The plan-in-a-binder era has ended. Today people want ongoing guidance through the complexities of modern finances and help making a multitude of money decisions filled with perilous nuances. But even with a greater focus on the present, preparing for retirement remains a key ingredient to good financial planning.
On this episode of Elementality, Reese explains to the clients of his RIA about where qualified plans fit within the planning puzzle. Reese talks about the practical details of several retirement plans—IRA, 401(k), Roth IRA, SEP, Simple IRA—and explains why putting together the right mix of Qualified Term (Qt) and Liquid Term (Lt) savings helps optimize retirement goals.
Podcast Transcript
Ryan Isaac:
There’s been times when I’ll see a client build up significant balances in 401Ks or simple areas, whatever they are, and a lot of money in brokerage accounts, but then the cabin, the second home, the beach house, the something comes up for grabs and they’ll just go wipe out a brokerage account. Hundreds of thousands of dollars for a down payment or a big project or something. And then I’m always left thinking, I’m really glad we have that qualified retirement plan because this might be the single thing. Yeah, this might…
Reese Harper:
That’s left.
Ryan Isaac:
Yeah, it might be the thing that’s left after years of work because if that behavior continues, which you wish you could prevent sometimes, you can’t always, this might be the thing that on top of a practice sale is the saving grace for cash flow in retirement.
Abby Morton:
Hey, Elementality listeners. It’s Abby. To help you better understand Elements, we’ve chosen another episode from the podcast at Reese’s RAA, The Dentists Money Show. On this episode, Reese and his co-host Ryan Isaac talk about the qualified term element. They look at various retirement plan options and discuss which ones to use for different client circumstances. Plus they underscore the importance of balancing qualified funds and liquid funds to meet retirement goals. Enjoy.
Ryan Isaac:
Today we’re going to be talking about what’s the role of all this pre-tax qualified money in that bottom row, which is basically what’s the role of pre-tax money in your net worth. So let’s just start that as a general question, Reese, for you. How should someone think about the role of qualified money in their entire net worth picture?
Reese Harper:
I think of qualified money as my first sure retirement bucket. Like I’m not going to use it for anything else but my basic living expenses during my retirement.
Ryan Isaac:
Your untouchable bucket.
Reese Harper:
This bucket of money, qualified term, really is dedicated money that you can’t touch till you’re 59 and a half or later without a penalty. The government has given you some benefits on it, meaning they’re going to let you, if you’re willing to put money into this thing and lock it up, then you can get a deduction today or you get to save money on your taxes. In the case of most qualified plans, they are saving you taxes today, but you’re going have to pay income taxes later. Some Roth or tax deferred options like a Roth, you get to not get a deduction today, but you get a deferral and then down the road, you also like in a Roth IRA or Roth 401k case, you don’t have to pay taxes later. Most dentists won’t qualify for Roth IRAs if they’re above the average income level of a dentist. And so you’re going to want to think of these as your, definitely your bucket of retirement money.
Ryan Isaac:
Yeah, we’ll actually hit that as part of the…
Reese Harper:
That’s how I think about it.
Ryan Isaac:
Yeah. So how about more specifically, do you have any opinions on the balance between the amount of someone’s net worth sitting in this pre-tax money that, you know, until you’re 60 it’s penalized. You can’t touch it. Most people do think about it as untouchable future money versus liquid money that you can get at and access. Like any thoughts about the balance between those two things?
Reese Harper:
You know I got opinions about everything if you give me a minute.
Ryan Isaac:
Yeah, it’s kind of a funny question to ask you. Do you have any thoughts on this? On this thing you’ve been thinking about for 15 years.
Reese Harper:
Yeah, so here’s the way I would think about the balance here for me is I’m not like a huge, you know, if somebody said if you had a choice and in one scenario you’re 65 years old, you have $4 million that you’ve saved up. And one person has that. That’s a ton of money by the way. Like I think anyone would be stoked. You know, the average person listening here would be stoked if that were their reality. You got millions of dollars saved up. Let’s say it’s four and you have four and it’s either in after tax investments or it’s in pre-tax investments. Okay? So you got pre-tax is our qualified bucket that we’re talking about today. Or you got after tax investments. That’s more of our liquid bucket that we’ve talked about before.
Ryan Isaac:
And by the way, if you’re looking at that bottom row of elements on our website that we’re talking about, the QT, it’s qualified, and then the LT, which is like non-qualified liquid stuff.
Reese Harper:
And if you had the option of which one would I want to have $4 million in, you’d definitely want it in a liquid one, not the qualified one, because the qualified, you’re still gonna have to pay taxes on. But traditionally what ends up happening is people who prioritize the qualified bucket in their life or the saving, both people won’t have $4 million, you know, usually what’ll happen if you are the person that puts all your money into the qualified, you’ll have more like seven versus four or 30% more, 40% more, sometimes 45% more, even 50% more money in the qualified bucket because you got to save all of this taxes upfront, it should result in a higher amount of total money that you can save across both your liquid and your qualified buckets of savings. And so the way you want to think about this is people that prioritize it generally save more money over their careers because they have more total cash in that year to save. Because when you put $10,000 into a 401k, you don’t have to pay, you know, between $3000 and $4000 in taxes, we’ll call it, based on your income level.
Reese Harper:
And so you have $3000 or $4000 now of that $10,000 that you can put into your liquid bucket and grow it too. But if all you do is the 401k and all you do is the qualified bucket and the other person does the same amount of savings into after tax, I would rather have the after tax bucket. I’d rather have more money in after tax than I would in pre-tax because it’s worth more if I had the same dollars. So if you’re gonna commit to a qualified plan which we think is generally a good idea, you should end up saving actually more dollars than the other person that doesn’t commit to this.
Ryan Isaac:
What have you noticed about the behavior of people’s qualified money or the way they invest it or the way they think about the risk they take in their qualified buckets versus the stuff that’s in brokerage accounts and mutual funds that’s liquid accessible, not penalized?
Reese Harper:
Yeah, you’ve probably seen the same thing I’ve seen, but people don’t touch their qualified bucket money. They leave it there. They don’t borrow it out. In many cases, they continue to keep their payroll going to max fund their 401k. Even during like a time where they have no cash, there’s like, well, it’s kind of a pain, might as well just keep going with it. I don’t even want to call my payroll person to have this conversation. I’ll see how things go. And so a lot of people, you’ll find this, a lot of people make the same kind of argument about automated savings. If you automate your savings, it’s going to be less likely for you to want to stop the drafts. But there’s just a difference in how people approach after tax liquid buckets of money, the liquid investments versus their qualified plans, they just tend to leave them alone and/or stay more consistent with them. So if I had to say what’s the number one reason you would recommend a qualified plan to people? In my experience, it’s the money that’s least likely to ever be touched for anything. It’s like sacred money. Like you never think of touching your IRA or your 401k to like…
Ryan Isaac:
Unless it’s like…
Reese Harper:
Buy a cabin or a house or a car or, you know? You’re gonna just keep your money in that account. But in your other accounts they’re always kind of like…
Ryan Isaac:
It’s up for grabs.
Reese Harper:
Like we call them liquid. Maybe we screwed it up. You and me are calling them liquid. We should have called them like sort of liquid but it’s a bad thing to take out of these too. [chuckle]
Ryan Isaac:
Yeah, don’t touch it. People think about their liquid buckets is, hey, should we back off or like should we stop buying stock? Should we sell some stock? Should we wait? But they don’t always ask that in a 401k because the 401k, again, is like mentally it’s this thing that’s like 30, 40 years from now. Like I don’t even care, like what… Like there’s better investment behavior in these plans because there is that untouchable wall between the person and the money and they stay invested during these like tougher market cycles where in a brokerage account they might be more tempted to sell out and go on the sidelines or wait or stop investing. Did you notice any of those conversations over the last couple months this year?
Reese Harper:
Yeah, yeah, I think it’s… You’re right. There’s a lot of people that are much more likely to think about their qualified plans as something they can’t touch till they’re 59. Like I was saying, it’s dedicated retirement money so they don’t often touch it.
Ryan Isaac:
They just don’t think about it. Yeah.
Reese Harper:
Or they stay more aggressive with it.
Ryan Isaac:
Exactly.
Reese Harper:
They stay more aggressive with it. And I think that’s kind of one of the biggest differences in terms of wealth accumulation between two people. Whether you’re earning… Whatever you’re earning, you have a chance to be able to accumulate more if you can handle more volatility and more downside and more risk and so if you’re willing to… My personal retirement account, it’s 100% stock, but also my brokerage account is my after tax savings is 100% stock. And I have a lot of clients who invest that same way because they’re a little bit younger maybe. They’re 10 years or more away from needing withdrawal. But most people in their after tax accounts, like I just, you tend to be more conservative there as well in how you want to invest the money. And it’s not always bad, but it does result in less growth over time.
Ryan Isaac:
Yeah. One thing you said I just want to touch on, we’ll go to the next subject, was kind of like that forced habit. And there’s been times when I’ll see a client build up significant balances in 401Ks or simple areas, whatever they are, and a lot of money in brokerage accounts, but then the cabin, the second home, the beach house, the something comes up for grabs and they’ll just go wipe out a brokerage account. Hundreds of thousands of dollars for a down payment or a big project or something. And then I’m always left thinking like, I’m really glad we have that qualified, that retirement plan because this might be the single thing… Yeah, this might…
Reese Harper:
That’s left.
Ryan Isaac:
Yeah, it might be the thing that’s left after years of work because if that behavior continues, which you wish you could prevent sometimes, but you can’t always. This might be the thing that on top of a practice sale is the saving grace for cash flow in retirement. Here’s point number two is, let’s throw a few examples out for people listening ’cause these are the questions they’re wondering. How does somebody think about the role of their qualified plan in terms of the cash flow they have left over every month. I’ll give an example. Let’s say someone has 4000 bucks a month to save on top of their expenses, their taxes, like that’s what’s left over. That’s their savings rate is 4000 a month. Is there… We’ve had some kind of general guidelines for where to begin with how much of that 4000 should go where, you know, how much should go to build liquidity, how much should go to pre-tax plans? It’s not that simple because different phases of career will allow for different types of plans which we’ll get into in a minute and, you know, later down the road someone might have more liquidity and can afford to put all their money pre-tax later in career but, do you want to just touch on like some general guiding principles on how to think about your monthly cash flow and how to split it up between pre-tax, untouchable, can’t get at this, and after tax liquid account savings?
Reese Harper:
Well, the general principle is you don’t want to have all of your money being accumulated inside of your qualified retirement plan exclusively. I would say that exception to that is when you’re an associate and there really isn’t like an alternative for you to accumulate more money and your qualified plan is all you’re saving in.
Ryan Isaac:
That’s your main savings, yeah.
Reese Harper:
Then I would say it’s okay to save like all of your money inside of a 401k and, you know, that would work. But for most people, when you don’t have liquidity, when you don’t have after tax savings, that’s meaningful. I’m saying for most business owners, for practice owners, once you get to the point to where you’re… If your liquid assets becomes too low, you’re going to start making decisions that you wouldn’t make otherwise. You’re going to start feeling more stress. You’re going to start feeling more financial anxiety and you’re going to get to the point to where you might make business decisions that are poor because you don’t have enough liquidity. And so we like to see business owners not usually dedicate more than half of their monthly discretionary income to qualified plans.
Ryan Isaac:
Cool.
Reese Harper:
So if you’ve got, you know, $3000 a month, you would only want $1500 going to qualified and $1500 going to after-tax. You know, if you’ve got only $1000 a month, maybe you’re just doing an IRA and an after tax savings. But if as a business owner the reason you’re kind of wanting to not just match your retirement plan or put all the money towards qualified is because there’s going to be situations where you get in a rough patch with your practice or your personal life or COVID or… In COVID-20. You know, we don’t know.
Ryan Isaac:
COVID-30.
Reese Harper:
What this looks like.
Ryan Isaac:
I know.
Reese Harper:
Right? So if you don’t have liquid assets, it can cause you to sort of make decisions in your practice that you wouldn’t normally make and in your financial life, just generally. And so regardless of what’s the most optimal tax efficient contribution, because putting more money into qualified plans gets you the most tax savings. That’s not always the right answer. And you want to make sure that you’ve got some accountability to somebody in your life, like a financial advisor, a CPA that you trust, who can kind of give you a little bit of guidance on the mix there. And if you feel like they don’t have any experience answering this question, or they haven’t thought about it ever, it’s probably not the right person to ask the question to because people who have seen the side effects of this, most wealth managers who’ve worked with dentists for a while, they would have good insight into this. There’s big consequences in the mixture that you have. So I’d say as a general rule, don’t contribute more than half of your discretionary cashflow to qualified plans. But it might even be, it might be less than that for some people.
Ryan Isaac:
Just depending.
Reese Harper:
And it might be more than that if you’re not a practice owner.
Ryan Isaac:
Let’s just cover the last section here really quick. We promised our awesome listeners that we would go through kind of a quick list of the types of plans that are available to everyone. And who they most apply to, we won’t go too deep in each one. This is definitely a conversation to call and have with one of our advisors and you can do so at dentistadvisor.com and schedule a free chat anytime you want, but let’s kind of hit a quick list of what’s out there, what’s available and who do they typically apply to? Let’s start at the low easy simple basic end of regular and Roth IRAs.
Reese Harper:
Well, I know what you’re thinking. [chuckle] You’re thinking that maybe the simple little Roth IRA and traditional IRA, it’s just a starter plan. Not you maybe, Rai, but our listeners, they’re like, you gotta get to the big boy stuff to really…
Ryan Isaac:
Talk to me about the pension.
Reese Harper:
Spice it up.
Ryan Isaac:
Yeah.
Reese Harper:
Well, it’s not Cajun spice. And the thing to remember is for most of you who make less than or very close to the average dentist nationally, which is always a fun debate, but you’re in the high 100s, low 200s, you know, it would be surprising if the average dentist was in the mid 200s, but that would be your kind of general range. Anyone pretty much, in my opinion, anyone at the mid 200s or lower, I would probably just say stick with a traditional IRA or Roth IRA. The reason I think that is just it’s like a lot simpler. It’s very inexpensive. You don’t have to have employee matches or payroll or time spent or annual filings or worry about compliance or get in trouble with some kind of employee loans. A lot of people adopt the 401k too early. In my view, the priority is after tax assets and high savings rate, you know, getting your, even for some of you, the priority might be getting a portion or a large chunk of a student loan paid off, you know, as a good way to get a nice return because you’ve got enough liquidity now, but your student loans are still at 7% and it’s not tax deductible.
Reese Harper:
I mean, there’s still like a lot of things to do before I would say like, let’s start a 401k plan. ‘Cause when you go to 401k plan, in my mind, you gotta go big. Like you don’t go like small. You really gotta be able to put all of your money into this deferral. You know, you wanna get 19,000 plus away. And you don’t wanna just be putting…
Ryan Isaac:
Preferably a spouse too.
Reese Harper:
And a spouse. And you wanna be in an opportunity where your spouse is doing work for your practice and getting compensated for that. And consequently, why wouldn’t she just put money in the 401k? But most people with an income in the mid twos to low twos to high 100s, I just don’t see the trade off being worth it. It’s a lot of work. And to me, it’s like, for most people, you should just stick with the traditional IRA and Roth IRA. Those are nice. The Roth IRA, you pay taxes now and you’ll never… You pay taxes on the money today and you never pay taxes again on it, which is nice, in the traditional you get a deduction, it’ll save you some money. If your income’s much into the twos, low to mid twos, I’d definitely even high 100s, okay? High 100s, I’d still probably go traditional. Because I don’t want to have like one year where I can do a Roth and then I end up with this random Roth account. That’s like the… You know what it is.
Ryan Isaac:
Everyone’s got their random Roth.
Reese Harper:
The orphan Roth. It’s like, yeah, I got a Roth. And we all thought it was going to be like, and then it’s like, you can’t qualify for it. And so you stop funding it. I would just rather have all my money in the account I’m going to continue to fund. So if you think your income is going to kind of stay at that low twos, high ones, mid twos, just do an IRA, spouse it, call it good.
Ryan Isaac:
Spouse it, call it good. In the IRA family, you do have the SEP IRA, which is an exception for great opportunity for associates on 1099 with their own S-Corp, LLCs, new practice owners whose employees will not qualify for the SEP. They’re easy to set up. No like…
Reese Harper:
That’s a gold mine.
Ryan Isaac:
Big limits. Yeah, they’re awesome. Yeah, too much to… Yeah. There’s some nuance to it, so call your CPA and your financial advisor.
Reese Harper:
Yeah, you can’t just set up a SEP and think that you’re fine. Like, there are some things here, like you can run awry.
Ryan Isaac:
Don’t mess it up. Don’t run awry. Your next level is the old simple IRA. And you got your… So now we’re into the world where you’re involving payroll and employees and matches and a good chunk of laws from the government making you stick to certain things. And so now we’re in that world that it’s at the practice levels. Yeah, so you have the Simple IRA, which is easier. Listen to… You know, it’s in the name.
Reese Harper:
There’s some decent platforms out there that can administer a Simple IRA and it’s not the hardest thing in the world. I mean, it’s…
Ryan Isaac:
And they are easier than a 401k.
Reese Harper:
Yes. There’s still a little bit of a pain, still some matching. You’re not getting like, when would I do Simple? I’m starting to consider a simple in that mid 200 range. I’m probably not considering it in my low twos or high 100s, are you?
Ryan Isaac:
I don’t know, man. The only exception to that would be, definitely don’t qualify for Roth. Spouse is on payroll and can also contribute to the simple.
Reese Harper:
Your living expenses are super low. And you got a lot of liquidity and you can save like, your income’s in the low to mid twos, but you’re saving like $5000 a month or more.
Ryan Isaac:
Yeah, we’re talking about this magic sweet spot. I mean, back to section two, what we talked about today, you don’t want all of your free cash flow going to the simple IRA between, you know, so you’d have to have low expenses and high savings rate to pull that off, but then you’ve got, you know, then you’ve got the move from the simple to the 401k. Are you gonna say something else there?
Reese Harper:
No, that’s great, you’re moving up a market, the 401.
Ryan Isaac:
We’re moving up in life. We’ve talked about this on other episodes when people are considering this. You know, at the point where spouse is on payroll, also doing a 401k, and for me it’s a no-brainer when profit sharing is near. You know, when profit sharing is near, which you have to have 401k in place to do your profit sharing, then a 401k over a simple IRA is like a no-brainer.
Reese Harper:
You can also add what’s called profit sharing to a 401k, which means that you can do like a discretionary contribution that lets you put up to the full profit sharing maximum away. Right now you’re going to be looking depending on which year you’re looking at doing you’re gonna be in the high 50s, mid 50s, right? And that’ll allow you to put away a big chunk of money. And then you’re gonna have to give away quite a bit to your team though, when you do that, not a ton, but sometimes it might be like, you gotta give away 5%, 6%, 4.5%. So the way you gotta know if this is good for you is you gotta look at the total contribution that you’re making to the plan and see how much of that is going to you versus your team. And then decide if that’s maybe worth it. It could still be worth it, even if your team’s getting a lot of the money because they really value it and you wanna build the type of culture that has low turnover and creates a really stable, nice, like employment package and benefits package for your team. And I’ve seen a lot of specialists who are like, look, man, my positioning in the market is, I’m an orthodontist with low turnover, and I do not want people leaving, and they really value having health insurance and a retirement plan.
Reese Harper:
And so in that case, you know, the math isn’t like, as we’ll call it, like one-sided. You’re not just looking at how much you’re getting away and then saying, is this worth it? But in most cases, Ryan and I would look at a lot of qualified plans and kind of, you know, we like to look at what percentage is going towards the owner’s family and household versus team and then decide if that makes sense. Because some teams just don’t value that. They would rather have a smaller cash bonus. They’d rather have gift cards at the end of every month to Applebee’s. Right? Shout out to Applebee’s though. I could have said Chili’s, you know?
Ryan Isaac:
Okay. So you’re just talking… Yeah, for everyone listening, you’re just saying like, and this is a multiple hour per year job. When you start analyzing profit sharing above that, that integrates with the profit sharing and 401ks, you’re talking about pensions, cash balance plans. Those are for high income, lots of savings rate, but those, they have to make sense so you don’t spend too much on them, you don’t give away too much of that money. And that is multiple hours that a good financial advisor or CPA will deal with. This month we focus on one of these subjects, one personal finance subject per month. The month of May coming up is the QT month. It’s qualified term. How much of your net worth is in qualified money? This is the month where we tackle these questions. Should you have an IRA? Should you upgrade to the simple? Should you upgrade from the simple to 401k? Is it time for profit sharing? Is it time for cash balance plan? That’s our job. So if you’re wondering like, this seems like a lot. Can someone just do this for me? Yes, this is part of our job that we do and this is the month that we spend hours analyzing this stuff and making sure it’s done right. And what you set in motion for a qualified plan for one year does not necessarily mean it’s the right one for next year and the year after that. These things do change as you progress throughout the phase of your career.
Reese Harper:
Yeah, as you’re saying is, one, just because you started with the old 401 doesn’t mean you’re going to stay with it your whole career.
Abby Morton:
Next time on Elementality…
Reese Harper:
If you send a nice offer like, hey, Abby said some great things about you. I would love to do a free financial assessment for you. You don’t have to meet. We don’t have to take your time. I just need you to download this app and put in your data and create a scorecard. And then I’m going to give you an assessment comparing you to other people like you that I see and give you some feedback. That is like a generous thing. It’s like, wow, thank you. That’s cool and it’s a little bit more value forward than like, hey, will you meet? Can we get together? It’s like, what are you gonna do when you get together? And like, is this gonna be worth my time? There’s all these like friction questions that come up.
Abby Morton:
To find out more about Elements, go to getelements.com/demo. Elementality’s executive producers are Reese Harper and Carl Richards. Elementality is produced by Tad Henderson and directed by Abby Morton. Have a good one!