ChooseFI
447 | Mailbag: Breaking up with your Advisor, I Bonds, 4% Rule, Accounts for Kids, Roth IRAs | Sean Mullaney
Mon Jul 24 2023Description
Dexa.ai is a new company that allows users to search and index podcasts, including ChooseFI. The episode features a mailbag segment with Sean Malini, discussing topics such as breaking up with a financial advisor, i bonds, the four percent rule, Roth IRAs, and opening accounts for children. The episode covers various aspects of transferring retirement accounts, considerations for transferring shares, donating appreciated stock and I bonds, taxation and strategies for I bonds, the 4% rule and investing for retirement, investment accounts for children, Roth IRA contributions and conversions, five-year rules for Roth IRAs, and withdrawal rules and exceptions for Roth IRAs.
Insights
Dexa.ai
Dexa.ai is a new company that allows users to search and index podcasts, including ChooseFI. Users can ask the Brad Barrett AI questions about topics discussed on the show and receive thorough answers with references and timestamps.
Breaking up with a Financial Advisor
When breaking up with a financial advisor, it is recommended to call the institution you want to transfer your funds to and initiate an ACAT (automated customer account transfer). Inherited IRAs require trustee-to-trustee transfers and specific titling. Traditional IRAs can be transferred through direct trustee-to-trustee transfers. Receiving checks from retirement accounts may trigger tax penalties if not moved within 60 days.
Transferring Retirement Accounts
Receiving checks from a retirement account sets off a 60-day clock and may result in tax and penalty if not moved within that time frame. Direct trustee to trustee transfer is recommended for moving an old IRA to a new institution. ACAT process allows for an in-kind transfer of securities, which can help avoid triggering capital gains tax. Initiating the process through the receiving institution can make the emotional component of breaking up with a financial advisor easier. Fees for ACAT transfers are usually not significant compared to the fees charged by legacy institutions. Moving shares from one institution to another does not trigger capital gains tax; it is only realized upon sale. It is advisable to capture basis information prior to moving securities between institutions, as some brokers may not maintain that information. Transferring shares purchased before brokers were required to maintain basis information may result in incomplete records at the receiving institution.
Considerations for Transferring Shares
When transferring shares to a new institution, it's important to have all your historical data and communicate with the receiving institution. Non-publicly traded securities may not be transferable through the ACAT process, which could require selling them in a taxable brokerage account. Decisions regarding fees and tax implications should be balanced when considering whether to sell or keep certain investments. The step-up in basis at death can be a factor to consider when deciding whether to hold onto certain positions for heirs. Passive investments tend to be more publicly traded and ACAT eligible. For IRAs and retirement accounts, selling proprietary funds or high expense ratio mutual funds within the account is not a taxable event. In taxable brokerage accounts, moving shares in-kind does not trigger a taxable event, but it may leave you with unwanted investments that need to be addressed. Mitigating the problem of appreciated stock in taxable brokerage accounts can involve strategies like chunking at capital gains or using donor advised funds for charitable giving.
Donating Appreciated Stock and I Bonds
Donating appreciated stock to a charity or a donor advised fund can help avoid capital gains tax. A put option can be used to protect against a significant decline in the value of a stock. Using a put option requires working with an options broker and paying an insurance premium. Holding onto the stock until death can result in a step-up in basis, eliminating the capital gains tax. Donating appreciated stock normalizes the relationship with the charity and provides a tax deduction. I bonds have a 30-year maturity but can be sold after one year, with potential loss of three months of interest. Taxation on I bonds is deferred until they are sold.
Taxation and Strategies for I Bonds
Interest income from I-bonds is not taxed until you exit. Interest payments are added to the bond total while holding the I-bond. When cashing out, the interest income becomes taxable as ordinary income. Higher earners may be subject to a 3.8% net investment income tax. You can elect to tax yourself on interest payments as they come, but it's more complicated and accelerates income. Current interest rates for I-bonds may be lower than other options like online banks. Consider penalties and future interest rates when deciding whether to sell I-bonds. The formula for financial independence is to multiply expenses by 25, but it doesn't account for age or life expectancy. The 4% rule is a rough guideline that may not apply to all ages. Financial independence at younger ages is unlikely outside of inheritance.
The 4% Rule and Investing for Retirement
The 4% rule is a general rule of thumb for retirement savings. It originated from testing done in the 1990s on financial asset portfolios surviving for 30 years. For younger individuals with longer life expectancies, the 4% rule may not be sufficient. Investing for returns higher than 4% is ideal, but market declines necessitate some conservatism. Considerations such as Social Security and healthcare costs should be factored into withdrawal rates. The goal of the 4% rule is to provide a specific target for retirement savings. Adjustments to spending can be made if financial assets underperform. The ChooseFI Facebook group has reached over 100,000 members and is a significant community for pursuing financial independence. When opening an investment account for children, consider options like Fidelity, Schwab, or Vanguard.
Investment Accounts for Children
Consider mom and dad's financial security before opening an investing account for kids. Options for kids' investing accounts include Ugma, Utma, and Roth IRA. Ugma and Utma accounts can be set up as taxable brokerage accounts with a named guardian. Roth IRA is an option if the child has earned income from a job. Teaching kids about finances through allowance and savings. Building lessons into investing by involving kids in the process. UTMA vs UGMA: Reach out to the financial institution to see which one they offer. Roth IRA can be a valuable investment vehicle for kids.
Roth IRA Contributions and Conversions
Teenagers with earned income can contribute to a Roth IRA based on their earnings. Contributions to a Roth IRA can be made with any money, not necessarily the exact dollars earned. Teaching teenagers about personal finance and taxes can be a valuable learning opportunity. Even small contributions to a Roth IRA can grow significantly over time. Roth IRA conversions can be done before retirement if there is taxable income and it makes financial sense. Taking a sabbatical or working in non-profit/government jobs with lower income can be opportune times for Roth conversions. Generally, it's better to do Roth conversions when in lower tax brackets during retirement years. Personal circumstances and future tax rates should be considered when deciding on Roth conversions. There is no regret in converting too early, but it's important to make informed decisions based on personal situations. Paying expenses when affordable may outweigh potential optimization of delaying expenses.
Five-Year Rules for Roth IRAs
There are two different five-year rules when it comes to Roth IRAs. The first five-year rule is about Roth IRA earnings and states that you must own a Roth IRA for at least five years before taking a tax-free withdrawal of earnings. This rule is rarely applicable because most people contributing to a Roth IRA won't touch it for more than five years, and the 59 and a half year rule tends to be the governing rule. Contributions come out before earnings, so withdrawals of contributions are tax-free. The second important five-year rule applies if you're under age 59 and a half and take a distribution from a previously taxable Roth conversion within five years of making that conversion. In this case, you would have to pay a 10% penalty. Regular annual contributions come out first, followed by taxable conversions in the order they were made. The ordering rules make it unlikely that you would access a conversion younger than five years old, but if you do before age 59.5, you will pay the early withdrawal penalty.
Withdrawal Rules and Exceptions for Roth IRAs
If a Roth IRA conversion is made at age 57, the withdrawal of the contribution itself is subject to a 10% early withdrawal penalty for the next two and a half years. During the next five years, withdrawals from earnings are subject to income tax but not the penalty, unless the individual is before age 59 and a half. The five-year holding period for qualified distributions from a Roth IRA can result in paying income tax even if the individual is over age 59 and a half. These rules are less relevant for most people who start contributing to Roth IRAs at younger ages.
Chapters
- Dexa.ai and Mailbag Segment
- Transferring Retirement Accounts
- Considerations for Transferring Shares
- Donating Appreciated Stock and I Bonds
- Taxation and Strategies for I Bonds
- The 4% Rule and Investing for Retirement
- Investment Accounts for Children
- Roth IRA Contributions and Conversions
- Five-Year Rules for Roth IRAs
- Withdrawal Rules and Exceptions for Roth IRAs
Dexa.ai and Mailbag Segment
00:00 - 06:54
- Dexa.ai is a new company that allows users to search and index podcasts, including ChooseFI
- Users can ask the Brad Barrett AI questions about topics discussed on the show and receive thorough answers with references and timestamps
- The episode features a mailbag segment with Sean Malini, discussing topics such as breaking up with a financial advisor, i bonds, the four percent rule, Roth IRAs, and opening accounts for children
- When breaking up with a financial advisor, it is recommended to call the institution you want to transfer your funds to and initiate an ACAT (automated customer account transfer)
- Inherited IRAs require trustee-to-trustee transfers and specific titling
- Traditional IRAs can be transferred through direct trustee-to-trustee transfers
- Receiving checks from retirement accounts may trigger tax penalties if not moved within 60 days
Transferring Retirement Accounts
06:35 - 13:16
- Receiving checks from a retirement account sets off a 60-day clock and may result in tax and penalty if not moved within that time frame
- Direct trustee to trustee transfer is recommended for moving an old IRA to a new institution
- ACAT process allows for an in-kind transfer of securities, which can help avoid triggering capital gains tax
- Initiating the process through the receiving institution can make the emotional component of breaking up with a financial advisor easier
- Fees for ACAT transfers are usually not significant compared to the fees charged by legacy institutions
- Moving shares from one institution to another does not trigger capital gains tax; it is only realized upon sale
- It is advisable to capture basis information prior to moving securities between institutions, as some brokers may not maintain that information
- Transferring shares purchased before brokers were required to maintain basis information may result in incomplete records at the receiving institution
Donating Appreciated Stock and I Bonds
18:49 - 25:18
- Donating appreciated stock to a charity or a donor advised fund can help avoid capital gains tax
- A put option can be used to protect against a significant decline in the value of a stock
- Using a put option requires working with an options broker and paying an insurance premium
- Holding onto the stock until death can result in a step-up in basis, eliminating the capital gains tax
- Donating appreciated stock normalizes the relationship with the charity and provides a tax deduction
- I bonds have a 30-year maturity but can be sold after one year, with potential loss of three months of interest
- Taxation on I bonds is deferred until they are sold
Taxation and Strategies for I Bonds
24:57 - 31:39
- Interest income from I-bonds is not taxed until you exit
- Interest payments are added to the bond total while holding the I-bond
- When cashing out, the interest income becomes taxable as ordinary income
- Higher earners may be subject to a 3.8% net investment income tax
- You can elect to tax yourself on interest payments as they come, but it's more complicated and accelerates income
- Current interest rates for I-bonds may be lower than other options like online banks
- Consider penalties and future interest rates when deciding whether to sell I-bonds
- The formula for financial independence is to multiply expenses by 25, but it doesn't account for age or life expectancy
- The 4% rule is a rough guideline that may not apply to all ages
- Financial independence at younger ages is unlikely outside of inheritance
The 4% Rule and Investing for Retirement
31:13 - 37:52
- The 4% rule is a general rule of thumb for retirement savings
- It originated from testing done in the 1990s on financial asset portfolios surviving for 30 years
- For younger individuals with longer life expectancies, the 4% rule may not be sufficient
- Investing for returns higher than 4% is ideal, but market declines necessitate some conservatism
- Considerations such as Social Security and healthcare costs should be factored into withdrawal rates
- The goal of the 4% rule is to provide a specific target for retirement savings
- Adjustments to spending can be made if financial assets underperform
- The ChooseFI Facebook group has reached over 100,000 members and is a significant community for pursuing financial independence
- When opening an investment account for children, consider options like Fidelity, Schwab, or Vanguard
Investment Accounts for Children
37:29 - 43:53
- Consider mom and dad's financial security before opening an investing account for kids
- Options for kids' investing accounts include Ugma, Utma, and Roth IRA
- Ugma and Utma accounts can be set up as taxable brokerage accounts with a named guardian
- Roth IRA is an option if the child has earned income from a job
- Teaching kids about finances through allowance and savings
- Building lessons into investing by involving kids in the process
- UTMA vs UGMA: Reach out to the financial institution to see which one they offer
- Roth IRA can be a valuable investment vehicle for kids
Roth IRA Contributions and Conversions
43:29 - 49:47
- Teenagers with earned income can contribute to a Roth IRA based on their earnings
- Contributions to a Roth IRA can be made with any money, not necessarily the exact dollars earned
- Teaching teenagers about personal finance and taxes can be a valuable learning opportunity
- Even small contributions to a Roth IRA can grow significantly over time
- Roth IRA conversions can be done before retirement if there is taxable income and it makes financial sense
- Taking a sabbatical or working in non-profit/government jobs with lower income can be opportune times for Roth conversions
- Generally, it's better to do Roth conversions when in lower tax brackets during retirement years
- Personal circumstances and future tax rates should be considered when deciding on Roth conversions
- There is no regret in converting too early, but it's important to make informed decisions based on personal situations
- Paying expenses when affordable may outweigh potential optimization of delaying expenses
Five-Year Rules for Roth IRAs
49:28 - 56:13
- There are two different five-year rules when it comes to Roth IRAs
- The first five-year rule is about Roth IRA earnings and states that you must own a Roth IRA for at least five years before taking a tax-free withdrawal of earnings
- This rule is rarely applicable because most people contributing to a Roth IRA won't touch it for more than five years, and the 59 and a half year rule tends to be the governing rule
- Contributions come out before earnings, so withdrawals of contributions are tax-free
- The second important five-year rule applies if you're under age 59 and a half and take a distribution from a previously taxable Roth conversion within five years of making that conversion. In this case, you would have to pay a 10% penalty
- Regular annual contributions come out first, followed by taxable conversions in the order they were made
- The ordering rules make it unlikely that you would access a conversion younger than five years old, but if you do before age 59.5, you will pay the early withdrawal penalty
Withdrawal Rules and Exceptions for Roth IRAs
55:44 - 1:00:48
- If a Roth IRA conversion is made at age 57, the withdrawal of the contribution itself is subject to a 10% early withdrawal penalty for the next two and a half years
- During the next five years, withdrawals from earnings are subject to income tax but not the penalty, unless the individual is before age 59 and a half
- The five-year holding period for qualified distributions from a Roth IRA can result in paying income tax even if the individual is over age 59 and a half
- These rules are less relevant for most people who start contributing to Roth IRAs at younger ages