Are You Using Your 401(k) the WRONG Way? (You'll Want to Watch This!)

are you using your 401k the wrong way you're going to watch this it's brian preston the money guy so brian this is what i think is going to be beautiful about this show i feel like we have a duty to the financial world there's been so much bad press out there so many folks saying oh you know 401ks aren't good anymore maybe you shouldn't be using them or this it's an old antiquated thing and we know that folks who think that way really don't understand just how powerful this tool in your financial tool belt can be well it's definitely something that i think if you don't understand how this works how can you harness the power of growing this towards financial independence if you let all these misconceptions if you let the negative stuff seep in sure you'll never get the maximum benefit so that's what we're gonna go deep dive here guys we're gonna try to both keep me honest don't let me get sidetracked on some you know going down a tangent that i don't need to be there's no way to make sure we keep this moving there's no way that i could do that no way can i actually keep you from that but i do think it's interesting because we're gonna walk through the basics you know where they came from how they work how they operate things you need to be careful for we're going to talk about some basic strategies then we're going to close out talking about some advanced strategies so this is going to be everything 401 k today yeah instead of reading four or five different blog posts or watching four or five different youtube videos this is going to be your source love it so let's jump in first where did these things come from how did we even get 401ks so we thought we'd put together a little timeline for you and if we go back to 1978 section 401 k was added to irc allowing employees to avoid taxation on deferred compensation so they wanted to move some of their income into the future they wouldn't have to pay tax on it present day were you excited when they passed that legislation i was super stunned 78 was a good good year for bo hansen i was really excited about that so that is i mean it is interesting so it is has allowed employees to avoid taxation on deferring the income to the future years but that's still that didn't really change anything what actually opened this up in 1981 in 1981 the irs started allowing employees to fund 401ks through payroll deductions so now rather than deferring compensation they could actually say you know what i want to take a little bit of my paycheck and have it go into my 401k account each pay period so 1978 building block 1981 is where they actually lit the firecracker and that's when this thing started building assets and how successful have 401k has become in buildings it's been pretty remarkable in 2020 401k plans now hold more than 5.6 trillion dollars in assets that's really a 40-year period that it's gone from zero to 5.6 trillion dollars so i always think it's important so for these things to catch on there has to be a why why did employers because let's face it pre-1980 define benefit pensions were kind of what was going on out there and look this is not i don't want to paint this um all cherries all unicorns and rainbows that 401ks are all great news because it was i mean it fell upon your employers to ensure that you came and you worked at a job and then they loaded up your retirement plan you participated as well but then when you retired that's why they're called defined benefit they guaranteed the benefits you would receive at retirement well as you can imagine populations growing companies are starting to to realize hey employees are starting to it's not like you take a job in 1970 and you work for the 30 or 40 years employees are starting to bounce around a little bit so they came up with this alternative and this is known as defined contribution break out the difference but the big thing is define benefit plans the risk rests on the employer they have to make sure that there is a retirement benefit that exists for their employee for the remainder of their life with a defined contribution the risk actually falls on you the participant if you want to have retirement assets you are the one that are responsible for saving those assets to get to retirement and then in retirement managing those assets for your benefit it was a big risk shift from employers to employees so that that's what i think is interesting because i asked daniel i said daniel when we're putting together the slides here's what i need i want to know how many plans existed like in 1980 1981 on the defined benefit and i want you to compare and contrast what has been the change over the last decades and he did a great job by the way he did this in a way because we didn't want to throw the numbers off by including companies that were less than a hundred he did only larger companies so 100 employees are greater and the numbers are pretty striking yeah so this is directly from the department of labor from 1975 all the way through the end of 2017 and you can see in 1975 there were a little over 20 000 defined benefit or pension plans well fast forward 2017 they're only about 8 000 pension plans available to employers with more than 100 employees contrast that to in 1975 there are a little over 8 500 defined contribution plans now there are over 82 000 defined contributions so there's been a huge shift in how employees save for and prepare for retirement bowie okay here's one of those tangents i can't help but go through when i see those things you asked me to not let you do you're about to do notice in 19 right between you know in the late 70s there were 20 000 defined benefit plans right now we know as of 2015 when this data was published that's cut by half you know a little more than half because it's at 8 000. so like wow okay so we did drop 60 of the plans but here's what i think is interesting there are 80 is that 82 82 000 82 000 defined contribution or 401k plans for 100 are greater employees this is why when i talk about the ever expanding pizza pie of the economy this is it guys there's just more employers that have over 100 employees that's a positive things for economies i think when innovation is growing and all these good things when people say well the markets keep going up i'm like yes because when we look at this 20 or 30 years from now there's gonna be a hundred and thirty thousand plans out there because the economy will keep growing okay that's the end of my sidebar it's just i get excited when i see that the economy does grow it's not a zero-sum where somebody loses so somebody else can win we are growing this thing forward and so it sounds like you know folks who are working folks who are building financial success have recognized that 401ks are a great vehicle to do that if you look at the ramsey solutions national study of millionaires 80 of millionaires acknowledged that they invested in their company's 401k plan and most folks when they reached millionaire status they did so around their late 40s inside of their 401k plan that's where they reached the millionaire status and that makes sense because if you think about what is probably one of the best ways and one of the habits or characteristics of what i see in millionaires and what it is is systematic forced and continuous savings that's exactly right and what do you know what a 401k does it allows you to systematize the savings and it doesn't matter good news bad news that volatility that you face because of a pandemic or whatever is going on with a global recession with a 401k if you do it right you set it forget it and you're buying the entire process it is that type of process that leads to by the time you're 49 you wake up one day and go wow all that money i saved has truly turned into an army of dollar bills so the natural question you're probably asked is okay i'm sold you've told me that ought to be doing this 401k thing i'm in i want to be a part of it all right walk me through now how do they work what's the simple gist of how a 401k plan works so let's talk about the first thing is is you're going to want to know you and you saw this was the legislation that passed in 1978 but then really was lit in 1981 is that you get to put money in that's the first thing you put money into the retirement plan yep and then that money grows either tax deferred or tax-free if you put it in as a roth type investment so what that means is while you put the money into the plan you're able to invest it and every year as the account goes up in value as the investments grow you don't pay any tax on that but when you get to retirement you start pulling that money out you take it out that's when you have to pay tax if you built it up in the pre-tax portion just like you said with the roth it also grows tax deferred except for when you pull it out then you actually didn't defer to taxes it's completely tax-free and when will you actually pull the money out if you keep the money in a qualified plan like the 401ks 457s for 403 b's you can pull it out at 55 if you've separated service or if it's in an ira at 59 and a half you have access to these assets so you can see the whole it's kind of like this big money machine you put the money in you kind of give it enough time to let it grow let your compounding interest kick kick in and then in the future you're pulling that money out for retirement so we just talked about brian how are you put money in and it can either grow tax free or tax deferred so it sounds like there's a choice in there do i want to put it in on a pre-tax basis or a tax-free basis well the next question that most people are probably going to ask is how do i know should i do roth or should i do traditional how do i know what's best for me as a 401k participant and these are unique times to kind of think about this because i always say it really depends depends on several factors and we'll go through those i'm just going to give a few overview things and then i want you to kind of go through each one i think your age is going to have an impact on this how far do you have from retirement because we know the younger you are the more powerful your army of dollar bills we also know what is your outlook i mean these are unique times yes tax rates have actually come down sure because of the the legislation that got passed at the end of 2017 that for the tax year starting 2018 but we know there's a lot of political discussion about taxes going back up so all these things come into play so bo kind of bundle that all up and tell people what are the decision points they need to consider yeah so basically if you're thinking about should i choose traditional should i choose roth we think choose traditional if you expect to be in a lower tax bracket in retirement so perhaps right now you're a high income earner you're in the higher tax brackets and you think that when you get to retirement taxes will be lower or your specific tax rate will be lower it probably makes sense to build assets in a pre-tax fashion or if you're someone who thinks later on i want to do some sort of in-plan roth conversions or actually pay the tax and convert traditional pre-tax assets into roth then you might want to choose traditional those are kind of the two times that we think traditional makes sense i also think i'd throw in there if you're somebody who thinks you're going to retire like 55 even six years you know part of your part of the fire movement and your situ you are going to go from a much higher tax bracket to where your income is going to get cut way off you might be able to manipulate through roth conversions or other things that fits into the kind of that second component on why you'd want traditional so then if you're trying to figure out when should you choose roth well choose roth you'd expect to be in a higher tax bracket in retirement either perhaps now you're in a low tax bracket but you know as your career changes and your lifestyle changes when you go to pull the money out taxes will be higher or perhaps you think that legislatively taxes will be higher at some point in the future when you retire roth is probably going to be a better solution for you or and this is exactly what you alluded to to start with brian if you're young and you expect that your income will increase and your lifestyle will increase roth might be a really great option for you and then lastly if you are getting closer to retirement thinking about when you want to start distributing your assets if you want to minimize the potential tax impact on your social security or your medicare part b premiums you may want to build assets in roth because when those you take those distributions they won't affect social security and medicare premiums so bo i got to tell you that at the end of that it starts going blah blah wow wow it turns into charlie brown we have some visual learners i'm sure that want an example can you kind of walk through traditional versus roth what are we talking about if you actually did an example with real numbers yeah so we think that case studies are always the easiest way to learn so we're going to lay out ralph uh roth ralph rolfe roth ralph and pre-tax patty thank you full-time equivalent daniel for those names ralph is going to invest in the roth 401k and patty is going to invest in a traditional 401k and then she's going to invest her tax savings because remember if we put in money in the traditional we have some tax savings we're going to assume that she invest that so let's assume that each of our two participants are 22 years old and they're going to retire at age 65. let's also assume that right now they both make 40 000 per year and they listen to the money guy show so they're going to save 20 of their gross income or 8 000 into the 401k let's assume that their salaries grow at three percent and let's assume that their invested assets whether it's in the pre-tax or roth are going to grow at about eight percent annualized over their working career we know that right now they're both in the 22 marginal tax bracket but because their income is going up and because their income will be higher later on let's assume that in retirement they're going to be in the 24 marginal tax bracket and because we know that paddy is going to be investing in an after-tax account let's just assume the tax on any capital gains that she generates is 15 now we're going to go through the actual numbers but i think there's some key things here if i was kind of like reading rainbow style highlighting the things that i think people ought to pay attention to both of these individuals are young 22 years of age letting their monies grow until they reach age 65 that's a clue huge the other part i think is interesting is that we have a big assumption here is that they're currently in the the 22 marginal tax bracket pretty reasonable but we think because of maybe future income sources pay raises or maybe even have you know some other income streams like rental property or something that's going to push them up into retirement into a higher tax bracket so they think when they retire taxes will actually go up that's another clue of something they ought to consider so go ahead and play out the numbers so uh if we just look at the 401ks remember both of them are putting eight thousand dollars in and that's that's going to grow each year so on the surface inside of the 401ks roth roth ralph has about 4.4 million by the time he gets to retirement and pre-tax paddy also has about 4.4 million by the time she gets retirement we're just looking at the 401k balance wait a minute those numbers are the exact same but wait a minute there's more to this because one is after tax contributions and one is pretext meaning you get a deduction when you make the contribution how did we make up for that so let's remember that pre-tax paddy gets a tax benefit every time she puts her money in she saves a little bit and we're gonna have her invest that so in addition to her 4.4 million dollar pre-tax 401k she's also going to have an after-tax brokerage account that's going to have about 765 000 in there now we know that in after tax accounts the money doesn't grow tax deferred it gets taxed annually so we just said let's assume that account grows at seven percent per year instead of eight percent okay so put a one percent kind of a tax extra headwind to it okay so what actually happens is at retirement at age 65 ralph has about 4.4 million dollars but patty actually has about 5.2 million dollars so if we stopped right there we buy it looks like taking the tax deduction actually was a good thing especially if you were disciplined enough to put the money to work but you're like wait a minute there's more to this there's more remember ralph has all his money in roth so when it comes out it's completely tax-free patty does not have that luxury so if we assign a 15 capital gains rate to the earnings in a rafter tax account yeah and a 24 marginal tax rate to her pre-tax account we see that her total available balance purchasing power balance of her assets is only about 4.1 million dollars while ralph's is still 4.4 million so in this scenario two identical savers it was actually more advantageous for ralph to build assets in the roth tax-free than for paddy to build assets pre-tax and save the tax savings each year so just kind of summarizing the 765 000 of after tax money once you took into account like a 15 capital gains yes tax rate just on the earnings contributions went down to 741. the 4.4 close to 4.5 million that was in the pre-tax as soon as you took your 24 because remember taxes went up in retirement that's what brought it down to the 3.4 bring those two together that's where we came up with the 4.1 now let me ask that i just want to play the other side devil's advocate sure because you said it right roth ralph would have been more advantageous because we assumed that taxes were to go up in retirement yep plus he was young so the the the you had a lot of growth here compounding interest if we were to flip the script and maybe change the tax rate from 22 but it went down to a 15 we just made a guesstimate of what rates might be in retirement this would have probably gone the other way it would have gone completely the other way pre-tax patty would have had more money now let's pause for a second and we talked about this a little bit in pre-show prep brian realistically it's not this static when it comes to saving money what often happens is while we're young and we have lower incomes we're saving the roth and then as our income gets higher and the tax benefit becomes more valuable we might start saving in pre-tax and taking advantage of the current tax benefit and then as we age and our tax planning changes we might go back to the roth or perhaps we split very likely you won't stay in one bucket for your entire working career and that's what makes this part science part math but also part art that's great though good job fte daniel also on helping us put this illustration together and that does lead to because i think we have to understand because we just alluded to there are really two participants in this retirement plan there is you the employee in your contributions and then there is your employer and their contributions but let's talk about when you the employee put money in you have essentially it sounds like two pots but we know because we get bonus credit points here there's actually three pots that you're putting into walk through those three different areas so uh almost every plan i'm going to say every single 401k plan will allow you to do pre-tax 401k contributions so your contribution is going before tax and then distributions are taxed well a lot of plans and this has changed over the last 10 to 15 years now have a roth option where you can your contributions go in after tax and distributions are completely tax-free now there's something interesting about roth 401ks roth 403 b's and 457's i know roth iras have income limits as a married couple gets you know right below 200 000 you kind of can't get traditional roth contributions anymore but roth 4 1 case has zero income limit so you can make a million dollars a year and still contribute to a roth 401k another thing i think is interesting if you are not over the income threshold for roth iras you can do roth 401ks and roth ira so don't don't let don't don't assume you have to just do one roth you can actually double up if you qualify for each individually now something that's probably a lot of people is going to catch them off guard a little bit they're like there's a third one there what after tax what does that mean they're actually for some plans now not every plan offers this you have to look to see if your specific plan does but there's actually a third contribution option called after tax 401k contributions and what happens is your money goes in after tax you don't get a deduction for it but the earnings grow tax deferred so it's different than the roth and it's different than the pre-tax it kind of combines the two so you put money in on after tax basis and the earnings grow tax deferred what's beautiful about this is we know that when it comes to pre-tax and roth contributions there are contribution limits annually it's 19 500 if you're under 50 right now or 26 000 if you're over 50. what's really interesting is if your plan allows after tax contributions you're not capped at the 1905 or the 26th you actually can put even more money than that into the 401k plan so this is a good setup and maybe because i i didn't see us put it directly here in the show notes because maybe it's the advanced strategy it is but this is the setup for what we call the mega run that's correct right yeah so but there's some cautionary tales because we're teasing that that we will come back later and give you in-depth details on how to do the mega roth conversion strategy but there is something cause i've had this conversation with several people recently first of all you have to make sure if you do go beyond the 1905 for those under 50 26 000 for those 50 and over that you don't crowd out your employer matching contributions and profit shares because there is a limit there's a 57 000 um or 63 500 if you're 50 and over there that you have to make sure that you don't squeeze all that out with contributions on your side that you don't leave enough room to get that employer free money exactly you could be walking away from free money if you don't leave room for that so if you are going to participate in the after tax portion of your 401k you got to do some mathematics over the course of the year to make sure that you're funding at an appropriate level now i've also because there's gonna be a lot of um business owners and others who are gonna get super excited about this because you know we've even checked that box a few times you also need to be very careful that you don't trigger any of the testing things because there is if when you fund the additional after-tax it can trigger some of those those highly compensated or top-heavy type testing requirements as well right yep that's exactly right so if you're just a participant in the 401k plan and it allows after tax contributions awesome do it take advantage of if it makes sense in your plan if you're a business owner and you're thinking about adding this in it might not all be sunshine and rainbows because there are some additional tests that you have to pass just make sure you check two three four times before you implement this and add this together it's a much better instead of me trying to go through every one of the ifs ands or buts you know on on trying to figure out the planning just it gets complicated it gets complicated so that we also said it's something there that i want to make sure we don't let just slip through if you're 50 you get bonus points with these type of retirement accounts because think about this iras because the government i don't know if they they feel bad because i'm quickly approaching this age where you reach 50 and they're like we need to give these guys because it's probably about that age that if you have not understood how powerful your army of dollar bills this is probably the age you're waking up one day and going uh-oh oh my goodness i need to save for retirement so the government's actually built into all the retirement savings vehicles an additional catch-up that you can save and i want to give you a perspective because they really have loaded it up when you talk about 401ks and 403bs specifically because iras as soon as you turn 50 you get an extra thousand bucks that's great so in 2020 it goes from six thousand dollar contribution to seven thousand dollar contribution simple ras they give you an additional 3 000 a year contribution so it gets a little bit better than just regular iras but as soon as you get into 401k territory they give you an additional 6 500 a year well you can think very quickly if you're someone that's in a higher marginal tax bracket that 6 500 if you're making pre-tax contributions can be some pretty material tax savings that was not available to your 49 year old self so that's really powerful we want to make sure we don't gloss over that because that's a powerful thing but that leads to because look that's all the money you're putting in that's that employee money right let's talk about the free money or the money that your employer is giving you bo walk them through what how does that work and what are the components yeah so your employer can make the uh the choice to put money into a 401k account on your behalf which is awesome they said you know what we're going to move away from the defined benefit we're going to move away from the pension plan but as a nod we're going to put some contributions into the plan for you and there's a few different types of contributions that they can make the first and most common is called a safe harbor contribution well the reason that employers offer this plan is just like we already mentioned at the end of every year 401k plans are required to do specific tests to make sure the plan does not disproportionately favor high income earners in the plan well what the irs came out and said is hey if you give your employees a minimum contribution a safe harbor contribution will allow you as owners or you as highly compensated employers to put more money in the plan so long as you're taking care of your people well the great thing about safe harbor contributions is they are immediately vested as soon as the dollars go in so just like the money you put into the plan is yours day one safe harbor contributions are the exact same way and what i think is interesting because these we see these take the shape of if your plan doesn't require participation it's usually around three percent sure if it's more of a matching type structure it's going to typically require you to put in four or five percent to get that four percent yep so that's because they they're making it and what's funny is that when you do these type of plans that free money we've told so many people you do you do not want to miss out on that free money that you're going to probably see pretty high participation so um usually you're going to see something you know in the three to four percent range so safe harbor contributions are one type of money that the employer can put in another type of money is what's known as a matching contribution where your employer says if you put money into the plan we'll put money in as well but you got to have some skin in the game in order to do that well depending on if it's a safe harbor matching contribution it might be 100 vested or if it's just a discretionary match where the employer says you know what if you put in seven percent we're gonna put in seven percent or whatever the formula is that's one other way that employers can put in money and then the third way that an employer can put in money is what's known as profit sharing and this isn't something where you necessarily have to have skin in the game the employer says you know what it's been a good year things are going well i want to reward our people so we're going to put profit-sharing contributions into the plan well the unique thing about discretionary matching contributions and profit-sharing contributions is often because it is a fantastic benefit for employers to make available to you they don't say you know what this is your money immediately they want to put a little bit of golden handcuffs on you to make sure you stay around they love you they value they want you to have this benefit but only if you stay with them only if you keep doing that so where safe harbor contributions are a hundred percent immediately invested matching a profit sharing contributions might be subject to a vesting schedule and they're really two types of main vesting schedules the first is a cliff where it says contributions are 100 vested after a certain period of time usually like three years so so long as you've been at the employer for three years all the money that the boss or the employer puts in on your behalf is yours you get to take it with you if you leave or tie or whatever or they might have a graded schedule where you get a certain percentage of vesting over a certain number of years so the most often we see is a six year schedule where it's zero percent after one year and then 20 40 60 80 100 after six years i do want to make one distinction because i know a lot of we're we have a lot of young our biggest group of youtube listener of youtube view youtube viewers are actually that 25 to 34 range zone and so that's the threshold where you're probably doing roth contributions and we get this question all the time where people say i'm doing roth but my son of a gun employer is doing pre-tax what's up with the money in the world we should put it in the roth because that's what i chose here's why guys your employer is going to take a deduction for that contribution the way the government just like they make you when you choose roth contributions for yourself they make you put that in with after tax money because there's a promise in the future you get to let it grow tax-free and pull it out tax-free they do kind of the same deal with your employers your employer is going to take the deduction now to give you that benefit so that's why the money has to go in pre-tax they didn't screw up they're not doing you wrong it's just kind of the way things are structured when you have employer money going into the plan so what that means practically is if you were ralph or patty who ended up with that 4.4 million dollar 401k there's a good chance that even though you did do roth contributions you'll have two different buckets of money you'll have a tax-free bucket of money but because the employer put money in on your behalf you'll likely have some pre-tax dollars in there as well so let's talk about because we've gone through vesting we've gone through employee employer matches but there's a lot of you guys that maybe you have just started a company we've gone through i think you know downturns in the economy are kind of like pruning a tree and the fact that sometimes we all the economy takes a trim back and you see more businesses get spurred and started and a lot of you guys might be and you're also probably side hustling that's what i was gonna say i see this a lot with side hustles you've seen a lot of people that have all kind of income sources so you might be thinking how do i save for retirement how do i do it well well the government has tried to encourage because traditional 401ks or those safe harbor 401ks or even some of the more complex ones that's for people who have a lot of employees there's actually a great shortcut you could call it 401k with training wheels for small businesses or businesses that have started out with solo 401ks yeah if you've ever had a small business or you've ever had like 1099 income and you went to see your account and one of the things that accountants used to always say is hey a really great way to shield some of that money is you ought to open up a sep ira which is great a sep ira is a mechanism where you can put 20 25 of whatever your business profit is into a retirement account and shield that from income tax well what's beautiful about a solo 401k is it actually is a 401k plan but here's what's unique about it you get to be both the employee the participant and the employer so we've already uncovered that there are two different types of people that put money into a 401k the employee and the employer if you have a solo 401k you get to be both of those people so not only can you do the employer contribution you can also do salary deferral contributions up to nineteen thousand five hundred so it's a great way to likely save more into a retirement account than you would if you were just doing like a sep ira for example i think it's important because i look i don't want to trash steps because i love selling sorry too because separates are one of the few savings vehicles that if you get a client or somebody who's made more money didn't plan ahead a sep can actually go back into the time you can go into last tax year open up a sep even all the way up until october 15th of the following tax year and get it in there you can't do that necessarily with a solo 401k but here is what's interesting sep iras are only funded by the employer meaning that it's all you could call it profit sharing and it depending upon how your business is structured it's probably going to be capped at 20 to 25 of your business income you didn't get any salary deferrals whatsoever where you could do up to 100 of your compensation solo 401ks fix all of that that's what that's really the secret sauce is because it's going to allow you to do what the sep ira does with the profit sharing that 20 to 25 of the profit of the business but it's also going to let you do that salary deferral that 19 500 or if you're 50 or older you get to stack another 6 500 on top of it that is super powerful stuff but here's the catch in order to have a solo 401k you can't have any employees you know you can have you and you can have your spouse or you can have a business partner but as soon as you have full-time for employees you can't do a solo 401k anymore you have to move to a traditional 401k type structure well and people like solo 401ks because you're probably like why do i even want a solo versus a tradition these things are are very easy to administer you don't have to follow what's called a 5500 initially they exempt you out of a lot of the stuff because they know that this is a savings vehicle for a very small business with no employees or the only employees are the business owners and maybe uh the spouses of the business owner but there is an issue with these things because remember and this is something i want everybody listen and lean forward and kind of pay attention because i see this mistake all the time with small business owners you started a company seven years ago and you heard from a money guy show or some other source that solo 401ks were the bomb diggity yup so you started doing you started saving and loading up your solo 401k and you love the fact that there's no filing requirements it's all good but you this thing it's like all things they start building every year you're adding your contribution and it's growing one day you wake up your solo 401k is 300 000 should be a reason to celebrate right that's deferred gratification at its finest if you've done everything right it's a moment to celebrate however if you haven't been following the annual 5500 because there is a threshold the government gives you a lot of slack in the system with the understanding that if you ever get the plan over 250 000 in assets you better start filing that annual 5500 that's just a tax form that tells the irs what's in your retirement plan there's not even taxes due it's more of just an informational super easy there's nothing complicated about it but they're not playing around if you don't do this 5 500 but what are the penalties associated with this the penalty for failing to file this form is 250 dollars a day but the good news is they max it right the maximum penalty that you can incur is 150 000 and fifty dollars a day up to a max of one hundred fifty thousand dollars all for getting to file a very easy easy form so if you are someone with a solo 401k right now stop what you're doing and think to yourself is it over 250 have asked my account if they're following the 5500 if they have not been go do pause this go do that come back and finish the show because there are ways that you can work on it i mean it's in the gray zone just because they keep changing the rules on it but there is something you can do but once you get a notice from the government you're in no-go territory so make sure if you've heard bose words you need to ask those questions is it over 250 am i filing my 5500 so okay brian we just went through like sort of a no-no with solo 401ks don't forget to file the annual 5500 we should probably talk about okay if i'm someone who just is an employee and i have a regular 401k what are some of the things that i should not do with my 401k what are some of the pitfalls that i ought to avoid when it comes to participating in this retirement vehicle well this one the first one's a big one we we get so excited when we talk about financial order of operations i think the biggest shocker for people is that we get you out of the ditch by covering deductibles first but then the very next thing we usually put and it's look 68 of small businesses have safe harbor plans so that means their matching contributions are completely vested the day they happen the second step of financial order operations is get that free money we're talking about your 401k match because it doesn't matter if it's is it 50 cents on the dollar match or is it 100 100 cents on a dollar it's a 50 or a hundred percent match that's a 100 percent rate of return you can't walk away from that you actually i mean if we were to say right now because hey all you got to do is go to moneyguide.com send us an email and we're going to send you 20 every single person listen this would do that yet we know through a vanguard study that 35 of employees don't get their full match 35 of employees out there are not taking advantage of free money so the number one mistake that you cannot make with your 401k is not taking advantage of getting the full employer match the second thing i just wanted to add on big mistakes i see people make is that i see this adage that people think i'm not going to live to be old i'm going to live for today i'm not going to defer gras i'm not going to take deferred gratification i'm not going to take a little bit of today for a great big beautiful tomorrow i'm going to make sure i max it out so that's why you see people when they change jobs they will take instead of rolling that money into either the new plan or an ira rollover they take the money and you know so that's a huge mistake we see with retirement plans we also see loans oh you're like well i'm not going i'm not gonna take a distribution but i'll just borrow off of my plan and here's the thing brian borrowing from your 401k is a genius idea because there's an imputed interest rate but guess who gets the money i do so when i borrow from my 401k i'm just paying myself interest well two very important things happen there one you take your soldiers off of the front lines they're no longer out there working for you and two it's an amortizing loan so just because the stated interest rate is five percent every contribution that you make back part of it is paying the interest and part of it is paying the principal so your rate of return is really really low rate of return on those dollars is really really low loans in your 401k should not be something you're doing if you can avoid it and i want to i want to give something specific we're in 2020 covet has been a big deal in the government so such a big deal that the government has actually changed distribution rules should people take these coveted distributions uh if you can avoid it absolutely not again because your 401k is supposed to be for retirement these are your soldiers in your army that are supposed to be working for your future self just because you can just because the government says there's a special opportunity just because some some restrictions get waived doesn't mean you should do this so it's the last resort last resort break the glass an emergency do everything in your power to let those dollars keep working for you because all that by the way all the rules did was it waived the penalty for to having early access to the money you still go pay income taxes on it so uncle is going to get a big cut of that money be very careful that also here's another two other big mistakes and i'm going to give you both sides of it i it bothers me when i see young people i'm talking about young people that have 20 30 40 years until they retire that are way too conservative meaning that instead of investing in like a target index retirement fund or a total market index they're in the cash reserves yep just having to go in the money market i mean because they don't want to lose any money so scared of the market but hey i know i'm gonna go get my free money so i'm gonna get my free money and just park it in cash inside the plan and then on the other side of the coin and this is something i i never thought if you remember i mean after the dot-com and all the things that people have gone through day trading is back i mean you hear i mean if you go on twitter you'll see all the memes about robin hood and all the other things it is legit that people are back to trying to play individual stocks day trading and you know it's just people are too aggressive you've got to have a plan for the future and unfortunately i think a lot of people have kind of forgotten that major stuff i even see this brian a lot of folks will set their 401k allocation when they're 20 years old and they'll do the great job of saving and putting money in their 401k but they'll never revisit and so they get to 45 and they still have the portfolio of a 20-year-old you have to make sure that you are paying attention to what your accounts invested in and making sure you're making decisions that match where you are so maybe one of the things that we should talk about that's worth noting is how should we invest in the 401k if we shouldn't be too conservative or we shouldn't be too aggressive when we shouldn't day trade how should we think about investing in our retirement plan well and this is one i think is so powerful because a lot of people look you have to love the one you're with you know not all 401ks are created equal you know when i go and look at the 401ks of my clients and even as we designed the 401k for our company abound wealth we wanted the best of the best meaning that we wanted to keep costs low we wanted to give our employees access to super low-cost investments that had a a great long-term track record and then we wanted to make sure we gave them all the features and benefits that would allow them to have maximum growth opportunities for their future so that's that's the ideal yep unfortunately not all plans are created equal i mean it's it's it's not uncommon because i by the way on twitter i had somebody ask me because there's some new legislation where you're going to be able to start grouping buying employment plans as a group especially a trade group can go this is all part of the new legislation and somebody said what do you how do you think this is going to go and my reality here's the reality is that you probably the big players that you want to play in this will not for a few more years you know you're not going to see fidelity vanguard and charles schwab immediately start doing these group plans who usually jumps in first are the insurance companies insurance companies are early to adopt but they usually have much higher expenses now look i've been shocked on some like 403 b's and other things i've dealt with some of these players are sharpening the pencil i don't know if it's because of fiduciary concerns or other things like that but it is one of those things you have to be an advocate this is the key point if you are somebody working for your employer and you look at your retirement plan you go i don't see any index funds i feel like i'm paying a lot for what we're getting go talk to your employer if you don't have roth i mean if you don't have roth access in your plan go talk to somebody and figure out why in the world are we structured the way we are and i i can actually name a number of plans where someone has been listening to the show and they said you know what i'm going to write hr and see if i can have the index added or see if i can have a roth option and we've actually heard firsthand that plans get changed here's another great one if you look at your 401k lineup and there's not either some sort of age based option or risk based option in the plan whether it be target retirement funds or perhaps even custom designed model portfolios that fit a specific demographic you should ask for that and target date funds are maybe some of the easiest that you can add into plans right now well and i think this ties in because people when we do shows like where should i go invest my money we we throw out there so it's just part of our language when we talk to people before you go hire a financial advisor do anything go leverage the ability of a target retirement fund because these things have a lot of benefits bo let's go through a few of these key benefits yeah so the first thing when you're starting out we think that all you should really be focused on are answering two questions how much do i want to save and when do i want to retire if you can answer those two questions a target date fund is great for you literally pick the date you think you're going to retire like the year 2060. you go and buy the 2060 fund well right now while we're a number of years away from that it's going to be more aggressive it's going to have a higher allocation of stocks but as you move through time it's going to become naturally more conservative for you so just like we said one of the things people don't do is they don't track their allocation through time a target date fund will do that for you automatically what lets you focus exactly what you said on the savings habit that's the most important thing don't get bogged down into where should my money go just get it in a target retirement fund focus on what you control which is starting that awesome habit of building wealth and saving for the future now one thing that we think is interesting that was not common knowledge number of years ago is that not all target date retirement funds are equal there are actually actively managed target date retirement funds and then there are indexed target date retirement funds i'll give you a guess which one we think is best we do like the index variety because it drives the internal operating expenses meaning the expenses of the portfolio to just operate and manage and what you pay you know you don't see a money flow out monthly or even quarterly but it's in there i promise you it's baked into the recipe i like index varieties of target retirement funds because they're usually less than like 15 basis points so 0.15 vanguard has good ones fidelity freedom index has some good ones so pay attention to what you have access to and the index varieties are much better and you've already said this if your plan doesn't have it don't be afraid to ask it's a really easy question to write hr hey can we add some target date index funds you may just be amazed that they say you know what yeah we do and we also were looking for a committee to form to review our investments annually you might have just volunteered yourself for that that's a great way to be an advocate for your for your army of dollar bills now i would be remiss if i didn't share that you know you will get to a point because everybody we you know we're a big advocate for these target retirement index funds but there's gonna come a time where complexity comes your sure you're going to get to where you have 300 400 500 000 of assets and then you go start worrying about asset location you're going to start worrying about financial planning matters you know retirement planning estate planning education planning that's where the abundance cycle kicks in we give you all this great free advice so hopefully you graduate to a level of success that you will consider reaching out taking the relationship to the next level we would be horrible business people as well as horrible educators if we didn't tell you there wasn't a level above this and that's actually a great time i want to talk about strategy bo how do you actually maximize 401k so we've already talked about how this tool is an incredible tool in your tool belt so we think that they're sort of what i'm going to call the basic strategy to maximize and everyone ought to know about and then there are some advanced strategies some things that maybe you don't know as much about but before we jump to the advanced let's talk about some of the very basic strategies you've already hit number one on the head we've driven this home get the employer match all right get that free money if you're not getting all of the free money available into your plan that's the single biggest change you can make right now in your financial life to really turbo charge building your army of dollar bills another basic thing you do just make sure you're maxing out all the your contributions as well as the catch-up contributions if they're there you have the income to support it make sure you're taking advantage of it i think a great thing to do is follow the financial order of operations go get that free money and then go look then knock over your water go check your tax-free accounts you have available then go back to your employer accounts there's nothing wrong with maxing out your salary deferrals now bo this is something i think that has happened you're seeing more and more with the side hustles you see people that have multiple employers that's right so if you have multiple employers basic knowledge is is you need to understand how 415 funding limits work that's exactly right across multiple plans you can only do certain salary deferrals you can only get one set of 19.5 you're going to get one set of 26 000 unless small caveat you have access to a 457 plan then you get two but if we're just talking about 401ks understand how your section 415 limits integrate and move together across different income sources different plans we'll talk more about that in advanced strategies so i just want to if you work for a university if you work for a hospital you probably or even governmental entity perk up because that key part about 415 limits and the integration between 401ks 457s is a hyper savings opportunity that we'll hit on so let's keep going now let's pivot into advanced strategies this is kind of the strategies of the millionaires the rich and famous this is what they're taking advantage of and you can leverage these for yourself too now look this is stuff you might not have heard of this is stuff that you just might not be aware of so i think the first one we ought to talk about is the what we call the ira isolation strategy right if you have a really good 401k available to you it may be possible for you to isolate your ira balances inside of your 401k and take advantage of a roth conversion remember a roth conversion is when you convert pre-tax assets into roth assets well there are two ways you can do that you can do it the taxable way or you can do it the tax free way we actually like the tax freeway surprise surprise so if you are thinking about can i do a roth conversion we have a little flow chart for you all right so if you start here first question asked is am i over the income limit here's what you do google income limit for contributing to a roth if the answer is no i'm not over it just contribute straight to a roth ira much easier just to contribute to the roth ira standard if the answer is yes then you have to ask yourself do i have any other ira assets now this doesn't include roth assets doesn't include inherited iras but it does include like separate simple rna yes i mean because you hear people by i saw it on twitter last night somebody was asking a question about the pro rating of bases on iras and i was like oh man they they need to know a little bit about this isolation strategy so if the answer is yes you cannot do a tax free roth conversion under your current structure what you might need to do is take those iras and assuming you have a really good 401k with really low cost investment options with really diverse investment options it might make sense for you to roll that traditional that sep that simple that ira rollover into your 401k all the pre-tax assets all the pre-tax assets to zero that out because if you can get it to where the answer is no i don't have any other ira assets then you can do what's affectionately known as the backdoor roth conversion or roth conversion strategy where you can contribute to a non-deductible traditional ira you don't take the deduction you convert it to roth and because the assets are all after tax it's a completely tax-free conversion why is this a 401k planning strategy because the 401k is the thing that allows you to zero out those pre-tax iras but you have to make sure you have a good 401k to do that yeah so that's what if you are sitting on those sep ras the simple ras because look i i've had them all yeah well if you think about my first company you don't start it off back then they didn't even have solo forces in case you always started with a sep ira then you graduated to a simple ira and then you started doing 401ks a lot of you guys are probably the same way you can roll those old ira assets back up into a great 401k and set yourself up for some of these advanced planning strategies so that's advanced strategy number one advanced strategy number two this is a big one and this is one that we alluded to earlier it's the mega roth conversion or the mega backdoor roth that's only available inside of specific 401k plans with specific provisions yeah and we you know what's what's interesting is that we've spoke to a few corporations we get to go in talk to executives and others and we see that some really good plan designs you will see a lot of the plans will offer after-tax contributions they'll allow in-service either distributions or in-service conversions right there within the plan that's all the magical recipes you need because that allows you to as bo talked about earlier we can load up the 57 000 that you can put into these qualified plans 63 500 if you're 50 or older and then any area that you have that's not crowded out by employer match employer profit sharing you can go above the salary deferrals with after tax contribute contributions and immediately turn them into roth funded contributions through a conversion so i'm going to give you an example brian check my math because math is not my jam when i'm doing it on the fly let's assume that you max out your salary referrals at 19 500 and let's assume your matching contribution your employer puts in is ten thousand five hundred dollars okay that takes us to a total of thirty thousand dollars you know math right if your plan allows for after tax 401k contributions you could elect to put another 27 000 into your 401k of after tax contributions if you stop there the 27 000 goes in after tax and any of the earnings will grow tax deferred and when you pull the money out the earnings would be taxable unless you have access to number two your employer allows you to in that same year roll those after-tax contributions to a roth or do an in-plan roth roll over once you do that that 27 000 of after tax contribution turns into 27 000 of roth that then all of the earnings all of the growth will be tax free forever if you think it's really cool to be able to do a six thousand dollar roth ira contribution or you think it's really really cool to be able to do a nineteen thousand five hundred dollar roth 401k salary deferral then you should think it's really really really cool to be able to do a 27 thousand dollar mega backdoor roth contribution i do want to kind of put some because i've had some questions on this and i know we're way in the weeds but this is the people who are hanging out now are the financial media so they'll appreciate this additional depth if you're a business owner and you know that you're either fully funding the 57 000 or the 63 500 if you're 50 or older this might not be as exciting to you especially if you have employees because if you know you're already fully funding that you have to worry about the task testing issues plus it's also d if you're in a higher tax bracket situation do you want to go ahead and pay at that highest tax bracket just so you can do a mega roth opportunity so it's not as great for those people this is really awesome for executive level employees that this additional after tax is actually more money you're saving it's more savings is what this enables is why you get so excited about it and then that more savings is actually tax free roth eligible that's the part that's the secret sauce that gets people excited it is somewhat complex and i have to clarify that because there's a lot of my my small business owners out there who just salivated the idea of having all this roth money that i always have to say yes but there's some guests you have to you have to check some boxes you have to go run some census data really nerdy stuff to make sure this is a good idea so let's transition to another strategy bo we call this multi-income source hacking yeah so one of the things that's really interesting we already acknowledged that when you have 401ks you only get one 19.5 or you only get 126 000 no matter how many 401ks you have however that 57 000 limit that can go into 401ks is per unique employer plan so if you're someone perhaps you're a doctor and you work for a medical group and then you get income from a hospital and then you have a book deal you have different income sources coming your way from different employers that are unrelated one of the things you can do is via solo 401ks if you have access you might be able to max out one plan at 57 000 and then have another plan where you're also taking advantage of either profit sharing contributions or possibly even after tax 401k contributions that 57 000 can go across multiple different plans remember here's the key parts of this contributions that go in these retirement plans are coming from two sources employees employers we know the employee money that's your 415 limits your salary deferrals it's capped out it doesn't matter how many employees employ and companies you work for import companies you own you only get one nineteen thousand five hundred now there is one hack on this four fifty seven seven you get to do both you can do 401ks and 457's different code section with with the irs but here's the thing i want to to make sure i bring everybody back with these multi-income source hacking is that it's the employer person portion that's enabling this is because that profit sharing that 20 to 25 of the income sources is what can fill up that second bucket of 57 000 so you've got a lot of income this is for somebody who owns very successful businesses very successful income sources so that they can hyper accumulate and build this type of thing but it does work now there is one word of caution control groups guys if you're relate if you because here's here's what the government's always worried about with retirement plans they don't want you to have some cruddy plan over here for your employees then you set up some really cadillac loaded up plan just for yourself or your executives so you're to the detriment of these people they always want to that's why they have all these control group rules that if you have common ownership and they you can have a parent subsidiary where it's a mega company that owns 80 of the smaller company you're going to run afoul of things because of the common ownership you might have a brother-sister control group where you have four or five individuals that own multiple companies with some common ownership between the two of them that is going to make you run afoul of this too the biggest thing you can do is if you have and i'll give an example you can own a company and you have income coming in but then you have this other thing out here that has no affiliation to this other company and you don't have any ownership with the way you get paid maybe you're 10.99 for this organization you can then load up that that profit sharing and that's what's going to allow you to kind of have multiple source income that loads up these these qualified retirement plans it's really powerful stuff it's powerful stuff if you're a high income earner and you have multiple sources of income once again the 401k can be a valuable valuable valuable tool in your tool belt but it gets complicated this is one of those areas where we talk about maybe it makes sense to know when to go pro to graduate to the next level before you start trying to figure out some of these strategies it probably does make sense to reach out to well and think about we didn't even talk about it in great detail but another one it's like cash balance plans these are these are additional plans they're not 401ks but you strap them on top you know as another qualified plan that you build into and what i think is interesting this kind of is the seinfeld full circle we know 401ks are defined contribution plans but i do think if you're in a very successful high income situation you do bring back some of those components from a defined benefit that's like a cash balance so you can really turbo charge the savings but also provide a benefit to some of the employees it's a win-win all the way around now brian at this point of the show i was like all right good end we're gonna say hey go subscribe go do this we're done awesome but you're like no no no no we can't stop that i asked fte daniel and i i guess you could call this this is kind of the touchdown dance because i had daniel i said daniel give me that slide one more time if you all remember we did a show and this is kind of what led to us doing this is that bloomberg posted this just ridiculous it was a headline grabber it was click bait i don't like this type of stuff because all the whole reason this was written was to get attention get more clicks and guess what it was extremely successful but the title was 401k plans no longer make much sense for savers bo i think that we have answered the question on this is that if you're not maximizing this if you can't see the benefit and by the way if you want to see this this whole argument destroyed go watch the start of our q a show because we actually do a deeper dive on this but i think do think by going even deeper into the planning strategies all the different components of 401ks we've hopefully showed you how you can harness the power of this very powerful tool that's going to help you build financial independence if you haven't had a chance yet to go check out our website go to moneyguy.com resources out there we have pdfs available for you we have resources we have spreadsheets if you've not done that do that if you have not had a chance to go check out the money guy financial order of operations course you're going to want to work through this because we really do believe that it can and it will change your financial life by letting you know exactly what to do with every soldier in your army of dollar bills well think about it you know please excuse my dear aunt sally has ensured for a generation multiple generations that we're doing math correctly we know finance is a big part of math why wouldn't it work for your money to have a financial order of operations as well we've essentially created the instruction manual for you to make sure you're maximizing and creating as much opportunity out of your money so that you're working as little in the future with your back brains and hands you're letting your army of dollar bills do all the heavy lifting so go check it out thank you for all i mean thank you for all the support we've been doing this since 2006 i can't believe how this journey has taken us to where we've fine-tuned the message we've created a a group of people a family that support us and now we're going to create things that are going to accelerate the wealth creation that gets me excited let's just stare at each other for a second talk about awkwardness money guy team out

Channel: The Money Guy Show

Views: 88,158

Rating: 4.9029126 out of 5

Keywords: money guy show, debt, budget, cash, real estate, insurance, how to make money, save, credit card, compound interest, buying house, buy stock, success, personal finance, Are You Using Your 401(k) the WRONG Way? (You'll Want to Watch This!)

Id: 0KpT5vHHMQQ

Length: 65min 42sec (3942 seconds)

Published: Fri Sep 04 2020