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Where to Save More, Beyond The Basics

| July 28, 2021
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In today's episode Nicholas Olesen, CFP®, CPWA® shares ideas about where you should save your capital, beyond the basics.

While everyone knows they need to save, there are a couple dozen types of accounts to save into and thus it can be confusing about where to save. Through this 15 minute podcast, Nicholas talks briefly about the basics and then dives into various types of accounts and the advantage to using them.  A few key takeaways covered are:

  • The building blocks of different accounts to grow into over time
  • Tax implications of different types of accounts
  • Restrictions or opportunities for each account
  • Investment options inside each account
  • Gifting concerns around 529s or trusts

Download this great flowchart that helps walk you through these decisions: Where to Save More - Flowchart

You can find a transcript of today’s show below.

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Please send us feedback and any topic or questions you would like us to cover.  Email us at: nolesen@kathmere.com 

Transcript from today’s show:

Hi, thanks for tuning into a wealth of advice. My name's Nicholas Olesen, Director of Private Wealth at Kathmere Capital.

Today we want to tackle the question of, Hey, what accounts should I consider if I want to save more. And I'm going to go over just the basics that we kind of expect you to have already done.

And then once you can ask this question, but some of the basics are things that our clients talk to their kids about. Or even, you know, some of our other clients are talking to their grandkids about it, making sure that they set themselves up for success on their savings and investing. And you know, the basic one is a habit, foundational savings.

Make sure you have set aside money that's roughly three to six months of your expenses, not your income, your expenses, is set aside for an emergency use. You know, whether that's I lost a job or, you know, car repair or you name it, make sure you have that amount set aside in a safe account. We do not expect those dollars to be growing.

Frankly, we expect that to be in a checking, savings, maybe a money market account, or kind of some higher yielding checking. But in today's interest rate environment, we're recording this in July of 2021. We do not expect to earn really anything inside that account. It is solely going to be used for a cushion account or an emergency fund.

So don't expect to earn anything on that. Do not get upset if you're not earning anything that, but if you do realize that, Hey, that cash account, that emergency fund continues to grow and I'm above and beyond that three to six months of expenses. What else should you do? And also then what should you do for savings in general?

So I'm going to first tackle it with the most common one, which is retirement savings. If you have more money and you want to be able to save more, what we expect you to have already done, or basically start off your savings is contribute enough to maximize the amount of any match offered by your employer.

If you have an employer 401k for three B pant plan something. Now we've, we've heard from others that they thought that they could contribute a percentage is the maximum they can contribute to the 401k, but it's actually a fixed the dollar amount that you can contribute. So you, as of 2021 can contribute 19,500 annually into your 401k plan.

Or if you're over the age of 50, you can contribute 26,000. Now, if you've already made that maximum salary contribution and you want to contribute more, do consider the mega backdoor Roth contribution. I did a podcast on that a few times back. So kind of scroll down. You'll find that one about the mega backdoor Ross.

It's a fantastic option. If you've contributed up to the maximum already and you have more funds to come. Then your decision on what to contribute or, or where to contribute is really down to, is that a Roth 401k, if you have that option or a traditional 401k now Roth 401k is really only became an option inside employer plans in the last five to 10 years.

So that they are very new and not all plans have them. But if you do have that option, your question comes down to where do you believe you're going to be tax wise? Now as you contribute the dollar versus when you take that dollar out and do you expect your income to increase in the future? I E you should use the Roth today, but five years from now, you should use the traditional side of it.

So if you do expect your income to be higher and or you expect your tax rate to be higher in the future, you probably want to consider a Roth 4 0 1. Where you pay taxes now contribute those dollars, but then when you take them out and you're at a higher rate, you do not pay taxes for that distribution.

Alternatively, if you're in a high income right now, and you expect your income to go down, you know, over the future, or you expect to retire early and be able to do some Roth conversions, things like that, you probably want to contribute to the traditional 401k, do not pay taxes on that dollar going and get the deduction.

And then when those dollars come out, you'll be at a lower rate. Again, if you. The other thing to consider if you can. And this is for those of you that if you're married, filing jointly and you make your effective or modified adjusted gross income number is under that $200,000 level or so then you can consider contributing to a Roth IRA.

That's 6,000 you can put in or 7,000 if you're over the age of 50. And if you're single that modified, adjusted gross numbers, 125,240, it's kinda when you phase out of the eligibility for that. So a lot of individuals have that as an option. But a lot of who we're talking to you know, with this question probably don't have that option because your income is over that.

Now, if you've, if your modified adjusted gross income is greater than that 208,000 as a married filing joint. And you've already maxed out your 401k salaries, but you want to save more? What can you do? And that's a lot of the questions that we get now. The most common one is a backdoor Roth IRA contribution.

Now there's a caveat. You have to make sure you do not have traditional IRA dollars already. Because of the prorata rule. If you need to look that up, go, go Google that prorata rule with backdoor Roth. You'll see that it really probably does not make sense for you to do the backdoor Roth IRA contribution.

For a lot of our clients were able to though, because they do not have that option. And again, as I said before, the other alternative is use the backdoor mega backdoor Roth, IRA contracts. So what else can you do? You know, the other thing that we've seen for retirement dollars is we recommended clients who have the option, use a healthcare savings account, an HSA account.

You can contribute $3,600 as an individual or $7,200 as a family into it. You can actually put another thousand if you're over the age of 55, and that is a tax preferred. I E you get a deduction for putting your dollar in. It actually grows tax-free because it can be invested. And then if you take that out for health care expenses, you will be able to take that out tax free.

So it's actually a triple tax advantage account, very unique. But there are some restrictions or quite a few restrictions on what you can use those dollars for. So, do be aware of that, but it is a great tool to. If you have that option available to you. Now, the other side of it is something that we hear.

Some clients have a question on, like, what's the difference between an HSA health care savings and an FSA, flexible savings account. They are very, very different HSA is can roll over meaning that they can continue on. You don't have to use the dollars every single calendar year. You can put money into it and then let that, that money grow an FSA, a flexible savings account.

You do have to take those dollars out every single year, and you can only contribute 27 50 into that. For the tax deductability so not really a great option for most the other side of it that we've seen once you've gotten beyond kind of these, these building blocks, if you will, is the next step is to look at any type of employer provided benefit or for our business owner clients, you know, looking at what type of plan they can set up to even add more.

And so for a lot of our businesses, No, we're going to set up a SEP or a traditional 401k for the business. Because as a business owner, you can actually contribute $58,000 or 64 5. If you're over the age of 50 into a 401k, because this includes both your employer and employee contributions. And so if you want to talk about, you know, how to set that up, what to set up for your business, we can, we can touch on that in a future one, or please reach out.

And you can save more than the 401k amount by opening contributing to a pension plan. We have a lot of business, our clients who are able to contribute a lot more into a pension plan, depending on a lot of different factors, most importantly, it's how many employees, ages of them and things like that that we look at to see if the pension plan would actually make the most sense for our business owners.

Now, if you're a business owner, do you have some minor children? I mean, that's one to consider. Offering your children, a paid position within the business can allow them to save in their name and it's taxed at their income bracket. And therefore Ross can be a super appealing way for them to save. If they have a real job they can do at your employer.

Or at your business now, single owner, LLC is sole proprietors partnerships where the only owners are the parents. You don't have to pay FICA taxes on the earnings of a minor child. So it's again, another benefit of if there's a real job for your child to do, you should consider hiring them for that job.

Again, whether it's, you know, as simple as clean up the office or you name it, there's some great options there where they can earn and then be able to put money into an account for themselves. Now the other one, that for those that are able to save a lot more outside of retirement plans and the most basic one is really just eight.

Brokerage account, you know, an investment account and when to consider it. And when you're thinking about it, you know, the most important thing inside of there is the tax ramifications of changes. You make everything else that we've talked about so far, 401ks, Roth, IRAs, HSHS, those plans do not tax you on transactions or gains and losses inside the portfolio.

When you buy and sell things, a traditional investment account or brokerage account. And so you want to make sure that you are being very smart about the way that you're managing your capital inside of there. You want to use the right investment tools and the right transaction timing on things. You know, long-term capital gains.

As of today. There is a debate about what this is going to be in the future, but as of today, long-term capital gains are taxed at a preferential rate upon sale. So there's no tax on the distribution from the account, unlike your retirement accounts, but you are taxed upon the transactions inside of it.

So long-term any investment that you hold more than 365 days, do you have that preferential rate as well as qualified dividends also have a preferential rate to it. So something to consider when you're looking at it. Other investments that we find really interesting inside of these investment accounts are ETFs are municipal bonds.

Some of these that have a, you know, mitigate any tax liability through the way that they are. The other thing to consider when you're looking at other accounts that are out there if you are already donating or you want to donate is, is use a donor advised fund. I touched on this in one of the podcasts not that long ago for some of our employers or I'm sorry, our, our executives who have executive compensation and they want to minimize.

Tax liability using a donor advised fund is really advantageous. So do consider that we'll do a whole nother one on that in the future. If you'd like, and then what about outside of these? You know, so far everything we've talked about is really towards retirement. It's kind of savings. What else can you do?

For both generation, future generations, and then also, you know, estate planning side of it. And so the two things that come to mind that we use most. On the education side is really a 5 29. They are a fantastic vehicle, you know, you can actually contribute into them up to your exclusion rate. And the exclusion rate is up to your annual exclusion for gifting.

I got a gift can be $15,000 per person per year into a to another year. When you look at that, that gift that you're giving, that's the way that the 5 29 contribution is viewed. It is a tax-free gift. You know, you don't pay taxes for giving and the individual does not receive, or does not pay taxes for receiving that type of gift.

So we do look at those 5 29 is a great option. Again, if a married couple is contributing to it, you can actually can contribute 30,000 to the 5 29 because you're each contributing 15. Alternatively, one thing that we've done quite frequently for clients is do a lump sum contribution with a what's called a five-year forward gift.

Which means you can actually put $75,000 per person into a 5 29 plan. So you can make a one-time contribution first $150,000 as a couple into a 5 29 plan and get that kind of five-year forward gift. Now, the only benefit of that. Is well there's two. The biggest one is that it grows tax-free over the lifetime of that 5 29.

And you can change the owner. I'm sorry. You can change the beneficiary of the 5 29 at any point. So whether it's your kids or your grandkids, you can always change the names on those plans and let that 5 29 continue to. The eligibility of a tax deduction is really just on a state side. So there's actually no federal deduction for a 5 29 contribution.

It's only on the state side of things. So if you're in a low state tax like Pennsylvania, like we are, it's only a 3% one, so it's really not a huge advantage. Advantageous, but not huge, but alternately, if you live in California and you're making that deduction to it, you know, then you're getting almost 13% depending on your income rate.

So it can be really beneficial depending on the state. So what else is out there? You know, what, what are kind of the other ones that we do? And some of the other ones really have to do with, you know, estate planning reasons or cash value of life insurance options. You know, if you have a, and you want to increase your life insurance coverage or your need, you, you can consider the benefits of buying a cash value, life insurance policy.

You know, it provides both life insurance and tax deferral on gains because of the way. That you can take distributions or borrow against those plans. So that's a really good option for those that, you know, need life insurance and have excess dollars to save into. So I hope this was a good kind of overview of them.

Again, you know, as simple as, Hey, make sure you have your foundational savings too. What are the other options in retirement accounts to, as a business owner? What should I do for it? And then, you know, if you are able to save outside of all of those plans and you still have more money and you're putting them in the investment account and just make sure you're being very small.

The way you're managing those dollars because they are taxed. You know, every transaction inside a regular investment account is taxed. So make sure you're being smart about the way that you do that. I hope this was beneficial. And if you guys have questions that you guys want us to add other types in the future, please do let us know.

We'd love to hear from you. You can reach out via email or just make a comment, any of the show topics and we'll take a look. Thanks so much.

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