Accessing Retirement Funds Before Age 59½ with The Mad Fientist

 Scott: Welcome to BiggerPockets Money. Show 18

Brandon: Early retirees are so different than standard retirees when it comes to taxes especially. If you think about it, most people have income that just gradually increases their entire career, and then all of a sudden they’re 65, and their income drops, and they’re spending hopefully, maybe drops a little bit. For early retirees we have this period of high income, that’s maybe 10 years, 20 years whatever your career happens to be. Then you have a big drop in income, and potentially low expenses, and low income for maybe 20 years before you even hit standard retirement age.

I realize that all the standard advice about retirement accounts really didn’t apply to people who are pursuing financial independence, or early retirement. That’s where I started looking into first.

It’s time for a new American dream. One that doesn’t involve working in a cubicle for 40 years, barely scraping by. Whether you’re looking to get your financial house in order, invest the money you already have or discover new paths for wealth creation, you’re in the right place. This show is for anyone who has money or wants more. This is the BiggerPockets Money podcast.

Scott: How’s it going everybody? I’m Scott Trench. I’m here with my co-host, Miss Mindy Jensen. How’re you doing today, Mindy?

Mindy: Scott, I’m doing really great. I am so excited for today’s show. As you know, I book a guest for both the BiggerPockets podcast where we talked about real estate investing, and this BiggerPockets money podcast, where we talk about money. For the listeners if you’d like to be a guest on either show, or you know someone who’d be great, go to BiggerPockets.com/guest and have them fill out the form, or fill out the form for them.

For these past 17 episodes of BiggerPockets money, I have pulled from my list of favorite people in the FI community and today’s episode is no different. Today we’re interviewing Brandon. Nope, not Brandon Turner. Brandon, the Mad Fientist. Brandon studies fience, or the science behind financial independence. Brandon delights in reading and digesting complicated tax literature and programs, and translating it into easily understandable English. His favorite sections of the tax code are, of course, those that have to do with retirement.

Scott: What we’re going to talk about today, for most of the episode is really this, how to use tax advantage to accounts like 401k and Roth IRAs to your advantage in the pursuit of financial independence. There’s a lot of talk about why 401k is great, it deferred taxes. Why Roth is great, because Roth can grow tax-free. He really has this strategy of using both of these in tandem.

Even for someone like me, I’ve historically not been the biggest fan of retirement accounts, this is the kind of strategy that I am probably going to begin pursuing during 2018. It’s just such a fantastic way to increase returns on your passive index fund investing. It’s such a good marriage of these. If you’ve already good finances in order, you are investing passively in index fund as primary part of your portfolio, this is, I think, the way to go.

It’s just great hearing it from someone who’s such an awesome thought leader in this phase.

Mindy: Yeah. I encourage anybody to listen to this episode. It doesn’t matter where you are on your retirement journey, this episode is for you. Some of these strategies take some additional planning. Some of them take a couple of years to implement.

Scott: This episode is really geared towards someone who’s got their financial ducks in a row. This is not going to be on saving or reducing your grocery bill, which is great. This is for someone who’s already got these things in place, and is looking to optimize their investment strategy, not their investments. This is still within the context of discretion of passive index fund investing.

If you’re going to max out that 401k and take your employer match, and put in 18,000, maybe more, into your retirement account, this is how you can really use a strategy to get the most out of the that. It works, of course. If you’re just investing smaller amounts of money into your retirement accounts, it’s something to learn about. It’s how to use those accounts to achieve financial freedom and have access to them, I think, earlier than most people think that they can.

Mindy: Yes. Yes. I encourage you to listen you to listen to the very end of this episode for a couple of reasons. First, Brandon’s amazing. Even if you don’t like his information, his made for radio voice is mesmerizing. Second, he shares tips for retirement planning that you need to know now, no matter where you are in your journey to financial independence. These are tips for optimizing your retirement and optimizing the money that you are saving. Lastly, I have taken over Brandon’s podcast a few times myself. The last time I did so, I rapped. I don’t want to give anything away, but I got 99 problems but taxes ain’t one. Hit me.

Scott: Yeah. Mindy’s rap is definitely a highlight of this episode and it’s fantastic. Yeah. Really excited to introduce Brandon. Brandon’s been a huge mentor to me, even if he maybe didn’t know it because I was a huge listener of his podcast, and follower of the Mad Fientist back when I was getting started on my very own personal finance journey. I am very grateful to all the things that he’s put together. With that, let’s welcome Brandon.

Alright. Brandon, the Mad Fientist. Welcome to the BiggerPockets Money show. It’s great to have you here. How’s it going?

Brandon: Oh, really well, thanks. Thanks a lot for having me. This is a real treat. I’m excited to chat with you both.

Mindy: I am super excited to have you on because you need to teach Scott about the concept of contributing to your retirement accounts. Scott has just recently contributing to his retirement accounts, but he is already almost 28, Scott. You’re so old now to start your contributions.

Scott: No, I think I had some reasons for not contributing to them. Those circumstances have changed, but I also want to hone my thinking and learn from Brandon who’s probably one of the foremost experts on this, how to use retirement accounts in pursuit of financial freedom, how to leverage that. Definitely looking forward to hearing from that.

Maybe we could get started by starting from your story, and hear about how did you begin pursuing financial independence in the first place? When did that first hit home, and how did you begin your journey?

Brandon: Sure. I’ve always been frugal. I don’t know where that comes from. My parents would keep me occupied in the summer by throwing quarters into the deep end of the pool, and I would spend all day diving into find them. I was like, ‘There’s money down there. There’s got to be more.’ I don’t know where my love of money came from, but that’s been with me for a long time.

It wasn’t until I think it was probably 2010, that I stumbled upon GetRichSlowly.org. At the time I was saving a lot of money. I was really good with money. Never had any crazy debts or anything. I stumbled on this site. That’s exactly what I’m doing. I want to get rich, but I want to do it the right way. I don’t want to have some scammy thing or just get lucky. I’m happy to work hard for a while to get rich.

At the time I didn’t understand what rich was to me. I just wanted to be rich. I wanted to have  a portfolio to manage. I wanted to tweak my investments look at my portfolio, and have spreadsheets and all this stuff. The richness wasn’t for any big house, or boats. or any sort of those things. To be honest, fancy things really stress me out. I’d much rather just have a beater car, and just a manageable house that doesn’t take a lot of time to clean, and all that sort of stuff.

I had no real big goal. I stumbled upon GetRichSlowly, and I was like, ‘Wow, this is amazing.’ Here’s some guy is just writing about his journey to get rich. He’s just a normal guy. That was actually the first blog I ever read. I didn’t even know what a blog was, which is shameful since I was a Computer Science major. I should know computers better than I do. I stumbled upon that. I think probably a year after seeing that blog and reading it everyday, there was a guest post from Early Retirement Extreme. It may not have been a guest post. It may have been a review of the book, Early Retirement Extreme. That’s a book by Jacob Lund Fisker.

He has a website, EarlyRetirementExtreme.com. It just laid out the math behind early retirement, which as you guys know is very simple. It’s the 4% rule, or any of these other Trinity studies that you hear talked about. I know you guys have talked about on the podcast. That was the biggest lightbulb of my adult life. I was, ‘This is what I’m saving for. I want my freedom.’ That’s worth buying.

That was probably 2011 at some point. Then I started the Mad Fientist in 2012, because I was like, ‘I know I can get to financial independence quicker, if I actually put in a lot of work to,’ at the time I thought it was going to be studying like investment strategies, I was like, ‘If I can become a better investor, I can get there quicker.’ I was like, ‘I’ll start this site.’ Two things. The need to publish post will force me to do the research that will help me get to financial independence quicker. I can also start a podcast at the same time, so that I can talk to people who have already retired early and I can find out all their secrets for how they got there.

That’s what I did. Early 2012, I started Mad Fientist. I started the Financial Independence podcast. It’s definitely helped.

Scott: Who is your first guest on that podcast?

Brandon: It was the same first guest as your first guest. It was Mr. Money Mustache. Back in 2012, luckily I was naive, and didn’t realize how big he was. He wasn’t, obviously as huge as he is today, but he was massive. I had no idea. I was like, ‘Yeah, here’s a software developer like me. Of course, I want to talk to him first.’ I sent him an email. He agreed, which is still shocking because I had nothing on my sites. I had nothing to offer him. I think he just liked my logo. I think that was it.

We’ve become friends over the years. It was a couple years ago, I was like, ‘Why did you say yes to me all those years ago?’

He’s like, ‘You’re the Mad Fientist.’

I was like, ‘Okay.’

Scott: Now I always like to mention that because I think that was really when it- I had been reading and learning about personal financial freedom for a while, but I think back when I first heard that podcast, your podcast with Mr. Money Mustache, that was my introduction. That was my moment when it clicked. You just talked about your moment where it clicked, where you read with Early Retirement Extreme with Jacob. Your show is where it clicked for me.

Brandon: That is amazing to hear. When you’re writing and stressing for so many years, that number you see, the numbers on the screen of how many people are reading, and things, you can’t really comprehend that. I know you personally. I know all the things you’ve gone and done with your life, and what you’re doing now, to think that I add some small, little part in putting you on that path, it’s just insane to me.

Scott: That’s awesome.

Mindy: I don’t think it was a small part. I think it was a pretty, big part.

Brandon: That’s crazy. That’s amazing to hear. Yeah. That’s awesome.

Scott: One of the things that you said that was interesting to me was, you started because you wanted it to help you become a better investor. It was one of the reasons why you started the Mad Fientist. The way you phrase that, it sounded like that maybe it wasn’t actually what happened. Can you maybe talk about how it did help you shape your view of personal finance?

Brandon: Sure. Yeah. When I started out, that’s exactly what I thought. I thought, ‘Alright. I’m going to become a better investor and this is going to make be do it. This is going to make me read corporate statements, and all this stuff, and force me to become this amazing investor.’ Then I started doing research. I quickly came to the conclusion that passive investing in index funds is has much higher probability of turning out well, and it allows you to control the things that you actually do control, like costs and things like that, and diversification. My second guest on the show was, J.R. Collins, who wrote, The Simple Path to Wealth.

It was really early on that I came to the conclusion that, ‘Hey, index funds are where it’s at.’ That’s something I feel confident in, and comfortable with. I’ll just focus on controlling the things that I can, like the fees, and making sure that my portfolio asset allocation is in check, and all that stuff. Yeah quickly, I was like, ‘Okay, all my optimizations that I thought I was going to be making, I’m not even going to look into anymore.’ That’s when I started looking into other ways to optimize.

Mindy: What does your portfolio look like right now? Do you have any individual stocks or are you all index funds?

Brandon: I have a very small amount of Apple. I talked to your husband about this is. This is probably, I don’t know, four years ago, that we were at ThinkCon. I was like, ‘ Man, like Apple’s getting tanked.’ I don’t buy anything, and yet I would buy a MacBook Pro no matter what the cost, because it’s just is such a nice experience and so good. At the time, it was like the stock price was roughly what the cash value of  it. They had that much in cash. I was like, ‘This is crazy.’

Back then, this was four years ago, I had an extra eight grand that I hadn’t invested yet. I poured eight grand into Apple. That’s obviously doubled, at least, since then. I maybe have max 20 grand in Apple, but that’s it. Everything else is index funds. It’s a very small, small percentage.

Mindy: Okay. I’m going to stop you right there. I want to address this to the people who are listening right now. Brandon is an incredibly intelligent person. For him to say, ‘Invest in index funds,’ that’s a really powerful statement. ‘I invested $8,000 in one stock, and my entire rest of my portfolio is index funds.’

Warren Buffett has said, ‘When I die, my wife is being instructed to invest in index funds, not specific stocks.’ Maybe Berkshire Hathaway, but that’s kind of its own index fund right there. Well, not really. It’s kind of it’s own mutual fund. I think that’s really powerful. Two really smart people are telling you invest in index funds. Do it.

Brandon: Yeah. Thank you. Thank you for putting me on the same playing field as Warren Buffet. That’s the first time that’s ever happened.

Mindy: It’s actually like this. Here’s Mad Fient. Here’s Warren, but don’t tell him that because I want to get him on the show too.

Brandon: You know, it’s great because this one stock that I have and still have, is still teaching me lessons. Even though with the right bet, and it’s doubled since I bought it, and like I said, it was four years ago, so it’s at least doubled, I haven’t checked in a while, but the fact that it’s doubled, and it’s in a taxable account, means that even though I made the right bet, if I want to unwind that bet, then I’m going to have a big, hell lot of tax consequences. The thing that I focus on now is buying an investment for life. I buy this investment, and I don’t ever plan to sell it. That is so much more tax-efficient, so much less stressful.

Yeah. Having this one stock in my portfolio that I would love to get rid of, because I like the simplicity of having just index funds. I would love to get rid of it, but I can’t because I would get a huge tax sit on it, and I don’t want that either.

Scott: It’s funny because I also invest primarily in index funds alongside real estate, which is one of the ways that what we do on BiggerPockets, obviously. What I think is so funny is, I’ve been through this phase, tried to become a better investor, better stock picker, look through all these 10Ks, all that kind of stuff, and try to figure out what the manager was going to do, and try to value companies based in a cash positions relative price to equity, all this stuff, I was terrible at it.

Then I read probably six, seven books on Stock Investing and then finally came to the conclusion that index fund investing is the right way to go. I think that’s a lot of aggressive seekers of financial independence will go through, because you think you can beat the market. You think you can pick these things. You think that you can do research. You really also, I think, have to go through this study of why index fund investing is the correct move, and why it is so powerful over time.

Brandon: Yeah. Absolutely. The good news is what you usually make these mistakes when you are young, when you don’t have a lot of money to blow, which is good. Then hopefully, by the time you do build up a nest egg, that would be sad if you lost, then you figured the stuff out by then.

Scott: To summarize your story here, you started off being pretty frugal. You’re a computer scientist, fientist, whatever. I would imagine you had a solid career and a high savings rate. You plowed things into index funds. You did this over a period of five, six, seven, ten years. Is that about right?

Brandon: Yeah. Absolutely. Yes. I graduated in 2004 with a degree in Computer Science, and then immediately started my career as a software developer. Yeah. I was frugal. I was maxing out my retirement accounts at the time, just because I know the power of compounding and stuff like that, even before I became the Mad Fientist, and all that. I was still aware of compounding. I’m just going to max on my retirement accounts, and all that stuff. Yeah. It was a nice base to start from once I realized that AFI is actually my ultimate gold.

Mindy: Where were you living at the time?

Brandon: Well, soon as I finished school, 2004 I moved over to Scotland. My wife is from Glasgow, Scotland. We met in my junior year. Soon as I graduated, we moved back to Scotland. I was there for the first four and a half years of my career, and then back in the States for the next six and a bit. Then I’ve been back here for another three since. Just keep flip flopping between Scotland and America.

Mindy: Do they have 401ks over in Scotland, or were you working for an American company?

Brandon: No. No. They have pensions, which is the bane in my existence because I started my first career here. I started contributing to a pension, and I only stayed there for four years. It didn’t get to be much. Now, since I have a 401 bank account, I have to tell the US government everything thing about it every year. It’s super annoying, and I can’t figure out how to get my money out of there just so I can stop having to do that. Yeah. Then, I guess I won’t. Eventually, when I’m 70, I’ll get like 25 bucks a week or something.

Mindy: Oh, nice. Nice. You can buy some haggis with that.

Scott: Well, let’s transition into talking about how to use these tax-advantaged accounts to your advantage over the course of a career. I’d love to get kind of different perspectives on this. What should someone who’s young, and planning to build businesses, and become an entrepreneur do? Does that change anything versus someone who’s just looking to see early financial freedom? I don’t know. Where should we start? How do we introduce the concept of tax and using these accounts for FI’er?

Brandon: Sure. Yeah. Well, just to go back to it my story of how this whole thing started. Once I realized that investing, I wasn’t going to do any sort of optimizations there, I just started looking for other ways. At the time, like I said, I was already frugal. The spending side of the equation was pretty sad. I don’t want to like go any crazier on that side. The income was pretty fixed. I was trying to build side income and stuff like that, but I had a good career, with a good salary.

Then there’s taxes. I think that’s something that people just don’t even think about because it automatically gets taken right out of their paycheck. They don’t see it. It’s not even a part of the equation, but it’s a huge part of the equation. It’s such a big chunk. It’s something that you don’t directly get a lot of happiness from in your spending. Obviously, the services that the government provides are great, but the US government wants you to pay the absolute bare minimum that you legally have to. They don’t want you to pay more. Paying the bare minimum still keep the country afloat, so there’s no reason not to try to optimize this huge chunk of your expenses.

That’s where I started to do some research. I knew that my research was going to be different than any of the other mainstream articles on this stuff. Early retirees are so different than standard retirees when it comes to taxes especially. If you think about it, most people have income that just gradually increases their entire career, and then all of a sudden they’re 65, and their income drops, and they’re spending hopefully, maybe drops a little bit. For early retirees we have this period of high income, that’s maybe 10 years, 20 years whatever your career happens to be. Then you have a big drop in income, and potentially low expenses, and low income for maybe 20 years before you even hit standard retirement age.

I realize that all the standard advice about retirement accounts really didn’t apply to people who are pursuing financial independence, or early retirement. That’s where I started looking into first. For early retirees, the reason this is so powerful is because you’re taking your taxes that you would be charged now in this period of high-income, high tax bracket, and you’re just shifting that to the future when you can control your income more, because you’re not just getting a salary every year. You can lower your income, and you can seriously lower your tax burden of Roth.

For an early retiree, the pre-tax accounts, I’m not sure how much you’ve discussed the different types of accounts, but pre-tax accounts are like, 401Ks, 403Bs, 401As, traditional IRAs. Those sorts of things where you don’t have to pay tax up front. Then the investments grow tax deferred, and then when you eventually take that money out, that’s when you have to pay tax on it. Those are super, super valuable for early retirees because you do have this long runway of [inaudible][00:22:16] income. That’s where I started. I was like, ‘Okay. I get that. That’s amazing. I’m just going to max these things out like crazy, and lower my taxes now when my tax bracket is high.’

Then that eventually led to doing a lot of researching, trying to get money out of those accounts early, because I reached a point where I invested a lot of money into that. That was going to fund my standard retirement. I was like, ‘Oh, I don’t want to just put so much in this if I can’t get it out.’ That was a whole other area of research, which I know we’re going to talk about today hopefully.

Mindy: Yeah. That’s really what I want to talk about today because I had made a comment earlier that Scott hasn’t been investing in his 401k. I was chiding him. Scott and I are friends. Brandon and I are friends. Any chiding that I do is in good fun. Scott actually did some pretty horrible stock investing in the beginning because you don’t know what you don’t know. You’re like, ‘Oh, this sounds great.’ Then you put money into it, like on Enron level. He bought Enron. The next day, it tanked. That is the level of his stock losses. When you get bit like that right in the very beginning, you’re going to shy away from that.

Scott: It was a Chinese fruit juice company. They had more cash in their bank account that their whole market cap. There was that. Of course, it was going to go up, except everyone else knew but me that Chinese companies are not well known for having incredibly audited financials that are accurate.

Mindy: Oh. Inaccurate financials. That can be detrimental to your investing career. Scott is younger than I am. He’s got a really long way to go. Instead of investing in his 401k, he’s purchased real estate, which is still an investment. It’s not like he’s just spending every dime that he makes. He’s purchased real estate that is now paying money. He’s earning money like a dividend on a stock. He’s earning money every month. He buys properties that are cash flowing from day one, right Scott, or close to day one? You were house hacking for awhile.

Scott: Yeah. The house hack was really what I started with. It was meant become eventually a real estate investment, but it was really meant to defray housing expenses at the start. Yeah. My thing was, I wanted to have the cash accessible, in case opportunities came up, rather than putting it into retirement accounts.

I now go back and I’m like, ‘Hmm, is that the right strategy for everyone? I don’t know.’ It seemed okay for me. Really, the big thing is if you’re using these accounts for early financial freedom, how do you at least come up with enough money outside of that, or access to that money, so that you can withdraw it and spend it at your age, rather than 65?

I think that’s exactly what you’re going to explain to us. There’s numbers strategy that we can harness to access that money. If you’re not actively investing index funds, this is a much better way to do it. It seems like they’re doing it in regular old after-tax brokerage account.

Brandon: Right. Absolutely. Before I get into that I want to say, I read your book and I know you’re doing fantastic. Despite your stock problems, you’ve obviously killed it with many other things in your life. Well done. Also before I get into the strategies, I just want to share how I think about this, because that could help you in your position where you’re like, ‘Do I really want to tie this money up?’ You mentioned earlier, ‘What if I’m going to be an entrepreneur after I retire, and I still have income coming in? What if I have these rental properties, and I’m always going to have the income? How does that change things?’

The way I think about it is, I always just want to optimize as much as possible with all the known information that I have. Give you an example. Some people email me. They’re like, ‘I don’t want to invest in my 401k because I think in the future I’m going to have a higher income.’

What I always say to these people is, ‘Okay. That’s the future. You can’t predict the future.’ All I know is, I want to take advantage of every single tax break that I can right now, and maximize that for all the 100% truth information that I know now. Then 10 years down the road, I’ll figure out a way to maximize. If I’m earning more income then, maybe that was the wrong choice, but I don’t want to look back on 2015 and say, ‘Oh man, I really wish I could have taken advantage of that $18,000 401k contribution because that would have really saved me like $4,000 that would have now grown to whatever.’

You can’t go back and you can’t take advantage of the past, you can take advantage of those 2013 limits, and things like that. I always just optimized for today with an eye towards the future. Obviously, you don’t want to just be doing crazy things, and that you know are going to happen in the future. Optimize for today. Worry about tomorrow tomorrow, and just have faith in yourself that you’re going to be able to optimize your situation then and lower your taxes. If you end up in a situation where you’re earning so much money that you’re going to get taxed to high heaven, there’s definitely worse problems to have, I think.

Mindy: In this article, How To Access Retirement Funds Early, what you just said was so perfect. You said the government only gives you one shot to deduct a big chunk of your current year’s income. You can’t change your mind in 2021 and say, ‘Hey, I’d actually like to contribute to my 2016 401k now so I can lower my 2016 taxes.’ I was talking to Carl about this. I’m like, ‘Yeah. He comes to the conclusion that it’s always best to max out your 401k.”

Carl said, ‘No, don’t say always. Don’t say always.’ If you’re making $30,000 a year, then it’s maybe not the best choice to max out your 401k which is $18,000, unless you can live on $12,000, which is probably going to be a little more difficult than you think.

Brandon: I definitely agree with Carl. Yeah. Never say always. If you’re in the situation where  you’re not going to pay tax anyway, then the last thing you want to do is put it in a 401k because you’re trading 0% tax for some unknown future tax. If that’s the case, if you’re in a low income right now, and you’re not going to pay tax anyway than the best option in that case would be put it into something like a Roth, where you’re locking in those tax free years. A Roth is like a flip flop. You pay tax now. It grows tax free and then you don’t pay tax when you withdraw it. You’re tax right now is 0%. You pay that, but it’s nothing. Then it grows tax free and then you can withdraw tax free. Always is definitely a bad word to use in finances.

Scott: Just for the listeners, so that they can follow what’s going on here. The debate here about whether to use a 401k or a tax-deferred account versus something like a Roth where you contribute after-tax dollars is based on, again, your level of current incoming, your level of expected future income. If you have a high income now, the general concept is you contribute to a 401k, if you expect your income to be lower later in life. For example, if you’re retiring, you don’t have any income. Now you can defer taxes in a high income year and pull that money out in a low-income year. The vice versa for the in case of a Roth.

I think what you’re saying, Brandon, is, okay, even if you have high income, contribute to the 401k, defer those taxes now, and if you happen to have a higher income later, okay, you lose a little bit, but that’s a good problem. Your life is good. Don’t worry about it at that point, because you’re taking advantage of a known information which is that you’re doing well now. You may or may not be in the future.

Brandon: Exactly. The amount of positive changes you can make in your life when you have some money saved up is just incredible. I have an article. It’s The Power of Quitting. I didn’t realize how powerful quitting was until I quit a few jobs. I was in a position of strength because I had this high net-worth. I think deferring those taxes to later gives you that confidence earlier, allows you to make those positive changes in your life.

You’re looking at a bank account that has maybe whatever 10,15 20% more than it would have otherwise. You’re like, ‘Wow, while I’m actually doing really well. I can survive for longer if I needed to.’ Then you start taking a little bit more chances, which I know you talked about in your book as well, and you start living this better life. Even if it’s a wash at the end of the day, the decision, just having more money up front, I think it’s incredibly beneficial.

Scott: Awesome. Alright. One thing that’s interesting about these tax deferred accounts as well as is that, you can actually contribute a lot of money to them. I think this year their limit for an employee contribution to a plan, is 18,000 or 18,500. Then you can stack on a match which can go up to that. The IRS allowable limit for contributing to these types of tax-deferred plans is actually much higher. I can’t remember the exact number. I think it’s in the 50 or 50,000 plus.

Brandon: 54,000. Yeah. 54 plus. Yeah.

Scott: Can you tell us a little bit about how someone would go about deferring that much money, when maybe your plan only allows you to contribute 18,000 or 18,500?

Brandon: Sure. When I realized how powerful these types of accounts were, I started to looking into every way that you could put as much money into these types of accounts as possible. Yeah. You’re absolutely right. For a 401k, an employee can put in up to 18,500 for an individual. Obviously, if you have an employer match then, that’s on top of that, but the actual upper limit is somewhere around 54,000. It may have increased for 2018.

What that space allows you to do is, if you want, there’s a very popular strategy called, The Mega Backdoor Roth. Anything above the employer match and the employee contribution, can be funded with after-tax dollars. What that means is, you pay tax on it. It can go in there. It’ll grow tax-free, but you also get taxed on the other side of it. That’s why it’s not as good as  a traditional or a Roth, because it’s like taxed on both ends. It does grow tax-free in the middle, so that makes it better.

The trick is, you can put all that money in, and then you can immediately roll that over to a Roth, which then allows it to grow tax free and withdraw it without paying taxes either. This is really advanced strategies. There is an article on my site called, ‘After Tax Contributions.’ It goes through all this stuff. Yeah, you’re right. The actual upper limit is 54,000 plus.

Scott: My understanding, and I could be wrong on this because I came in thinking that the upper limit, you could actually defer almost all of that by using something like a SEPP-IRA or something like that, with your self employed income.

Brandon: Yeah. Exactly. There is even more SEPPs. SEPPs are for, if you are self employed and if you have a business income, you can contribute to that. A solo 401K is even better if you don’t have a workplace retirement plan, because then you can put in 25% of your profits as the employer, and then the employee can still put in 18,5  as just like a normal 401K. Even if you don’t have a side business, you can still reach that upper limit with that Mega Backdoor Roth strategy that I talked about.

Scott: That’s awesome.

Mindy: How would you find out more information about the Mega Backdoor Roth? I think that is going a little bit more in depth that this will necessarily want to discuss. Is that something that your CPA will help you with? How do you set that up? How do you do that?

Brandon: I’ve never actually personally done it, but I wrote a big, detailed post about all the theory behind it and other people have executed it with their CPAs, and their tax attorneys, and things like that. It would definitely be something you’d want to talk to them about. Yeah. You’re absolutely right. This is way too in the weeds for a podcast episode to get into.

The first step, I guess, you could check out the Mega Backdoor Roth posts on my site. Then from there, you would just send that to your tax person, and hope that they had heard of it before, because you don’t usually have a lot of people beating down the doors to try to contribute as much as possible. They probably may have not come across it.

Mindy: Okay. Yeah. We will link to that in the show notes. The show notes can be found at BiggerPocket.com/moneyshow18.

Walk us through some of the early FI options from a 401k. Let’s say that I am a medium to high income earner. I’ve been maxing out my 401k, or at least contributing to it every year. I’ve hit my FI number. I’ve quit my job, or I’m considering quitting my job. What’s my first step?

Brandon: Sure. After you leave an employer, you can roll your 401k over into a traditional IRA. There’s benefits of doing it, and then there’s downsides as well. I haven’t done it for mine yet, but that’s because my 401k had good investment options. It had low fees. It’s with Fidelity, whereas most of my other money as with Vanguard. I just like having them separate, just might as well.

The first step if you were wanting to access that early though is that, you would open up a traditional IRA. Just open a new one, even if you have a traditional IRA that you’ve been contributing to already. Just open up a new one. Then you can just do a transfer from the 401K into the traditional IRA. If you do it properly, if you’re using Vanguard or something, you can just tell them to do it. They’ll tell you everything you need to do, so that you don’t get taxed on it. If you just transfer it between those two accounts, then it’s not a taxable event. That’s the first step.

Mindy: Yeah. If you take all of your money from the 401k, you have to have the cheque written out to the new account. If you have it written out to yourself, that constitutes a taxable event. Then you’re hit with a penalty, and the tax. It’s a terrible thing. I wanted to reiterate. Make sure you transfer it between the two or the one 401k account is going to have to be closed out. They will have to write a cheque, but it has to be written to the IRA account.

Brandon: Definitely. Yeah. Like I said, whomever you’re dealing with, hopefully they’ll be able to hold your hand through it. They do this a lot, and you have to get it right.

Mindy: Yeah. I’ve had great experience with Fidelity.

Brandon: Oh, good.

Mindy: Okay. You make the new IRA. You transfer over your money, without triggering a taxable.

Brandon: Exactly. From here you have a few options. The first strategy that I came across which was a complete game changer for me, this is when I made the decision to just go full  force with all these tax-advantage accounts, it’s something called the Roth conversion ladder. The way it works is, you have this money sitting in your traditional IRA.

Say you live on 20,000 a year. You know that you’re early retirement. You’re going to want to live on something like 20,000 a year. What you do is, you convert 20,000 from your traditional IRA into a Roth IRA. Since you’re converting from traditional to Roth, that’s a taxable event because you won’t have to pay tax on it in the Roth when you take it out. That’s when you pay your tax on it. Hopefully, at this stage, that’s your only taxable income because you’re potentially living off of long-term capital gains, and qualified dividends, which you could have up to $79,000 worth of those, depending on how much you’re converting and still not pay tax on it.

You could be living off of these tax-efficient income sources, like long-term capital gains or qualified dividends. You can do these conversions. Once it gets converted into the Roth, it has to sit there for five years before you can touch it. Once that five years is up, then you can take that out penalty-free. Obviously you pay taxes on it when you did the conversion, so penalty and tax-free when you actually take it out.

You can build this ladder. If you know you need 20,000 every year, then every year you convert 20,000. Then after the first five years then, you can potentially just withdraw that money from the Roth every year, until you hit standard retirement age. That just changed the game for me.

Mindy: When I read your article, it was eye-opening. Oh my goodness. Wait, I can get at my retirement funds early. This is fantastic. My big thing, I struggle to get over the whole penalty because I don’t want to pay. What is it, a 10% penalty?

Brandon: 10%, yeah.

Mindy: Yeah. That’s a lot of money.

Brandon: Yeah. 10% early withdrawal.

Mindy: The early withdrawal penalty. I just worked all this time to save up all this money. I don’t want to pay a penalty on it just to access my money. It’s still five years out, but it’s so fantastic. Now, when I convert it from the IRA to the Roth IRA, I’m paying taxes at my whatever that tax level is.

Brandon: Exactly. Yeah. If you’ve already retired at this point, then potentially you’re not paying any tax on it.

Scott: This is great for someone who is meticulous planner, who knows they’re going to have very little income, or very highly a tax-efficient income. Again, from the entrepreneurial side of things, suppose you go out and you’re planning to start a businesses or whatever, what if you have a year where you have a big loss from one of your businesses, because you have a big write off or whatever, can you roll over a ton of money in that year to fill this up?

Brandon: You can do it. Yeah. Absolutely. If you’re taking a gap year, if you’re taking a sabbatical, if you’re trying a little mini retirement, if you go out and just spend a ton of money, and you have a lot of business expenses that lowers your income to a loss, then yeah. These are all perfect scenarios for just computing it, just doing the math, talking to your tax person, and being like, ‘ Okay, I want to use all this tax-free space or maybe even that just the low tax bracket space, to just convert it as much as I want, as much as I can, and then that way I just lock in those gains forever. I don’t have to worry about paying tax on that money ever again.’

That’s exactly. That’s a perfect strategy for people who may not be retiring early in the traditional sense, where they’re not earning any earned income anymore.

Mindy: The meticulous planning part is why I wanted to talk about this. Five years ago, would have been a really great time to know this. I didn’t have any income. I was a stay at home mom. Now, my husband doesn’t have any income. This is a really great time for us to start planning things like this.

Scott: I came into this thinking, the Roth seems to be the better option, from a very basic consideration. This is not exactly how I feel now. I’m learning things even now as we talk about this. The advantage of the Roth is, you can pull at your contributions, the tax and penalty free, it grows tax-free, it’s good if you think you want to have a good career, acquire lots of investments and properties over in the span of 30, 40 years, and hit 65, and hopefully be pretty well off.

It seems like that’s not necessarily a disagreement. That’s what everyone in this community things, or at least what you, who are kind of pioneer in this kind of thought space field. The goal is just, ‘Hey, we can get to the Roth. We’re just going to go about it a little bit more round about way so we can save money huge on both sides of this equation, both before tax, and after tax. The way we’re going to do it is, deferring it in the high income years, and rolling it over in the low income years.’

Brandon: Yeah. This was like mind-blowing to me. I was so excited. The early retirees,  people who were wanting to just step away from the daily grind, this is like the perfect people to take advantage of this. You could potentially have tons of completely tax-free income, if you work it out correctly.

Mindy, you mentioned the 10% early withdrawal penalty. You also mentioned that article of How To Access Retirement Accounts Early. For that article, I actually did some analysis and showed that for early retirees, even paying the penalty could potentially be more beneficial just based on the whole income spending differences between early retirees, and standard work till your 65 people. It’s really that powerful.

Mindy: Yeah. No, I read that article. I was like, in many situations it’s still better to contribute to your 401k, and then just pay the penalty, if necessary, to get at your money versus not contributing at all. Just the amount of tax that you’re deferring during your high income years, is so much better to not pay that and pay the 10% penalty on the back end.

I have a couple of questions about the Roth conversion ladder. Can you have a Roth IRA and a traditional IRA at the same time?

Brandon: Yes. Although for a conversion what I would recommend is you would open a Roth IRA just for the conversion. You can have as many Roth IRAs as you want. You can have as many traditional IRAs as you want. To make the record keeping cleaner, if you’re going to do a conversion, if you already have a Roth IRA, I would open up a brand new one, and just use that for conversions from the traditional IRA. Yeah. You can have both.

Mindy: Okay. What is the limit that I can convert from a traditional IRA to a Roth IRA? I know the donation or the contribution limits are like $5,500 a year or something. It’s pretty low compared to the 401K and the IRA.

Brandon: Yeah. There’s no limits on conversion. It’s treated completely differently. If you wanted to, you could convert a million dollars tomorrow into your Roth IRA from your traditional. Obviously, you wouldn’t want to do that, because you would get hit with a lot of tax, because that would be considered income. Yeah, you could do as much as you want.

It’s really, you could tailor it to your life. You’re like, ‘I’m happy living on $30,000 a year so I’ll just do 30,000 every year.’

Scott: This is fience. This is such fience.

Mindy: He blinded us with fience.

Brandon: It’s my goal. That’s what I try to do every day.

Scott: I guess my issue with the whole retirement account contribution thing in the first place is, I think that most people go through life without having a specific plan, specific financial planning, perhaps. They contribute to these retirement accounts, maybe actively manage mutual funds with high fees, and don’t really think about what they’re going to do with them or how they’re going to harness them. That just doesn’t really do anything for them, except provide something of a nest egg for them when they do enter retirement, because it’s still better than nothing.

If you’re going into it, with a plan like this to harness your contributions at an early age for an early retirement, or just have access to that money in case you want it, these really do provide an incredibly powerful way to get deferred taxes and get huge returns on your investments relative to what you could do with anything basically after tax.

Brandon: Absolutely.

Scott: Yeah. I’m coming around on this line of thinking.

Brandon: I think you mentioned, maybe some of these accounts don’t have great investments, and they have high fees and things like that. That was some other analysis that I did. My buddy, JL Collins, who wrote The Simple Path to Wealth, he was wondering if it was worth it with, if you have these terrible investment options, and if you’re paying ridiculous fees. We did the math. It definitely turned out to be the case.

In that case, what you would want to do is, as soon as you leave that employer, you would then make than conversion instantly, from 401k to traditional IRA at Vanguard or something. There’s no use paying those fees when you’re not with your employer, but you’re locked in until you leave your employer.

Mindy: Hey, Brandon, is there anyway you can find out what kind of fees you are paying?

Brandon: Yes. There’s loads of different ways.

Mindy: Personal capitals fee analyzer.

Brandon: Yes. That’s what I use.

Mindy: I love the fee analyzer because that tells you exactly how much you’re paying, and not only that, it extrapolates that for you, if you stay here for the next 25 years, you are going to pay $76 million in fees. Do they give you an option to like, ‘Here some lower fund fees,  lower fee funds?’

Brandon: Not sure if they actually give you options, but they do break it down per fund, which I think is awesome. You can see every single one. It makes such a difference and that’s why that fee analyzer is so powerful. .6% doesn’t seem like a lot, but when you extrapolate that out to until you want to tap into that money, it’s just massive. I love that thing.

Mindy: That is amazing. I will link to that in the show notes as well, the personal capital fee analyzer because it’ll change the way you invest.

Brandon: Absolutely.

Scott: It seems like this is very straightforward from the first part of it, during the working part of your career, which is max out your 401K. If you’re going to invest in index funds for the long-term, that’s your primary means of investing, that this makes a lot of sense as an approach for you to consider as to take all these tax advantages. Once you do decide to, making the leap to early retirement, where can I go to find a professional that would actually walk me through the nuts and bolts of these positions, so I don’t screw up on the paperwork or get hit with a fee? Does that exist, call an accountant or an attorney?

Brandon: Yeah. Yeah. I would talk to an accountant, but it’s hard to find a good accountant because, like I said, these strategies are, not many people are doing this stuff. Like I said, we’re so different than most career track people. Most people are normal career track people. The two things when looking for someone who could help you with this would be, one, make sure their fiduciary, so that they’re always going to be acting in your best interest. Then, try to find a fee-only advisor, if you can, just so that you’re not paying some crazy asset, under management percentage of your portfolio.

I know Michael Kitces, from Kitces.com. I know he has some Pinnacle Advisory Firm. There’s an XY Planning Network, that I think are fee only advisors. Those are maybe two places to start. I don’t have any first hand experience with it. I trust Michael Kitces. He’s a really good guy and he’s a really smart guy. I’m hoping that the advisers that he works with our are the same. Yeah, those two things are the big things to keep in mind. Yeah, it may be difficult to find someone who is familiar with this stuff right off the bat, but I’m sure they can learn it.

Scott: Well, let’s link to this guy, Michael on the show notes or whatever, if we can to make sure that folks have at least a starting point for the research there. I do think that’s an important part of this. I’ve never considered it. I would want help walking through that and not getting hit with a 10% penalty.

Mindy: Yes, if you’re trying to avoid that. I know him from Nerd’s Eye View.

Brandon: Yeah, that’s the name. Sorry. Kitces.com is the URL. Nerd’s Eye View is the name of the blog.

Mindy: Oh okay. Okay. We’ve talked about the Roth conversion ladder. I’ve read through your whole article. It talked about the SEPP. The SEPP is used too much in early retirement retirement planning because this one means substantially equal periodic payments. Let’s talk about this. You don’t want to do the Roth or you don’t want to wait five years. How long do you have to wait if you do the SEPP? Well, first what is the SEPP, and then how long do you have to wait?

Brandon: Sure. We can say 72t instead of SEPP. Yeah. I agree. SEPP is overused because there is SEP IRAs and things like that. 72t is the IRS code for for this. People reference it by that as well. Yeah, with the 72t is, say you know that you’re going to need $10,000 a year. You know that’s your bare minimum spending. Maybe you have a side business or something. You’re going to have some other additional income, but you’re like, ‘I know I need at least 10,000 from my traditional IRA every year, and I don’t want to wait for the five year Roth conversion ladder to kick in, so I’m just going to set out this 72t.’

What it is is, you can calculate, the calculations- there’s three options for how do you calculate this, and it’s way too complicated to get into here, but that’s something you’d want to do with the tax attorney, but you’d make this calculation and then every year you can take that amount out with no penalties and no waiting. You can pay the tax on it when you take it out, because, as I said, it wasn’t taxed going into those accounts. You just set up this thing. It’s a certain amount. Some of the calculation methods change, so it means that you can increase every year based on inflation, things like that.

Anyway, you can take out the set amount which is a percentage of your portfolio, and you can take that out every year. No penalties. You don’t have to worry about waiting five years. The one thing to keep in mind is, you have to continue that. That’s the downside. If you set this up and then 10 years down the road, you have this incredibly successful business, and you’re like, ‘I don’t need to be taking 10 grand out of traditional IRA every year.’

If you stop it, then you’ll get penalized on all those previous withdrawals, and you don’t want that. This sort of thing is, it’s a lot less flexible, but if you know you need a certain amount of money every year, it could be very useful.

Mindy: You’re paying taxes based on your current income. If this 10,000 is your only current income, you’re just paying taxes. It’s possible to not pay any taxes on this money as well.

Brandon: Exactly. Yeah. Yeah. Exactly. The same principles apply as far as like, when you’re early retired, your income is probably lower so, any tax you’re going to have to pay on these distributions is going to be quite low and potentially nothing, depending on the amounts.

Mindy: Okay. A lot of these problems are good problems to have. You have so much money that you don’t need the $10,000 anymore. Can you take that $10,000 that you’re continuing to take out and put it back in?

Brandon: If you’re able to contribute to a traditional IRA, then yeah. You could put $5,500 in that year. If you make too much, and you can potentially put into a Roth IRA, or if you have a solo 401K, you can put into that. Yeah. What you do with it after the government doesn’t care. They just want to know that you’re still taking that out, and you’re still paying taxes on it as you take it out.

Scott: This strategy is probably more appealing, I would imagine, to someone who is a little closer to the traditional retirement age of 59 and a half, then it would be to someone that’s retiring in their 30s. There’s so much uncertainty in a 30 year period between now and retirement age, versus the five to ten years for someone who’s just getting ready to leave work, maybe a decade earlier.

Brandon: Exactly. Yeah. I would say so. That’s why it hasn’t appealed to me because I want more control. The Roth conversion ladder allows me to control it completely. If I have a year  with high income, then obviously I’m not going to do my conversion that year, because I don’t want to pay a bunch of tax on the conversion, whereas the SEP, you have to do it every year no matter what the life situation is at the time.

Yeah, you’re right. If you’re older that may make more sense. I know I need this much of money every year until retirement. If you’re younger, than yeah, it’s going to be a bit more pain to deal with for every year, and you don’t know what the future holds.

Mindy: Do you have to make it a decision to do this 72t when you retire? Can you choose to do this starting, let’s say you retire at 30, can you choose to start this at age 40 or 45?

Brandon: Yeah Absolutely. You don’t have to ever start it. You can just decide 10 years down the road, and you’re like, ‘Okay, I know my income is leveled out. My spending is pretty much normalized. I know this is what I’m just going to be spending, and then I know I need that money for my traditional IRA, so I’m not going to screw around with the conversion ladder anymore. I’ll just do a SEPP 72t and just get that money every year.’

Scott: Outside of the 72t and the Roth conversion ladder, are there any other ways to get the money out of your retirement accounts early, or is that pretty much it, without paying a penalty?

Brandon: Without paying the penalty, those are the two main strategies. Like I said, paying the penalty, that gives you a lot of flexibility, and it’s still usually works out to be beneficial, but obviously if you can plan ahead, then one of these other strategies is going to be better. Yeah, those are the big ones.

Mindy: Okay. In your article, you mention the ultimate retirement account. Do you want to talk a little bit about that?

Brandon: Sure. Like I said, when I realized that I could tap into these accounts early, then it  was just a mad dash to see how many of these accounts I could find. The HSA, the health savings account, is something that came onto the scene in a few years before I started researching it, I think. Again, its pre-tax. You don’t pay tax on the money going in, which is exactly what feature other retirees want, and it grows tax-free, and then you pay tax on it coming out, or you don’t pay tax on it if you use it for medical expenses.

Right of the bat it’s already the best of both worlds potentially. If you use it for medical expenses, then it means that you never pay tax on it ever, at any stage of the game. You don’t have to even worry about any of these more complex strategies. If you build up a HSA balance, which is what I attempted to do during the last five years in my career, you can invest it just like you do a normal investment account.

This is a real life scenario, so I had an appendectomy, I don’t know, three years ago. I just came down with appendicitis. Had to get my appendix out. I think my out of pocket max was $2,500 or something. I had to pay $2,500  because obviously the appendectomy was way over that. I had some decisions to make. I could either pay cash for that. I could use my HSA to pay for that. Like I said, if you use your HSA for medical expenses, that money isn’t taxed, so you can take that out of your HSA tax free, and pay for the medical expense. There’s no rule in the tax code that says you have to take that money out immediately.

What I did, since I had already maxing out on my retirement accounts, and had money that I wanted to invest. I paid for my appendectomy just with my normal checking account. I took pictures of all the receipts. Now I have $2,500 that’s growing tax free in my HSA. I’m just going to leave that there until I need it. Potentially that money is going to grow tax free for next 30 years.

Then say, I want to buy a boat or something, which I have never would, but let’s just say I would. I could take that $2,500 out of my HSA to buy the boat, because I have the receipt with to match it up with a medical expense that I incurred after setting up the HSA. I’m getting all this tax free growth that I wouldn’t otherwise, had I just paid for that appendectomy straight out of my HSA.

Mindy: Okay. Let’s talk loopholes on this one.

Scott: Whoa!

Mindy: Yeah. Yeah. That’s why I wanted him on the show. For all of these ridiculous, I would never even think of that.  I would have had been like, ‘Oh, my appendectomy is 2500. Here, I’ll just pay for it.’ I wish I would have had an HSA when I was having babies, because they’re expensive. I could have saved up all of that those receipts, and put them in- I’m not going to have anymore babies. Don’t make that suggestion.

Scott: Oh, that was not where I was going with that. I was about to chime in, but that was not  what I was thinking.

Mindy: What I would like to say to the person from my company who chooses what sort of healthcare options we get, I would like to say please listen to this part of the episode.

Scott: That’s me.

Mindy: That’s Scott.

Scott: Let me walk you through it, thinking which is now wrong, for why we did not offer an HSA at BiggerPockets, to the BiggerPockets employees was, because we have a good healthcare plan, with a very low out-of-pocket. Premiums are paid for. There’s very good coverage, very good network, all that kind of stuff, and so because our out of pocket maximums are so low, no one qualifies for an HSA. We did not realize that people would want these, as a big group.

I know that if there’s an HSA, and that’s what I have, I’d max it out because that’s just good finance. I didn’t realize all of the stuff that you’re talking about right now, I don’t know what I do for a living. I didn’t realize that. We came up with a good healthcare plan. I think next year we’re really going to look into trying to give everybody a HSA that wants one.

Of course, the downside to an HSA is that you do have a plan that has a little bit of a higher  out of pocket maximum, and higher deductible.

Brandon: Right. You have to have a high deductible health plan to qualify for it. What you’re doing is good too. Having a great health plan is great as well.

Mindy: Well, here’s a different way to think of it. I am not a sick person. I go to the doctor very rarely. My children are not sick. They go to the doctor very rarely. For us, having great health insurance is always great. It sounds like I’m complaining that we don’t have an HSA, but the reason we don’t have an HSA is because we have really awesome health care plan. I’ve got great health care and that’s a concern that that we’re not going to get into in this show, but I am looking for somebody to talk about health care.

For this episode, I have great health care. It’s wonderful. I would have preferred an HSA because we never go to the doctor, because we don’t use our Healthcare very frequently, having the ability to save a lot of money in this account is better for me. If you do have chronic illnesses, if you have these high doctor bills all the time, having the HSA maybe isn’t the best choice for you.

We have an FSA, which I believe is tax-deferred as well. That’s a pre-tax.

Brandon: Yeah. That’s a very different account. You can’t do this strategy with an FSA. I think an FSA is like use it or lose it in a year. I’m glad you brought that up, because that’s always something I need to make sure I say whenever I’m talking about an HSA. If people try to do this with an FSA, that would be a disaster.

Mindy: Especially if they’re not sick.

Scott: Yeah. The FSA programme works like, you pay a 100 bucks or something a month into the plan, and you use that within the calendar year. You start in January. Suppose you have a $1000 that you want to spend on health care in January well. You can spend it right then, but you’ll be contributing the 88 bucks, or whatever 1000/12 is. You’ll contribute that throughout the year. If you use it in December, it’d be the same way. If you don’t use it, you just lose all that contribution although it is, again, tax deferred.

Mindy: Yeah. What we do in December is buy a lot of bandaids, and saline solution, and things on the list that we’ll use the next year, because they don’t want to lose that money. Also because we’re really, healthy family, I don’t put a lot of money into the FSA, because it’s a use it or lose it. The HSA just continues to roll over forever.

What are the contributions to an HSA?

Brandon: I think for an individual it’s somewhere around $3,100 or $3,200. For a family, it’s about double that. I don’t know the exact ones for 2018, but yeah somewhere around 3100. It’s the smaller than an IRA, so you’re not going to be having insane, crazy high balances in these, unless you have a very long career, I guess, or you have really good investments in there.

That’s worth noting too. You can invest the funds in there. Obviously, it differs based on the custodian of the HSA, but a lot of agencies have good low cost, index fund investment options. Sometimes you have to keep a certain amount in cash, but you can invest the rest, which is obviously what you’d recommend because, if you treat it like a super IRA, then you want to obviously, have some nice tax free growth in there.

Scott: It’s good business because it’s much cheaper to offer a health care plan at an HSA, than it is to offer a really, really expensive health care plan with low premiums and low deductibles.

Mindy: There you go.

Scott: Low deductibles and low out of pocket maximum, sorry.

Brandon: That’s the thing to look at. That’s the big thing. The out of pocket maximum is the number you really need to look at, when you’re looking and thinking about, ‘Do I want a high deductible health plan, so I can take advantage of an HSA?’ If paying that out of pocket max is going to put you under, then obviously that’s not the plan for you. Like with my appendectomy,  I would have never expected that because I hardly ever go to the doctor either. Luckily, the out of pocket maximum was low enough that it didn’t really matter.

Mindy: I also am sans appendix. All of a sudden, I’m fine, blam, I’m in the hospital. They like, ‘Yeah, we’re going to go do surgery in 10 minutes.’ Wait, what? Having an HSA now that you’re allowing to grow tax-free forever, or well not forever, until you need it is a really great backup plan for somebody who’s not a sickly person.

Scott: I think it goes without saying that all these strategies that we’re talking about, the HSAs, these tax deferred retirement accounts, all that kind of stuff, this is stuff that is really good and useful advice, that can help save a lot of money. The foundation, that does not mean you should start from a position of credit card debt, and not having an emergency funds setup, not be able to handle the ordinary expenses of life, You got to have that stuff in order prior to really thinking about how to optimize your tax advantaged early retirement.

Brandon: Absolutely. Exactly. You don’t want the tail to wag the dog either. Like you said, yeah, FSA contributions are tax deferred, but if that just disappears at the end of the year, there’s no point in that. Yeah, you saved on tax, but then you just threw a bunch of money away. I couldn’t agree more. These are higher level optimizations for people who have the basics and they’re just wanting to choose the things a little bit more, and be even more optimized.

Have those core things in place. Then, never sacrifice a good investment, just so that you can save taxes or things like that. The taxes, the secondary concern.

Scott: Even you, the Mad Fientist, you had a five, six, seven year career that you were applying the basics on very, very systematically, prior to really beginning this, or at least understanding all of the potential of these optimizations.

Brandon: Yeah. I wish I was that young. I’ll take that compliment. My career was sadly a bit longer than that, but yeah.

Scott: Oh no. I was trying to do that, 2004-.

Brandon: Do the math.

Mindy: Yeah. I also graduated from college in 2004. Scott, when did you graduate from college?

Scott: ’13.

Mindy: ’13.

Brandon: Oh god.

Mindy: Okay. Yeah. Scott’s like nine. That’s really important to look at when you graduated from college and what the stock market was doing. For the whole time you were in college, the stock market was in the toilet. I’m assuming that you, Scott Trench became conscious of money and finances and all of that in high school. No?

Scott: Basically immediately after college. I had a job at, it was labelled the meanest place in America to work, I did not have necessarily have the whole ordinary four year career. My advantage was more not having any big head start, but really wanting to look toward financial freedom, within three or four months of starting my career.

Then, I have figure it this out. I had the Mad Fientist, Mr Money Mustache, Real Time Extreme, and all these other guys that telling me exactly how to do it. It’s easy to follow once it’s laid out.

Brandon: It’ll be interesting to see what happens to the next bear market there. Since this whole FI resurgence has just exploded online, I started in 2012, and that was four years ago. Three years into the bull market, and three years away from the financial crisis.

It’s been a crazy ride since then. I was an investor in 2007. I know how that feels. Luckily it was a lot less money, and I didn’t freak out, but it would be interesting to see the next bear market. What that does and how people react.

Scott: I think the only people that are going to be worse off then people who have invested heavily in the market, and built a large personnel net worth, are the people who didn’t.

Brandon: Oh. Absolutely. That’s the beautiful thing of having a blog. In 2012, people were like, ‘Oh, the market’s gone up like crazy. I can’t invest now. What should I do?’ You don’t know what’s going to happen. Yeah, you have to just invest.

2013, more people are like, ‘Whoa, now it’s really gone up. It’s been going up for so many years. I can’t invest now. I have to wait until the dip.’ No, you don’t know what’s going to happen.

Here we are in 2018, and it’s just been crazy ever since. Yeah, you’re exactly right. It’s the people that I’ve been waiting on the sidelines, or took money out after 2008 and just haven’t had a chance to put it back in really.

Mindy: No, they’ve had chances. They haven’t done it on purpose.

Scott: Oh yeah.

Brandon: Exactly that.

Scott: Again, it comes back to you have consistently, sounds like, spent less than you earned and contributed in the tax advantage way, and done so consistently over a long period of time, and that’s the rule of thumb. You can do these tax optimizations or not, they sound like these are absolutely things that anybody who is considering passive index fund investing as a primary wealth building source should really consider.  End of the day, as long as you have that high savings rate, and contribute consistently to an investment of your choice, you’re probably going to be able to achieve financial freedom sooner than later.

Brandon: Absolutely. That’s an added benefit of these types of accounts too, that I didn’t even talk about. A 401k, that’s usually much easier to set up, and automated investing plan for. You sign up to a new job. They’re like, ‘Alright. What do you want to do here?’ Then you just sign up, and you’re like okay, whatever. 10% or we have max it out up to the match. You automate that. If I was able to look back on to my portfolio and compare my tax advantage portfolio performance to my taxable account performance, I would bet that the tax-advantaged account is way higher, because those automated investments were happening every month no matter what.

Yet in my taxable account, it took me 5 years to set that up. I was always trying to, not in and out of the market, but trying to go in at opportune time. I’d wait until a dip, and then I’d put money in, but then I would miss these big increases. Then I would just get in on the next step, which if I was smarter, I would have just put it in in the beginning, would have had a lot more money.

I think that automated investing, that’s inherent with these tax advantaged accounts, like a 401k, even makes your investment performance much better than it would be otherwise.

Mindy: It sounds like you’re saying don’t try to time the market, Brandon. Is that what I’m hearing?

Brandon: I am. I am trying to say that, but I am saying that to myself too, because I still struggle with it. I’m sitting on too much cash now. I haven’t deployed it because I’m like, ‘Oh, it feels really high.’ I’ve started setting up. I’ve just increased my automated, taxable account in best thing. Hopefully, I’ll get through it. I know better. I should just put the whole lump sum in the hat right now, because time in the market is much better than trying to time the market.

Yet I can’t, because that’s the thing. This personal finance stuff, this investing, it’s all personal and psychology is the thing that drives returns the most, and influences the most. We understand the math. We understand the mechanics. It’s our stupid brains get in the way. My stupid brain still gets in the way, even though I write about this stuff and I know better.

Mindy: I can help you with that cash. Just send me a cheque.

Brandon: You’re probably good. I would trust you. I think you would invest very wisely.

Mindy: I will invest it in a new car, in a new house. I’ve got some rental property I want to buy.

Scott: I guess we should probably get started moving on to our Famous Four, here. Are they any other final thoughts you want to leave us with on this subject, either your back story or these retirement accounts?

Brandon: Yeah. I would just say don’t let this overwhelm you. This stuff can be super overwhelming. Like we’ve talked about earlier, we don’t want this to detract from the core investing principles and stuff like that. If you’re someone like me, or someone who just wants to get to financial Independence quicker, this is a fantastic avenue to explore. It’s a way to do it that doesn’t negatively impact your quality of life much. It’s not like you’re cutting out your favorite coffee in the morning, or something like that. It’s a way to optimize with money that you weren’t really having fun spending anyway.

Scott: Love it.

Mindy: Not having fun spending. Again, send me that cash. I will show you. I will have a lot of fun with it. Okay. In the past, I have taken over Brandon’s podcast, and in the last episode, I had a rap. I performed a parody rap. This is a new rap for you that I wrote just for today’s show.

Got to dance.

Having IRS problems, I feel bad for you son. I got 99 problems but taxes ain’t one. I save my money. I put it away into my pre-tax accounts. My 401k. Need to access it early? That don’t matter. Mad Fientist showed me a Roth conversion ladder.

Don’t like the ladder? There’s more to see. Substantially equal periodic payments. 72t. SEPP. Hit me.

Brandon: Oh. Fantastic. You’re ridiculously talented.

Mindy: I am, well.

Scott: That was awesome.

Mindy: Ridiculous in anyway.

Brandon: You made this all worthwhile.

Mindy: Oh come on. This was all worthwhile before the rap. This is just bonus.

Okay. Let’s move on to the Famous Four.

Brandon: Let’s do it.

Mindy: Brandon, what is your favorite finance book?

Brandon: Favorite finance book, I would probably say JL Collins, The Simple Path to Wealth. That’s really everything you need to know to be a good stock investor. I would say that. I would also pitch another book, which isn’t technically a finance book. It is exactly what you need if you’re going to try to do this alternative early retirement lifestyle.

That is, How to Obtain Freedom in an Unfree World. Actually the guy who recommended that is JL Collins, the guy that I mentioned first, The Simple Path to Wealth. It changes your mindset. It just makes you realize that you’re completely in control of your life. Anything that you thought you had do or what direction you needed to go in, you don’t need to do that. Some of it’s a bit more controversial. You don’t have to agree with everything in it, but it is mindset shifting book. Just like when I stumbled upon earlier, Retirement Extreme, changed my financial life. This changed my outlook on non financial life.

Mindy: Yeah. Mindset is such a huge part of it. We had a guest on episode 12. David Green. The way he thought just about being a waiter, was not the way that I thought about being a waitress at all. It raised his success level, just small little tweaks made him so much more successful at his job, and put more money in his pocket, which is ultimately the whole reason why you’re waiting tables.

Brandon: Right. I agree. I couldn’t recommend it more. It’s definitely a book everyone should check out if you’re wanting to live a less conventional life.

Mindy: Definitely checking that out.

Scott: I’ve been reading this new book about anti-gravity. I just can’t put it down. What was your biggest money mistake?

Brandon: Oh god. Sorry. I wasn’t cued for the joke round yet. It took me second to get that one.

Mindy: All day, every day at work. Okay. Scott, I don’t think he even heard that question. Ask him again.

Scott: Oh yeah.

Brandon: Sorry. No.

Scott: What was your biggest money mistake?

Brandon: Yeah, my biggest money mistake, like I said, I moved to Scotland right after graduating from college in 2004. Like I said, I was always into money, so I was so excited to be an adult. My girlfriend, now wife, we bought our first house. We did it up. In two and a half years we sold it for over 50% more than we bought it for. We’re just like, ‘Yes, this is amazing. We’re so good.’ This is in 2007.

The week we were closing, there was a banker on one of the big UK Banks, and that’s when the whole world was starting to show signs of it falling apart. Anyway, we sold it. It was great and we had this big, hunk of cash that we never had expected, and never had that much money. I was so excited to manage my money, that I just looked online for a financial planner, picked the top one, no referrals, no reviews nothing. Picked the top one.

He came over. He started giving it all the talk like, ‘Oh yeah. I’ll get you out on the golf course with me.’ Just playing up to the fact, he obviously saw that I just wanted to be a big shot with a big portfolio, and all this. He put me into the funds that have performed the best over the last five years. They all had ridiculous fees. He made a killing off of us.

Then all of our money was tied up into these accounts for five years. If we had withdrawn it early, we would have paid insane penalties. It was so stupid. I just wanted to invest so badly that I didn’t do any research. I didn’t think I could. I guess there was a part of me that was like, ‘Oh, I just need to learn. Somebody has to tell me what to do.’

From that point on, I never trusted anyone else with my money, and I did all the research myself. Really, it’s not that difficult. It’s not that complicated. It turned out to be a good thing overall, but it was very painful lesson to have to face so early in my investing career.

Mindy: Did you lose money during that time? Your ending balance was smaller than your beginning balance? You were paying fees.

Brandon: Yeah. Yeah. Within six months, it dropped 50% or less because of the financial crisis. That was painful with itself. This is how I knew I was ok to be an investor. That wasn’t the thing that really scared me or worried me. I was like, ‘Okay. it dropped 50%. That’s terrible, but you know I’m not going to take it out, so it’ll go up hopefully.’ It was when I learned about the fees, and then learned about the fees that I would face if I took it out.

It was something like if you took it out a year early, you pay 2%. If you took it out two years early, you’d pay 4%. What did I say? It was two, four, six, eight, something crazy like that. That’s what really angered me, and felt like, ‘Okay, I just got taken for a ride from these people.’ Then the fees obviously, were just dragging on the portfolio. Even though the portfolio and the investments themselves were covered after the crisis, the fact I was paying so much in fees meant that we didn’t get all our money back by the time I withdrew it.

I ended up withdrawing it one year early and paying the 2% because I just want to be done with this guy. I just want to be in some sensible investments, because by then I had learned what’s important, the things you can control, what’s your fees, and just going low cost.

Mindy: Okay. That’s a good lesson to learn. I don’t want to make you feel bad, but did you ask about these fees? Did you not know to ask about the fees? Did he try to hide them?

Brandon: Didn’t know. No. Didn’t know. He showed a chart. I don’t even know if the chart had them on there. It just showed like, ‘Oh this one’s up 50% every last three years. This one’s up 14.9%. I’ll put you in those two because they are the best.’ Fees didn’t even come into my mind, I don’t think at that stage. It wasn’t until, like I said, three years later probably that I was like, ‘What are we in? What are we even in? How much are we paying?’ Then that’s when I looked into it, and then was obviously shocked, and not happy.

Mindy: Okay. Moving on, what is your best piece of advice for people who are just starting out?

Brandon: It’s to align your spending with what you want out of your life, which is super difficult. I didn’t do this until after I already achieved financial independence. I was just so tunnel visioned to hit FI as soon as possible that I just made myself miserable in the process. After the fact, I realized like that’s so stupid, because you need to know what you’re going to be doing after you achieve this goal. If you’re not working towards that while you’re saving up, then it’s going to be a very difficult transition.

I would really think hard about what’s your perfect life look like? What would you want to be doing with your days, if you had all the freedom in the world? What do you want to leave behind? What you want to accomplish in your life? These are like super, big questions, and really hard to answer. You are pretty bad at knowing what you want. You have to try things out, and realize that hey, maybe I don’t want that.

For me, I thought that I would travel full time after achieving financial independence. I won’t have a job. I can just go all over the world. I did it for three months right after I quit my job. I realize that I didn’t want to be on the road that much. I liked being home, and getting stuff done, and making progress and projects that I’m working on. It’s things like that. Trying things out, not just assuming that life’s going to be better once you hit FI. Trying to figure out like what your ideal life is, and then tailoring your spending just for that.

I don’t have cable, because it’s not important to me. I would rather be making something than just consuming cable TV. Just making those sorts of spending decisions allows you to then feel like you can spend as much as you everything, because you’re only spending it on certain few things that make you really happy.

Now I feel like, I can just [inaudible][01:21:43] to my heart’s content. I just know that spending more or spending more on different things aren’t going to make me happy. It’s not even like I miss it. I’m just completely completely optimized. That took a long time. Start that now, no matter where you are in the journey to financial independence, just start that. Try to really figure out what you want out of life, and how to make your spending align with that.

Mindy: Perfect.

Scott: That’s really awesome, just general life advice. Yeah. Absolutely. I’ve made the same mistake where I’ve just went way too hard for a couple years. For those couple of years, I was unable to date I biked. I would have perfect days where I would wake up in the morning and I made healthy omelette, biked to work, leave at nine or ten o’clock, spend no money throughout the entire day. I was like, ‘Financial freedom is not worth that.’

Brandon: No. No.

Scott: Align your spending with what you actually like. I’m much happier now with little bit more spending that I get all the things I want.

Brandon: Like I said, you’re bad at knowing what you want. Try before you buy. Experiment with little cash outlay, because I’ve talked to people who’ve sold their house, bought the sail boats. Then 10 days at sea, they realize they’re miserable. They’re not sleeping. The dishes are bashing against everything. Everyone’s seasick. It’s not a life that they thought they wanted to live. I was just going to interject there and say, experiment and try before you actually spend a lot of money, or make drastic changes in a lifestyle that you may not actually want.

Scott: We dangle partying by the beach or relaxing, playing video games all day in your underwear, as the carrot for a lot of people that want to achieve FI. Really, that’s not the purpose of this. The purpose of this is, you maybe do that for  a couple of months, but then you settle down and get to work on something that’s your unique passion, that you really can’t do in a true corporate setting, or maybe it is for some individuals.

The fact that you can then do that means that your ability or potential to maybe have an positive impact in your own unique way in the world, is exponentially increased. So much more potential, once you do this. If you’re doing it right, and are not depriving yourself of the basic happiness that you deserve and want.

Brandon: Absolutely.

Mindy: Yeah. If I had to sit around and play video games in my underpants, I would work forever. That is not my ideal-.

Brandon: Oh yeah. Same here.

Mindy: Carl went and bought the little Nintendo. Two Nintendos just came out which has every game on it. He’s like, ‘Oh do you mind if I played?’ No, please. Go and play.

Brandon: Has he actually played it though?

Mindy: He’s played it four times. The girl play it more.

Brandon: Now he’s back at work. Working harder than ever because I know the type of guy he is.

Mindy: Yeah. Yeah. I could go on a tangent for that forever, but it’s not my show. It’s your show. Now Scott is going to ask you the question.

Scott: Alright. What is your favorite joke to tell at parties?

Brandon: Mindy knows me, and Scott you know me, not as well as Mindy. We’ve had some quite wild party nights at certain conferences and things. Not usually one to tell jokes. I’m trying to think back to the last time I probably told a joke at a party.

Scott: I’ve always known you as the joke guy.

Brandon: No. Definitely not.

Mindy: He’s really funny.

Brandon: When I tell the joke, you’ll realize what era it was probably told in. Why do girls wear makeup and perfume?

Scott: I don’t know. Why?

Brandon: Because they’re ugly and they smell bad. I love the simplicity of it. Obviously, my outlook on women has changed dramatically since when I told this, which was probably in third grade. There’s a beautiful simplicity to that joke.

Scott: You win. You win.

Mindy: Oh my goodness. That’s a terrible joke.

Brandon: I know. I have a beautiful wife. She is not ugly, and she does not smell bad. My thoughts have changed since second or third grade whenever that joke entered into my brain.

Scott: We’ll let the listeners know there’s a little bit of explicitness at the end of the episode when you tell your joke. They can [inaudible][01:26:05] beginning.

Mindy: Brandon, where can people find out more about you?

Brandon: MadFientist.com, which is m, a, d, f, i, e, n, t, i, s, t.com. It’s a word I made up, and let’s you get the domain name whenever you want it. Everything’s there. The podcast, the blog. I have written some software over the years to help you track your journey to financial independence and stuff like that. All that can be found there. Then yeah, on Twitter and Facebook. I’m not too active on either of this. The blog’s the best bet.

Mindy: Yeah. You have to tag him on Twitter if you want him to talk to you. Show him a picture of really good beer, from a really great microbrewery.

Brandon: That always get a love or a like or whatever the heart icon is.

Mindy: Alright Scott, shall we get out of here? We should wrap this up. This went really long today, because Brandon just had so much fabulous information.

Scott: Yeah. This is great. Thank you so much for coming on, Brandon. You’re a thought leader, I think, in this space. It’s just fantastic to hear what you had to say. You’re so knowledgeable on every aspect of this. It’s great. Thank you.

Brandon: You’re too kind. Thank you for having me on. It’s been a pleasure. The rap, highlight of my day, so thank you.

Mindy: Alright. That was an amazing episode with Brandon. I love talking to him just on a regular basis, but all of that information is really mind-blowing. I just learned about this Roth version ladder, and the 72t separate but equal payments thing. I kind of knew about, but not really.

I encourage you to take a trip over to his site, and read through that whole entire article, How To Access Retirement Funds Early, because he lays out so much information that we didn’t even get to today, and today’s show went really, really long.

Scott: I love this kind of episode because we really get a little bit into the details about some of these things that can save you tons of money over time. Again, I know that a lot of this information was really more applicable and really more mind blowing, and maybe the potential to really be a game changer for you, once you get into that position of having a strong savings rate and being able to contribute large amounts of money into these retirement accounts.

That’s the point you have to get to. If you’re not there yet, use the show as motivation to get to that point, because once you do, there’s a lot of opportunities to save a ton of money on taxes, a lot chances to really invest efficiently and get access to those funds.

Mindy: Right. I think that a lot of people don’t go into the depth that Brandon does when you’re thinking about these retirement accounts. ‘Oh, I’m saving taxes on the front end.’ Well yeah but you can also save taxes on the back end, especially if you’ve got several years to be planning this out. You can start planning your choices. Maybe you’re reducing the amount that you’re putting into your pre-tax accounts, now that you know you can take that out at the end. It’s just, wow. So much great information. I’m so glad he had the time to share it with us today.

Scott: Yeah. Absolutely. I thought I mistakenly came into this episode thinking that you had to be a fantastic planner to be able to pull this off. What he showed us with the Roth conversion ladder is that, in a bad year or depending on how your life goes, you can take out a bunch of money and roll it over in a bad year where you have low income or very low taxed income, or you can not contribute at all if you have an end up having in a year where you earned a lot of income.

There’s a lot of control you can have over this, even if you’re not a planner. That was my big fear, I think, or my big reservation about having to go through this is, I kind of go through life is an opportunist, I guess, in a lot of ways. I want to have access to my money for all the opportunities, but it sounds like this Roth conversion strategy really marries well with that line of thinking, because you can in a good year, or a year with low income make a big move, and in a year with high income, not make any moves or make a small move.

Mindy: Right. You can still be an opportunist while planning your retirement, now you have this in your head. This isn’t something that you can just take and go do right now. It’s something I think this is a great seed to plant into people’s heads, especially if they’ve got a few years left for early retirement. Obviously, if you have already retired, you can take this and start your Roth conversion ladder, especially if you’re not close to your 59 and a half retirement fund withdrawal age, whatever they call that. That wasn’t it all hymn handed.

This episode ran really long. I want to get out of here, and let people get back to their day but thank you very much for listening all the way to the end. The rap was worth it, right?

Scott: Yeah. Of course. It was for me.

Mindy: Okay. From episode 18 of the BiggerPockets Money show, this is Mindy Jensen. Over and out.