How to Determine the Priority of Investing
On Episode 73 of the Your Financial Pharmacist podcast, Tim Ulbrich, founder of Your Financial Pharmacist, and Tim Church, YFP Team Member, continue a month-long series on investing by talking through the various retirement/investing options available, key principles for retirement savings, and how to prioritize investing. The figure below summarizes the episode and lists the 2019 annual contribution limits for the most common retirement accounts.
Summary
On this episode, Tim and Tim discuss the priority of investing in retirement and other accounts. Tim Church mentions savings accounts aren’t able to pay the amount that inflation rises each year (2-3%), so it’s important to think about other options on how to beat inflation while paying a minimal amount of taxes. This episode focuses on using disposable income to save for retirement.
Most listeners will be presented with the options of 401(k), 403(b), or TSP (Thrift Savings Plan) and will be offered matches that vary employer to employer. There are a number of different retirement options available. Traditional varieties, Roth, IRA, backdoor Roth IRA, HSA, and SEP-IRA are all potential options for investment. Details are given for each of these options, including how much you are able to contribute as an employer each year and the age in which you can withdraw funds.
When it comes to the priority of investing, YFP suggests that you first use the employer match as it’s free money and should be the priority in your financial plan. Then, use the HSA if it’s offered to you as it carries a triple tax benefit and is a powerful tool for investing. Roth IRA and Roth 401(k) can then be contributed to as they offer tax free savings over time. You’ll pay the taxes today, allowing your money to grow tax free. After that, max out your traditional 401(k) and then a SEP- IRA. If you’ve maxed out the contributions to everything previously mentioned, you can then consider investing in brokerage accounts.
It’s important to note that this is not a financial plan, everyone’s situation is different and therefore different options may work better for you than what is mentioned, and not everyone will agree with what we have suggested.
Episode Transcript
Tim Ulbrich: Hey, what’s up, everybody? Welcome to Episode 073 of the Your Financial Pharmacist podcast. Excited to be here alongside, in-person, with Tim Church to talk about prioritizing your investing for the future. Tim Church, how we doing?
Tim Church: Doing great, Tim. Glad to have you down here. How’s the weather feel?
Tim Ulbrich: It’s unbelievable. So here we are, mid- to end of October, came from northeast Ohio, below freezing weather, and they had to de-ice the plane before I got here. Came, landed, walked out, and I was overdressed, too warm for the day, saw the palm trees, so excited to be here. And Andrea has been an incredible.
Tim Church: Well, thanks. That’s basically why I’ve been down here the past seven years if you haven’t figured that out yet.
Tim Ulbrich: Yeah, for those of you that don’t know, Tim grew up in the Snow Belt and has made the wise decision of coming down south, where it’s a little bit warmer. So I get it now. I see what you’re doing here every day. So here we are, we’re talking about investing in and prioritizing in terms of the means in which people are investing. I think this is a long overdue topic. We acknowledge we haven’t done a ton on the topic of investing on this podcast, a little bit here or there. We did Investing 101 back at the beginning of the podcast, but that’s what this month-long series is all about. And probably one of the most important questions, most frequent questions we get is, so with all these options available, where should I actually be putting my money? And in what order? Especially for those that are coming out as new practitioners. So long, long overdue. Would you agree?
Tim Church: Yeah, definitely. I think so. And I think there’s a lot of great questions and things that come up with investing. And especially as you guys talked about in the Dave Ramsey episode, what comes first — investing versus paying off student loans and other debts. But I think this topic that we’re talking about just in terms of, OK, you’ve got these retirement investment options available. How do you prioritize and how do you say, OK, this is the first one I’m going to go after. And then after I do that, I’m going to go to the next one. And there’s a lot of questions that come up with that.
Tim Ulbrich: Absolutely. And I know as a new practitioner, new grad, I struggled with that myself, not only where does this fit within the other context of other goals, but also should I be maxing out my employer account? Everyone says Roth IRAs, putting money into those. I get emails about these brokerage accounts, what should I be doing and in what order? So we’re going to talk about that and give you our opinion on that topic. But I think it’s first important to start with what are the key principles of retirement savings? And as you and I were talking about this episode, we talked a little bit about inflation, taxes, and the power of investing early and often. So give us a little bit more information around those principles of investing.
Tim Church: Alright. So if you look at inflation over the years, over several decades, it’s typically 2-3% per year, which most savings accounts are not paying that, right?
Tim Ulbrich: Absolutely.
Tim Church: And so when you look at that, you have to say, OK, what are the other options that are available to me that I can use to not only get a better return to beat inflation, but the other consideration is how do you do that with paying the minimal amount of taxes that you can so you’re keeping most of that money that’s growing?
Tim Ulbrich: Yeah, and I think just to add to that, the one advantage that young pharmacists have is that you’re coming out with a great income, typically — many graduates are coming out in their mid- to late 20s, you’ve got lots of years ahead of you in terms of investing a significant percentage and portion of your income and allowing that time for compound growth. So I like to think of inflation as kind of this gnawing thing that is just always coming after you. And I think it’s important to do that. And I read a couple books several years ago that if you really look at the impact that inflation can have on your finances, it’s something we don’t think a lot about, almost like fees on investment vehicles and other things. So inflation, taxes, and starting early and often. Now, Tim, it’s important that we talk about for everybody listening to this podcast, their personal situation is going to be different. And here, we’re going to talk specifically — almost in a silo of investing, right? And we know that those listening, some are looking at $100,000-200,000 in debt, other people are out of debt, personal life situations that are very different, all types of things. And so here, we’re really looking at if somebody has disposable income and they’re looking to invest that for retirement, in what order are they going to do that, right? So when I say if somebody has disposable income, what are we referring to there?
Tim Church: Basically, you’re talking about money that you have after you’re paying your expenses every month. So anything that you have to pay for your bills, how much it costs to live, what is that additional amount of money that you have that could be going towards investment? Many people, like you said, are flooded in debt, and so you could be listening to this episode, and saying, ‘What disposable income do I have? I’m just trying to survive. I’m trying to make it.’ But that’s really where we’re getting at is let’s just assume you’re going into this episode that you have money to invest to put in retirement accounts. Now, if that’s who you are listening to this episode and saying, I don’t have any money to put in investments because of the bills and things I have, well, it’s a pretty simple equation. That in order to increase your disposable income, you’ve got to increase your earnings, get a side hustle, work more hours, or you’ve got to decrease your expenses. And so that’s where really budgeting comes into play.
Tim Ulbrich: Absolutely, yeah. And I think that idea of it’s a simple equation — you either increase your earnings or you decrease your expenses. And just a shout out to the work you’ve been doing with the side hustle series, giving people ideas. We’ve got more content coming there. And just before we jump into the buckets of investing, I think it’s important that we are not — and we’ve had this conversation multiple times on the previous episodes — but we’re not going to have a conversation about should I be investing or should I be paying off my debt? And as I mentioned before, one of my concerns with an episode like this where we talk about investing or even the month-long series in a silo is that this is one part of a comprehensive financial plan. And you’ve got to look at the whole picture. So if you want more information on our thoughts about investing while in debt and how does that fit in with emergency funds and other life goals, head on over to episodes 068, where Tim Baker and I tackle that, where we reviewed the pros and cons of the Dave Ramsey plan. And I’m sure that’s evoked a lot of emotional reactions because it usually does.
Tim Church: Yeah, that was a great episode. And I think you guys did a great job talking through some of the controversy, but also some of the positive things that are in that plan and some of the behavioral aspects of it. And so when we’re talking about these major buckets, things that you can invest in for retirement, one of the things that came to mind, Tim Baker, he recently did an investing webinar. And he showed this image of actual buckets, and he was naming the buckets and putting one in. And I don’t know if when you were a kid, Tim — do you ever remember that show, Bozo the Clown? Do you ever remember that?
Tim Ulbrich: Yeah, yes.
Tim Church: And in that show, at the end of the episode — I think it was at the end — they actually were throwing ping pong balls into buckets. And they progressively — but there was a specific order that you had to put them in. And for some reason, he really evoked that memory when he was showing that figure. But it’s cool because it’s really, that’s what we’re talking about here. We’re talking about, OK, what’s the first bucket that you’re going to put your money toward? And then how do you go to the next level and what do you do?
Tim Ulbrich: And I think the visuals he used as well with the buckets in that presentation, it was a good reminder that these are vehicles and not the investments themselves. That’s an important point. We’ll talk more throughout this month. But when we talk about 401k’s, 403b’s, IRAs, etc., those are essentially the tax advantage shield in which you’re investing. But within that, you’re going to be choosing the individual investments, whether that’s stocks, bonds or mutual funds, etc. So let’s jump into these buckets. So probably for the vast majority of our listeners, they’re going to be presented by their employer with an option of a 401k, a 403b and what’s referred to as a TSP, which is a VA employee, right, that’s you.
Tim Church: Right, that’s the Thrift Savings Plan.
Tim Ulbrich: The Thrift Savings Plan. So we’re going to group these together because I think we throw around these words like we assume everyone understands exactly the implications of them. So let’s review quickly — a 401k, a 403b, and a Thrift Savings Plan, these are employer-sponsored retirement plans. So obviously, in order to get this benefit, you’re working for somebody. They’re going to offer this. And at what level they’re offering this benefit in terms of a match and what they can contribute is all over the place. And I think one of the things that we’ll talk in future episodes is as you’re looking at different jobs and comparing benefits and things, it’s a key thing to be looking at what is the benefit that you have? And I know the VA, that’s a pretty lucrative benefit on your TSP, is that correct?
Tim Church: Yeah, through the TSP — a couple different reasons. No. 1, they do offer a match up to 5%. But one of the other things is that they have very low fees in the funds that they have available. And I know that, Tim Baker always talks about that when you’re looking at different options within your 401k, is that you have to pay attention to those fees because even if you’re not seeing that change in your accounts, like over time, it can really eat at the earnings that you have.
Tim Ulbrich: Absolutely. And so let’s talk first — we’ve got 401k’s, 403b’s or TSPs, let’s talk about the traditional variety first because what has complicated this whole equation is that — you know, I remember when I came out of school, we were looking at primarily a traditional 401k or a Roth IRA. And now, we’ve got hybrids of these vehicles such as a Roth 401k or a Roth 403b, which I think has made this very complicated and probably make it even difficult to talk about it on the podcast in something like this. It’s good for a visual. So when we talk about a traditional 401k or 403b, essentially what we’re referring to there is that you are deferring the payment of taxes to the future. So those are a deductible in terms of income taxes today. You are not paying taxes on the contributions today. But when you go to withdraw those funds, no earlier than the age of 59.5 without penalty — and there’s a required minimum distribution at the age at which you’re beginning to have to force to take out that money — the maximum amount that you can put in as an employee into these accounts in $18,500 in the year of 2018. We’ve seen that climb each year by $500 or so. Now, there is an additional amount that you can put in after the age of 50. And that is $6,000, which essentially is a catch-up provision that allows you, if you’re behind in savings, to be able to save more beyond that $18,500. Now, what this does not include, which is a really critical, important piece here, is that $18,500 does not include the portion in which your employer would provide in the form of a match. Now, if you’re not familiar or haven’t heard of that term, match before, as Tim gave the example with the VA, it’s a 5% match. Essentially, 5% of his salary that he contributes, the VA will contribute dollar-for-dollar. And this is all over the place with employers. Some will do a 3% match, some will do a 6% match, some will do a dollar-for-dollar, some will do 50 cents on the dollar. But essentially as you’ll see when we get into the priority of investing, the match is free money. And that’s really the critical piece here. So why is this number important? Because what we’re referring to is that you obviously are growing money tax-free for a period of time. But ultimately, when it comes to being pulled out, you’re going to be paying taxes on that money. But if you make $100,000 — just out of simplicity — $100,000 per year, and you contribute $15,000 into your 401l, essentially you are going to be paying income taxes on $85,000. So it’s reducing your taxable income today. That money is growing all along, and you’re not going to pay taxes until the point you distribute it. And obviously depending on the income tax bracket you’re in and what the income tax bracket rates are at the time, you’re then going to be slapped with an income tax bill in the future.
Tim Church: Yeah, and I think that’s a good point to bring up is that when you’re looking at those account balances, somewhat really of an illusion when you’re looking at that bottom line if all of your contributions are traditional because it’s going to get taxed eventually, it’s just at what level is going to depend on where you are at the time when you’re making those withdrawals. Versus the Roth version — so many employers now offer the Roth version, and that’s even for the Thrift Savings Plan, where basically, you’re going to make contributions after-tax. So you’ve already been taxed on your income, and you’re going to allow those contributions to grow tax-free. So when I say tax-free, it basically is at the time at which you’re eligible to make the withdrawals, you’re not going to be taxed on that money. Now, that’s a whole separate animal in terms of determining what is best for you. Should you do traditional contributions? Should you do Roth contributions? And there’s a lot of different factors that can play into that, such as what your projected tax bracket’s going to be at the time of retirement or eligibility. And that could be a couple different things there. Does the government change the tax brackets? But then also, what is your projected income going to be? And things could obviously change with your job, so it’s really sort of difficult to predict everything. But there are some simulations out there online where you can kind of go through that.
Tim Ulbrich: And I think your point earlier about considering the tax implications is so critical to retirement planning because we often — and we’ve talked before on the podcast about a nest egg, how much you need at the point of retirement. Well, that number, if a majority of that’s in a traditional 401k, for somebody else that’s maybe saved a lot in a Roth IRA, which I’m going to talk about here in a minute, how that’s going to play out when you’re in retirement is very different in terms of the total amount that you have and how it’s going to be taxed. So I say that because I think the tax implications are a key planning piece as you’re thinking about exactly how much do I need at the point of retirement, and what’s going to be taxed? And what’s not going to be taxed when you get to the point of withdrawal? So again, 401k, 403b, TSP, max contributions in 2018 are $18,500 for the majority of people that will be listening to this podcast. And that number I think will be important because you often hear people say generally, to meet your retirement goals, you’re probably looking at somewhere around maybe 15-20% of your income that needs to be saved. So if you figure out the numbers, a pharmacist making $120,000, obviously you’re starting to get that point with the 401k, 403b, but there’s other vehicles that we’re going to talk through right now. And let’s go to that next one, which is an IRA. So Tim Church, IRA, Individual Retirement Arrangement, this one has different figures, different numbers, but also has a traditional form of it as well as a Roth form of it. So talk us through that one.
Tim Church: Correct. So this is something that anybody with an earned income is eligible for. They can contribute up to the max, which as of 2018 is $5,500. And there’s an extra $1,000 if you’re 50 or olders, so $6,500 if you’re 50 or older. But anyone who is earning an income can contribute to this. And what’s important is this is something outside of your employer. So this is something that you set up on your own, either through a brokerage account — but the other thing here too is besides what you’re able to contribute, if you’re a married and you have a non-working spouse, they can also contribute up to that limit. So technically, if you’re less than age 50, your household if you’re working and you have a non-working spouse, you can contribute up to $11,000 per year.
Tim Ulbrich: Yeah, and I think that’s an important provision. I know for Jess and I, so Jess is at home with the boys, she’s not working. But to your point, a non-working spouse, so for us, when we talk about a Roth IRA, we both contribute that $5,500 per year to be able to make that contribution. So this has both a traditional version as well as a Roth version. And again, I think that’s where it gets confusing when people hear Roth 401k, Roth IRA. So traditional IRA looks very much — obviously the numbers are different, the $5,500 per year — but looks very much tax-wise like a 401k or 403b in that you are — if you meet the income qualifications — you are deferring the payment of taxes to a later point in time. You know, many pharmacists don’t qualify in terms of the income limits for a traditional IRA.
Tim Church: Right. And if you look at the IRS has some different rules depending on whether you are covered by a 401k or whether you’re not covered by a 401k. But if you are, the phase-out if you’re single is $73,000. And for being married filing jointly, it’s $121,000. So if you make above those limits, you actually can’t deduct the traditional IRA contributions. And so that kind of leads into well then why would I ever do that, right?
Tim Ulbrich: Absolutely, yeah. And I think that we’ll talk in a minute about the back-door Roth IRA, and we’re going to actually in our upcoming Q&A episode even talk a little bit more about it. But when we talk about a Roth IRA, and I think why Roth IRA’s have all the rage these days, rightfully so, is that you are paying taxes today, that money is growing, but you are never paying taxes on that money again in the future. So if I were to contribute up to the max, $5,500 per year in a Roth IRA, and Jess did the same, that’s money that is being contributed that we’ve already paid our taxes on. So got my paycheck, paid taxes, then I make the contribution into the Roth IRA. I invest that money, it grows at some percentage every year, hopefully that compounds, let’s say that turns into a half million dollars, I’m at the age of 70, I start to withdraw that money, I’m no longer paying taxes on that money because I already paid taxes on the money before I put it into the account. Now, this gets into the whole debate about, well, would I be better off putting money in a Roth IRA or a 401k, and that gets back to the point that Tim Church made in terms of the tax brackets and what’s going to happen in the future, and largely, I think most people would agree we probably don’t know at this point in time. Now, this also has income limits to directly contribute. So for those that are single, the phase-out of contributions at $135,000. For those that are married filing jointly, there’s a phase-out that’s at $199,000. And so this is where you’ll hear people and you’ll hear pharmacists say, ‘Well, I really like that idea of tax-free growth, I pay taxes now, I’m not going to pay taxes in the future. But I exceed that income limit,’ and insert the back-door Roth IRA. Now, we could have a whole separate episode probably about the back-door Roth IRA. There’s some great tutorials, resources online. I know the White Coat Investor — just shout out to what he’s done — he’s got some great tools and resources about how people can go through that process. But essentially, what you’re doing in a back-door Roth IRA is you’re contributing to a traditional IRA, and then you’re converting that to a Roth component. And so we’re going to come back to that in our Investing Q&A. But all that to say if you’re somebody that exceeds the income limits of a Roth IRA, that does not mean you cannot take advantage of the benefits of a Roth IRA because of that back-door components.
Tim Church: Right. And I think the key is to keep in mind that it really is about the timeframe at which you make that conversion and whether there’s any gains on the money when you make the contributions to a traditional IRA. So if there’s any gains in between that conversion, you’re going to pay taxes on it. The other thing is too is that if you’ve already had past traditional IRAs, and you didn’t convert them, there can be some tax implications with that as well.
Tim Ulbrich: You know, the other thing I love about Roths, which I don’t think is talked about enough is that they do not have the forced required minimum distribution that come with the 401k or 403b. So if somebody’s out there thinking, you know what, maybe I’m going to be working until I’m 75 or 80 or maybe I have other sources of wealth, real estate investing, businesses, whatever, and you think you may not need that money at the required minimum distribution age in the early 70s that you’d be forced to take in a 401k or 403b, to me, that’s one of the great advantages of a Roth IRA, that you continue to let that money grow, and you don’t have to take it out. Alright, we’ve got another big bucket here, Tim, in terms of the HSA or the Health Savings Accounts, which we talked about in Episode 019 in details for those that want to go back and look at those. But give us the down-low on HSAs. I know you have this benefit through the VA, but this has the lethal triple-tax benefits, which are talked about often. So why are HSAs so powerful?
Tim Church: Well, exactly just like you said. It has the triple tax benefit. But yeah, this is one of the cool things that I started for my wife and I for this year for 2018 because I didn’t really know much about it before and what the implications were. But just going through as we talked about through YFP, I mean, it really has a lot of power. And the name itself is really a misnomer because you look at that and you say, Health Savings Account, so it’s just a regular savings account that I can use to pay health expenses, right? Well, not exactly. It can actually be an investment vehicle. It’s really an investment account in disguise. It really depends on your intentions or how you’re going to use it. And for some of these accounts, you have to have a certain amount before you can unlock those investment options. So for example, for me, is I had to have $2,000 in the account before I was allowed to contribute anything towards an actual investment.
Tim Ulbrich: Does that vary by who offers the accounts?
Tim Church: Yeah, I think it does. I don’t believe that that is an IRS stipulation. I think it does depend on the bank that is servicing the HSA.
Tim Ulbrich: I thought I saw that on the Facebook group, people were talking about, well, ‘with my employer, that number is different,’ so yeah.
Tim Church: Right. So like we were talking about is, how you’re going to manage this account really depends on that intention. So you could be using this account to strictly pay for medical expenses, and the benefit of doing that is you’d be paying for them pre-tax, which is not a bad thing. I mean, that’s a great way if you have anticipated medical expenses and you want to be able to pay for them with some tax efficiency, then that’s great. But you can also look at this from the perspective as I’m going to use my HSA as an investment vehicle. So you’re going to say, I’m going to pay for all of my medical expenses out-of-pocket, and I’m just going to invest the rest, and I’m going to treat it like an IRA or I’m going to treat it like my 401k in that my goal is to beat inflation to actually get some compound growth.
Tim Ulbrich: And is the thought here if you’re going to pay for your medical expenses out-of-pocket now and really let that grow, it sounds like it’s got the benefits of a Roth IRA plus you’re not paying taxes now. It’s got that, you know, the highs of the 401k, 403b and also the highs of the IRA. But at some point, are you forced to use those on medical expenses?
Tim Church: No, so it’s really kind of interesting about the account. So just to jump into that triple tax benefit. So the first one is that it will lower your adjusted gross income. So you can — any contributions you’re making to the account are tax-deductible.
Tim Ulbrich: Like a 401k and 403b.
Tim Church: Correct — if they’re traditional, correct.
Tim Ulbrich: Yep.
Tim Church: And then that account, any contribution that you put in are going to grow tax-free. Now, the withdrawals are tax-free as long as you can prove that they’re being used to pay for a qualified medical expense because otherwise, you’re going to pay a 20% tax if you take the money out before age 65 for a non-qualified expense. Now, if it’s after age 65, to my knowledge, there’s no additional penalty, there’s no additional tax. You basically, it’s like a regular retirement account. Now, here’s the caveat. So — and this is one thing that I didn’t know until I really got into it is that let’s say you contribute to an HSA over 20-30 years. And those accounts are growing, you’ve been investing them aggressively, and you’ve got some great growth on them. And let’s say you’re 60. Can you pull out some of that growth that you’ve had, some of that money that’s in there, but without paying taxes on it? And you can because the caveat is that if you keep track of all of your medical expenses you paid over that time that you’ve been contributing and can prove that you’re essentially reimbursing yourself, you’re not going to have to pay those taxes. But the key is really, you have to keep a good record of those receipts. What I’ve been doing is basically putting anything I have into the cloud, into Google Drive, and doing that for every year so I know exactly what I’ve paid and what I can technically claim as being a reimbursable expense.
Tim Ulbrich: Sounds like you need to develop like an HSA tracking expense app.
Tim Church: Yeah, there’s probably something out there.
Tim Ulbrich: Maybe it’s the next business project. But so unfortunately, not everybody has these available. But for those that do — and we’ll get into this prioritization — you often hear people putting these at the level of, OK, take your match, and then you think about an HSA. We’ll come back to that, but the reason that is and why they are so highly regarded in terms of priority investing is because of the tax benefits that you were just talking about. But not everybody qualifies. I know I haven’t with the employers I’ve worked with. In the state benefits, we didn’t have what was considered a high-deductible health plan. So to qualify, you have to be enrolled in a high-deductible health plan. What basically is a high-deductible health plan? Well, this year, for an individual, it’s having a plan with a deductible of at least $1,350. And for a family, that deductible is at least $2,700. Now, I think what we’ve seen with health insurance benefits pushing some of the costs back into the consumer and obviously increasing deductibles, we’ve seen more people being eligible for these. And I think it’s a great time to talk about this because of the time period around open enrollment. So if you’re somebody saying, do I have a high-deductible health plan? Do I not? Does my employer offer an HSA or not? Now is the time to look to see where this may fit in the context of your prioritization of investing.
Tim Church: And I would say that the two major reasons that my wife and I, we decided to switch from a traditional PPO health plan to a high-deductible health plan, really for the opportunity to contribute to the HSA but also the other benefit is that high-deductible health plans typically have lower premiums. So with the old plan, I was paying a lot more each month, but I wasn’t using any of the insurance that I was paying for. So if you’re relatively healthy, I think it’s a great option. So if stuff comes up, you might be paying some money out-of-pocket, but again, you wouldn’t have had that option otherwise to even contribute to an HSA. And you have to really look in the context of what your premiums are.
Tim Ulbrich: That’s a great point. And I think what you just said too speaks to the power of the emergency fund and having an emergency fund because if you can afford to take on that risk of, you know, maybe I’m healthy now, something comes up unexpectedly, I get slapped with a huge payment. Then ultimately, you’re ready to take that on, and you can afford it without feeling that risk of that. So what we didn’t talk about here with HSAs is the max contribution amount. So we talked about it with 401k’s and 403b’s or the TSPs, we’re looking at $18,500. We talked about with the IRAs, $5,500. What about the HSAs?
Tim Church: So as of 2018, if you’re single, it’s $3,450. And then if you’re self plus one or family, it’s $6,900. And an additional $1,000 if you’re 55 or older for catch-up. And this — just like the other accounts — this typically changes every year, every couple years.
Tim Ulbrich: So what I like, if you start to string these together between a 401k, a 403b, a Roth IRA or a traditional IRA, if you qualify as well as if you have access to an HSA, you can start to get to a point where you’re saving a significant percentage of your salary, probably more than many listening, especially in the contest of other goals. But nonetheless, you have the option to be saving a significant portion of your salary that has tax advantages. And I think that’s key because one of the last things that we want to talk about here is the taxable or brokerage accounts. And so with the taxable brokerage accounts, why I said that previous point I think is important is that I see a lot of new graduates getting ads and promotions for some of these apps and tools and things that are out there. But they’re investing outside of the tax-advantaged accounts. And so I think as we talk about taxable or brokerage account, where we see this fit in is once you’ve exhausted all your other tax-favored retirement plans, this probably is the final option that you’re looking at because of the loss of tax-shield capital gains taxes that you have to pay, etc. So good news here is if you get to the point where you max out everything and you’re looking for options, there’s lots of options out there in which you can invest. But don’t get too far ahead of yourself if you’re not taking advantage of the match or other tax advantages that we’ve talked about previously. So last one quickly before we talk about prioritization of these buckets would be the SEP IRA. And I think this is timely because of your side hustle series. And so maybe we have people out there that own their own business, are starting their own business, want to, and to me, when I see information about a SEP IRA, that makes me want to start some businesses because you’ve got some really good advantages with retirement options. So what is a SEP IRA? And what flexibility and freedom does it give you in terms of retirement?
Tim Church: So a SEP IRA stands for a Simplified Employee Pension. And basically, if you’re self-employed, you own your business, you have this opportunity, this benefit available to you. And this could be in addition to a 401k that you have available. So this could be something that you’re doing on the side, an additional business you own. But one of the advantages is that there’s a lot more money you could potentially contribute versus what’s available with a 401k or IRA. I mean, it’s a huge difference. But obviously, you have to be making that much money up to that certain point to be able to. So right now, what the guidelines are, is that you can contribute up to the lesser amount of either 25% of your compensation or $55,000. But when I see those kind of numbers — like you’re shaking your head here, Tim — that just gets people fired up, I think, to say, hey, what if I was able to bring in an additional amount of income that I’m no longer capped out at this 401k, this IRA max that’s there.
Tim Ulbrich: Yeah, reason No. 403 to start a side hustle, right? I mean, when you see those numbers, and it gets me fired up even for the work that we’re doing that to your point, it’s dependent on compensation, obviously, you mentioned the lesser of those numbers. But in addition to other retirement vehicles, you can obviously make some great headway if you’re in a position to do that. OK, let’s jump in now. We’ve set the stage, we’ve spent a decent amount of time talking about the buckets, which is important because before we can talk about prioritization, we have to know what we’re talking about. What is a 401k? What is a 403b? What is a Roth? Now, a couple disclaimers here that I think we have to talk about because we’re probably going to take some flack regardless, which is OK. But not everyone is going to agree with the prioritization that we’re talking about. Not necessarily that there is one right way in terms of order of investing. Now, we’re going to give a framework on that that we think many listening will follow, but to my point earlier, everybody has different personal situations in terms of income earned, in terms of other financial priorities, in terms of other goals, when you want to retire, all types of variables that may come into play in terms of how you actually execute this.
Tim Church: Yeah, and I think like there’s a lot of people out there that are really into real estate, and they look at that as even taking priority over some of these retirement accounts because either they’re all-in or they’re confident that they’re going to get good returns there. And I think that’s great. I think for some people, that is an awesome option. But I think here, like you said, we’re talking in the context of, OK, let’s focusing in on these retirement accounts and just really try to figure out, well, what is the best order?
Tim Ulbrich: Yeah, and I think the other situation I think about, Tim, is those that are on fire about the FIRE moment, the Financial Independence Retire Early, waiting until 59.5 to access your accounts may not be the goal they’re after. And so you know, obviously again, this to me really speaks to the power of sitting down with somebody like Tim Baker and financial planning and talking about what are your goals and then putting out a map to be able to achieve those. The last thing I have to say here as a disclaimer before we jump into the prioritization — if Tim Baker was here, he would make me say this — is what we are saying is not financial advice, right? So we don’t know of the thousands of you listening, we don’t know what your own personal situation is. So we’re looking, again, down the lane of investing. If you have disposable income to invest, this is the priority we think you should consider. But we’re not saying, run out and do this tonight. You’ve got to think about the context of the plan. OK, No. 1 — I think everyone agrees with this. I mean, maybe there’s a person or two out there, maybe? I don’t know.
Tim Church: I haven’t seen — so what I was looking at to see what else is on the Internet and some of the other bloggers, I think this is one thing almost everybody I think actually agrees on.
Tim Ulbrich: For how much disagreement there is.
Tim Church: Right.
Tim Ulbrich: So No. 1, as you may have guessed it, is the employer match, right? No surprises here, most people agree on this. You are getting free money from your employer. If you don’t take it, you’re leaving it on the table. And so we even believe, we talked about this in the Dave Ramsey episode, Episode 068, the match has to be a priority in your financial plan, even in the context, I think, of student loan debt — maybe a different conversation depending on personal situations, but you have to take that money. Now, for you, you mentioned that 5% match. So let’s just use a hypothetical. Somebody’s making $100,000, they put in 5%, they get 5%, that’s $10,000 of tax-deductible retirement savings that are going to grow over time. You’re putting in 5, your employer’s putting in 5. And again, as I mentioned earlier, you’ll see this in different situations in terms of the percentage of salary match. It may be 5%, 6%, 3%, no percent, dollar-for-dollar, $.50-per-dollar. And so it’s all over the place.
Tim Church: Or what you get. What have you gotten at schools? You’ve gotten like 14%?
Tim Ulbrich: Well, I’m unemployed right now.
Tim Church: Oh, OK.
Tim Ulbrich: But you know, yeah. So you know, I’m lucky to work in the state teachers’ retirement system, which we actually are forced to put in. I remember when I was in the grinding out of paying off debt, it was painful. But we are forced to put in 14%, and there’s some fees and things that shakes out to that they match around 10%. So it’s kind of a forced combined contribution of about 24% total, which is really nice. But the downside is I actually don’t get any Social Security, so I won’t receive that Social Security benefit in the future if it’s there. But we’ll see. So No. 1, employer match. Now, No. 2 is HSAs or Health Savings Accounts. Take the employer match, and I think what often, people do right after the employer match is they just go up and maybe max out their 401k. I think what you’re making a point here is maybe after that match, move into the HSA if you have it available.
Tim Church: Yeah, and I think — but even going back to is that a bad option of putting more money in your 401k? So I think like in the context, which is interesting here is that really, even if you’re switching up the order on some of these, like really, it’s still not a bad decision. The decision to actually put money into the accounts to grow is a good thing. But I do think, you know, the HSA with that triple tax benefit, it’s hard to argue against that, right?
Tim Ulbrich: Absolutely.
Tim Church: I mean, it’s such a powerful tool. I think Dr. James Daly of the White Coat Investor, he calls it the Stealth IRA, which is pretty cool.
Tim Ulbrich: I love it.
Tim Church: Because it’s basically like you’re getting the opportunity to contribute to another IRA if that’s your intention behind it. But it can really be a powerful way to get some additional retirement savings.
Tim Ulbrich: I do have HSA envy. I don’t have access to an HSA, so unfortunately, yes, great match, but I wish I had that HSA option. So No. 1, we said employer match. No 2, HSA triple tax benefit makes a whole lot of sense.
Tim Church: If available, right? Because not everybody’s going to have that.
Tim Ulbrich: Right. High-deductible health plan, you may or may not have it. Now, No. 3 here, we’re getting into the IRA. And really what we’re getting at is the Roth IRA component. And obviously, for those that don’t meet those income qualifications, they would have to do a back-door Roth IRA. But what we really want to take advantage here is the tax-free savings that are going to happen over time. You’re paying taxes today, you put the money in, it grows tax-free, you go to pull it out, you’re not paying taxes anymore. So even though this doesn’t have the same maximum as the 401k, 403b’s, you’re not going to be able to have these be equally weighted, pre- and post-tax, right? $18,500, $5,500. To me, I see this as the way that you’re balancing out getting to the point of retirement, you’ve got some free and post-tax savings. So if I’m maxing a Roth IRA at $5,500 per year or back-door Roth IRA to get there, and then I’m putting in $18,500 in a 401k or 403b, of course I’m going to have more in accounts that are going to get taxed than I am in accounts that are not going to get taxed. But I’m balancing those out a little bit.
Tim Church: It also depends too if you have a Roth 401k, then also that could be after-tax contributions, so it’s possible you could have both. You could do the Roth IRA and a Roth 401k and basically putting everything in after taxes and then letting your accounts grow tax-free. I think going back to what we talked about is that since most pharmacists are not going to get the deduction if they contribute to a traditional IRA, it sort of makes sense to always go to the back-door Roth. Well, I think one of the interesting questions — and this has come up before — is why would I not just go up higher on my 401k versus contributing to an IRA? And really, you know, the way I look at that is either one is still a great option in terms of the contributions. The difference, really, is that with the IRA, this is outside of your employer, which means a lot more options.
Tim Ulbrich: Yeah. And that’s why you hear — we won’t get into it here — but that’s why you hear when you switch employers, there’s value in rolling that over into an IRA where you can unlock those options. And one of the things I’ve seen with Tim Baker’s help is the variety of what people have available to them in an employer-sponsored 401k or 403b, both options and fees, good or bad, is all over the place. Some have very limited options, very high fees, and maybe their employer doesn’t even really recognize or acknowledge the value. Others are maybe working with a Fidelity, Vanguard, whomever, have tons of options, can get low-fee accounts. So this really is an individualized decision.
Tim Church: I totally agree because when I look at the Thrift Savings Plan, one of the benefits of a Thrift Savings Plan, like we talked about earlier, is there’s such low fees on that. And so with a situation like that, I mean, you could make the argument that either one is going to be fine. But if I’ve got really low-fee options that are getting great growth, then I may go and try to max out my 401k or increase prior to going to the IRA.
Tim Ulbrich: And I think your point is a good one. At the end of the day, we’re splitting hairs, right? If you’re having this debate, there’s lots of opinions, lots of nuances, but at the end of the day, you’re doing a good job, you’re being intentional, you’re saving for the future. I tend to favor the prioritization of really maxing out the Roth component before I go back to max out the traditional 401k because of what I mentioned earlier and having that balance of pre- and post-tax, but again, people have different answers on that based on what they think is going to happen in terms of the tax component. So just going back in order here — your employer match, HSA, IRA component, we talked specifically about the Roth component of an IRA or a Roth 401k, right? And then going back to your traditional 401k, maxing that out to the $18,500. Now, if you get to this point, and you’ve taken an employer match, you’ve maxed out an HSA if you have it, you’ve maxed out the IRA, and you’ve maxed out your 401k, you’re crushing it.
Tim Church: Yeah, I mean, that’s pretty awesome. I mean, I’m not quite there yet. But it really is encouraging to see those numbers as a goal, really, to say, hey that’s where I want to be.
Tim Ulbrich: When you put those numbers together, we’re talking about $18,500, another few thousand, another $5,000 — you’re saving a significant percentage of your salary, looking at several million dollars with compound growth over 30-40 years. Now, after we max out the 401k or the 403b or the TSP, then obviously, if people have access to a SEP IRA, they’re going to take advantage of that. Now, after Step 5 here…
Tim Church: Right, that would depend if they have some kind of additional income or potentially they don’t work as a W2 employee, and their main business or their main job is as an employer or a small business. So that actually could be somewhat reversed depending on the situation and depending on what kind of job you have.
Tim Ulbrich: What you have available, yes. I think what we’re doing here is — before we get to the last one, which we’re calling them brokerage accounts, which as I made the point earlier, these don’t have the same tax advantages that all these others do. So what we’re advocating for is really maxing out the opportunities you have to save in tax-advantaged vehicles and then ultimately if you’re still looking to save more, personally I’d probably advocate for maybe some real estate investing, some business stuff, other things before even brokerage accounts. But you’ve got lots of options available.
Tim Church: You’ve got lots of options. And the other thing too is as long as you’re not continually trading fees and different things like that, I mean, capital gains tax is actually still tax efficient versus some other things that are out there that you’re going to get taxed ordinary income.
Tim Ulbrich: Absolutely. Fun stuff. We covered a lot here, packed full of information. I think this is one we’re going to hopefully go back and say, ‘Hey, you got questions about the different investing buckets, prioritization, go back to Episode 073, we’ve got some great information.’ And this is a reminder, for those of you that haven’t yet done so, if you could leave us a review in iTunes, if you like what you heard, or whatever podcast player that you’re listening to, we would greatly appreciate it. Also, if you haven’t yet done so, make sure to head on over to YourFinancialPharmacist.com, where we’ve got lots of resources, guides, calculators, that are intended to help you as the pharmacy professional on your path towards achieving financial freedom. Tim Church, this has been fun and looking forward to coming back and finishing up the series.
Tim Church: It’s been great, Tim.
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