optimizing your tax strategies. Hit the bell icon 🔔 to get notified of new episodes!
#️⃣ Hashtags: #TaxPlanningStrategies #SeanMullaney #TheFITaxGuy #FederalIncomeTaxChanges #TaxBrackets #StandardDeduction #HighIncomeEarners #TaxOptimization #EarlyRetirementTaxPlanning #Solo401k #FinancialIndependence #BuyBorrowDieStrategy #TraditionalRetirementAccounts #TaxMisconceptions #RetirementInvestmentAdvice #TaxDeductions #TaxExemptions #TaxCredits #TaxTailWagTheInvestmentDog
The discussion is intended to be for general educational purposes and is not tax, legal, or investment advice for any individual. David and the Forget About Money podcast do not endorse Sean Mullaney, Mullaney Financial & Tax, Inc. and their services.
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Transcript
Introduction to Sean Malaney and Podcast
00:00:00
Speaker
The CPA of the Financial Independence Community explains the tax planning strategies you need to know to help you retire early. Here we go.
00:00:12
Speaker
Welcome to the Forget About Money podcast, where we encourage you to take action today so that you can focus on what matters most to you. Today we have Sean Malaney, also known as the Phi Tax Guy. Sean is a CPA and financial planner who specializes in helping clients achieve financial independence through smart tax strategies. We've known each other for more than a few years now, and I think of Sean as the guy who makes taxes more approachable for the rest of us. So thank you for that, Sean, and welcome.
Sean's Journey and the Birth of His Blog
00:00:42
Speaker
David, thanks so much for having me. Looking forward to this conversation. Today, we're going to discuss fundamental tax planning strategies, some advanced tax strategies and concepts, and how the financial independence community may be getting it wrong when it comes to taxes. Let's start with you, Sean. You have been a voice in the financial end independence community for quite some time. And honestly, I can't think of another tax professional that as such
00:01:11
Speaker
focus on the financial independence community specifically. ah Can you just talk about your role in the financial independence community and what your goal is there? Yeah, David, so um part of the reason I make content for the financial independence community is financial independence sort of um opened or turned the light on for me when it comes to a lot of these tactics. So what do I mean by that? I used to be, sort of a before I changed my career to a financial planner, I was a bit of a hobbyist when it came to personal finance. you know Back in the day, I would read The Wall Street Journal, Weekend Investor, and I'd see, oh, there's an article on the backdoor Roth IRA. Isn't that interesting? Or let's talk about index investing. Isn't that interesting? And it was in early 2017, I found the Choose a Five podcast.
00:02:00
Speaker
And what it did was it said, okay, we have these different tactics out there, 401k contributions, backdoor Roth, index investing, whatever it might be. And it made them a whole. right Instead of just talking one off about the backdoor Roth IRA and moving on with our life, that's great. Well, what it did was it said, no, no, no, there's a goal here. There's a framework here. We put all these things together in some orderly fashion for ourselves and it makes sense holistically. It's not about a one-off conversation or going down a rabbit hole. It's about putting it all together.
Key Tax Strategies for Financial Independence
00:02:33
Speaker
And so that's what the financial independence community did for me in terms of the way I approach personal finance.
00:02:39
Speaker
And then you know i I did a career change in 2018, 2019, became a financial planner. And in order in today's environment to sort of have a presence, you got to produce some content. And I sort of stumbled on, hey, why don't I produce content that's relevant for a particular audience, in this case, the financial independence community? And that was actually inspired by somebody you know very well, Stephen Boyer, your brother. um I went to a camp five back in 2018. And I was having a conversation with a woman who happens to be the admin for the Chooseify San Diego group, Jennifer Ma. And we were talking and it was very obvious I was interested in taxes. And so she said, hey, Sean, you know why don't you come down here and speak to us? um So I went down on a saturday afternoon down or Saturday morning down to San Diego, spoke about taxes and financial independence. And I was doing my career transition at that time.
00:03:31
Speaker
So you know midway through that talk, I got the bright idea, well, I did a lot of prep work for this talk. Maybe I could turn some of that prep work into a blog. And that's where the idea for the phytaxguide.com blog came from. i you know I can't say it was all this great machination, this incredible you know thought that I had. No, it was literally, I talked to some people, you know they talked to me, I did some stuff and then an idea came into my head and not because I have some grand marketing genius, it was just like, hey, wait a minute, this makes sense. I've already done a lot of the legwork on this. I could probably set up a blog and hey, it it appeals to the financial independence community. So that was a ah lot of strokes of luck and people like your brother, people like Jennifer Ma you know helping out, they didn't intend for me to have a blog. They just said, hey, Sean, here's a forum. You can come speak to people, hear people. And it worked out really well.
00:04:24
Speaker
I think that's very interesting about how things evolve for each of us in this community. Somebody attends a campfire. Next thing you know, theyre they've got a blog. They're starting their own business. They're getting their spouse on board. They're making significant changes in their financial picture for the better. It's pretty amazing how it all works out. And I feel like we're all on this kind of ride together in a very positive direction. And thank you for all your help. And i'm I'm glad that you took action to start your blog as well as I don't know how many times you've spoken at a campfire now. I know personally of at least three. I'm not sure if it's more than that, but probably. At least four times. It's each of the last
00:05:04
Speaker
um I've been sort of lucky to be able to go to Camp Phi each year. I think it's every year that Stevens held one other than 2020. I have gone to a Camp Phi, and I believe I've spoken at the last 21 through 24, so that's easy math four times, it's and it's been great. Really enjoy them. Right now, we're talking about the financial independence community specifically, but taking a step back to the broader personal finance world, taxes are something that we all need to be very aware of and at least have some kind of cursory understanding of how it impacts and how our actions can impact taxes and our overall net worth growth.
00:05:45
Speaker
over time, if you were going to provide a list of your top five tax planning strategies, what would they be and why? Yeah, so David, I would step back even further from that and say, we got to think about strategy, we got to think about tactics, right? And if we talk about five tax strategies, we might be here all day. um I think for the audience, I'm going to give you one strategy and then five tactics that I really like for many in the audience. right We're not giving individual advice here, but I think we're going to provide some good educational knowledge.
Tax Planning for Early Retirees
00:06:16
Speaker
so The first thing is the strategy. I think for most in the Fi community,
00:06:20
Speaker
The overall strategy is let's use retirement accounts to limit total lifetime income taxation. right Basically, it's a fancy term for that is tax rate arbitrage. What we're doing is we're saying, hey, we have these high earning years at work. We're saving up. We're saving up. we're at our highest tax rates in terms of marginal tax rates. So we take our deductions then as best we can get them. Then we get into a retirement that's somewhat early by conventional standards, and now we're cooking with gas. We have abilities to manipulate the tax code perfectly legal. right this This is all about legal, very legal, very bread and butter tax planning where we say, hey
00:07:00
Speaker
We're early retired. Guess what? We've got low taxable income. We're now going to cook with gas in terms of maybe Roth conversions, charitable giving, that sort of thing. Okay, so that's the overall strategy. Let's use these retirement contributions to limit total lifetime income tax. Well, how do we do that tactically? um I'll give you five ah tactics that I tend to like. The first one is the traditional 401k, and this one comes in for some heat from some other personal finance content creators out there. They say, oh no, these traditional 401ks are infested with taxes. My work yields, hey, you know what? They're not all that bad on the out end.
00:07:41
Speaker
And the thing is, people forget the tremendous benefit when we're saving for retirement. We are taking home a tax benefit, federal and possibly state, at our highest marginal rate. That is such a very powerful benefit. And that actually leads me to my second tactic, which is taxable accounts. People say, oh, no, taxable accounts, they're taxable. That sounds bad. Well, we live in an incredible environment, qualified dividends, long-term capital gains. Many of those can go at a 0% tax rate in retirement. So why not build up some of those things, live off them first in early retirement, and it turns out your tax burden can be very, very low and you can do some additional planning where you do Roth conversions.
00:08:25
Speaker
So I'd say first tactic, traditional 401k contributions while we're working. Second tactic, taxable accounts, um just building those up for an early retirement. The third tactic would be the Roth IRA while we're working. And this could be a backdoor Roth IRA, where we do a two-step transaction to get around something called a pro-ratter rule, or it could be just a regular annual Roth IRA contribution. I like Roth IRAs for a number of reasons. One, they can be an emergency fund if we need to. We don't like to use it as an emergency fund, but we can. And then second, we generally don't sacrifice in most cases, not all cases, but most cases, we don't sacrifice a tax deduction when we do a Roth IRA contribution the same way when we do a Roth 401k contribution, we're sacrificing a tax deduction.
00:09:12
Speaker
And then the fourth kind of the fourth tactic I'll mention is the health savings account, right? This is where we are signing up for a high deductible health plan. So oh, by the way, we're lowering our ah medical insurance premiums. That's a good outcome. And we're taking a deduction for contributions into our HSA. So that's great. And then when we retire, we can take that money out tax and penalty free because we have old unreimbursed expenses or we have current expenses and we just pay for them that way. So the fourth tactic would be the health savings account. And then the fifth tactic would be Roth conversions. And this is where I and other financial planners and content creators very much align. right This is the flavor of the day. Get to retirement, especially in early retirement, and do these Roth conversions, um even in a conventional retirement. There could be very, very powerful opportunities because what you're doing is you're whittling down that traditional retirement account
00:10:08
Speaker
at your timing, not the government's timing. You're saying, hey, you know what? um I have an artificially low tax return this year. so instead of you know One thing I think most of the audience want to avoid is filing a ah negative tax return, where your taxable income less your standard deduction is a negative number. right ah That's an indication that before your end, don't let that happen. ah Do a rock conversion please get back to zero you might want to do more by the way you might want to do a lot more by the way you got to do your own analysis but. um Usually a negative tax return is something to be a boy so i'd say those would be my five tactics and we can do as you want to we can explore any or all those in more detail.
00:10:49
Speaker
I remember a conversation that you had and I believe that the overall conversation was about how our habits themselves can reduce how much taxes we pay practically in our daily lives. So let me ask specifically, maybe you'll talk about this. What are some ways we can reduce our taxes today, not necessarily just in retirement? Yeah. So the big one in terms of today is these traditional 401k contributions. If we've got that at work, we got to think long and hard before not making those contributions. It's just such a great way to reduce our taxes. And you got to remember we have progressive tax brackets. So what I mean by that is we have a standard deduction, which is effectively a 0% tax bracket. And today it's very high. I think it's 29,200 for a married couple. That's a very high amount.
00:11:41
Speaker
Okay, then we have a 10% bracket, a 12% bracket, a 22% bracket. Well, during your earning years, what happens is this, you make 401k contributions, the tax benefit isn't at the 0% or 10% bracket, it's at your highest bracket, because it comes off the top. So it's it's the most tax dollars that you'd be putting into that 401k and not paying tax on them. That's part of what makes the 401k so powerful is you're taking the highest tax dollars and you're saying, don't tax me on them today. Well, wait a minute. I'm going to be taxed on them tomorrow. Yes, but I'm going to go back through the brackets and I'm not going to have that much income to fill up those brackets.
00:12:21
Speaker
So they're gonna be some people who take some of that 401k out, maybe it's a traditional IRA at that point in retirement, and it's gonna be protected by the standard deduction. I call that the hidden Roth IRA. Because I'm saying, wait a minute, I'm taking money from a retirement account, I'm not paying tax on it. That's a Roth IRA. No, it's a hidden Roth IRA that lurks inside a traditional 401k. So powerful. But even if it, you know, hey, I have other income fine, it goes maybe against a 10% bracket, the 12% bracket. Well, if I deducted at 24, 32%, and I included back at income at 10%, 12%, 22%, I'm still printing money off the government because I deducted at a rate that's higher than the rate I later included it back into income, right? So that'd be the big thing. The other thing about habits and your taxes, and this tends to be more true in retirement than during your working years.
00:13:10
Speaker
In retirement, the income tax tends to look like a consumption tax. So what do I mean by that? A lot of times, one way we can reduce our taxes in retirement is by consuming less, taking less out of our traditional ah retirement accounts, um less out of our our taxable accounts. In retirement, the income tax starts to morph and look a little bit more like a consumption tax, not perfectly so. So if we're not spending on things that are just going to go into closets and we're never going to see them again, and it was just a quick dopamine hit, we're actually going to reduce our taxes. So look, I'm not here to say be a miser in retirement, far from it. I think the 4% rule actually, I think often makes us too conservative in retirement. So don't be a miser in retirement, but why are we spending for the knickknacks
00:13:58
Speaker
that get dusty we never see again and then create a deferred problem for our loved ones when we die they now have a decision make do i throw this out do i sell it to recycle it. Like why are we doing that when that tends to increase our taxes in retirement so i think just getting in that habit of like hey you know what i just want to be intentional with my spending. not that i'm I'm miserly. I think many in the fight community need to avoid miserliness, but also avoid the the the accumulation of, look at all these closets I got in my house that are packed to the gills and how much how often do I use this stuff? Yeah. Yeah, that's a very good point. Just our habits today, not only is that you're not paying the taxes on that right now, but you're benefiting
High-Income Retiree Tax Reduction Strategies
00:14:41
Speaker
your future by having
00:14:43
Speaker
other income going to those tax deferred accounts or tax exempt accounts for your future. So yeah, that's a very good point. And I was very inspired by that talk at camp five, it was camp five Southwest a couple of years ago, you gave that one. Our focus generally is on those who are striving for early retirement. And, but when we first learned about early retirement, you know, we were gung ho on all the blogs, the podcasts, just like this one. And then, okay, we get the of the optimized retirement accounts, doing this, doing that, emergency fund, Roth, 401k, their savings plan, max out, max out, max out. But we really don't think about taxes that much at that time. Those are all good things to do. But at some point, something in our brain goes, wait, what about taxes? How
00:15:30
Speaker
is tax planning different for those who retire early compared to those who retire at a traditional retirement age? I would say that for those retiring early, it tends to be incredible. It tends to be that much more advantageous. I have a ah little saying that the federal government, through its tax laws, wants you early retired and it wants you married. right Now, that said, single people can absolutely get to early retirement and have tons of play in the joints and create tax planning. you know let's Let's imagine somebody who retires at age 70, right? So they work through up to their 70th birthday. So they have all this W-2 income and it just fills up their tax return. they have a lot of lot few They have fewer planning opportunities from a tax perspective.
00:16:17
Speaker
And then at 70, they have to take Social Security anyway, and it's going to be higher because they work later. And so they have a situation where the tax plan is going to be a lot more challenging because they don't have years of very low income. Well, you say, well, what about somebody who retires at age 50? Okay, let's think about that person. So they have the high W2 income in their 40s. We know that. So the tax plan is going to be limited there. Maybe you know do your traditional 401k, maybe a backdoor Roth IRA, maybe some charitable giving. Fine. But once we get to age 50, now we're retired. We have to think about what would hit our tax return if we're fully retired. Let's just say we're fully retired. Well, we know we can't take Social Security until age 62 at the very earliest. So we're going to have 12 years at least and probably more with no Social Security income. Great.
00:17:02
Speaker
Well, okay, maybe we have a small bank account, and maybe that generates 4% to 5% interest. It's something, but how um how much do we really are we going to have in the cash? But okay, that's a little bit income, but not much. And then all we have ah in our taxable brokerage accounts, we have domestic equities, we have international equities, say. Well, domestic equities, if we look at the broad-based index funds, these days they yield like 1.5%, something like that. right So how much income? i mean Let's say we ah had a million dollars invested in a taxable brokerage account um in retirement, and it's a diversified US index fund.
00:17:40
Speaker
All right, that's $15,000 of income on a on a million dollar holding. That's incredible it's how low that is. And then you got to remember that qualifies as mostly qualified dividend income. So it might be taxed at a 0% rate. So that 50-year-old has a tax return that says, hey, I'm poor. Now, they're probably not poor if they're retired at 50, but their tax return says they're poor. So that makes it so much powerful if we can get to early retirement tax return without any other planning says we're poor, well, great. We can now fill up you know the standard deduction, the 10% bracket, 12% bracket with these Roth conversions and be cooking with gas where we're getting that money over out of our traditional retirement account to our Roth account. And it's going to be relatively lightly taxed because we're going to be going up through the standard deduction, the 10% bracket,% bracket.
00:18:34
Speaker
um You know for those on the fence and in the community you know out there listening to the podcast and fifty three years old i just don't know should i retire should i not. The internal revenue code is saying you probably should ah you know so ah that's why getting to early retirement can be so much more powerful but even if we retire in our sixties we still have opportunities right and this is all or nothing. I think another, correct me if I'm wrong, but another benefit of showing little to no income in retirement or early retirement is that you also qualify for other subsidies such as medical coverage. Yeah, so the premium tax credit. And so that is something, look, by the way,
00:19:12
Speaker
There are people out there, this exists in the world where they get to 55 or something like that and the employer pays for the medical insurance for the 10 years between 55 and 65, right? So that exists, but most people in the audience, I mean, there's tri-care, that exists too, but most folks in the audience are probably going to look at an ACA plan if they retire before the age of 65. And what you're alluded to is something called the premium tax credit where, hey, you know what? If we can keep our income low, we can get a very high premium tax credit against the high premiums. And one of the ways to do that is to have you know be taking our money from our taxable accounts instead of say traditional accounts. And why do I say that? Well, let's say your living expenses are $100,000 in early retirement.
00:19:59
Speaker
You could use a 401k or a traditional IRA, and it's not even that
Solo 401k Benefits for Solopreneurs
00:20:03
Speaker
bad, but pretty much all 100,000 is now income, which could reduce your premium tax credit. Okay. We'll say, I don't want to do that because I want more of a premium tax credit. Well, if you lived off 100,000 of a mutual fund in a taxable brokerage account, you just sell the 100,000. Well, what happens there? Well, when you sell it, you know you're not taxed on 100,000, you're taxed on the gain. So you got to have some basis in that thing. I mean, unless the thing just shot to the moon, right? ah You got to have 20,000, 30,000, 40,000, 50,000, 60,000, a basis. So the income isn't going to be 100,000. It might be 80,000, 70,000, 60,000, maybe 40,000. So we're we're keeping our income low by using these taxable accounts. And that keeps our premium tax credit high. And we still may have some room for some good Roth conversions in that scenario too.
00:20:57
Speaker
So we just focused on the benefits of having or at least showing low income, but many people are actually retiring on a high income. I know there's the you know things I hate about the fire community, things going around, especially lately, but Not everybody in the fire community is so frugal that they have to live or decide to live on $23,000 a year. Some are higher earners still in retirement. What if a person is a higher earner or if they have a pension, how does a high income earner reduce their taxes? So David, um um it's it's funny. Later today, I'll be working on my own YouTube channel. I have a little YouTube channel, show them a lady videos for those in the audience. Great, good.
00:21:41
Speaker
i'm going to do like to I'm going to record a video where I've got a 66-year-old married couple where they spend $150,000 a year in retirement. And in that year, they will pay zero federal income tax. And you say, that's a scam, Sean. There's no way. Well, I prove it in the in the video. I've got a little spreadsheet I'll have in the video. um how does How does that high earner, that affluent couple, reduce their tax or pay very little tax?
00:22:12
Speaker
And in my little video, the main way they do it is through capital gains, is they say, well, we're going to spend 150, but our gains are going to be 75 or whatever, you know, i'm forgetting the exact numbers in the video um that I'm going to make later today. So that's part of the reason I'm forgetting it, but okay. um So that's one of the ways that couple winds up paying zero federal income tax even though they're spending twelve thousand five hundred a month, right? Think about it. If you spend twelve thousand five hundred a month in retirement, you're probably going on some nice vacations, yada yada. So that's a pretty good place to be.
00:22:45
Speaker
So that's one way you can limit your income in retirement. Another way is strategic Roth distribution. right Financial planners hate taking money out of Roth IRAs. um um um low you know I worry about it because, hey, that's tax-free growth we're giving up. But say, David, someone like you um has a military pension or something like that. So military pension is going to create taxable income. but That's my understanding. I don't really work. There's only so many types of people I can work with and military just hasn't come across my radar. But I'm going to assume just for the purposes of this conversation, that's a taxable thing. Sure is. Yeah. and And that's a good problem to have. But maybe somebody like you, and I'm not giving you individualized advice here, but just academically, you should think about this.
00:23:31
Speaker
Maybe somebody like you is taking your military pension and you got a little bit of other income and the YouTube channel's blowing up and so that's throwing off some income and that sort of thing. So it's blowing up so big right now. David's got this huge problem now, guys. Yeah. yeah that you know Hit like and subscribe. But anyway. um So let's just say you're in you're coming up to December and you're like, oh, I'm looking at my YouTube income, my military pension, interest dividends, and hey, I'm on the border of a tax bracket. So maybe I'm just at the top of the 12% bracket or top at the top of the 22% bracket or even the top of the 24% bracket.
00:24:09
Speaker
And I need some money to live for December. right i just need like Literally, we got to get some groceries, got a few more Christmas gifts to get. i got you know I got the heating bill to pay and all this sort of stuff. So um okay, I got to take some money. If I take it from the traditional retirement account, it's going to increase, it you know get me into the 24% bracket or the 22% bracket. I don't want to do that. Well, maybe I take a Roth distribution instead for December. I do that so that I don't slosh over into that next tax bracket. Roths are great and we love tax-free growth, but let's use them strategically in terms of our drawdown where, hey, there's some years where our income got higher and we're back to go over that next bracket.
00:24:54
Speaker
why don't we take a Roth distribution tax-free, and in most cases it will be, particularly if we're over 59 and a half and five years it's going to be tax-free, but for most Roth distributions from a Roth IRA before 59 and a half, they tend to be tax-free too. So let's take a little Roth distribution, use that for our living expenses and not go into that next tax bracket. And I think for those in the audience with pensions, I think that sort of thinking is going to be very important because it's going to be harder for you guys to say, oh, I'm just in the 10% bracket, or I'm in 12% bracket, and I don't have to worry about 22 or 24. When we have a pension, we're creating income that's just filling up that 0%, 10%, 12% a lot quicker. And we just got to be a little more strategic about it. All right, I'm gonna have a lot more questions on a one on one with you at some point. Because I ah pay a lot of taxes. Sean,
00:25:44
Speaker
Let's move on to advanced tech strategies and concepts. You have written a book, and I don't know if you know this, but I actually purchased that book. Thank you for your business. I appreciate it. Yeah, and there'll be a link in the description for those who are interested. How does a solo 401k plan fit into your overall tax planning strategy, especially if you're a small business owner? And can you define a small business owner? So the solo 401k is like my book title says the solopreneur's retirement account. And by the way,
00:26:15
Speaker
I was at a conference last year, and someone claimed there's a statistic
Real Estate for Tax-Free Cash Flow
00:26:19
Speaker
out there. I'm not i'm not going to be exactly right, but directionally, it's something like there's 28 million businesses in the United States. So that's everything from Apple computers to Shammalay's YouTube channel, right? And everything in between. And of them, 21 million of those businesses have one and only one owner. So that means there's 21 million businesses that should at least be thinking about the Solo 401k. Solo 401k is the 401k for those people who own their own small business. And it works a lot like a traditional 401k at a large employer like Apple computers. But to my mind, it's better for two main reasons.
00:26:59
Speaker
One is you decide the investments and the financial institution. right So you go to work for Apple computers, that's fine, but they have their own 401k. Their HR department picks the financial institution, the investments. When you have a solo 401k, you get to go on the internet and do your research of the different financial institutions, the different investments, and you decide which financial institution, which investments. That's great. The second thing is, and you know one of the one of the drawbacks of being a solopreneur is that it is a great way to pay a ton of taxes, right? Because now you pay both halves of payroll tax, you pay income tax. Now, the solo 401k doesn't reduce payroll taxes, but it can significantly reduce income taxes when we're working.
00:27:46
Speaker
And um you know i know it again to a large employer for one case let's use a round number hundred thousand dollars. Say there's somebody who works for a large employer to make a hundred thousand dollars and say there's somebody who's a solopreneur and they make a hundred thousand dollars on the cause schedule see it's a report it's a form that report your income from your business okay. So, you work for a large employer, you do the 23,000 contribution to your regular 401k, great. And then your employer has probably a small match. So, maybe it's a 100% up to 3% of compensation, maybe it's 50% up to 6% of compensation, maybe it's even a very generous match, it's 100% up to 6% of compensation. So, that would be a $6,000 employer contribution. That's great, okay?
00:28:35
Speaker
Solo 401k is much better because now the only things you're limited by on the employer side, you get that 23,000 yourself. Okay, great. What do you get on the employer side? Well, you're only limited by the tax law and your cash flow. And the tax law says the limit for about $100,000 is something like $18,500 and a little change. So instead of maybe a 3,000 employer contribution or a 6,000 employer contribution with the same numbers, we're at $18,500 and some change. That's pretty good. And we could tax-deduct all that. That's fantastic.
00:29:13
Speaker
um you know When we're self-employed, we got a lot of things on our plates, and retirement savings can be a little complicated. But the Solo 401k, it's not rocket science. I know that to be true because I wrote a 200-page book about it. right So it's definitely not rocket science. um And it's a very powerful opportunity to reduce our taxes during our working years and build up tax advantage wealth for our retirement. So I'm a big fan of the Solo 401k. I like to joke that I'm both a pusher and a user. I have one myself.
00:29:46
Speaker
um And yeah, it's just a very powerful account for you know so a form of employment that is growing. right In a tech-enabled world, we're just going to see more solopreneurs out there. And so I think we just need to raise visibility and awareness around these solo 401ks. Now, that this might be a completely dumb question, but what is who is limited? Who can't do a solo 401k? Can a sole proprietor do a solo 401k? Yeah. and And David, that's generally the person it's targeted for, the sole proprietor. So let's talk about who... Okay, so you don't have to be an LLC, you don't have to be an S-corp or C-corp. You can be a sole proprietor yes and still have a solo. Yes. So let let's talk about who can and can't do a solo 401k.
00:30:28
Speaker
If you don't have a ah so a business of your own, so you have a W2 job, you you report every day, great. That's fine. You can't do a solo 401k because you don't have your own trader business. If you're retired, you're fully retired. Well, that's fine, but you can't contribute to a solo 401k because you have no self-employment income. um The main requirements for establishing a solo 401k is having a trader business that produces self-employment income to you. And then you have to generally have few, if any, employees. And this varies plan to plan. So if you have no employees other than yourself, you're good.
00:31:07
Speaker
right? But then you have to say, well, wait a minute, I have this part time employee, then you got to go through some hurdles, right? And to the extent we have full time employees, it's going to be very difficult, if not impossible. Full time is generally defined as 1000 hours, but can be 500 hours a year if it's you know in two consecutive years or two years, ah the rules are changing in this regard. But basically, it's it's intended for those whose only coworkers, generally speaking, are their spouse or maybe they have business partners. like This can exist with a partnership or an S-corporation.
00:31:40
Speaker
And you don't have to have an LLC, but you can have an LLC. You don't have to have an S corporation, but you can have an S corporation. So in the book, I touch on and I go over the eligibility, um but it's really for the solo, it's for the sole proprietor, colloquially referred to as the solopreneur, but there's some play in the joints there. Okay, so you said something that con confused me just a bit. In my case, I'm retired military, I have a pension. I do some things on the side that could get an income. Yep. Would I qualify for a solo 401k?
00:32:14
Speaker
So, what i can do what I can tell you, David, is what you have to look at is, do you have a trader business? right And so, trader business requires some level of... It should be a trader business for this purpose. You don't have to be Apple computers. right You don't have to be selling iPhones in 50 states and 100 countries. But you have to have something that looks like a business. You can't just like mow the neighbor's lawn one time for 50 bucks and say, Hey, I'm now i'm going to open my solo 401k. That doesn't work. But like I said, being a trader business does not exactly require Apple computers level of commerce. So it's it's a subjective determination. um The other thing to keep in mind too, is if we're if we're only making like 500 bucks,
00:32:59
Speaker
Well, the opportunity on the table is like 500 bucks to get into a solo 401k, right? So part of what we want to think about is, well, wait a minute. Yeah, I have some side hustles, but they make me like a thousand bucks a year. It's like, what are we doing doing solo 401k? That's just not going to have much impact on our lives. um But like I'm saying, it doesn't it doesn't need to be the level of Apple computers. I can actually send you for the show notes. There's an IRS website that lists the factors that they look at, which I think is a helpful website for us on the taxpayer side to at least, hey, we've got some factors the IRS is looking at to determine whether we've got a trade or business here.
00:33:34
Speaker
Okay. I'm just writing that down. Sean, one of the things that have been floating on my YouTube algorithm gets fed to me is a strategy that ah somehow I've dodged it all these years of like even looking at it or finding it, which is hard for me to believe because I, like many others in the financial and independence community have searched and explored the entire web.
Simplifying Investment Strategies
00:33:58
Speaker
for all of this money stuff. But recently, ah it seems like every day I get three or four videos talking about a strategy, and that strategy is called the buy, borrow, die strategy. Can you quickly... I know it's not a simple strategy, but can you quickly, as quickly as practical, describe what that is and then
00:34:22
Speaker
let me know and the listeners know if that's something even worth exploring and why it might be or might not be. Yeah. So um what this strategy mostly leverages off of is real estate. um And oh, by the way, we all are, many Americans tend to use a very small version of this in their own personal finances. I'll come to that. But in theory, what you could do is, let's say, David, you're worth $10 million. okay let's just Let's just assume that to be true for a second. okay um Great assumption. What you could do is you could park that money in like rental real estate. so Literally, you just go buy 10 million of condos or whatever, and
00:35:05
Speaker
That produces an income to you that's very tax-advantaged because of depreciation deductions. So you might not pay any tax or you pay very small tax because of these depreciation deductions on the income generated by $10 million dollars of assets. Think about if you had said invested that in bonds at 4% or 5%, that would have produced $400,000, $500,000 of taxable ordinary income. So it's a great way, just putting the money in the real estate hides it out from Uncle Sam because of depreciation deductions. So that's one thing we're doing that's really advantageous. But you say, you know, Sean, um that rental income, that's not enough for my high flying lifestyle.
00:35:43
Speaker
So what's step two here? Step two is take out some loans on that $10 million dollars of rental real estate. The bank will give you a loan. And especially before we got to 78% interest rates, this was very attractive. Oh, I got to pay 2% to the bank. Oh, this is fantastic. So now you're cashing out of that um of that real estate and you're not paying any tax on it because it's alone a loan. A loan is not taxable to you. So now you have a way of getting cash, live your lifestyle. You've just borrowed to fund your lifestyle against a real asset, an that but an asset that also is very tax-advantaged by itself. So now you have two sources of cash to live your lifestyle.
00:36:27
Speaker
rental income, which is protected by depreciation deductions, and loan proceeds, which is not taxable. So you've now created tax-free cash flow, which is fantastic. And then you say, well, but at some point, we got to pay the piper here. Well, okay, why don't we do this? We die holding this. And um all right, so our heirs get 10 million of real estate with a step up in basis. So maybe it grew up to 12 million. Well, their basis isn't the 10 you paid, it's 12 million or whatever the fair market value is on your day of death. But yeah there's still debt in this picture. right Well, all they have to do is on the way home from the funeral, they call their real estate agent and they say, hey, sell one or two of these properties to satisfy the debt. They don't have a capital gain on the property right because they have the step up in basis at your own death. So now they pay off the bank
00:37:19
Speaker
And nobody ever paid tax on any of it. And oh, by the way, in the property they keep, they get to step up the depreciation deductions based on the new fair market value at your death. And now they can repeat it, right? So in theory, this is like, oh, isn't that fantastic? Now, that has it has plenty of drawbacks, right including you have to be good at real estate. It's not for everybody. In fact, its i I'd argue it's not for most people. But what tends to happen during our accumulation years is we tend to do a little mini version of this through our home mortgage. right So what that home mortgage is doing, you know technically, it's a lean debt against our primary residents.
00:38:00
Speaker
But what it's really doing is it's opening our runway to invest in the stock market through our 401k, through our taxable brokerage. By not paying down the mortgage sooner than it's 30 years and just even having it for the 30 years, we have more runway to put into the stock market. So we're borrowing from the bank. Yes, technically it's to acquire the house, but functionally money's fungible. So what it tends to do is it allows us to invest more in the stock market that way. So we're doing a mini version of this anyway. I will say though, you know you should not let have the tax tail wag the investment dog and rental real estate. There's no guarantee you, I, or anyone else will be successful at rental real estate. That's a business and you have to have knowledge and skill to be good at it.
00:38:45
Speaker
You mentioned accumulation versus decumulation. And in the buy, borrow, die strategy, would there be a difference if you were trying to accumulate versus, is it decumulate? Is that a word? Decumulate, deaccumulate? Yeah, so I, I, decumulation, um, I've heard that term used at the Bogleheads conference that, you know, they talk about accumulators versus decumulators. I think that's like the term mentee. It wasn't really a word, but people just made it up so much. I think it's becoming a word. ah But anyway, that's a different conversation for a different day. um I view this, I think, in the Fi community, at least in theory, this is more of a strategy in the decumulation phase. And again, I think most people should just look, it's it's it's it's putting everything in our in the rental real estate basket. We may not even be good at it, so I don't think it's really all that advisable.
00:39:35
Speaker
But what it's trying to do is it's trying to generate tax-free cash flow for your living expenses. you know For those of us in the accumulation phase who have a W2 or self-employment, we have the expenses for our living or we have the cash flow for our living expenses through our work. So the need just isn't really there. I mean, in theory, you could do it, but you're just creating cash flow that you don't really need. So it tends to be more of a conceptual thing in our de-accumulation phase than our accumulation phase. Something else I've seen regarding this is even if you didn't have real estate, let's say you had a million dollar portfolio, taking an SB lock against that portfolio and then reinvesting that in the market. And as long as you don't get a margin call on that portfolio, then you still basically bank the two or 3% difference.
00:40:23
Speaker
over time. And that's one way to beat the market, I would think. But to me, that seems like it would be a big risk too, just in case. Of course, it would depend on what you're invested in and how much you're actually withdrawing or taking a loan against those things. But I'm thinking of what are some ways that even me personally or someone in my situation who's got some net worth, they've got a bit of time, some they they might want to put some effort or energy towards something but don't want an actual job job. How can they use their current net worth to continue to build their net worth over time without many more keystrokes?
00:40:56
Speaker
Do you have any ideas for that? Yeah, David. mean And you're alluding to what they call margin, right which is borrowing on securities. The problem with borrowing on securities, first of all, it's highly regulated, there's all sorts of rules around it, and it's highly risky. right Because you know the rental real estate, whatever you want to say about it, it at least has residual value. But margin tends to be around individual equities, and who knows if that company is going to zero, right and Ron went to zero and all this sort of stuff. so you know If you borrow to buy Enron and it goes to zero, you got a real problem. You borrow you know in part to buy a house. Well, the land has some residual value. The house tends to have residual value. so um yeah it's it's you know i I tend to be a simplicity advocate um in so many different things, and particularly in our investment life. and and Look, I'm not here to give anyone investment advice, but
00:41:47
Speaker
you know I just tend to say, hey, what are those things that we can do in our investment life that reduce volatility, that reduce expenses, and anything that's getting a little fancy, I sort of question. um and i just i think you know If we look at somebody like John Bogle, right the gentleman who created the index fund to my knowledge, I think 1975 was the first index fund. um We look at jail columns, a simple path to wealth. um you know Sometimes we say, well, wait a minute, simple isn't best. Well, I'd counter to that. Simple and best are not necessarily mutually exclusive. You have to do your own analysis and your own thinking, but it's very possible that maybe simple is the best.
00:42:32
Speaker
And so that's sort of the way I like to approach the investment game. I'm a huge advocate for simplicity as well. Maybe I'm just getting bored and looking and seeing this. Maybe I'm also getting inspired by these YouTube videos and what I'm seeing. I don't know if it's best or not, but I'm definitely a huge advocate of simplicity, not only just in money, but even in life as well. It's a constant effort to get there. but it it is one I think worth pursuing.
FI Community's Take on Retirement Accounts
00:43:00
Speaker
You've said it here in this podcast episode and I've heard you say it before. You've been known to say don't allow the tax tail to wag the dog. ah What is the concept of allowing the tax tail to wag the dog mean and can you provide examples of how this can be applied effectively in tax planning?
00:43:16
Speaker
Yeah. So David, I think most people in the audience should say, I want a portfolio of investments that is appropriate for the level of risk I want to take, my goals for the future. And when they come up with that portfolio, they shouldn't be worried about Roth IRA or traditional 401k or any of that stuff to start, right? Literally come up with a portfolio that for getting taxes, what makes sense for you? Okay. And I think if we do that, we'll get to a portfolio that we can make work even with the tax planning. um So let's let's step back. right Rental real estate. right The folks doing rental real estate are not insane from a tax perspective. It makes a ton of sense. right And I did an example at Camp Fi a couple of weekends ago. So let's say, David, you're sitting on $100,000.
00:44:11
Speaker
Okay? You go take that $100,000 and go buy... I'm going to give a ticker here. It's not investment advice for you or anyone else, but you go buy $100,000 of VTS-AX. Okay. VTS-AX will pay dividends. You'll get tax on those. Okay, fine. Right? um The basis that you created does nothing for you and in fact may never be relevant. to You may leave that to your kids at your death and it'll just get stepped up and that basis never did anything for you to help your tax picture. right You have the 100,000 a basis, but it might be totally irrelevant or 30 years from now you sell and the $100,000 is worth so much less because of inflation.
00:44:50
Speaker
Well okay so that's one investment option for David Boyer. Second investment option for David Boyer is a condo down the road. Let's imagine it was $100,000 but it's not really going to be $100,000 because it's going to be $500,000. So what you're going to do David is you're going to take your $100,000. You can go to the bank and say, loan me $400,000. So now you have a $500,000 condo that you bought with the $100,000 and you get depreciation deductions. And let's assume it's a high rise and there's no no or no material ah value attriable but attributable to land for a second. In most years, you're going to take the $500,000, you're going to divide it by 27.5 and you're going to create an $18,000, whatever that math is, something like $18,000 deduction.
00:45:39
Speaker
every year against the rental income you created. So that $100,000 a basis, which did nothing for you in VTS-AX, we'll now do will now generate 18,000 of tax deductions every year for 27.5 years. okay That's pretty dang good from a tax perspective. But that said, if the only reason you're doing that is that tax advantage, I just pointed out to you, you're letting the tax tail wag the dog. um So, I think rental real estate makes a ton of sense from a tax perspective, but it's not the only consideration. And you should basically start your investment analysis and picture in a tax-free world and then say, well, how do I make this work considering the different tax situations I have? And I think there are many ways you could do that.
00:46:26
Speaker
One thing I love to do these days is put all our bond investments tend to work really well in like a traditional IRA or traditional 401k so that the bond interest doesn't hit our tax return, that sort of thing. So you can make that work. But um just because rental real estate is a great tax play doesn't mean it's the right investment option for you or anyone else. But don't you think it'd be kind of hard to argue if that $18,000 swing a year isn't helping someone achieve early retirement sooner than they otherwise would? Well, let's talk about that a little bit, right? So rental real estate can be the right answer um and was more likely to be the right answer when interest rates were 2% and 3%.
00:47:06
Speaker
right So now we got interest rates at more like 7% and 8%. We've got ah higher valuations in real estate, and we have less diversification. right Because instead of buying you know ah a diversified fund, and again, none of this is investment advice for you or anyone else, but um instead of buying something that has exposure to all sorts of geographies and industries and sectors and that sort of thing, we're buying a condo or we're buying 10 condos in the state of Georgia, the state of California, or five in Alabama and five in Arkansas. I mean, we've got concentrated risk there. right So um it's great that on one metric, the real estate rental real estate is a great thing, but do we want to be paying you know seven or eight percent interest? And the other thing too, so years ago, I went to a campfire and Scott Trench from Bigger Pockets spoke and He had a great point about real estate. He said, as you deleverage the real estate, which is a fancy way of saying ah paying off the loan, I'm paraphrasing here, but as you pay off the mortgage, your your return tends to go down. and it tends to get very real if If we have unleveraged real estate, we tend to have very low returns.
00:48:16
Speaker
Now, in theory, if you had 100 doors with no mortgage and it pays your living expenses and you're good at it, fine. like Who cares that your return is 2%? I'm just giving an example. If it's paying your expenses, great. You go with that, you do you. But that was sort of an interesting observation to me is that leverage increases risk and increases return on average. But boy, if we don't leverage this thing, our returns might be very, very low. And is that something we really want to do? So um yeah, I struggle with the rental real estate game. You got to do you, but I think you just got to remember it's a business, right? In a way that holding mutual funds is not a business. Absolutely true. And and I do think
00:48:58
Speaker
There's no shortage of real estate gurus out there and even great ones. I mean, very close friends, you and I both know great people who are advocates for real estate. You know, Chad Carson, Mindy, ah you know, and Carl Jensen and many, many others, so great people and very good at what they do. But I also think that if you see those content that content, I think that it's just going to be that easy to go in and get a couple, especially in today's environment, which is very, very tough historically, or at least in the last 20 years, historically ah tough, then you got another thing common, especially when compared to how simple and easy, well, maybe not easy, but simple it is just to get a basic understanding of where to put some money that you're earning in some of these tax advantage and tax exempt accounts and even taxable accounts for all the reasons that you mentioned earlier in this episode.
00:49:49
Speaker
Yeah. So um if you're listening to this and you're wondering, say you're 25 years old and you're wondering, should I pursue real estate or maximize my retirement accounts? Usually what I advocate, and i and I have had real estate, I do own real estate, rental real estate. At my peak, I had seven properties and now own three. I've sold four in the last, I don't know, a handful of six years or so for the sake of simplicity. And I would i would offer that, at least in my perspective, it's much more foundationally solid to focus on that W2 job if you' if you're one of the fortunate ones out there these days to actually have a solid one. I know that's another whole other topic right now. And then work on that, build up those build up some of those accounts, your taxable accounts, your Roth, your 401k, your throw settings plan if you're military or a government employee.
00:50:38
Speaker
And then maybe the market does soften over the next few years and you hit 31, 32, and then you have a good reason to add that. And if you think you have a good reason to add real estate to your portfolio at that time, then explore rental real estate. but But even in the world of real estate, there's so many options and there's much more passive options like REITs or REITs than actually owning and operating your own property. so That's kind of like my take on the real estate versus way more simple, just direct index fund investing approach. But I have i've done both throughout my career. How do members of the financial independence community typically think about traditional retirement accounts and where might they be getting it wrong? You talk about the tax dog wagging, tax till wagging the dog.
Financial Independence vs. Dependence
00:51:23
Speaker
And then you mentioned maybe a misconception of how people use the traditional 401k or at least perceive the 401k as compared to practical, how it plays out for your clients. What else? So I i think there's at least some in the fight community who are just biting too hard into the Roth apple, right? So what I worry about is maybe if you do everything Roths, Okay, and you get to age 56 and you're now early retired. Well, okay, that's fine, right? And if you have enough money, okay, there's nothing wrong with that. But you we come back to this premium tax credit you raised earlier, David. And it turns out there's two sides to that coin. One of the sides of the coin is this. In order to qualify for a premium tax credit, you have to have a minimum level of income.
00:52:13
Speaker
on your tax return, and it's it's based on state rules of you know household size, level of of poverty. I think it could be 100%, 138%, 150% of federal poverty level for the household of your size. um I know in California, that number today for a household of four, something like $41,000, something like that, that's real income. Well, okay. um If you have everything you own in a Roth account, Okay, how do you generate that income? right If it's all in a Roth IRA, you have no way to generate income other than going back to work. So I don't like this idea of let's have every last penny in our Roths. One, we can do very tax-free Roth conversions or very tax low-tax Roth conversions. It might be tax-free, by the way, but at least it will be a relatively low-tax.
00:53:04
Speaker
And two, we're setting ourselves up for some potential failure on the premium tax credit side, because we have to be able to generate at least some income. If we have $300,000, $400,000 in a traditional retirement account, in addition to the Roth, great. We do these Roth conversions. just you know We look up the federal poverty level that we got a hit to get this premium tax credit, great. you know We round up right because we don't want to be $3 short, of course. right So we round up And we do this Roth conversion. We're going to pay very little tax on that anyway. And now we're going to capture all these premium tax credits. We're doing great. So I'm just worried some people are a little too heavy on Roth these days. And Roth, look, Roth has its role in both accumulation and accumulation, absolutely. But we want to make sure we can at least toggle on some income in our early retirement.
00:53:55
Speaker
You and I went back and forth a little bit before recording this. And one of the topics you said you were passionate about was concepts that might be inadvertently making people in the financial independence community dependent rather than independent. What are some of the things that members of the financial independence community do that actually shift their mindset from being financially independent to financially dependent? I'm going to give you three and I'm actually just writing them down so that I can remember them. All right, first one is medical insurance. I think as a merit, this isn't necessarily a phi issue, but I think it becomes a phi issue, right?
00:54:36
Speaker
um I believe we over medicalize our problems, right? A lot of our problems probably can be so solved through diet, through environmental exercise, not through somebody in a lab coat, okay? And I think too many in the fight community are too attached to their current employer medical insurance plan. And look, I think everybody needs medical insurance, because you or I can be the fittest, healthiest person in the room, we get into a car accident, we're probably going to need some medical attention. okay So I'm not saying don't have medical insurance. But I think, especially for the young person in the audience, high deductible health plan, get used to being the CEO of your own medical and you know your health your own healthcare care, your own medical situation. And that way, when you get to early retirement and you say, oh, no, I can't leave this job because this medical insurance, you're less likely to say that. You say, you know I've managed my own health for so long,
00:55:27
Speaker
An ACA plan is going to work very well for me, and I'm going to be the CEO, you know the chief cook and bottle washer when it comes to my own health. Okay, so that's one area where I think some people are a little too dependent. And look, I get there are people now with chronic conditions, and that's just not going to be a thing. But if we're really young in this audience, I think we want to really take radical ownership of our own health and be less dependent on any one employer's health insurance. Second one's annuities. Okay. So you know one thing we're doing when we sign up for an annuity is we are now hitching a big chunk of our financial life to one and only one insurance provider. And you say, well, wait a minute, Sean, isn't there going to be something like the pension benefit guarantee corporation that's going to protect me? Well, the answer is maybe not. Annuities are protected by a state patchwork.
00:56:21
Speaker
So you got to look at the relevant states involved in terms of, well, wait a minute, I have this financial contract with one and only one life and or one and only one insurance company. What happens if they go belly up? Well, it might be that the backstop in terms of any sort of state protections may not be as robust as you think. ah There's a paper on SSRN on this. I could send you the link in the show notes for that. um I just worry about annuities where, hey, wait a minute, are we really solving for something here? Or are we setting up single-party credit risk? right We were now a creditor of this one and only one insurance company. I worry about that. We're becoming more financially dependent on their finances. I just don't know about that. I'm not here to give you advice as to whether or not to get annuity, but that is something I worry about. And the last one is long-term care.
00:57:11
Speaker
and long-term care is a challenging situation. But my my thinking sort of shifted recently on this question because people worried about, hey, how do I pay for long-term care? And I tend to think that's the wrong question to ask. I think the right question to ask is how do I avoid long-term care? Why is it a good outcome to be to wind up in a facility because I can't do one or more activities of daily living? right Think about that. You're now in a place where you can't do one or more activities of daily living because of deterioration of your own health. um Why is it a good outcome to be there, but it's paid for? I don't see that as a good outcome. um I think we got to become more independent, and this includes financially, um on our own selves to you know get our own bodies and good health and
00:58:01
Speaker
you know think about what we're putting in our bodies are we in the standard american diet and setting up chronic disease setting up long-term care and why is it a good outcome oh well that's insured so i'm fine. You can't do one or more activities of daily living so. I'm doing some noodling on this in my own life and my own um situation.
Evaluating Annuities and Real Estate Investments
00:58:22
Speaker
But those would be three areas where it's like, okay, I hitch my wagon to somebody else, usually an insurance company, and I feel good about it. I'm not so sure we should be feeling so good about it.
00:58:32
Speaker
I'm very glad he brought up at least two of those topics. One, over my last number of years, and and I think I've been like this most of my life, is and we've always heard ah taking ownership. And in the Fi community, we usually just, there are, it's a spectrum, but like there's a lot of people who just focus on the money aspect of it. But there's a Venn diagram of health, money, happiness, all of those things. So thank you for bringing up at least the idea that we should be thinking more than just the dollars when it comes to ownership and our health. At the older we get, I don't know your age, I'm 46, but I can tell you I'm in great health for 46, but I am a not in perfect health. I've had back surgery and I've taken care of my body. I've never been obese.
00:59:19
Speaker
I've got good genetics, so I'm fortunate in that way, but I say that to say somebody's listening to this, no matter what, you have to prioritize your own health. Things will happen, but what you can do is mitigate the downside risk of those things happening to you. and financially yeah mitigate mitigate a big risk by remaining healthy outside. And we're talking in general terms, I'm not talking out on the outskirts of you know instantaneous accidents, auto accidents and things like that, that might cause yeah you know you serious issues, annuities.
00:59:57
Speaker
I just, the episode is doing very well. Christine Benz just published ah this last Wednesday, but in that conversation and definitely after that conversation stopped recording, she and I got into it about annuities and she is a brilliant person and other brilliant people like Paul Merriman and I have had conversations about annuities and I just can't get over the hurdle that they're a good thing. They think they advocate for them and while i At its face, I just can't. um And I don't know if that's on my lack of knowledge or just maybe goes back to the direct ownership thing. I have a problem giving the ownership away. If I have $500,000, why would I give that to somebody else to manage? I've just managed that money my entire life. And I'm i'm more confident in my ability than somebody I can't see or control or influence. I understand the basic trade-offs.
01:00:43
Speaker
But I think annuities is something either I'm missing out on parts of it. Maybe there's a spectrum of annuities where some are more vanilla and you know less fees, maybe more regulations about particular annuities to protect the buyer, that kind of thing. I don't know what you're seeing in your experience or with your clients. Or even if you advocate, can you can you say you even advocate or don't advocate annuities? Look, I'm not here to give advice up to any person, but I tend to think that annuities increase expenses, increase single party creditor risk, right? We're now taking on a creditor risk. We don't have to take if we do mutual funds, ETFs, that sort of thing. um The other thing I don't like about annuities is this.
01:01:24
Speaker
How often do the people talking about annuities start the conversation this way? Do they ever say, you know, hey, David, you're a an American. You've built up a Social Security earnings record. So you already have an annuity, right? Think about this. Most Americans have one, if not two, because they're married, or even maybe they've got ah that there's ah such thing as divorce benefits when we have Social Security too. So most and Americans have one or possibly two annuities already. Social Security is an annuity.
01:01:58
Speaker
So they never start the conversation by saying, Hey, David, you already have one of these things, but let me tell you why you need a second one, right? That would be a more robust, ah intellectually honest way of destroying that conversation. um It's sort of like, you know, David, if I walked in, if I worked at Best Buy, and I walked into your living room and I see David's got a 100-inch big screen TV, best picture you ever saw, and you know great sound, the whole bit. You would think a little odd of me if I said to you, you know what, David? You need you need another 100-inch big screen TV for this living room.
01:02:37
Speaker
Now, there could be a use case. You could say, hey, Sean, you know, I happen to be the world's biggest SEC football fan. Every Saturday, I want two games on my, you know, okay, great. We now have unique facts. We have a unique use case for a second big screen TV. How many people got this unique use case for a second um annuity in their life? right Now, one one argument I've heard for them is, well, what happens is people get worried. People say, I'm going to run out of money, so I'm not going to take the the trip to the tropics. I'm not going to five fly first class.
01:03:14
Speaker
Well, my counter to that one is those people are letting emotions govern, not letting ah reason govern. And maybe we need to all work on being governed by our emotions a little less, right? But two, there are people who get the direct deposit from Social Security and don't spend it. So you're telling me they're going to now get the direct deposit from the annuity and they're going to spend that though, right? um Just because something might trick you know people into spending more doesn't mean one, they should need to be tricked or two, it will even be effective. Maybe it won't be effective. Maybe they're going to get that annuity payment and be like, well, I can't spend that. I need that money.
01:03:54
Speaker
So um' I'm sort of with you, David. I really struggle with them and this issue of of of we're increasing risk, right? If what happens if this insurance company goes under and it may be that the state patchwork in terms of protecting annuitants isn't as strong as we think, hasn't really been tested. ah Look, I'm not here to like raise like, Oh my goodness, I have an annuity. I've got this huge problem. The odds are that your lived experience is going to go just great, right? That's the odds, no guarantees. But why are we taking on this single party credit risk when we may not, it may be solving for a problem that we don't really have. Yeah.
01:04:37
Speaker
The very last statement you said, we might be solving for a problem we don't really have. It takes me back to like military planning. Very first thing you have to come up with so that your efforts are actually in alignment is you have to create a problem statement. And if this doesn't happen, this is a likely outcome and then work backwards from there. And maybe that is what we need to start focusing more on these types of conversations and even at camp fives when you're standing around having a couple drinks. you know like Let's focus on what is the objective? What problems are you having? And then go back rather than just a blanket, everybody needs rental properties. Everybody should, ah even though I really firmly believe this for the majority of people, should just funnel money into low cost broad market index funds forever. ah you know Or whatever that is, that seems to be streamlined as far as the messaging in circles. But
01:05:25
Speaker
fundamentally, in our lives, we're solving for a problem.
Future of Tax Cuts and Planning Trends
01:05:29
Speaker
And we have to know what that problem is and then work backwards from that. So thanks for putting that in that perspective. For me, the issue with annuities is when you die, it goes away. It's no longer in your, I mean, unless you have some kind of special circumstance or something, which i'm not I'm not educated on annuities, it's enough to know, but the basics, I understand it. You buy it, you trade, give somebody your money, you get some payments until you die, then your heirs get zero, basically. So i'm sure there's like maybe exceptions to that out there but that's the problem i have with it if you manage your money. I could say like this if you're if you're a proponent of the financial independence movement or understand financial personal finance all that stuff you understand the four percent rule that to me that's building your own annuity you've just built your own annuity. And if you have complete control over it so i'm not why not just look at it like that and then completely forget not with the balls always in your court.
01:06:22
Speaker
you yeah David, it's interesting. you You make a great point. There's a gentleman on YouTube, I think he's called Stan the Annuity Man, and he's he does some great content. He has a ton of subscribers on YouTube. and you know He made the point I made about Social Security, and he added to it. He said, well, you know Americans also have these so-called required minimum distributions from their traditional retirement accounts, and he viewed those as an annuity. Now, I sort of disagree, but you know I think there's there's some merit to that thinking. um But and then back to what you're saying in terms of, yeah, are are we really solving a problem here or is there another simpler way that doesn't involve paying an insurance company and taking on single-party credit risk?
01:07:04
Speaker
yeah We won't get into it now, but just just you throwing that out there made me think of how much of a role philosophy plays in this. There's plenty people out there who think, you know, die with zero is the way to go. And there's people out there who want generation generational wealth. And the two may not be completely mutually exclusive, but but I think depending on but the fall philosophy that you follow that might ah influence on these types of decisions that we're seen or talking about, annuity or no annuity, yeah that kind of thing. Moving on, Sean, you are always at the forefront of not only, I'm sure the tax code for your work, but you are also in the forefront of the financial independence community and the issues that affect us. The Tax Cuts and Jobs Act of 2017 is set to expire by 2025. Do you think these provisions are going to be extended? It's an election year, who knows? But if so, is that a good idea? And why do you think so?
01:08:03
Speaker
All right, so I have a little saying, there's nothing more permanent than a temporary tax cut. You have to remember why it was a temporary tax cut. It was passed in late 2017. And like you're saying, David, ah according to current law, it expires on New Year's Day, 2026. I strongly think most of it will not go away. And I think it's also a good idea to preserve most of it. um It's been very beneficial for the financial independence community, particularly in the retirement phase. Well, so why do I say that? Well, it increased the standard deduction. And that's a big part of what makes financial independence, tax planning, very powerful right now is get to early retirement, you have that high standard deduction, you essentially have a very high 0% tax rate,
01:08:50
Speaker
um I think that will get extended. If that didn't get extended, that's a big tax hike on millions of Americans, and it would hurt the poorest workers the most. So I think politically, it's unpalatable to not extend it. That's my opinion. You do you. um I think one thing that's really helped in the financial independence movement, we have so many solopreneurs, there's something called this Qualified Business Income Deduction. That came in in the Tax Cuts and Jobs Act. That's temporary. I think that will get extended. In fact, a few years ago, the Democratic... you know so Tax Cuts and Jobs Act was mostly... you was President Trump, mostly Republicans. Might've been all Republicans for all I know. You'd go back and look on thomas.lope.gov or whatever. um But essentially, it was a Republican Tax Cut Bill.
01:09:36
Speaker
I believe it was in 2021, a gentleman named Ron Wyden, who's a Senator Democrat from Oregon, ah proposed his own version of the qualified business income deduction. I was very happy to see that. So that made, said, oh, well, Democrats are sort of on board for a version of this. Either way, the five communities are going to benefit from that. So I think the the QBI deduction, that qualified business income deduction that most solopreneurs get, that will get extended. um something it was The 15% became the 12% bracket. That very much helps in retirement planning. I think that will get extended. Now, you might say, hey, Sean, I disagree with you.
01:10:15
Speaker
I think the Tax Cuts and Jobs Act is not going to get extended. If you thought that, you might want to do something like delaying charitable contributions, right because you think in 2026, the tax rates are going to go up. If your income is the same level, it might be better to take the the charitable deduction in 26 or later than in 25. Again, i don't think it's I think most of it will get extended, maybe not every last piece of it. But I do think most of it will get extended. And if I was in the audience, I wouldn't have this be like a fundamental driver. It's fun to talk about, but I wouldn't have it be a fundamental driver of my financial independence planning, my tax planning.
01:10:55
Speaker
Whether it be in the media, YouTube, other podcasts, inside financial independence community or at large, do you see any tax trends right now that are either becoming more popular that you think is pertinent for us to do some more exploration? So one thing I'll mention to you, David, is if you look at, this isn't necessarily financial independence, it's more personal finance. If you look a lot at a lot of the personal finance content creators, there's a lot of fear about, oh no, the federal government's got this huge debt and deficits, and so taxes are going to go up. and so What they so they're saying is, well, retirees, you better look out, you're going to get these traditional 401Ks, traditional IRAs, you're going to get taxed to oblivion. Well, I say a couple things about that. One is we have to look at what Congress has actually done in recent years. and I've laid this out.
01:11:49
Speaker
Congress, in the last you know decade or so, has enacted five different, it's something like it's four different um tax cuts for retirees. They keep cutting taxes on retirees. The US Treasury got involved. The RMD table got more generous to retirees. So the prediction is taxes are going up, up, up on retirees. The lived experience is Congress is always getting in there and tinkering and just, you know, we're going to cut taxes just a little more for retirees. And now we're going to cut taxes a little more for retirees. So I think
01:12:20
Speaker
um the the The lived experience, as demonstrated, boy, Congress seems to like to cut taxes on retirees. Retirees tend to vote, and you also have to look at the political incentive. right The political incentive is for Congress to keep rewarding retirees. The other thing is, Congress leaves a lot of money on the table. right There's other mechanisms that can create tax revenue in the future that don't have to tax retirees, right other than very, very, very affluent retirees. right You know if i'm arin rogers and i'm thinking about my retirement and i'm gonna be at the top bracket cuz i'm gonna have endorsement deals and hollywood deals and broadcasting. but Yeah i i might be a little concerned about the future of tax rates but if i'm in the fire movement i'm not anywhere near as concerned about the future of tax rates in retirement.
01:13:07
Speaker
Sean, thank you so much for all of that information today. Is there anything else you'd like to add? No, David, I think you and so many others are doing great work, you know just having these conversations. um you know We all have to come up with our own decisions and it's not about, oh, I found Sean Mulaney, or Paul Merriman, or J.L. Collins, or whoever it is, Brad Barrett, David Boyer. It's not, oh, I found so-and-so, and they're always right. It's, oh, interesting. Paul Merriman's making this argument. Brad Barrett's making that argument. Mindy Jensen's making a third argument. Great. Let me critically assess it and come up to my own decisions and say, oh, boy, you know
01:13:47
Speaker
Mindy on these three points was totally right. And I dug in and that's why I agree with her not because oh, well, Mindy said, or Sean said or David said, that's great. But that by itself is not how we make our decisions. and I think sometimes in in the fight community, we get a little too, oh, so and so has a big platform that you know, and so I'm just gonna follow them. No, step back and say, hey, nobody's perfect. Let me do my own analysis. And I think we could all figure out good paths for each of us. Yeah, thank you, Sean. I think that goes back to the earlier sentiment of, you know, take ownership, you know, as soon as you align yourself too much with other people for the sake of just doing that, then you're giving that ownership away and you're giving that power away. You want to own all of that.
Closing Advice on Tax Planning
01:14:33
Speaker
And that way you get the credit and you're also responsible for maybe the the the not so great things, but over but over time, that's a much more powerful and empowering way to go forward.
01:14:45
Speaker
Thank you, Mr. Sean Malaney, for sharing your valuable knowledge and tax planning strategies, especially tailored to those who are pursuing financial independence and early retirement. It's clear that effective tax planning can make a significant difference in achieving our financial goals, but they should not wag the dog. And thank you all for watching and listening.